PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
Not Applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not Applicable.
ITEM 3. KEY INFORMATION
A. Selected Financial Data
The following selected consolidated statements of operations data for the years ended December 31, 2010, 2011 and 2012 and the selected consolidated
balance sheet data as of December 31, 2011 and 2012 have been derived from our audited consolidated financial statements, which are included elsewhere in this annual report. Our selected
consolidated combined balance sheet data as of December 31, 2008 and selected consolidated combined statement of operations data for the year ended December 31, 2008 have been derived
from our unaudited consolidated financial statements that are not included in this annual report. Our selected consolidated combined balance sheet data as of December 31, 2009 and 2010, and
selected consolidated combined statements of operations data for the year ended December 31, 2009 have been derived from our audited consolidated combined financial statements that are not
included in this annual report.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For Years Ended December 31,
|
|
|
|
2008
|
|
2009
|
|
2010
|
|
2011
|
|
2012
|
|
|
|
(US$ in thousands, except share and per share data)
|
|
Consolidated and Combined Statements of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Online business
|
|
|
125
|
|
|
6,877
|
|
|
33,683
|
|
|
40,331
|
|
|
32,169
|
|
Offline business
|
|
|
|
|
|
189
|
|
|
2,290
|
|
|
5,066
|
|
|
8,039
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenues
|
|
|
125
|
|
|
7,066
|
|
|
35,973
|
|
|
45,397
|
|
|
40,208
|
|
Cost of services(1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Online business
|
|
|
(115
|
)
|
|
(1,913
|
)
|
|
(5,166
|
)
|
|
(6,035
|
)
|
|
(6,950
|
)
|
Offline business
|
|
|
|
|
|
(90
|
)
|
|
(686
|
)
|
|
(1,653
|
)
|
|
(3,048
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
10
|
|
|
5,063
|
|
|
30,122
|
|
|
37,709
|
|
|
30,210
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product development expenses(1)
|
|
|
(314
|
)
|
|
(1,444
|
)
|
|
(4,649
|
)
|
|
(10,304
|
)
|
|
(12,318
|
)
|
Sales and marketing expenses(1)
|
|
|
(183
|
)
|
|
(893
|
)
|
|
(1,570
|
)
|
|
(6,255
|
)
|
|
(9,966
|
)
|
General and administrative expenses(1)
|
|
|
(407
|
)
|
|
(1,161
|
)
|
|
(5,729
|
)
|
|
(7,965
|
)
|
|
(10,078
|
)
|
Other operating income
|
|
|
|
|
|
|
|
|
278
|
|
|
1,734
|
|
|
5,512
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
(904
|
)
|
|
(3,498
|
)
|
|
(11,670
|
)
|
|
(22,790
|
)
|
|
(26,850
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
(894
|
)
|
|
1,565
|
|
|
18,452
|
|
|
14,919
|
|
|
3,360
|
|
Interest income, net
|
|
|
4
|
|
|
7
|
|
|
240
|
|
|
1,410
|
|
|
2,647
|
|
Other income (expenses), net
|
|
|
2
|
|
|
(10
|
)
|
|
(115
|
)
|
|
667
|
|
|
859
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes and share of profit in equity method investments
|
|
|
(888
|
)
|
|
1,562
|
|
|
18,577
|
|
|
16,996
|
|
|
6,866
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax (expense)/benefit:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
(22
|
)
|
|
(7
|
)
|
|
(2,539
|
)
|
|
1,279
|
|
Deferred
|
|
|
|
|
|
(271
|
)
|
|
2,511
|
|
|
812
|
|
|
(424
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Total income tax (expense)/benefit
|
|
|
|
|
|
(293
|
)
|
|
2,504
|
|
|
(1,727
|
)
|
|
855
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income before share of profit in equity method investments
|
|
|
(888
|
)
|
|
1,269
|
|
|
21,081
|
|
|
15,269
|
|
|
7,721
|
|
Share of profit in equity method investments
|
|
|
|
|
|
49
|
|
|
494
|
|
|
4,224
|
|
|
1,140
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
(888
|
)
|
|
1,318
|
|
|
21,574
|
|
|
19,493
|
|
|
8,861
|
|
Net loss attributable to non-controlling interest
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income attributable to Taomee Holdings Limited
|
|
|
(888
|
)
|
|
1,318
|
|
|
21,574
|
|
|
19,493
|
|
|
8,862
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deemed dividend on Series A convertible redeemable preferred shares
|
|
|
|
|
|
(210
|
)
|
|
(469
|
)
|
|
(200
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income attributable to holders of ordinary shares
|
|
|
(888
|
)
|
|
1,108
|
|
|
21,105
|
|
|
19,293
|
|
|
8,862
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2
Table of Contents
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For Years Ended December 31,
|
|
|
|
2008
|
|
2009
|
|
2010
|
|
2011
|
|
2012
|
|
|
|
(US$ in thousands, except share and per share data)
|
|
Earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.0018
|
)
|
$
|
0.0020
|
|
$
|
0.0367
|
|
|
0.0292
|
|
|
0.01
|
|
Diluted
|
|
$
|
(0.0018
|
)
|
$
|
0.0020
|
|
$
|
0.0360
|
|
|
0.0278
|
|
|
0.01
|
|
Weighted average number of shares used in calculating earnings per share(2):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
500,000,000
|
|
|
467,123,300
|
|
|
450,000,000
|
|
|
606,648,098
|
|
|
731,303,362
|
|
Diluted
|
|
|
500,000,000
|
|
|
467,123,300
|
|
|
458,482,370
|
|
|
640,377,175
|
|
|
753,533,499
|
|
-
(1)
-
Includes
share-based compensation expenses as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For Years Ended December 31,
|
|
|
|
|
2008
|
|
2009
|
|
2010
|
|
2011
|
|
2012
|
|
|
|
|
(US$ in thousands)
|
|
|
Share-based compensation expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of services
|
|
|
|
|
|
1.0
|
|
|
14.8
|
|
|
203.6
|
|
|
255.3
|
|
|
Product development expenses
|
|
|
|
|
|
10.1
|
|
|
80.9
|
|
|
814.2
|
|
|
498.5
|
|
|
Sales and marketing expenses
|
|
|
|
|
|
0.2
|
|
|
69.1
|
|
|
63.4
|
|
|
69.0
|
|
|
General and administrative expenses
|
|
|
|
|
|
61.9
|
|
|
5.6
|
|
|
915.6
|
|
|
1,383.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
73.2
|
|
|
170.4
|
|
|
1,996.8
|
|
|
2,206.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
(2)
-
Calculated
based on the number of ordinary shares of our company after the recapitalization transaction in April 2009, which has been retrospectively
reflected as if the recapitalization transaction occurred at the beginning of the first period presented.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
2008
|
|
2009
|
|
2010
|
|
2011
|
|
2012
|
|
|
|
(US$ in thousands)
|
|
Consolidated and Combined Balance Sheets Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
|
348
|
|
|
10,835
|
|
|
43,087
|
|
|
120,679
|
|
|
118,571
|
|
Accounts receivable, net
|
|
|
135
|
|
|
800
|
|
|
438
|
|
|
1,423
|
|
|
2,371
|
|
Total current assets
|
|
|
642
|
|
|
12,338
|
|
|
47,684
|
|
|
127,066
|
|
|
126,967
|
|
Total assets
|
|
|
900
|
|
|
13,461
|
|
|
53,032
|
|
|
134,454
|
|
|
139,758
|
|
Total current liabilities
|
|
|
764
|
|
|
7,063
|
|
|
34,297
|
|
|
31,303
|
|
|
26,007
|
|
Advances from customers
|
|
|
47
|
|
|
3,497
|
|
|
8,684
|
|
|
10,223
|
|
|
8,142
|
|
Deferred revenue
|
|
|
46
|
|
|
1,904
|
|
|
10,783
|
|
|
12,913
|
|
|
12,062
|
|
Dividends payable
|
|
|
|
|
|
|
|
|
8,950
|
|
|
|
|
|
|
|
Mezzanine equity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Series A convertible redeemable preferred shares
|
|
|
|
|
|
5,159
|
|
|
5,628
|
|
|
|
|
|
|
|
Ordinary shares
|
|
|
10
|
|
|
9
|
|
|
9
|
|
|
15
|
|
|
15
|
|
Treasury stock
|
|
|
|
|
|
|
|
|
|
|
|
(563
|
)
|
|
(747
|
)
|
Additional paid-in capital
|
|
|
993
|
|
|
988
|
|
|
1,158
|
|
|
70,782
|
|
|
72,437
|
|
(Accumulated deficit) retained earnings
|
|
|
(955
|
)
|
|
153
|
|
|
11,258
|
|
|
30,551
|
|
|
39,413
|
|
Noncontrolling interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
78
|
|
Total equity
|
|
|
136
|
|
|
1,239
|
|
|
13,107
|
|
|
103,151
|
|
|
113,751
|
|
Total liabilities, mezzanine equity and equity
|
|
|
900
|
|
|
13,461
|
|
|
53,032
|
|
|
134,454
|
|
|
139,758
|
|
Exchange Rate Information
Our business is primarily conducted in China and substantially all of our revenues are denominated in RMB. This annual report contains
translations of RMB amounts into U.S. dollars at specified rates solely for the convenience of the reader. For all dates and periods through December 31, 2008, exchange rates of RMB into
U.S. dollars are based on the noon buying rate in The
3
Table of Contents
City
of New York for cable transfers of RMB as certified for customs purposes by the Federal Reserve Bank of New York. For January 1, 2009 and all later dates and periods, the
exchange rate refers to the exchange rate as set forth in the H.10 statistical release of the Federal Reserve Board. Unless otherwise noted, all translations from RMB to U.S. dollars
were made at a rate of RMB6.2301 to US$1.00, the exchange rate set forth as of December 31, 2012. No representation is made that the RMB amounts referred to in this annual report could have
been or could be converted into U.S. dollars at any particular rate or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the
conversion of RMB into foreign exchange and through restrictions on foreign trade. On April 12, 2013, the exchange rate was RMB6.1914 to US$1.00.
The
following table sets forth information concerning exchange rates between the RMB and the U.S. dollar for the periods indicated. These rates are provided solely for your
convenience and are not necessarily the exchange rates that we used in this annual report or will use in the preparation of our periodic reports or any other information to be provided to you.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noon Buying Rate
|
|
Period
|
|
Period End
|
|
Average(1)
|
|
Low
|
|
High
|
|
|
|
(RMB per US$1.00)
|
|
2008
|
|
|
6.8225
|
|
|
6.9193
|
|
|
7.2946
|
|
|
6.7800
|
|
2009
|
|
|
6.8259
|
|
|
6.8295
|
|
|
6.8470
|
|
|
6.8176
|
|
2010
|
|
|
6.6000
|
|
|
6.7603
|
|
|
6.8330
|
|
|
6.6000
|
|
2011
|
|
|
6.2939
|
|
|
6.4475
|
|
|
6.6017
|
|
|
6.2939
|
|
2012
|
|
|
6.2301
|
|
|
6.3088
|
|
|
6.3879
|
|
|
6.2221
|
|
2012
|
|
|
|
|
|
|
|
|
|
|
|
|
|
October
|
|
|
6.2372
|
|
|
6.2627
|
|
|
6.2877
|
|
|
6.2372
|
|
November
|
|
|
6.2265
|
|
|
6.2338
|
|
|
6.2454
|
|
|
6.2221
|
|
December
|
|
|
6.2301
|
|
|
6.2328
|
|
|
6.2502
|
|
|
6.2251
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January
|
|
|
6.2186
|
|
|
6.2215
|
|
|
6.2303
|
|
|
6.2134
|
|
February
|
|
|
6.2213
|
|
|
6.2323
|
|
|
6.2438
|
|
|
6.2213
|
|
March
|
|
|
6.2108
|
|
|
6.2154
|
|
|
6.2246
|
|
|
6.2105
|
|
April (through April 12, 2013)
|
|
|
6.1914
|
|
|
6.1991
|
|
|
6.2078
|
|
|
6.1914
|
|
Source: Federal Reserve Bank of New York and Federal Reserve Statistical Release
-
(1)
-
Annual
averages were calculated by using the average of the exchange rates on the last day of each month during the relevant year. Monthly averages are
calculated by using the average of the daily rates during the relevant month.
B. Capitalization and Indebtedness
Not Applicable.
C. Reasons for the Offer and Use of Proceeds
Not Applicable.
4
Table of Contents
D. Risk Factors
Risks Related to Our Business
Our limited relevant operating history makes it difficult to evaluate our business and prospects. We have incurred net losses in the past and may experience net losses or
earnings declines in the future and we may not sustain our historical revenue growth rate or profitability.
We commercially launched our first virtual world, Mole's World, in September 2008. Our limited operating history may not be able
to provide a meaningful basis for you to evaluate our business. It is also difficult to evaluate our prospective business, because we may not have sufficient experience to address the risks frequently
encountered by early stage companies operating in a new and rapidly evolving industry, which may adversely affect our business and results of operations. These risks may include our potential
failure to:
-
-
retain existing users and attract new users;
-
-
develop, license, or acquire additional virtual worlds that are appealing to users;
-
-
anticipate and adapt to changing user preferences;
-
-
adapt to competitive market conditions;
-
-
timely respond to technological changes or resolve unexpected network interruptions;
-
-
adequately and efficiently operate, upgrade and develop our online entertainment community;
-
-
maintain adequate control of our expenses; and
-
-
attract and retain qualified personnel.
We
incurred net losses of US$887,591 for the year ended 2008. We cannot assure you that we will not incur net losses in the future. We have experienced significant revenue growth in a
relatively short period of time. Our net revenues increased from US$0.1 million in 2008 to US$7.1 million in 2009 and US$36.0 million in 2010, and amounted to
US$45.4 million in 2011 and US$40.2 million in 2012. We may not be able to sustain our historical levels of revenue growth of 2008 to 2011 in future periods due to a number of factors,
including, among others, economic factors out of our control, competition in the children's entertainment industry in China, in which market share can be quickly acquired or lost, the greater
difficulty of growing at sustained rates from a larger net revenue base, and adjustment to our strategic decision in response to changing circumstances that emphasize long-term influence
over short-term growth. Our net revenues decreased from US$45.4 million in 2011 to US$40.2 million in 2012 primarily due to increased competition and the implementation of
our strategy to focus less on short-term revenue growth and instead invest in long-term brand enhancement and platform expansion to attract new users and increase user
stickiness in the online business segment. We also expect that our total operating expenses will increase as we further grow our business. We incur substantial costs and expenses to develop, market
and operate a virtual world and may not collect revenues in connection with the virtual world for some time after its commercial launch or at all. We may not succeed in our expansion in the offline
business. Any failure or delay in generating revenues could result in material operating losses and harm our
financial condition. Accordingly, you should not rely on the results of any prior period as an indication of our future operating performance.
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As we currently depend on a limited number of virtual worlds for substantially all of our revenues, if any of these virtual worlds incur any adverse developments or if we
are unable to develop, purchase or license additional virtual worlds that are attractive to users and result in overall revenue growth, our business, financial condition and results of operations may
be materially and adversely affected.
Our virtual worlds, Seer, Gong Fu Pai and Mole's World, contributed to the majority of our revenues in 2012. We anticipate that these
and other existing virtual worlds of ours will continue to account for a substantial portion of our revenues in the near term. Accordingly, any of the following could materially and adversely affect
our business, financial condition and results of operations:
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failure by us to make quality upgrades, enhancements or improvements to the existing virtual worlds in a
timely manner;
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delay in or discontinuation of regular content updates;
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any reduction in or failure to grow the user base of these existing virtual worlds, any decrease in their popularity in
the market due to intensifying competition or other factors;
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any decrease in or failure to grow the amount of revenues generated from the existing virtual worlds; or
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any breach of virtual world related software security, prolonged server interruption due to network failures, hacking
activities or other factors or any other adverse developments relating to our existing virtual worlds.
We
entered into revenue sharing agreements with third-party game developers, and primarily collect payments from game players in connection with the sale of in-game
currencies and remit certain agreed-upon percentages of the proceeds to the game developers and record revenue net of remittances. Purchases of in-game currency are not
refundable after they have been sold unless there is unused in-game currency at the time a game is discontinued. Typically, a game will be discontinued when the monthly revenue generated
by a game is insignificant. We always use our best efforts to help the game players eliminate their loss before a game is discontinued, therefore we have never been required to pay cash refunds to
game players or game developers as a result of discontinuation of a game, or for any other reason. However, we cannot guarantee that we will not be required to pay such cash refunds in the future,
which may have adverse effect on our revenues.
In
addition, in order to achieve our long-term profitability and financial and operational success, we must continually develop, purchase or license new virtual worlds that
are attractive to users. Although we currently have new virtual worlds in development, they may not be released on time, may not be profitable or popular among children in China.
The
success of our internally developed virtual worlds will require additional investment prior to commercial launch. Furthermore, our ability to purchase or license successful virtual
worlds will depend on their availability on acceptable terms, including price, our ability to compete effectively against other potential purchasers or licensees to attract the developers of these
virtual worlds, and our ability to obtain government approvals required for the purchase or licensing and operation of these virtual worlds.
The
virtual worlds that we develop, purchase or license may not be attractive to users, may be viewed by the regulatory authorities as not complying with content restrictions, may not be
launched as scheduled or may not compete effectively with our competitors' products. If we are not able to successfully develop, purchase or license virtual worlds appealing to users, our future
profitability and growth prospects will decline.
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We may not be able to maintain our revenues and profitability as we operate in a competitive industry and compete against many companies.
We believe that there are a number of competing developers and operators in China providing online and offline entertainment to
children. Given the relatively low capital requirements and entry barriers, we expect more companies to enter the children's entertainment industry in China. For example, our competitors could
introduce a wide range of virtual worlds targeting children to the China market in a relatively short period of time. We believe our principal competitor in online children's entertainment in China is
Tencent Holdings Limited, or Tencent, the developer of Roco Kingdom. Our other competitors include BaitianInfo Co., Ltd., the developer of Aobi Island. Potential competitors also include
major Internet portal operators, other domestic and foreign virtual world developers and operators, media companies focused on children's entertainment and alliances between our existing and new
competitors. Some of our competitors, especially major foreign and China-based publicly listed media and virtual world operators, have significantly greater financial and marketing resources and name
recognition than we have. We also face competition on the mobile front with respect to mobile applications, as there is an increasing number of Internet companies in China tapping into the mobile
market with applications and services targeting children. We also face these and other competitors in our offline business. Our competitors may adopt loss-leading pricing or other tactics
or business models, and if these prove to be more attractive to children on a temporary or permanent basis, our users may switch to our competitors' services and products at our expense. We cannot
assure you that we will be able to compete successfully against any new or existing competitors, or maintain our user base and number of active paying accounts when competitors launch promotional
campaigns targeting our user base, which could have a material adverse effect on our revenues and profitability.
We face risks and uncertainties regarding the growth of the online entertainment industry for children and market acceptance of our online products and services.
The online entertainment industry for children in China, from which we currently derive most of our revenues, is a relatively new and
evolving industry and concept. The growth of the online entertainment industry for children and the level of demand and market acceptance of our virtual worlds and other online products and services
are subject to a high degree of uncertainty. Our future operating results will depend on numerous factors, some of which are beyond our control. These factors
include:
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the growth of personal computer, mobile devices, Internet and broadband users and penetration in China and other markets
in which we offer our virtual worlds, and the rate of any such growth;
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whether the online entertainment market in China, and in particular the online entertainment market for children,
continues to grow and the rate of any such growth;
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general economic conditions, particularly economic conditions adversely affecting discretionary spending on children's
entertainment;
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the availability and popularity of other forms of entertainment, particularly console system games; and
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our ability to create new digital entertainment products appealing to our users, including the ability to timely update
our existing virtual worlds and other services and introduce new virtual worlds and other services that attract existing and new users.
If
we fail to anticipate and effectively manage these risks and uncertainties, our market share may decrease, our business, financial condition and results of operations may be
materially and adversely affected.
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Our digital entertainment products and services including new virtual worlds and mobile applications may attract our users away from our established virtual worlds, and
enhancements and updates to our established virtual worlds may result in certain users deciding not to participate in them, which could materially and adversely affect our business, results of
operations and financial condition.
Our digital entertainment products and service including new virtual worlds and mobile applications may attract our users away from our
established virtual worlds, particularly with respect to virtual worlds with similar story lines. Although we intend to target different types of users with new virtual worlds and therefore
minimize users of our existing virtual worlds
migrating to later launched virtual worlds, such movement may nevertheless occur and may lead to fewer active users, reduced network effect and lower spending on subscriptions and
virtual items.
In
addition, in order to retain our existing users and to attract new users, we periodically introduce new features and make changes to our established virtual worlds based on feedback
gathered from our users. However, these changes may result in some of our existing users deciding not to participate in our virtual worlds, either temporarily or permanently. Our users may not respond
well to enhancements to our virtual worlds or policy changes in our online entertainment community, which could materially and adversely affect our business, results of operations and financial
condition.
We have no control over our distributors or licensees except through agreements we entered into with them. Our brands and reputation could be harmed and our results of
operations could suffer if our distributors or licensees fail to comply with our agreements with them.
We rely on our distributors to distribute our prepaid cards, through which our users pay subscription fees and purchase online virtual
items. We also rely on our licensees to manufacture and distribute products of our licensed franchises. We have limited ability to manage the activities of our distributors and licensees, who are
independent from us, except through the enforcement of agreements with them. If a significant number of our distributors or licensees fail to comply with our agreements with them, such as distribution
targets, brand and service promotion arrangements, quality control standards, or protocols on approving the presentation or portrayal of our franchises, our brands and reputation could be harmed and
our results of operations could suffer as a result.
We may not be successful in effectively promoting our brand or enhancing our brand recognition, and any negative publicity, regardless of its veracity, may harm
our brand.
Promoting the "Taomee" brand and enhancing its recognition as a family-friendly brand dedicated to children's entertainment is an
integral part of our growth strategy. There is no assurance that we will be able to effectively promote or develop our brand and if we fail to do so, our growth may be adversely affected. In addition,
negative publicity or disputes regarding our brand, products and services, company or management could materially and adversely affect public perception of our brand and the virtual worlds and other
products and services we offer. Any negative publicity in relation to our services or products, regardless of its veracity, could harm our brand image among children and their parents and, in turn,
result in decreases in the number of users and average net revenues per paying account from the operation of our online business. Any impact on our ability to effectively promote our brand and any
significant damage to the public perception of the "Taomee" brand or our virtual worlds could materially and adversely affect our prospects and results of operations.
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Unauthorized use of our intellectual property by our distributors, licensees or third parties, and the expenses incurred in protecting our intellectual property rights, may
harm our brands and reputation and adversely affect our business.
We regard our copyrights, trademarks and other intellectual property as critical to our success. Unauthorized use of our intellectual
properties may harm our brands and reputation and adversely affect our business.
We
have historically relied on a combination of trademark and copyright law, trade secret protection, restrictions on disclosure and other agreements that restrict the use of our
intellectual properties to protect our intellectual property rights. Although our contracts with distributors and licensees prohibit the unauthorized use of our franchises, brands and other
intellectual property rights, we cannot assure you that they will always comply with these terms. Although we presently enter into confidentiality agreements with most of our employees, we cannot
assure you that these confidentiality agreements will not be breached, that we will have adequate remedies for any breach, or that our proprietary technology, know-how or other
intellectual property will not otherwise become known to, or be independently developed by, third parties.
As
of December 31, 2012, we received approval for 211 and seven trademark registrations in China and Taiwan, respectively, and are in the process of applying for registration of
an additional 187 trademarks in China. In addition, we have obtained 48 copyright registrations for software we developed, two of which were jointly developed and owned by us and other
parties, three copyright registrations for Mole's World and Seer animation series and 356 copyright registrations for artworks owned by us. We also registered 30 domain names, including
www.61.com, our primary operation website. While we actively take steps to protect our proprietary rights, such steps may not be adequate to prevent the infringement or misappropriation of our
intellectual property. In addition, we cannot assure you that any of the above trademark applications will ultimately proceed to registration or will result in registration with adequate scope for our
business. Some of our pending applications or registrations may be successfully challenged or invalidated by others. If our trademark applications are not successful, we may have to use different
marks for affected products or services, or seek to enter into arrangements with any third parties who may have prior registrations, applications or rights, which might not be available on
commercially reasonable terms, if at all.
Implementation
of intellectual property laws in China has historically been lacking, primarily because of ambiguities in the laws and difficulties in enforcement. Accordingly,
intellectual property right protection in China may not be as effective as in the United States or other countries. Policing
unauthorized use of our proprietary technology, trademarks and other intellectual property is difficult and expensive, and litigation may be necessary in the future to enforce our intellectual
property rights. Future litigation could result in substantial costs and diversion of our resources, and could disrupt our business, as well as have a material adverse effect on our financial
condition and results of operations.
We rely on our nationwide distribution network for a significant portion of our net revenues. If we fail to effectively manage our distributor relationships or our
distributors fail to adhere to our agreements with them, our results of operations could suffer as a result.
Although we no longer rely on any single distributor as we did before 2010, we do rely on a number of provincial and regional
distributors to sell our prepaid cards. Online payment systems in China are still in a relatively early stage of development and are not as widely acceptable to users in China as compared to the
United States. Also, compared to adult online users, children have fewer means to make payment through online payment channels. As a result, although we make our prepaid cards available for
purchase online using an online payment system, our business is dependent on the performance of our regional distributors. In 2010, 2011 and 2012, 87.1%, 80.3% and 73.9%, respectively, of our net
sales proceeds collected were from the sales of prepaid cards to our
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distributors,
respectively. Our largest distributor accounted for 25.9%, 10.3% and 9.8% of our net sales proceeds generated from prepaid card sales in 2010, 2011 and 2012, respectively. Although we
typically enter into semi-annual contracts with and provide performance based incentives to our distributors, our distribution agreements are not exclusive and do not prohibit our
distributors from selling our competitors' game cards. Maintaining relationships with a significant number of distributors may be difficult and time-consuming. If we fail to maintain good
relationships with, or to effectively manage, our distributors, if these new distributors may not strictly adhere to our agreements with them or provide targeted distribution in locations frequented
by target users, or if the distributors promote our competitors' service and products at our expense, our results of operations could suffer as a result.
Unauthorized character enhancements, other hacking or cheating activities, and undetected programming errors or defects in our virtual worlds could harm our online business
and reputation and materially and adversely affect our results of operations.
With the increase in the number of virtual world users in China, virtual world operators have increasingly encountered problems arising
from the use of unauthorized character enhancements, theft of user account passwords and other hacking or cheating activities. We have from time to time detected a number of users who have gained an
unfair advantage by installing hacking or cheating tools to facilitate character progression. In response to these activities, we have installed detection mechanisms in our virtual worlds to identify
various hacking and cheating activities, and have expanded our technical team dedicated to detecting unauthorized character enhancements and resolving other hacking issues.
In
addition, our virtual worlds may contain undetected programming errors or other defects. Continued occurrences of unauthorized character enhancements, other hacking or cheating
activities, and undetected errors or defects in our virtual worlds may negatively impact the image of our virtual worlds and users' perception of their reliability, decrease the number of users,
reduce the users' interest in purchasing virtual items, shorten the life span of the virtual worlds and adversely affect our results of operations. A constant recurrence of these activities may
require us to shift our management's and personnel's attention from research and development and other operations to focus instead primarily on anti-hacking programs and activities, which
could hurt our ability to develop and launch new virtual worlds and could materially and adversely affect our business, financial condition and results of operations.
If we fail to successfully execute our growth strategies, including our current expansion into film and merchandise sales, our future results of operations and growth
prospects may be materially and adversely affected.
As part of our growth strategy, we have expanded from the online business to the offline business, such as film and merchandise sales.
Expansion into these or other new businesses or adoption of other new business models present operating and marketing challenges that are different from those that we currently encounter. We face
competition from existing players within these markets who may have more experience and resources. We may need to satisfy different regulatory requirements and obtain additional licenses or permits
from relevant regulatory authorities. If we cannot successfully address these new challenges and compete effectively in these markets or under these business models, we may not be able to operate
these offline businesses, attract a sufficiently large number of audience or customers, or recover costs incurred for developing and marketing these products or services, and our future results of
operations and growth strategies could be materially and adversely affected as a result. Pursuing these and other growth strategies in our offline business may also require us to expand our operations
through internal development efforts and through partnerships, joint ventures, investments and acquisitions. If we are unable to successfully implement our growth strategies, our revenue and
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profitability
may not grow as we expect, and our competitiveness may be materially and adversely affected.
We may undertake acquisitions, investments, joint ventures or other strategic alliances, which could have a material adverse effect on our ability to manage our business. In
addition, such undertakings may not be successful.
Our strategy includes plans to grow both organically and through acquisitions, joint ventures or other strategic alliances. Joint
ventures and strategic alliances may expose us to new operational, regulatory and market risks, as well as risks associated with additional capital requirements. We may not be able to identify
suitable future acquisition candidates or alliance partners. Even if we identify suitable candidates or partners, we may be unable to complete an acquisition or alliance on terms commercially
acceptable to us. If we fail to identify appropriate candidates or partners, or complete desired acquisitions, we may not be able to implement our strategies effectively or efficiently.
In
addition, our ability to successfully integrate acquired companies may be adversely affected by a number of factors. These factors include diversion of management's attention,
difficulties in retaining personnel of the acquired companies, unanticipated legal liabilities, and tax and accounting issues in association with the acquisition and business combination. If we fail
to integrate acquired companies efficiently, our earnings, revenues growth and business could be negatively affected.
Furthermore,
the acquired companies may not perform to our expectations for various reasons, including legislative or regulatory changes that affect the products in which the acquired
companies specialize, and the loss of personnel. If we are not able to realize the benefits envisioned for such acquisitions, our business and results of operations could be materially and adversely
affected.
Our limited resources may affect our ability to manage our growth.
Our growth to date has placed, and our anticipated further expansion will continue to place, a significant strain on our management,
systems and resources. For example, during the period following the commercial launch of our first virtual world in September 2008 to December 31, 2012, the total number of our employees
increased from 52 to 640. We may increase our employee headcount even further by adding research and development personnel. To accommodate our growth pursuant to our strategies, we anticipate that we
may need to implement and maintain a variety of new and upgraded operational and financial systems, procedures and controls, and to improve our accounting and other internal management systems, all of
which require substantial management efforts. We also will need to continue to expand, train, manage and motivate our workforce, and manage our relationships with our users, our distributors and
third-party product and service providers. All of these endeavors will require substantial management effort and skill and the incurrence of additional expenditures. We cannot assure you that we will
be able to efficiently or effectively implement our growth strategies and manage the growth of our operations, and any failure to do so may limit our future growth and hamper our business strategy.
Our failure to anticipate or successfully implement new technologies could render our game engines, development platforms or virtual worlds unattractive or obsolete, and
reduce our revenues and market share.
Our proprietary engines for powering our virtual worlds, online games, and mobile applications, our flexible and secure software
framework and anti-cheating expertise are critical to our success. Our industry is subject to rapid technological changes. We need to anticipate the emergence of new technologies and
assess their market acceptance. We also need to invest significant resources, including financial resources, in research and development to keep pace with technological advances in order to make our
development capabilities and our virtual worlds competitive in the market. However, development activities are inherently uncertain, and we might encounter practical difficulties in
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commercializing
our development results. Our significant expenditures on research and development may not generate corresponding benefits. Given the fast pace with which virtual world technology has
been and will continue to be developed, we may not be able to timely upgrade our engines or the software framework for our virtual world development in an efficient and cost-effective
manner, or at all. New technologies in virtual world programming or operations could render our technologies, our existing virtual worlds or the virtual worlds that we are developing or expect to
develop in the future obsolete or unattractive, thereby limiting our ability to recover related product development costs, purchase costs and licensing fees, which could result in a decline in our
revenues and market share.
We may be subject to intellectual property infringement claims, which could be time-consuming and costly to defend and may result in diversion of our financial
and management resources and our inability to continue providing some of our existing virtual worlds.
We cannot assure you that our franchise characters, our plots, or other content posted on our websites or made available through our
video site or our partners' site, has not infringed or will not infringe upon patents, valid copyrights or other intellectual property rights held by third parties. We may be subject to legal
proceedings and claims from time to time relating to the intellectual property of others in the ordinary course of our business within the relevant statute of limitation. If we are found to have
violated the intellectual property rights of others, we may be enjoined from using such intellectual property, be forced to pay fines and damages, and we may incur licensing fees or be forced to
develop alternatives. In addition, we may incur substantial expenses and diversion of our financial and management resources in defending against these third-party infringement claims, regardless of
their merit. Successful infringement or other intellectual property rights claims against us may result in substantial monetary liabilities, which may disrupt our operations and materially adversely
affect our business, results of operations and prospects.
Some
of our employees were previously employed at other companies, including our current and potential competitors. We also intend to hire additional personnel to expand our development
team and technical support team. To the extent these employees are involved in the development of content or technology similar to ours at their former employers, we may become subject to claims that
such employees or we may have appropriated proprietary information or intellectual properties of the former employers of our employees. If we fail to successfully defend such claims against us, our
results of operations could be materially and adversely affected.
We could be liable for our users' privacy being compromised, which may have a material adverse effect on our reputation and business.
Although we seek to provide a safe playing environment for our users by implementing a sophisticated security mechanism, our virtual
worlds are subject to infiltrating behaviors from child predators and others who hack the accounts of our users to gain progression advantages, access these users' accounts, or for other purposes.
Despite our efforts to employ security features to filter offensive content and monitor users' interactions, there is no guarantee that we can successfully keep our users free from predatory behavior,
offensive contact or other acts that violate the privacy of our users. A significant number of failures to prevent our users' exposure to such infiltration would severely harm our reputation
and business.
We could be liable for breaches of security of our website and third-party payment systems, which may have a material adverse effect on our reputation and business.
In 2010, 2011 and 2012, 12.9%, 19.7% and 26.1%, respectively, of our net sales proceeds collected were generated from sales of our
virtual currency through third-party payment systems. In such transactions, secure transmission of confidential information, such as users' debit and credit card numbers and expiration dates, personal
information and billing addresses, over public networks,
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including
our official website, is essential for maintaining user confidence. We currently provide password protection for all of our users' accounts. In addition, we are developing new tools to
better ensure the security of our users' accounts in the future. While we have not experienced any breach of our security to date, we still must prevent future breaches and current security measures
may be inadequate. In addition, we expect that an increasing number of our sales will be conducted over the Internet as a result of the expanded user base and the growing use of online payment
systems. We also expect that associated online crime will likely increase accordingly. We must therefore be prepared to increase our security measures and efforts so that our users have confidence in
the reliability of the online payment systems that we use. We do not have control over the security measures of our third-party payment operators, and their security measures may not be adequate at
present or may not be adequate with the expected increased usage of online payment systems. We could be exposed to litigation and possible liability if we fail to safeguard confidential user
information, which could harm our reputation and our ability to attract users and may have a material adverse effect on our business.
The successful operation of our online business depends on the performance and reliability of the Internet infrastructure and fixed telecommunications networks
in China.
Our online business depends on the performance and reliability of the Internet infrastructure in China. Almost all access to the
Internet 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.
In addition, the national networks in China are connected to the Internet through international gateways controlled by the PRC government. These international gateways are the only channels through
which a domestic user can connect to the Internet. Although the PRC government has pledged to improve the Internet infrastructure in China as part of its stimulus packaged introduced in the first
quarter of 2009, a more sophisticated Internet
infrastructure may not be developed in China. We or the users of our virtual worlds may not have access to alternative networks in the event of disruptions, failures or other problems with China's
Internet infrastructure.
Unexpected network interruptions, network security breaches or computer virus attacks could have a material adverse effect on our business, financial condition and results
of operations.
Any failure to maintain the satisfactory performance, reliability, security and availability of our network infrastructure may cause
significant harm to our reputation and our ability to attract and maintain users. All of the servers operating our virtual worlds, all of the servers handling log-in, billing and data
back-up matters for us, and all of our backup servers are hosted by third-party service providers, and are maintained by our internal personnel. Major risks involved in such network
infrastructure include any break-downs or system failures resulting in a sustained shutdown of all or a material portion of our servers, including failures that may be attributable to sustained power
shutdowns, or efforts to gain unauthorized access to our systems causing loss or corruption of data or malfunctions of software or hardware.
In
the past, our server network has experienced unexpected outages for several hours and occasional slower performance in a number of locations in China as a result of failures by
third-party service providers. Our network systems are also vulnerable to damage from fire, flood, power loss, telecommunications failures, computer viruses, hacking and similar events. Any network
interruption, virus or other inadequacy that causes interruptions in the availability of our virtual worlds or deterioration in the quality of access to our virtual worlds could reduce our users'
satisfaction and ultimately harm our business and results of operations.
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We face risks associated with the licensing of our virtual worlds overseas, and if we are unable to effectively manage these risks, they could impair our ability to expand
our business internationally.
In order to expand into overseas markets, we have licensed our virtual worlds to overseas third-party operators, including Mole's
World, Seer, Seer II, Flower Fairy and Gong Fu Pai. As of the date of this annual report, our virtual worlds are licensed in countries and regions including Korea, Russia, Hong Kong, Taiwan and Macau.
We may license our existing and new products in other countries and regions in the future. The offering of our products in the international markets could expose us to a number of risks,
including:
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difficulties in identifying and maintaining good relationships with licensees who are knowledgeable about, and can
effectively distribute and operate our products in, international markets;
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difficulties in maintaining the reputation of our company and our products, given that our virtual worlds are operated by
licensees in the international markets pursuant to their own standards;
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difficulties in protecting our intellectual property rights internationally and the associated costs;
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difficulties and costs relating to compliance with the different commercial, legal and tax requirements of the
international markets in which we offer our products, such as foreign ownership restrictions, game import regulatory procedures, taxes and other restrictions;
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difficulties and uncertainties in obtaining software export contract registration license from the relevant PRC
authorities;
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fluctuations in currency exchange rates; and
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interruptions in cross-border Internet connections or other system failures.
If
we are unable to effectively manage such risks, they could impair our ability to expand our business internationally. We have ceased our cooperation with some of the third-party
operators because the operation results did not meet our expectation.
Our business depends substantially on the continuing efforts of our management and other key personnel. If we lose their services, we could incur significant costs in
finding suitable replacements and our business may be severely disrupted.
Our future success heavily depends upon the continued services of our management and other key personnel. In particular, we rely on the
expertise and experience of Mr. Benson Haibing Wang, our chief executive officer, Mr. Paul Keung, our chief financial officer, Mr. Crow Zhen Wei, our chief technology officer,
Mr. Roc Yunpeng Cheng, our president and Mr. Frank Chenghua Zhu, our executive vice president. If one or more of our senior management or key personnel were unable or unwilling to
continue in their present positions, we might not be able to replace them easily or at all. Our business may be severely disrupted, our financial condition and results of operations may be materially
and adversely affected, and we may incur additional expenses to recruit, train and retain key personnel.
If
any of our management or key personnel joins a competitor or forms a competing company, we may lose users, distributors, know-how and key professionals and staff
members. Each of our executive officers has entered into employment agreements and confidentiality agreements and the majority of them have entered into non-competition agreements with us.
However, if any dispute arises between our officers and us, the non-competition provisions contained in their non-competition agreements may not be enforceable, especially in
China, where most of these executive officers and key employees reside, on the ground that we have not provided adequate compensation to these executive officers for their non-competition
obligations, which is required under the relevant PRC regulations.
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We may not be successful in attracting and retaining qualified personnel and our business and results of operations could be negatively impacted.
We will need to hire and retain additional qualified employees to support our existing operations and planned expansion. Our ability to
anticipate and effectively respond to changing user needs depends in part on our ability to attract and retain experienced personnel for our online and offline businesses in technology, graphic
design, operation and other functions. The effective operation of our information technology system, call center, logistics and other back office functions also depends in part on our professional
employees. Since our industry is characterized by high demand and intense competition for talent, we may need to offer higher compensation and other benefits in order to retain key personnel in the
future. We cannot assure you that we will be able to attract or
retain the qualified key personnel that we will need to achieve our business objectives. In addition, as our business has grown rapidly, our ability to train and integrate new employees into our
operations may not meet the increasing demands of our business.
Our principal shareholders have substantial influence over our company and their interests may not be aligned with the interests of our other holders of our ordinary shares
and ADSs.
As of December 31, 2012, our founders, Mr. Jason Liqing Zeng, Mr. Benson Haibing Wang, Mr. Crow Zhen Wei
and Mr. Roc Yunpeng Cheng, who beneficially own our shares through a number of holding entities, and the Qiming Funds together hold 66.0% of our outstanding share capital. Accordingly, our
founders and the Qiming Funds have substantial influence over our business, including decisions regarding mergers, consolidations and the sale of all or substantially all of our assets, election and
change of directors and other significant corporate actions. This concentration of ownership may discourage, delay or prevent a change in control of our company, which could deprive our shareholders
of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ADSs. Alternatively, these principal shareholders may cause a merger,
consolidation or change of control transaction even if it is opposed by our other shareholders.
Our operating results fluctuate from period to period, making them difficult to predict and may not be indicative of future performance.
Our operating results from period to period are highly dependent upon, and will fluctuate as a result of a variety of factors,
including:
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seasonal trends in revenue generation as a result of seasonal fluctuations of active users and online play time, which
peaks during summer and winter school vacation periods, which usually occur in the first and third quarters of each year when children have more online playtime, and falls during second and fourth
quarters of each year, and generally increases during the Chinese New Year holidays, which occurs in the first quarter of each year, when children are given extra pocket money;
-
-
the introduction of virtual worlds and other online and offline services and products;
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-
the quality, variety, popularity and mix of virtual items and online and offline services and products available for
purchase and related promotional efforts;
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the period of time over which we recognize revenue for some of our virtual items in our virtual worlds, which in certain
cases is based on the estimated lifespan of our virtual items, which may be adjusted from time to time;
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the period of time which we launch our films and recognize the films related revenue;
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content development costs and licensing or royalty payments; and
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the expansion of our distribution network and the related discounts and rebates.
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For
example, as a result of the seasonality effect discussed above, our revenue from online business was higher in the first quarter of 2012 as compared to the second quarter of 2012 and
we expect a similar decrease in revenue from online business in the second quarter of 2013 as compared to the first quarter of 2013.
Additionally,
because most of our operating expenses are expected to increase in absolute amount in the future as we continue to expand our business, our net income during any given
quarter may be adversely affected by any decrease in revenue due to the seasonality effect.
Due
to these and other factors, our operating results will vary from period to period, will be difficult to predict for any given period, may be adversely affected from period to period
and may not be indicative of our future performance.
If we fail to establish or maintain an effective system of internal controls over financial reporting, we may be unable to accurately report our financial results or prevent
fraud, and investor confidence and the market price of our shares may, therefore, be adversely impacted.
As a U.S. public company, we are subject to reporting obligations under the U.S. securities laws. Our reporting
obligations as a public company will place a significant strain on our management, operational and financial resources and systems for the foreseeable future. We are required to prepare a management
report on our internal controls over financial reporting containing our management's assessment of the effectiveness of our internal controls over financial reporting. In addition, depending on our
market capitalization, our independent registered public accounting firm may be required to attest to and report on our management's assessment of the effectiveness of our internal controls over
financial reporting. Our management may conclude that our internal controls over our financial reporting are not effective. Moreover, even if our management concludes that our internal controls over
financial reporting are effective, our independent registered public accounting firm may still decline to attest to our management's assessment or may issue a report that is qualified if it is not
satisfied with our controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us.
Our
company was founded in October 2007, and our first virtual world was commercially launched in September 2008. Prior to the initial public offering, we had been a
private company with a short operating history and limited numbers of accounting personnel and other resources with which to address our internal controls and procedures. In connection with the audit
of our consolidated and combined financial statements for 2008, 2009, 2010 and 2011, we and our auditors, an independent registered public accounting firm, identified certain significant deficiencies
and deficiencies in our internal control over financial reporting as defined in the standards established by the U.S. Public Company Accounting Oversight Board, or PCAOB. In connection with our
management's assessment of the effectiveness of our internal controls over financial reporting as of December 31, 2012, we have not noted any material weakness, as defined in the standards
established by the PCAOB, in our internal controls over financial reporting.
We
will continue to implement measures to remedy any significant deficiencies to meet the deadline imposed by Section 404 of the Sarbanes-Oxley Act. If we fail to timely achieve
and maintain the adequacy of our internal controls, we may not be able to conclude that we have effective internal controls over financial reporting in the future. Moreover, effective internal
controls over financial reporting are necessary for us to produce reliable financial reports and are important to help prevent fraud. As a result, our failure to achieve and maintain effective
internal controls over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact
the market price of our ordinary shares. Furthermore, we anticipate that we will incur considerable costs and use significant management time and other resources in an effort to comply with
Section 404 of the Sarbanes-Oxley Act.
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The audit report included in this annual report are prepared by auditors who are not inspected by the Public Company Accounting Oversight Board and, as such, you are
deprived of the benefits of such inspection
Our independent registered public accounting firm that issues the audit reports included in our annual reports filed with the US
Securities and Exchange Commission, as auditors of companies that are traded publicly in the United States and a firm registered with the US Public Company Accounting Oversight Board
(United States), or the PCAOB, is required by the laws of the United States to undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States
and professional standards. Because our auditors are located in the Peoples' Republic of China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the
Chinese authorities, our auditors are not currently inspected by the PCAOB.
Inspections
of other firms that the PCAOB has conducted outside China have identified deficiencies in those firms' audit procedures and quality control procedures, which may be addressed
as part of the inspection process to improve future audit quality. This lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating our auditor's audits and its quality control
procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.
The
inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditor's audit procedures or quality control
procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our
financial statements.
At
the discretion of the government of the PRC in accordance with the Scheme for the Localization Restructuring of Chinese-Foreign Cooperative Accounting firms, Deloitte Touche Tohmatsu
CPA Ltd. has restructured to a new partnership and changed its name to Deloitte Touche Tohmatsu Certified Public Accountants LLP, effective from January 1, 2013. Deloitte Touche
Tohmatsu Certified Public Accountants LLP has succeeded Deloitte Touche Tohmatsu CPA Ltd. for all purposes and assumed all of the obligations and rights of Deloitte Touche Tohmatsu
CPA Ltd. with effect from January 1, 2013. Our board of directors and audit committee have approved this change in entity of the external auditors.
We may be unable to secure additional funding in the future or to obtain such funding on favorable terms.
We believe that our current cash and cash equivalents and the anticipated cash flow from operations will be sufficient to meet our
anticipated cash needs for the next 12 months. We may, however, require additional cash resources to finance our continued growth or other future developments, including any investments or
acquisitions we may decide to pursue. The amount and timing of such additional financing needs will vary principally depending on the timing of new product launches, investments and/or acquisitions,
and the amount of cash flow from our operations. If our resources are insufficient to satisfy our cash requirements, we may seek to issue additional equity or debt securities or obtain a credit
facility. The issuance of additional equity securities or securities convertible into our ordinary shares could result in additional dilution to our shareholders. The incurrence of indebtedness would
result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. Our ability to obtain additional capital on acceptable terms is
subject to a variety of uncertainties. Financing may not be available in amounts or on terms acceptable to us, if at all, especially if there is a recession or other events causing volatilities in the
capital markets worldwide.
We have limited insurance coverage which could expose us to significant costs and business disruption.
Other than insurance for some of the vehicles used in our business, we have not purchased any insurance to cover our assets, property
and business. If we were to incur substantial losses or liabilities
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due
to fire, explosions, floods, a wide range of other natural disasters or accidents or business interruption, our results of operations could be materially and adversely affected.
Risks Related to Our Corporate Structure
If the PRC government determines that the contractual arrangements that establish the structure for operating our business do not comply with applicable PRC laws and
regulations, we could be subject to severe penalties.
We are a Cayman Islands company and, as such, we are classified as a foreign enterprise under Chinese laws, and our PRC subsidiary,
Shanghai Shengran Information Technology Co., Ltd., or Shanghai Shengran, is a foreign-invested enterprise. Various regulations in China currently restrict or prevent foreign-invested
entities from holding certain licenses required to operate online virtual worlds, including Internet content provision, Internet culture operation and Internet publishing licenses. In light of these
restrictions, we rely on our VIE, Shanghai Taomee, to hold and maintain the licenses necessary to operate our virtual worlds in China. We do not have any equity interest in Shanghai Taomee but receive
its economic benefits through various contractual arrangements and certain corporate governance and shareholder rights arrangements. In addition, we have entered into agreements with Shanghai Taomee
and its shareholders which provide us with a substantial ability to control Shanghai Taomee. For a description of these contractual arrangements with Shanghai Taomee, see "Item 4. Information
on the CompanyC. Organizational StructureContractual Arrangements with Shanghai Taomee and its Shareholders."
The
Circular on Strengthening the Administration of Foreign Investment in and Operation of Value-added Telecommunications Business, or the MII Circular, issued by the MII, in
July 2006, reiterated the regulations on foreign investment in telecommunications businesses, which require foreign investors to set up foreign-invested enterprises and obtain a business
operating license for Internet content provision to conduct any value-added telecommunications business in China. Under the MII Circular, a domestic company that holds an Internet content provision
license is prohibited from leasing, transferring or selling the license to foreign investors in any form, and from providing any assistance, including providing resources, sites or facilities, to
foreign investors that conduct value-added telecommunications business illegally in China. Furthermore, the relevant trademarks and domain names that are used in the value-added telecommunications
business must be owned by the local Internet content provision license holder. The MII Circular further requires each Internet content provision license holder to have the necessary facilities for its
approved business operations and to maintain such facilities in the regions covered by its license. In addition, all value-added telecommunications service providers are required to maintain network
and information security in accordance with the standards set forth under relevant PRC regulations. Due to a lack of interpretative materials from the regulator, it is unclear what impact the MII
Circular will have on us or the other Chinese Internet companies that have adopted the same or similar corporate and contractual structures as ours.
In
the opinion of Allbright Law Offices, our PRC counsel, (i) the ownership structure and the business and operation model of Shanghai Shengran and Shanghai Taomee are not in
violation of any provisions of applicable PRC laws and regulations, and (ii) each contract under Shanghai Shengran's contractual arrangements with Shanghai Taomee and its shareholders is valid
and legally binding. However, there are uncertainties regarding the interpretation and application of PRC laws and regulations, including the MII Circular. Accordingly, we cannot assure you that the
PRC regulatory authorities will ultimately take a view that is consistent with the opinion of our PRC counsel.
If
we are found to be in violation of any existing or future PRC laws or regulations, including the MII Circular, or fail to obtain or maintain any of the required permits or approvals,
the relevant regulatory authorities would have broad discretion in dealing with such violation, including levying fines, confiscating our income, revoking Shanghai Shengran or Shanghai Taomee's
business or operating
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licenses,
requiring us to restructure the relevant ownership structure or operations, and requiring us to discontinue or restrict our transaction with our VIEs or PRC subsidiaries, limit our business
expansion in China by contractual arrangements, or restrict or prohibit our use of proceeds to finance our business and operation China. If any of these actions results in our inability to direct the
activities of VIEs that affect their economic performance, and/or our failure to receive the economic benefits from VIEs, we may not be able to consolidate the operating results of our VIEs into our
consolidated financial statements in accordance with U.S. GAAP. However, we do not believe that such actions would result in the liquidation or dissolution of our company or our wholly owned
subsidiaries.
If the PRC government determines that our ownership structure does not comply with the restrictions contained in the GAPP Notice, we could be subject to severe penalties.
Our virtual worlds are deemed online games by relevant PRC government authorities and we are subject to relevant PRC regulations on
operators of online games. On September 28, 2009, the General Administration of Press and Publication, or the GAPP, together with the National Copyright Administration, and National Office of
Combating Pornography and Illegal Publications jointly issued a Notice on Further Strengthening of the Administration of Pre-examination and Approval of Online Game and the Examination and
Approval of Imported Online Game, or the GAPP Notice. The GAPP Notice provides, among other things, that foreign investors are not permitted to invest in online game operating businesses in China via
wholly-owned, equity joint venture or cooperative joint venture investments, and expressly prohibits foreign investors from gaining control over or participating in domestic online game operators
through indirect ways such as establishing other joint venture companies, or contractual or technical arrangements. We are not aware of any online game companies adopting the same or similar
contractual arrangements as ours having been penalized or ordered to be terminated since the GAPP
Notice first became effective. As advised by our PRC counsel, Allbright Law Offices, there is uncertainty with respect to the implementation of the GAPP Notice; however, the GAPP is unlikely to
directly affect our control over our PRC subsidiary and VIEs without joint actions with other authorities including the Ministry of Culture, based on the GAPP Notice, since (i) according to the
relevant provisions of the Regulation on the Main Functions, Internal Organization and Staffing of the GAPP issued by the General Office of the State Council on July 11, 2008, or the Regulation
on Three Provisions, the GAPP is authorized to approve the publication of online games before their launch on the Internet, while the Ministry of Culture is authorized to administer and regulate the
overall online game industry; (ii) a circular on the interpretation of the Regulations on Three Provisions, which was issued by the office of the Central Organization Establishment Commission
on September 7, 2009, provides that once an online game is launched on the Internet, it will only be regulated by the Ministry of Culture, and that if an online game is launched on the Internet
without prior approval of the GAPP, the Ministry of Culture, instead of the GAPP, is the direct authority to investigate the game; and (iii) the original set of our contractual agreements with
our significant VIE took effect in June 2009, which was prior to the effective date of the GAPP Notice. There are, however, uncertainties regarding the interpretation and application of the
GAPP Notice. Accordingly, we cannot assure you that the GAPP will not ultimately take a view that is contrary to the opinion of our PRC legal counsel. In the event that we, our PRC subsidiary or VIEs
are found to be in violation of the GAPP Notice to operate our online virtual worlds, the GAPP in conjunction with the relevant regulatory authorities would have the power to investigate and deal with
such violations, including in the most serious cases where relevant licenses and registrations would be suspended or revoked.
Our contractual arrangements with Shanghai Taomee and its shareholders may not be as effective in providing control over Shanghai Taomee as direct ownership of
this company.
We conduct our business in China through Shanghai Taomee. Our contractual arrangements with Shanghai Taomee and its shareholders
provide us with effective control over Shanghai Taomee. See "Item 4. Information on the CompanyOrganizational StructureContractual Arrangements with
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Shanghai
Taomee and its Shareholders." As a result of these contractual arrangements, we are considered to be the primary beneficiary of Shanghai Taomee and accordingly, we consolidate the results of
operations, assets and liabilities of Shanghai Taomee in our financial statements.
Although
we have been advised by Allbright Law Offices, our PRC legal counsel, that each contract under these contractual arrangements is valid and legally binding, these contractual
arrangements may not be as effective in providing us with control over Shanghai Taomee as direct ownership of this company. If Shanghai Taomee or its shareholders fail to perform their respective
obligations under
these contractual arrangements, we may have to incur substantial costs and resources to enforce such arrangements, and rely on legal remedies under PRC law, including seeking specific performance or
injunctive relief, and claiming damages, which we cannot assure you will be effective. See "Risks Related to Our Corporate StructureOur ability to enforce the Share Pledge
Agreements between us and the shareholders of Shanghai Taomee may be subject to limitations based on PRC laws and regulations".
These
contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in
accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the
United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements, which may make it difficult to exert effective control over
our VIE, and our ability to conduct our business may be negatively affected and we may not be able to consolidate the financial results of our VIEs into our consolidated financial statements in
accordance with U.S. GAAP. See "Risks Related to Doing Business in ChinaUncertainties with respect to the PRC legal system could have a material adverse effect
on us."
The shareholders of Shanghai Taomee may have potential conflicts of interest with us, which may materially and adversely affect our business and financial condition.
Shanghai Taomee is jointly owned by Mr. Jason Liqing Zeng, our chairman, Mr. Benson Haibing Wang, our
co-founder, director and chief executive officer, Mr. Crow Zhen Wei, our co-founder, director and chief technology officer, Mr. Roc Yunpeng Cheng, our
co-founder, director and president, Mr. Bin Wang and Mr. Yuliang Feng. In addition, except for Mr. Bin Wang and Mr. Yuliang Feng, the above other individuals
are also directors or executive officers of Shanghai Taomee. The PRC Company Law provides that a director or member of management owes a fiduciary duty to the company he directs or manages. The
abovementioned individuals, except for Mr. Bin Wang and Mr. Yuliang Feng, must therefore act in good faith and in the best interests of Shanghai Taomee and must not use their respective
positions for personal gain. These laws do not require them to consider our best interests when making decisions as a director or member of management of Shanghai Taomee.
Conflicts
of interests between these individuals' role as shareholders or directors of Shanghai Taomee and their duties to our company may arise. We cannot assure you that when conflicts
of interest arise, these individuals will act in the best interests of our company or that conflicts of interest will be resolved in our favor. In addition, these individuals may breach or cause
Shanghai Taomee to breach or refuse to renew the existing contractual arrangements that allow us to effectively control Shanghai Taomee, and receive economic benefits from it. Currently, we do not
have arrangements to address potential conflicts of interest between these individuals and our company and a conflict could result in these individuals as officers of our company violating fiduciary
duties to us. We believe these individuals will not act contrary to any of the contractual arrangements, and the option agreements entered into by each of these individuals with our company entitled
us to remove the shareholders as beneficial shareholders of the VIEs should any of them act in a way that is detrimental to our
company. We rely on these individuals as our directors and executive officers to fulfill their fiduciary duties and abide by laws of the PRC and Cayman Islands and act in the best interest of our
company.
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However,
if we cannot resolve any conflicts of interest or disputes between us and any of the shareholders of Shanghai Taomee, we would have to rely on legal proceedings, which could result in
disruption to our business, and there would be uncertainty as to the outcome of any such legal proceedings.
Our ability to enforce the Share Pledge Agreements between us and the shareholders of Shanghai Taomee may be subject to limitations based on PRC laws and regulations.
Pursuant to the Share Pledge Agreements with the shareholders of Shanghai Taomee, such shareholders agreed to pledge their equity
interests in Shanghai Taomee to secure their performance under the relevant contractual arrangements. The equity pledges of Shanghai Taomee under these Share Pledge Agreements have been registered
with the local branch of State Administration for Industry and Commerce pursuant to the new PRC Property Rights Law. According to the PRC Property Rights Law and PRC Guarantee Law, the pledgee and the
pledgor are prohibited from making an agreement prior to the expiration of the debt performance period to transfer the ownership of the pledged equity to the pledgee when the obligor fails to pay the
debt due. However, under the PRC Property Rights Law, when an obligor fails to pay its debt when due, the pledgee may choose to either conclude an agreement with the pledgor to obtain the pledged
equity or seek payments from the proceeds of the auction or sell-off of the pledged equity. If Shanghai Taomee or its respective shareholders fail to perform their obligations secured by
the pledges under the equity pledge agreements, one remedy in the event of default under the agreements is to require the pledgor to sell the equity interests of Shanghai Taomee in an auction or
private sale and remit the proceeds to our wholly owned subsidiary in China, net of related taxes and expenses. Such an auction or private sale may not result in our receipt of the full value of the
equity interests in Shanghai Taomee. We consider it very unlikely that the public auction process would be undertaken since, in an event of default, our preferred approach is to ask Shanghai Shengran,
our PRC wholly owned subsidiary and a party to the Option Agreements, to replace or designate another PRC person or entity to replace the existing shareholders of Shanghai Taomee pursuant to the
direct transfer option we have under the Option Agreement.
In
addition, in the registration forms of the local branch of State Administration for Industry and Commerce for the pledges over the equity interests under the Share Pledge Agreements,
the amount of registered equity interests in Shanghai Taomee pledged to us was stated as RMB10,000,000, which represents 100% of the registered capital of Shanghai Taomee. The Share Pledge Agreements
with the shareholders of Shanghai Taomee provide that the pledged equity interest shall constitute continuing
security for any and all of the indebtedness, obligations and liabilities under all of the contractual arrangements. In case of a breach of the contractual arrangement, Shanghai Shengran, as the
pledgee, can require the shareholders of Shanghai Taomee to sell the pledged equity interest in a private sale or auction in order to realize Shanghai Shengran's right to the pledged equity interest
in Shanghai Taomee. However, if the proceeds obtained by the shareholders of Shanghai Taomee from the foregoing realization process are insufficient to cover the full amount payable to Shanghai
Shengran, the uncovered part will be determined as unsecured debt and will rank pari passu with other unsecured debt of the shareholders of Shanghai Taomee. We do not have agreements that
pledge the assets of Shanghai Taomee for the benefit of us.
Contractual arrangements we have entered into may be subject to scrutiny by the PRC tax authorities, and a finding that we or our affiliated entities owe additional taxes
could reduce our net income and the value of your investment.
As required by applicable PRC laws and regulations, arrangements and transactions among related parties need to be periodically filed
with local tax authorities and may be subject to audit or challenge by the PRC tax authorities. We could face adverse tax consequences if the PRC tax authorities
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determine
that the contractual arrangements between Shanghai Shengran and Shanghai Taomee do not represent pricing at arm's length and adjust Shanghai Taomee's income in the form of a transfer pricing
adjustment. A transfer pricing adjustment could, among other things, result in a reduction, for PRC tax purposes, of expense deductions recorded by Shanghai Taomee, which could in turn increase its
tax liabilities. In addition, the PRC tax authorities may impose late payment fees and other penalties on our affiliated entities for underpaid taxes. Our net income may be adversely affected if our
affiliated entities' tax liabilities increase or if they are found to be subject to late payment fees or other penalties.
Risks Related to Doing Business in China
Changes in economic and political policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could adversely affect
our business.
Substantially all of our business operations are conducted in China. Accordingly, our business, results of operations, financial
condition and prospects are subject to a significant degree to economic, political and legal developments in China. For example, due to the global financial crisis, the growth of the Chinese economy
also slowed down in the second half of 2008 and early 2009. Any prolonged slowdown in the Chinese economy, in particular the information technology industry, could have a negative impact on our
business, operating results and financial condition in a number of ways. For example, our users may decrease spending on our products, while we may have difficulty expanding our user base fast enough,
or at all, to offset the impact of decreased spending by our existing users.
Although
the Chinese economy is no longer a planned economy, the PRC government continues to exercise significant control over China's economic growth through direct allocation of
resources, monetary and tax policies, and a host of other government policies such as those that encourage or restrict investment in certain industries by foreign investors, control the exchange
between RMB and foreign currencies, and regulate the growth of the general or specific market. These government involvements have been instrumental in China's significant growth in the past
30 years. If the PRC government's current or future policies fail to help the Chinese economy achieve further growth or otherwise negatively affect our business, our growth rate or strategy,
our results of operations could be adversely affected as a result.
Uncertainties in PRC government policies and regulations regarding virtual worlds and online games and children's Internet use in China may adversely affect
our business.
In April 2007, the GAPP, the MII, the Ministry of Education, the Ministry of Public Security, and other relevant government
authorities jointly issued a circular concerning the mandatory implementation of an addiction prevention program in virtual worlds and online games, which aims to protect the physical and
psychological health of minors. This circular requires all virtual worlds to incorporate an addiction prevention program and an identity verification system, both of which limit the amount of time
that a minor or other user may continuously spend participating in a virtual world or playing an online game. Failure to do so may subject us to certain penalties, such as suspension of Internet
publishing operation and relevant Internet-access services or revocation of relevant licenses.
On
June 3, 2010, the Ministry of Culture, or the MOC, adopted the Provisional Administration Measures of Online Games, or the Online Games Administration Measures, which became
effective as of August 1, 2010. The MOC also issued a notice regarding the implementation of the Online Games Administration Measures. We are required to establish the identity verification
systems within three
months of the effectiveness of the Online Games Administration Measures for online games and virtual worlds which started operation after August 1, 2010, and within six months for those which
started operation prior to August 1, 2010. Failing to do so may subject us to an order from relevant authorities to rectify and a fine up to RMB20,000 (approximately US$3,210).
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However,
since the users of our virtual worlds are principally minors, the implementation of an identity verification system has practical difficulties, mainly because most minors do not
have PRC identity cards. We understand that the purpose of identity verification system required under the abovementioned circular issued in 2007 is to facilitate addiction prevention, hence, we have
implemented addiction prevention programs for all users of our virtual worlds. We have established the identity verification system in all of our virtual worlds (including the three virtual worlds
launched after August 1, 2010) and are currently using it as one of the ways for registration. We plan to use the identity verification system as the only option for registration once required
by relevant authorities.
In
addition, a notice jointly issued by several central governmental agencies in February 2007 increased the punishment for Internet cafés admitting minors. As
Internet cafés provide means for children to access the Internet especially in smaller cities, this restriction may adversely affect our plan for growth in these cities. Further
strengthening of these regulations, or enactment by the PRC government of any additional laws to further tighten its administration over the Internet, online games, and, in particular, the Internet
use and access to online games and virtual worlds by children, may result in less time spent by users or fewer users, which may materially and adversely affect our business results and prospects for
future growth.
The laws and regulations governing virtual worlds and online games in China are developing and are subject to future changes. If we or the third-party publishers we work
with fail to obtain or maintain all applicable permits and approvals, our business and operations would be materially and adversely affected.
The online game industry in China is heavily regulated by the PRC government. Various regulatory authorities of the PRC central
government, such as the State Council, the MIIT, the GAPP, the Ministry of Culture and the Ministry of Public Security, have the authority to issue and implement regulations governing various aspects
of the online game industries.
We
are required to obtain applicable permits or approvals from different regulatory authorities in order to operate our virtual worlds. An Internet content provider, or ICP, such as
Shanghai Taomee, must
obtain an ICP license in order to engage in any commercial ICP operations in China. Online game operators must also obtain a license from the Ministry of Culture and an Internet publishing license
from the GAPP in order to distribute games through the Internet. We hold the Internet culture operation license issued by the Ministry of Culture and the Internet publishing license issued by GAPP.
Prior to obtaining the Internet publishing license from GAPP, we worked with third party publishers to publish Mole's World, Seer, Flower Fairy, Magic Haqi and Gong Fu Pai. We have obtained
12 approvals from the GAPP in total, covering the Internet publications of all the virtual worlds which are developed by us and have been commercially launched, including the above-mentioned
five franchises of Mole's World, Seer, Magic Haqi, Flower Fairy and Gong Fu Pai. If we cannot obtain the GAPP approval for our virtual worlds to be launched in future or fail to maintain any of our
permits or approvals, we may be subject to various penalties, including fines and the discontinuation or restriction of our operations. Any such disruption in our business operations would materially
and adversely affect our business, financial condition and results of operations.
As
virtual worlds and online game industry is at an early stage of development in China, new laws and regulations may be adopted from time to time to require additional licenses and
permits other than those we currently have. As a result, uncertainties exist regarding the interpretation and implementation of current and future PRC laws and regulations applicable to virtual
worlds. We cannot assure you that we will be able to timely obtain required licenses or any other new license required in the future, or at all. We cannot assure you that we will not be found in
violation of any current or future PRC laws and regulations.
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The laws and regulations governing virtual worlds and online games in China are developing and are subject to future changes. If we, as the developer of our mobile games,
are required to obtain applicable permits and licenses before their release online, or if we are required to obtain approval for the release of our e-books on mobile platforms, it may
materially and adversely affect our business results and future growth.
According to the Regulation on Three Provisions, the term of online games refers to all the online game works provided to the public
through the Internet (including wired Internet and wireless network) for online user interaction or download, which includes but is not limited to MMORPG, webgames, casual games, PC game downloading,
games with net connection function, online counter strike game platforms and online mobile games. In addition, the distribution of online games to the public through the Internet for online user
interaction or download is deemed as publication of such online games and is subject to the approval of the GAPP before such online games are distributed online.
To
further build our franchises and animated characters, we expanded into mobile platforms and have developed diversified mobile games and applications. Since the release of our first
mobile game, Mole's World iOS version in October 2011, we have further expanded our mobile game portfolio to include Mole Kart and Seer based on our Mole's World and Seer franchise. All of our
mobile games can be downloaded onto iPhones and iPads through Apple's App Store, and some games can also be downloaded onto Android based mobile devices. Some games such as Mole's World are free to
download and have an in-application purchase system for virtual items, while other games such as Seer charge a fee to download and also have an in-application purchase system
for virtual items. Currently, there is no official or public interpretation on the distinction between the terms of online games and mobile games, and we understand that the term of online mobile
games are covered by the definition of "online games" under the Regulation on Three Provisions, and we have obtained the approvals from the GAPP covering all of our online games, including Mole's
World and Seer. However, it still remains uncertain whether we need to obtain approvals for our online mobile games before we distribute such mobile games online. Furthermore, even under the
assumption that our mobile games are subject to separate approvals before they are released online, it is still unclear whether we, as the developer of our games, or the third-party operators who
manage and operate the platform where our mobile games are offered to the public for download, are required to apply for the approval from GAPP before such online mobile games are distributed online.
We
have also released over ten e-books in the middle of 2012 which featured the Mole's World franchise, and Seer animation application on Apple's iOS platform. According to
the Opinions of GAPP on the Development of E-Books
Industry
, which was promulgated by GAPP on October 9, 2010 and took effective on
the same day, enterprises engaging in e-book industries are subject to approvals and administration from relevant governmental authorities. In addition, enterprises engaging in the
creation, editing and publication of e-books or in the operation of platform where the e-book resources are delivered to users are deemed as e-book publishers and
are subject to approvals for the publication of e-books. Since there is no official or public interpretation on the definition of e-book publication, we are not certain whether
our release of e-books on mobile platforms will be deemed as publication and therefore be subject to the approval of GAPP.
If
relevant governmental authorities retroactively determine that we should obtain separate approvals for our online mobile games before we distribute them online, or that we should
apply for approval for the release of our e-books on mobile platforms, we may be subject to penalties or an order to withdraw our mobile games and/or e-books from the Internet,
which may adversely affect our business results and prospects for future growth.
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The laws and regulations governing animation televisions and films in China are developing and are subject to future changes. If we or the third-parties we work with fail to
obtain or maintain all applicable permits and approvals, our business and operations would be materially and adversely affected.
The film and animation industry of PRC is regulated mainly by the State Administration of Radio, Film and Television, or SARFT. The
administration of the foregoing industry is mainly focused on the production and broadcasting of a film and animation television series.
According
to the Regulations on the Administration of Movies promulgated by the State Council of PRC on December 25, 2001 which took effective as of February 1, 2002, the
film production entity is required to either obtain a Film Production License for engaging in film production activities or an One-Time Film Production License for each single film to be
produced. In addition, upon the completion of the film making, the film production entity is required to submit the film to the local branch of SARFT for examination. SARFT will issue a License of
Public Screening for each film that passes such examination, allowing the broadcast of such film to the public.
On
July 19, 2004, SARFT promulgated the
Administration Rules on the Production and Operation of Broadcasting Television Programs
,
pursuant to which an entity that plans to produce and operate television and broadcast programs in China is required to obtain the License for Producing and Operating Television and Broadcast
Programs. On July 11, 2006, SARFT issued
Provisional Regulations on Filing and Publicity of Domestic Television Animations
, stipulating that
registrations for domestic television animations must be filed with, and be publicly displayed by, SARFT prior to their production. On February 14, 2008, SARFT promulgated the
Notice of the State Administration of Radio,
Film and Television on Strengthening the Administration of the Broadcasting of Domestic Animation Series
and on May 14, 2010, SARFT further promulgated
Regulations on Content of Television Series
, which stated that for each domestic television
animation completed, the animation production entity is required to obtain the Domestic Animation Publication License prior to the broadcast of such domestic television animation to the public.
We
cooperate with third parties with the requisite qualifications and licenses in the production and distribution of the animation series and film based on our Mole's World franchise and
the film based on our Seer franchise. Shanghai Taomee Animation Co., Ltd. has obtained (i) the license for the production and broadcasting of radio and television program, and the
license for the broadcasting of Seer I, Seer II and Mole's World III animation series, and (ii) one-time film production license for the third film based on our Seer franchise. If
we fail to renew the Broadcasting and Television Program Production License obtained by us or if we or the third parties we worked with cannot obtain the license from SARFT for any of our future
animation television series or films, the business of animation and film production will be adversely affected. Any such disruption in our business operations would materially and adversely affect our
business, financial condition and results of operations.
The laws and regulations governing broadcasting audio/video programs through the Internet in China are developing and are subject to future changes. If we or the
third-parties we work with fail to obtain or maintain all applicable permits and approvals, our business and operations would be materially and adversely affected.
On July 6, 2004, the SARFT promulgated the Rules for the Administration of Broadcasting of Audio/Video Programs through the
Internet and Other Information Networks, or the Audio/Video Broadcasting Rules. The Audio/Video Broadcasting Rules apply to the opening, broadcasting, integration, transmission or download of
audio/video programs via the Internet and other information networks. Anyone who wishes to engage in Internet broadcasting activities must first obtain an audio/video program transmission license,
with a term of two years, issued by the SARFT and operate
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pursuant
to the scope as provided in such license. Foreign-invested enterprises are not allowed to engage in the above business.
On
December 20, 2007, the SARFT and the MIIT jointly issued the Rules for the Administration of Internet Audio and Video Program Services, commonly known as Document 56, which
came into effect as of January 31, 2008. Document 56 reiterates the requirement set forth in the Audio/Video Broadcasting Rules that online audio/video service provider must obtain a
license from the SARFT. Furthermore, Document 56 requires all online audio/video service providers to be either wholly state-owned or state-controlled. According to relevant official answers to
press questions published on the SARFT's website dated February 3, 2008, officials from the SARFT and the MIIT clarified that online audio/video service providers that already had been
operating lawfully prior to the issuance of Document 56 may re-register and continue to operate without becoming state-owned or controlled, provided that such providers have not
engaged in any unlawful activities. This exemption will not be granted to online audio/video service providers established after Document 56 was issued.
In
January 2012, in cooperation with a number of China's leading online video websites who have obtained the audio/video program transmission licenses, we launched v.61.com, a
website that offers animation series based on our franchises, such as Seer and Mole's World, as well as other content from these websites. In November 2012, we jointly developed with Turner
Broadcasting System Asia Pacific (the parent company of Cartoon Network) ben10.61.com, a dedicated Chinese online zone for Ben 10 fans featuring videos, online games, wallpaper
downloads, e-comics and character profiles. If the governmental authorities determine that our website v.61.com falls within Document 56, we may not be able to obtain the audio/video
program transmission license as required, and we may become subject to penalties, fines or an order to suspend our website v.61.com.
Regulation and censorship of information disseminated over the Internet in China may adversely affect our business, and we may be liable for information displayed on,
retrieved from, or linked to our Internet websites.
The PRC government has adopted certain regulations governing Internet access and the distribution of news and other information over
the Internet. Under these regulations, Internet content providers and Internet publishers are prohibited from posting or displaying over the Internet content that, among other things, violates PRC
laws and regulations, impairs the national dignity of China, or is obscene, superstitious, fraudulent or defamatory. Failure to comply with these requirements could result in the revocation of ICP and
other required licenses and the closure of the concerned websites. The website operator may also be held liable for such prohibited information displayed on, retrieved from or linked to
such website.
In
addition, the MIIT has published regulations that subject website operators to potential liability for content included on their websites and the actions of users and others using
their websites, including liability for violations of PRC laws prohibiting the dissemination of content deemed to be socially destabilizing. The Ministry of Public Security has the authority to order
any local Internet service provider, or ISP, to block any Internet website maintained outside China at its sole discretion. Periodically, the Ministry of Public Security has stopped the dissemination
over the Internet of information which it believes to be socially destabilizing. The State Secrecy Bureau, which is directly responsible for the protection of State secrets of the PRC government, is
authorized to block any website it deems to be leaking state secrets or failing to meet the relevant regulations relating to the protection of state secrets in the dissemination of online information.
As
these regulations are subject to interpretation by the relevant authorities, it may not be possible for us to determine in all cases the type of content that could result in liability
for us as a website operator. In addition, we may not be able to control or restrict the content of other Internet content providers linked to or accessible through our websites, or content generated
or placed on our websites by our users, despite our attempt to monitor such content. To the extent that regulatory authorities find
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any
portion of our content objectionable, they may require us to limit or eliminate the dissemination of such information or otherwise curtail the nature of such content on our websites, which may
reduce our user traffic and have a material adverse effect on our financial condition and results of operations. In addition, we may be subject to significant penalties for violations of those
regulations arising from information displayed on, retrieved from or linked to our websites, including a suspension or shutdown of our operations.
There are currently no laws or regulations in the PRC governing property rights of virtual assets and therefore it is not clear what liabilities, if any, we may have
relating to the loss of virtual assets by our users.
Users of our virtual worlds acquire and accumulate some virtual assets, such as performance-enhancing items, clothing, accessories and
other in-game items. Such virtual assets can be highly valued by users. In practice, virtual assets can be lost for various reasons, such as data loss caused by delay of network service by
a network crash, or by hacking activities. There are currently no PRC laws and regulations governing property rights of virtual assets. As a result, it is unclear who the legal owner of virtual assets
is and whether the ownership of virtual assets is protected by law. In addition, it is unclear under PRC law whether an operator of virtual worlds such as us would have any liability (whether in
contract, tort or otherwise) for loss of such virtual assets by users. Based on several judgments regarding the liabilities of online game operators for
loss of virtual assets by users, the courts have generally required the online game operators to provide well-developed security systems to protect such virtual assets owned by users. In
the event of a loss of virtual assets, we may be sued by users and may be held liable for damages.
Restrictions on virtual currency may adversely affect our game operations revenues.
Our virtual world operations revenues are collected through the sale of our prepaid cards. The Notice on the Reinforcement of the
Administration of Online Games issued by the Ministry of Culture and other governmental authorities on February 15, 2007, directs the People's Bank of China to strengthen the administration of
virtual currency in online games to avoid any adverse impact on the PRC economy and financial system. This notice also applies to virtual worlds we operate. This notice provides that the total amount
of virtual currency issued by online game operators and the amount purchased by individual users should be strictly limited, with a strict and clear division between virtual transactions and real
transactions carried out by way of electronic commerce. This notice also provides that virtual currency should only be used to purchase in-game items. On June 4, 2009, Ministry of
Culture and Ministry of Commerce jointly issued Notice on the Reinforcement of the Administration of Virtual Currency in Online Games, which defines what virtual currency is and requires that entities
obtain the approval from the Ministry of Culture before issuing virtual currency and engaging in transactions using virtual currency in connection with online games. We have obtained the approval from
the Ministry of Culture for the issuing of our virtual currency. These restrictions on virtual currency may result in lower sales of our prepaid cards, and could have an adverse effect on our revenues
from online business.
Our business benefits from certain government tax incentives. Expiration, reduction or discontinuation of, or changes to, these incentives will increase our tax burden and
reduce our net income.
Shanghai Taomee, as a "software enterprise," enjoys a full exemption from enterprise income tax, or EIT, in 2009 and 2010 and a 50%
reduction in the EIT rate from 2011 to 2013. The reduced applicable EIT rate of Shanghai Taomee would be 12.5% from 2011 to 2013. Shanghai Taomee's tax holiday period was approved by relevant tax
authorities in May 2010. Shanghai Shengran, as a "software enterprise," enjoys a full exemption from EIT, in 2010 and 2011 and a 50% reduction in the EIT rate from 2012 to 2014. Shanghai
Shengran's tax holiday period was approved by relevant tax authorities in May 2012, and would apply retroactively to 2010 and 2011. If Shanghai Taomee and
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Shanghai
Shengran fail to maintain their respective qualification as a "software enterprise," the effective EIT rate will increase, which could adversely affect our results of operations.
Various
local governments in China have provided discretionary preferential tax treatments to us. However, these local governments may decide to reduce or eliminate these preferential
tax treatments at any time. Furthermore, these local implementations of tax laws may be found to violate national laws or regulations and we may be subject to retroactive imposition of higher taxes as
a result. Any expiration, reduction or discontinuation of, or changes to, these tax incentives will increase our tax burden and reduce our net income and thus have a material adverse effect on our
operating results.
Further roll-out of the PRC government's plan to replace business tax with value-added tax, or VAT, may subject us to higher tax rate, which could adversely
affect our results of operations.
Pursuant to the PRC Provisional Regulations on Business Tax, taxpayers providing taxable services falling under the category of service
industry in China are required to pay a business tax at a normal tax rate of 5% of their revenues. In November 2011, the Ministry of Finance and the State Administration of Taxation promulgated
the Pilot Plan for Imposition of Value-Added Tax to replace Business Tax. From January 1, 2012, VAT has replaced business tax in the transport and shipping industry and some of the modern
service industries in Shanghai. In July 2012, the Ministry of Finance and the State Administration of Taxation promulgated the Circular concerning Implementing the Pilot Plan for Imposition of
Value-Added Tax to Replace Business Tax for Transport and Shipping Industry and Certain Modern Service Industries in Eight Provinces and Municipalities (including Beijing), which expanded the pilot
regions to other eight provinces and municipalities including Beijing, Tianjin, and Shenzhen. Under the pilot plan, a VAT rate of 6% applies to certain modern service industries. Most of our
consolidated affiliated entities are located in these pilot regions, and the revenues recognized from part of our businesses operated by Shanghai Shengran and Shanghai Taomee are subject to VAT at a
rate of 6%, while other part of our business are still subject to PRC business tax at a statutory tax rate of 5%. If this plan is extended to apply to other part of our business, we may be subject to
VAT rate which is higher than the business tax rate, which would adversely affect our results of operations.
We principally rely on dividends and other distributions on equity paid by our PRC subsidiary to fund any cash and financing requirements we may have, and any limitation on
the ability of our PRC subsidiary to make payments to us, or the tax implications of making payments to us, could have a material adverse effect on our ability to conduct our business.
We are a holding company, and we rely principally on dividends and other distributions on equity from our subsidiary in China for our
cash requirements, including the funds necessary to service any debt we may incur. Current PRC regulations permit our PRC subsidiary to pay dividends to us only out of its accumulated profits, if any,
determined in accordance with Chinese accounting standards and regulations. In addition, our subsidiary in China is required to set aside at least 10% of its after-tax profits each year,
if any, to fund a statutory reserve until such reserve reaches 50% of its registered capital. These reserves are not distributable as cash dividends. The registered capital of Shanghai Shengran is
US$2.5 million. As of the date of this annual report, Shanghai Shengran has made allocations to its statutory reserve fund in compliance with the applicable PRC laws and regulations.
Furthermore, if our subsidiary in China incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other payments to us. Most of
our assets are held by, and substantially all of our earnings and cash flows are attributable to, our PRC subsidiary. If earnings from our PRC subsidiary were to decline, our earnings and cash flow
would be materially and adversely affected. Our cash flows are principally derived from dividends paid to us by our PRC subsidiary. As a result, our ability to distribute dividends largely depends on
earnings from our PRC subsidiary and its ability to pay dividends out of its earnings. Our PRC subsidiary does not have a history of paying dividends. We cannot assure you that our PRC subsidiary will
generate
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sufficient
earnings and cash flows in the near future to pay dividends or otherwise distribute sufficient funds to enable us to meet our obligations, pay interest and expenses or declare dividends.
In
addition, under the PRC Enterprise Income Tax Law and the Implementing Rules, both of which became effective on January 1, 2008, dividends generated from the business of our
PRC subsidiary after January 1, 2008 and payable to us may be subject to a 10% withholding tax if the PRC tax authorities determine that we are a non-resident enterprise, unless
there is an applicable tax treaty with China that provides for a different withholding arrangement and we are deemed to be entitled to such favorable treatment.
We may be classified as a "resident enterprise" for PRC enterprise income tax purposes, which could result in our global income becoming subject to 25% PRC enterprise
income tax.
The PRC Enterprise Income Tax Law provides that enterprises established outside China whose "effective management" are located in China
are considered "resident enterprises" and will generally be subject to the uniform 25% EIT rate as to their global income. Under the implementation regulations, "effective management" is defined as
substantial and overall management and control over such aspects as the production and business, personnel, accounts and properties of an enterprise.
In
April 2009, the State Administration of Taxation released a circular that sets out the standards and procedures for recognizing the location of the "effective management" of an
enterprise registered outside of the PRC and funded by Chinese enterprises as controlling investors, or a Chinese Funded Enterprise. Under the circular, a Chinese Funded Enterprise is considered a
resident enterprise if all of the following applies: (i) a Chinese Funded Enterprise's major management department and personnel who are responsible for carrying out daily operations are
located in the PRC; (ii) the department or the personnel who have the right to decide or approve the Chinese Funded Enterprise's financial and human resource matters are located in the PRC;
(iii) the major assets, account book, company seal and meeting minutes of the Chinese Funded Enterprise are located or stored in the PRC; and (iv) the directors or management personnel
holding no less than 50% voting rights of the Chinese Funded Enterprise habitually reside in the PRC. The circular explicitly provides that the above standards apply to the enterprises which are
registered outside the PRC and funded by Chinese enterprises as controlling investors, and therefore such standards may be cited for reference only and may not be directly adopted when considering
whether our "effective management" is in the PRC or not. Accordingly, it is still uncertain whether we may be considered a resident enterprise under the PRC EIT Law. If we are considered a resident
enterprise and earn income other than dividends from our PRC subsidiary, we will be subject to a 25% PRC income tax on our global income and such 25% PRC EIT on our global income could significantly
increase our tax burden and materially and adversely affect our cash flow and profitability.
If we are classified as a "resident enterprise" for PRC enterprise income tax purposes, you may be subject to PRC withholding tax on dividends from us and to PRC income tax
on gain realized on the transfer of our ADSs or ordinary shares.
Under the PRC Enterprise Income Tax Law and related implementation regulations, PRC EIT withholding tax at the rate of 10% is
applicable to dividends payable to investors that are "non-resident enterprises," which do not have an establishment or place of business in the PRC, or which have such establishment or
place of business if the relevant income is not effectively connected with the establishment or place of business, to the extent such dividends have their sources within the PRC. In addition, any gain
realized on the transfer of ADSs or shares by such investors is subject to 10% PRC income tax if such gain is regarded as income derived from sources within the PRC unless a treaty otherwise provides.
If we are considered a PRC "resident enterprise," it
is unclear whether dividends we pay with respect to our ordinary shares or ADSs, or the gain you may realize from the transfer of our ordinary shares or ADSs, would be treated as income derived from
sources within the PRC and be
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subject
to PRC tax. If we are required under the PRC EIT Law to withhold PRC income tax on dividends payable to our non-PRC investors that are "non-resident enterprises," or if
you are required to pay PRC income tax on the transfer of our ordinary shares or ADSs, the value of your investment in our ordinary shares or ADSs may be materially and adversely affected.
Uncertainties with respect to the PRC legal system could have a material adverse effect on us.
We conduct our business primarily through our subsidiary and affiliated entities in China. Our operations in China are governed by PRC
laws and regulations. The PRC legal system is based on statutes. Prior court decisions may be cited for reference but have limited precedential value.
Since
1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a
fully integrated legal system and recently enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are
relatively new, and because of the limited volume of published decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In
addition, the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result,
we may not be aware of our violation of these policies and rules until some time after the violation. In addition, any litigation in China may be protracted and result in substantial costs and
diversion of resources and management attention.
Restrictions on currency exchange may limit our ability to receive and use our revenues effectively.
Substantially all of our cash inflows and outflows are denominated in Renminbi. We may convert a portion of our revenues into other
currencies to meet our foreign currency obligations such as payment of dividends declared in respect of our ordinary shares. Under China's existing foreign exchange regulations, our PRC subsidiary is
able to make payments of current accounts, such as dividends to its offshore holding companies, in foreign currencies, without prior approval from SAFE, by complying with certain procedural
requirements. However, we cannot assure you that the PRC authorities will not take further measures in the future to restrict access to foreign currencies for current account transactions. We may also
have different views with the PRC authorities with respect to certain foreign exchange transactions. These and other uncertainties with respect to currency exchange controls may have a material
adverse impact on our operations and financial condition.
Governmental control of currency conversion may affect the value of your investment.
The PRC government imposes controls on the convertibility of the RMB into foreign currencies and, in certain cases, the remittance of
currency out of China. We receive substantially all of our revenues in RMB. Under our current corporate structure, our income is primarily derived from dividend payments from our PRC subsidiary.
Shortages in the availability of foreign currency may restrict the ability of our PRC subsidiary to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy its
foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from
trade-related transactions, can be made in foreign currencies without prior approval from SAFE by complying with certain procedural requirements. However, approval from 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 loans denominated in foreign currencies. The PRC
government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient
foreign currency to satisfy our currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs.
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We may be subject to penalties, including restriction on our ability to inject capital into our PRC subsidiary and our PRC subsidiary's ability to distribute profits to us,
if our PRC resident shareholders or beneficial owners fail to comply with relevant PRC foreign exchange rules.
SAFE issued a public notice in October 2005 requiring PRC residents to register with the local SAFE branch before establishing
or controlling any company outside of China for the purpose of capital financing with assets or equities of PRC companies, referred to in the notice as an "offshore special purpose vehicle." PRC
residents that are shareholders and/or beneficial owners of offshore special purpose companies established before November 1, 2005 were required to register with the local SAFE branch before
March 31, 2006. In addition, any PRC resident that is a shareholder of an offshore special purpose vehicle is required to amend its SAFE registration with respect to that offshore special
purpose company in connection with any increase or decrease of capital, transfer of shares, merger, division, equity investment or creation of any security interest over any assets located in China or
other material changes in share capital. In May 2007 and May 2011, respectively, SAFE issued relevant guidance to its local branches with respect to the operational process for SAFE
registration, which standardized more specific and stringent supervision on the registration relating to the SAFE notice.
All
our individual shareholders who are subject to Circular 75 have completed registration with SAFE with regard to the establishment of our company or their shareholding in our
company as required under Circular 75, and they have also filed application for change of registration to reflect our company's investment activities and later share subdivision. We are
committed to compliance with Circular 75 and have taken steps to ensure that our shareholders and beneficial owners who are subject to Circular 75 also comply with the relevant
rules. However, we cannot provide any assurance that all of our shareholders and beneficial owners who are PRC residents will comply with our request to make, obtain or update any applicable
registrations or comply with other requirements required by the SAFE notice or other related rules. In case of any non-compliance on any of our PRC resident shareholders or beneficial
owners, our PRC subsidiary and such shareholders and beneficial owners may be subject to fines and other legal sanctions, including restriction on our ability to contribute additional capital into our
PRC subsidiary and our PRC subsidiary's ability to distribute dividends to our offshore holding companies, which will adversely affect our business.
All employee participants in our share incentive plans who are domestic individuals may be required to register with SAFE. We may also face regulatory uncertainties that
could restrict our ability to adopt additional option plans for our directors and employees under PRC law.
In December 2006, the People's Bank of China promulgated the Administrative Measures for Individual Foreign Exchange, which set
forth the respective requirements for foreign exchange transactions by PRC individuals under either current account or the capital account. In January 2007, SAFE issued the Implementation Rules
of the Administrative Measures for Individual Foreign Exchange, which, among other things, specified approval requirements for certain capital account transactions such as a PRC citizen's
participation in the employee stock ownership plans
or stock option plans of an overseas publicly-listed company. On February 15, 2012, SAFE promulgated the
Notice regarding Foreign Exchange Administration for Domestic
Individuals Participating in Employee Stock Option Plan of Overseas-Listing Companies
, or the Stock Option Rule, which substitutes the
Application
Procedure of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plan or Stock Option Plan of Overseas-Listed Companies
promulgated
by SAFE on March 28, 2007. Under the Stock Option Rule, the domestic individuals as defined under the
Foreign Exchange Administration Regulations
who are granted stock options or other incentive alternatives by an overseas publicly listed company are required, through a PRC agent or PRC subsidiary of such overseas publicly listed company, to
register with SAFE and complete certain other procedures.
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We
and our relevant employees participating in our stock incentive plan are subject to the Stock Option Rule. Failure to comply with the Stock Option Rule and other relevant rules will
subject us or our relevant employees participating in our stock incentive plan to fines and other legal or administrative sanctions and impose restrictions on our execution of option plans, including
the grant of options under such plans to our employees, which could adversely affect our business operations. As the laws and regulations of PRC in relation to domestic individual's participation in
the stock option plan of overseas companies are developing, we may also face regulatory uncertainties that could restrict our ability to adopt additional option plans for our directors and employees
under PRC law.
Fluctuation in the value of the RMB may have a material adverse effect on the value of your investment.
The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes
in political and economic conditions. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under the new
policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy resulted in an over 20% appreciation of the RMB against
the U.S. dollar over the following three years. For almost two years after reaching a high against the U.S. dollar in July 2008, however, the Renminbi traded within a narrow band
against the U.S. dollar, remaining within 1% of its July 2008 high. As a consequence, the Renminbi fluctuated sharply since July 2008 against other freely traded currencies, in
tandem with the U.S. dollar. In June 2010, the PRC government announced that it would increase RMB exchange rate flexibility. However, it remains unclear how this flexibility might be
implemented. There remains significant international pressure on the PRC government to adopt a more flexible currency policy, which could result in greater fluctuation of the RMB against the
U.S. dollar. Substantially all of our revenues and costs are denominated in RMB, and a significant portion of our financial assets are also denominated in RMB. We principally rely on dividends
and other distributions paid to us by our subsidiary in China. Any significant revaluation of the RMB may materially and adversely affect our cash flows, revenues, earnings and financial position, and
the value of, and any dividends payable on,
our ADSs in U.S. dollars. Any fluctuations of the exchange rate between the RMB and the U.S. dollar could also result in foreign currency translation losses for financial reporting
purposes.
The approval of the China Securities Regulatory Commission, or the CSRC, may be required in connection with our initial public offering under a PRC regulation. The
regulation also establishes more complex procedures for acquisitions conducted by foreign investors that could make it more difficult for us to grow through acquisitions.
On August 8, 2006, six PRC regulatory agencies, including the Ministry of Commerce, the State Assets Supervision and
Administration Commission, or SASAC, the State Administration for Taxation, the State Administration for Industry and Commerce, the CSRC, and SAFE, jointly adopted the Regulations on Mergers and
Acquisitions of Domestic Enterprises by Foreign Investors, or the New M&A Rule, which became effective on September 8, 2006 and was amended by the Ministry of Commerce on June 22,
2009. The regulations require offshore special purpose vehicles that are controlled by PRC companies or residents and that have been formed for the purpose of seeking a public listing on an overseas
stock exchange through acquisitions of PRC domestic companies or assets to obtain CSRC approval prior to publicly listing their securities on an overseas stock exchange. On September 21, 2006,
the CSRC published a notice on its website specifying the documents and materials that special purpose vehicles are required to submit when seeking CSRC approval for their listings outside of China.
The interpretation and application of the above regulations remain unclear, and the initial public offering which we completed in June, 2011 may require approval from the CSRC, and if it does, it is
uncertain how long it will take us to obtain the approval. If CSRC approval is required for the initial public offering, our failure in obtaining or delay in obtaining the CSRC approval for the
initial public offering would subject us to sanctions imposed by the CSRC and other PRC
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regulatory
agencies, which could include fines and penalties on our operations in China, restrictions or limitations on our ability to pay dividends outside of China, and other forms of sanctions that
may materially and adversely affect our business, results of operations and financial condition.
Our
PRC counsel, Allbright Law Offices, has advised us that, based on their understanding of the current PRC laws, regulations and rules and the procedures announced on
September 21, 2006, we will not be required to submit an application to the CSRC for the approval of the listing and trading of our ADSs on the New York Stock Exchange, because we do not
constitute a special purpose vehicle, as defined by the New M&A Rules, which is required to obtain approval from the CSRC for overseas listing, and no public record is found indicating that any
of the issuers having similar onshore corporate structures and already listed on an off-shore stock exchange has been required by the CSRC to procure the approval of the CSRC prior to
its listing.
The
new regulations also established additional procedures and requirements that are expected to make merger and acquisition activities in China by foreign investors more
time-consuming and complex, including requirements in some instances that the Ministry of Commerce be notified in advance of any change-of-control transaction in
which a foreign investor takes control of a PRC domestic enterprise, or that the approval from the Ministry of Commerce be obtained in circumstances where overseas companies established or controlled
by PRC enterprises or residents acquire affiliated domestic companies. We may grow our business in part by acquiring other companies operating in our industry. Complying with the requirements of the
new regulations to complete such transactions could be time-consuming, and any required approval processes, including approval from Ministry of Commerce, may delay or inhibit our ability
to complete such transactions, which could affect our ability to expand our business or maintain our market share.
We face risks of health epidemics and other disasters, which could severely disrupt our business operations.
Our business could be materially and adversely affected by the outbreak of swine influenza, avian influenza, severe acute respiratory
syndrome, or SARS, or another epidemic. In 2009 and early 2010, there were outbreaks of swine influenza in certain regions of the world, including China. Any adverse public health developments in
China could require the temporary closure of our offices. Such closures could severely disrupt our business operations and adversely affect our results of operations.
Our
operations are vulnerable to interruption and damage from man-made or natural disasters, including wars, acts of terrorism, earthquakes, fire, floods, environmental
accidents, power loss, communications failures and similar events, all of which may disrupt our business. If any significant man-made or natural disaster were to occur in the future, our
ability to operate our business could be seriously impaired.
The enforcement of labor contract law and increase in labor costs in the PRC may adversely affect our business and our profitability.
China adopted a labor contract law effective on January 1, 2008, which was amended by the Standing Committee of the National
People's Congress on December 28, 2012, and its implementation rules effective on September 18, 2008, respectively. The labor contract law and its implementation rules impose more
stringent requirements on employers with regard to, among others, minimum wages, severance payment upon permitted termination of the employment by an employer and non-fixed term employment
contracts, time limits for probation period as well as the duration and the times that an employee can be placed on a fixed term employment contract. Due to
the limited period of effectiveness of the labor contract law and its implementation rules and the lack of clarity with respect to their implementation and potential penalties and fines, it is
uncertain how they will impact our current employment policies and practices. Our employment policies and practices may violate the labor contract law or its implementation rules and we may be subject
to related penalties, fines or legal
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fees.
Compliance with the labor contract law and its implementation rules may increase our operating expenses, in particular our personnel expenses, as the continued success of our business depends
significantly on our ability to attract and retain qualified personnel. 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 manner that we believe to be cost-effective or desirable, which could adversely affect our
business and results of operations.
We may be adversely affected by the future outcome of the administrative proceedings brought by the SEC against the five major accounting firms in China.
Recently, the SEC commenced administrative proceedings under Rule 102(e) of its Rules of Practice and also under the
Sarbanes-Oxley Act of 2002 against the Chinese affiliates of the "big four" accounting firms, including our auditors, and also against BDO China Dahua. The Rule 102(e) proceedings initiated by
the SEC relate to these firms' failure to produce documents, including audit workpapers, is response to the request of the SEC pursuant to Section 106 of the Sarbanes-Oxley Act of 2002, as the
auditors located in the PRC are not in a position to lawfully produce documents directly to the SEC due to restrictions under PRC law and specific directives issued by the China Securities Regulatory
Commission. As the administrative proceedings are ongoing, it is difficult to determine their outcome or the resulting consequences to us. The issues raised by the proceedings are not specific to our
auditors or to us, but affect equally all audit firms based in China and all China-based businesses with securities listed in the United States. However, if the administrative judge were to
find in favor of the SEC under the proceeding and depending upon the remedies sought by the SEC, these audit firms could be barred from practicing before the SEC. As a result, listed companies in the
United States with major PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the PRC, which may result in their delisting. Moreover, any
negative news regarding the proceedings against these audit firms may erode investor confidence in China-based, United States listed companies and the market price of our ADSs may be adversely
affected.
Risks Related to Our ADSs
The market price for our ADSs has fluctuated and may be volatile.
The market price for our ADSs has fluctuated since we first listed our ADSs. Since our ADSs became listed on the NYSE on
June 10, 2011, trading price of our ADSs have ranged from US$3.15 to US$17.90 per ADS, and the last reported trading price on April 15, 2013 was US$4.50 per ADS.
The
market price for our ADSs may be highly volatile and subject to wide fluctuations in response to factors within and outside our control including, but not limited to,
the following:
-
-
actual or anticipated fluctuations in our quarterly results of operations;
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-
regulatory developments affecting us or our industry;
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-
changes in the economic performance or market valuations of other companies operate in our industry;
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changes in financial estimates by securities research analysts;
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announcements by us or our competitors of new services, acquisitions, strategic relationships, joint ventures or capital
commitments;
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fluctuations of exchange rates between RMB and the U.S. dollar;
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intellectual property litigation;
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economic or political conditions in China;
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-
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additions to or departures of our senior management;
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-
release or expiry of lock-up or other transfer restrictions on our outstanding ordinary shares or
ADSs; and
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sales or perceived potential sales of additional ordinary shares or ADSs.
In
addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of any particular
companies. These market fluctuations may also have a material adverse effect on the market price of our ADSs.
Substantial future sales or the perception of sales of our ADSs or ordinary shares in the public market could cause the price of our ADSs to decline.
Additional sales of our ADSs or ordinary shares, including ADSs or ordinary shares issuable upon the exercise of our outstanding stock
options, in the public market, or the perception that these sales could occur, could cause the market price of our ADSs to decline. If our shareholders sell substantial amounts of our ADSs, including
those issued upon the exercise of outstanding options, in the public market, the market price of our ADSs could fall. Such sales also might make it more difficult for us to sell equity or
equity-related securities in the future at a time and price that we deem appropriate. If any existing shareholder or shareholders sell a substantial amount of ordinary shares, the prevailing market
price for our ADSs could be adversely affected.
In
addition, we may issue additional ordinary shares or ADSs. If we pay for our future acquisitions in whole or in part with additionally issued ordinary shares or ADSs, your ownership
interests in our company would be diluted and this, in turn, could have a material adverse effect on the price of our ADSs.
You may not have the same voting rights as the holders of our ordinary shares and must act through the depositary to exercise your rights.
As an ADS holder, you may only exercise voting rights with respect to the underlying ordinary shares in accordance with the provisions
of the deposit agreement. Under the deposit agreement, you must vote by giving voting instructions to the depositary. Upon receipt of your voting instructions, the depositary will vote the underlying
ordinary shares in accordance with these instructions. Otherwise, you will not be able to exercise your right to vote unless you withdraw the ordinary shares underlying your ADSs.
Pursuant
to our third amended and restated memorandum and articles of association, we may convene a shareholders' meeting upon ten days' notice. When a shareholder's meeting is convened,
you may not receive sufficient advance notice to withdraw the ordinary shares underlying your ADSs to allow you to vote with respect to any specific matter. If we give timely notice, the depositary
will notify you of the upcoming vote and arrange to deliver our voting materials to you. We cannot assure you that you will receive the voting materials in time to instruct the depositary to vote the
ordinary shares underlying your ADSs. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for the manner of carrying out voting instructions.
This means that you may not be able to exercise your right to vote and there may be nothing you can do if the ordinary shares underlying your ADSs are not voted as you requested.
You may not be able to participate in rights offerings and may experience dilution of your holdings as a result.
We may from time to time distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement
for the ADSs, the depositary will not offer those rights to ADS holders unless both the rights and the underlying securities to be distributed to ADS holders are
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registered
under the Securities Act, or the distribution of them to ADS holders is exempted from registration under the Securities Act with respect to all holders of ADSs. We are under no obligation
to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared effective. In addition, we may not
be able to rely on an exemption from registration under the Securities Act to distribute such rights and securities. Accordingly, holders of our ADSs may be unable to participate in our rights
offerings and may experience dilution in their holdings as a result.
You may be subject to limitations on transfer of your ADSs.
Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from
time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our
books or the books of the depositary are closed, or at any time if we or the depositary deem it advisable to do so due to any requirement of law or of any government or governmental body.
You may face difficulties in protecting your interests, and your ability to protect your rights through the U.S. federal courts may be limited because we are
organized under Cayman Islands law, conduct substantially all of our operations in China and the majority of our directors and officers reside outside the United States.
We are organized in the Cayman Islands and substantially all of our assets are located outside of the United States. We conduct
substantially all of our current operations in China through our subsidiary and affiliated entities in China. The majority of our officers and directors reside outside the United States and a
substantial portion of the assets of those persons are located outside of the United States. As a result, it may be difficult 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 securities laws or otherwise. Even if you are successful in bringing an action of this kind,
the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. In addition, there is uncertainty as to whether
the courts of the Cayman Islands or the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws
of the United States or any state, and it is uncertain whether such Cayman Islands or PRC courts would be competent to hear original actions brought in the Cayman Islands or the PRC against us
or such persons predicated upon the securities laws of the United States or any state.
Our
corporate affairs are governed by our memorandum and articles of association, as amended from time to time, and by the Companies Law (2012 Revision) and the common law of the Cayman
Islands. The rights of shareholders to take legal action against our directors and us, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands
law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands
as well as from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our
directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in some jurisdictions in the United States. In particular, because the
Cayman Islands law has no legislation specifically dedicated to the rights of investors in securities, and thus no statutorily defined private causes of action to investors in securities such as those
found under the Securities Act or the Securities Exchange Act of 1934 in the United States, it provides significantly less protection to investors. In addition, shareholders of Cayman Islands
companies may not have standing to initiate a shareholder derivative action before the federal courts of the United States.
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As
a result of all of the above, our public shareholders may have more difficulty in protecting their interests through actions against our management, directors or major shareholders
than would shareholders of a corporation organized in a jurisdiction in the United States.
Our articles of association contain anti-takeover provisions that could discourage a third party from acquiring us, which could limit our shareholders'
opportunity to sell their shares, including ordinary shares represented by our ADSs, at a premium.
Our third amended and restated articles of association contain provisions to limit the ability of others to acquire control of our
company or cause us to engage in change-of-control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at
a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. For example, our board of directors has
the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix their designations, powers, preferences, privileges, and relative participating,
optional or special rights and the qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all
of which may be greater than the rights associated with our ordinary shares, in the form of ADS or otherwise. Preferred shares could be issued quickly with terms calculated to delay or prevent a
change in control of our company or make removal of management more difficult. If our board of directors decides to issue preferred shares, the price of our ADSs may fall and the voting and other
rights of the holders of our ordinary shares and ADSs may be materially and adversely affected.
We believe we may be a passive foreign investment company for U.S. federal income tax purposes, which could result in adverse U.S. federal income tax
consequences to U.S. Holders of our ADSs or ordinary shares.
Based on the market price of our ADSs and composition of our income and assets, we believe we were a passive foreign investment
company, or PFIC, for U.S. federal income tax purposes for our taxable year ended December 31, 2012. A non-U.S. corporation will be a PFIC for any taxable year if
either (i) at least 75% of its gross income for such year is passive income or (ii) at least 50% of the value of its assets (based on an average of the quarterly values of the assets)
during such year is attributable to assets that produce passive income or are held for the production of passive income. Because the value of our assets for purposes of the PFIC test may be
determined, in part, by reference to the market price of our ADSs or ordinary shares, our PFIC status will depend in large part on the market price of the ADSs or ordinary shares, which may fluctuate
significantly. Because we believe we were a PFIC for our taxable year ended December 31, 2012, certain adverse U.S. federal income tax consequences could apply to U.S. Holders
(as defined in "Item 10. Additional InformationE. TaxationUnited States Federal Income Taxation") of our ADSs or ordinary shares with respect to
any "excess distribution" received from us and any gain from a sale or other disposition of our ADSs or ordinary shares. See "Item 10. Additional InformationE.
TaxationUnited States Federal Income TaxationPassive Foreign Investment Company."
We have incurred increased costs as a result of being a public company, and we cannot predict or estimate the amount of additional future costs we may incur or the timing of
such costs.
As a public company, we have incurred a significantly higher level of legal, accounting and other expenses than we did as a private
company. In addition, the Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC and the New York Stock Exchange, have required changes in the corporate governance
practices of public companies. These rules and regulations have increased our legal, accounting and financial compliance costs and made some of our corporate activities more time-consuming
and costly.
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After
we became a public company, we have established additional board committees and adopted and implemented additional policies regarding internal controls over financial reporting and
disclosure controls and procedures. In particular, compliance with Section 404 of the Sarbanes-Oxley Act, which requires public companies to include a report of management on the effectiveness
of their internal control over financial reporting, has increased our costs. In addition, we have incurred costs associated with public company reporting requirements, such as the requirements to file
an annual report and other reports with the SEC. We expect these rules and regulations to increase our legal and financial compliance costs going forward, but we cannot predict or estimate the
additional costs or the timing of initially additional costs we may incur.
ITEM 4. INFORMATION ON THE COMPANY
A.
History and Development of the Company
Our legal and commercial name is Taomee Holdings Limited. We commenced operations of our business of children's online entertainment in October 2007
through Shanghai Taomee, a limited liability company established in China. Shanghai Taomee holds our licenses required for the above business
under PRC laws and is in charge of the operation of our websites for our virtual worlds. To enable us to raise capital from international investors, our holding company, Taomee Holdings Limited, was
incorporated under the laws of the Cayman Islands in September 2008.
In
November 2008, we incorporated Taomee Holdings (HK) Limited, or Taomee HK, our wholly-owned subsidiary in Hong Kong. In June 2009, Taomee HK established its wholly-owned
subsidiary, Shanghai Shengran, in China. Taomee HK is our base for overseas investors relationship and investment management as we continue to explore investment and acquisitions opportunities outside
of mainland China. For discussions of tax implications related to Taomee HK, see "Item 5. Operating and Financial Review and ProspectsA. Operating
ResultsTaxationHong Kong."
PRC
laws, rules and regulations currently restrict foreign-invested entities engaging in the operation of Internet-related businesses, including virtual worlds, in China. To comply with
PRC laws, rules and regulations, we operate our virtual worlds through our VIE, Shanghai Taomee. In June 2009, through Shanghai Shengran, we entered into certain contractual arrangements with
Shanghai Taomee and its shareholders through which we gained effective control over the operations of Shanghai Taomee.
In
April 2009, we issued in a private placement an aggregate of 125,000,000 Series A preferred shares for an aggregate purchase price of US$5.0 million to the
Qiming Funds.
In
December 2009, we obtained a minority interest in Elyn Corporation and its wholly owned subsidiary Taiwan Taomee, of which 20% equity interests was initially held through a
related party, as consideration, in exchange for a three-year exclusive right to operate certain of our virtual worlds in Taiwan, Hong Kong and Macau. As we have the ability to exercise
significant influence over Elyn Corporation, we account for this investment using the equity method of accounting.
On
February 25, 2011, we entered into an agreement to effectively sell a 10.5% equity interest in Elyn Corporation that had been indirectly held by the related party on our
behalf. Of the 10.5% equity interest in Elyn Corporation, 9.14% was sold to Qiming Funds which are our existing shareholders and 1.36% was sold to a third party investor for US$3.4 million and
US$0.5 million, respectively, in cash. A gain of US$3.7 million was recognized in share of profit in equity method investments in the consolidated statement of operations. In addition,
the nominee shareholding agreement was terminated with the related party and we held all of our 29.5% equity in Elyn Corporation directly, and continued to account for this investment using the
equity method.
On
August 12, 2011, our equity interest in Elyn Corporation was diluted from 29.5% to 28.8% as a result of Elyn Corporation's issuing shares to its employees.
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In November 2011, Taiwan Taomee went through a reorganization and contemporaneously issued new ordinary shares to existing shareholders and certain
employees. As a result of such transactions, our equity interest in Taiwan Taomee was changed from 28.8% interest held through Elyn Corporation to a 27.6% effective interest which was held through
(1) 29.50% in Elyn Corporation, which held 72.09% of Taiwan Taomee, and (2) 28.77% in Joy Children Technology Co., Ltd., or Joy Children, a shell company with no
operations, which owned 21.86% of Taiwan Taomee after the reorganization. The change in equity interest reflected a dilution resulting from shares issued to Taiwan Taomee's employees, which were
accounted for by Taiwan Taomee as stock compensation. In addition, we paid total consideration of US$668,992 in cash for the newly issued shares of Taiwan Taomee through Joy Children, which was
recorded as an increase in equity method investment.
In
July 2012, our aggregated equity interest through Elyn and Joy Children in Taiwan Taomee was diluted from 27.6% to 27.1%, i.e. (1) 29.50% in Elyn, which holds 70.88% of
Taiwan Taomee and (2) 28.77% in Joy Children, which holds 21.49% of Taiwan Taomee. The dilution was mainly due to the issue of new ordinary shares by Taiwan Taomee from capital surplus and
appropriations of 2011 earnings to certain existing shareholders and employees.
In
October 2010, Shanghai Taomee invested a 17.65% equity interest in Shenzhen Ruigao Information Technology Co., Ltd., or Shenzhen Ruigao, a newly established
Chinese company principally engaged in the research and development of hardware and platform for handheld game consoles in China. In May 2012, a third party investor obtained 7.5% equity
interest in Shenzhen Ruigao through capital
injection, and our equity interest in Shenzhen Ruigao was reduced to 15.61%. In July 2012, Shanghai Taomee transferred all its equity interest in Shenzhen Ruigao for US$1.0 million and
recorded a gain of US$0.3 million, also see "Item 7. Major Shareholders and Related Party TransactionsB. Related Party TransactionsTransactions with
Certain Officers, Shareholders and Affiliates and Key Management Personnel."
In
November 2010, Shanghai Taomee established its wholly-owned subsidiary, Shanghai Taomee Animation Co., Ltd., or Shanghai Animation, in China, which primarily
engages in the business of animation design and development.
On
February 14, 2011, our shareholders approved a 50-for-1 share split of each of our ordinary shares and Series A preferred shares which
became effective immediately. At the same time, the par value of the shares was changed from US$0.001 per share to US$0.00002 per share. Unless otherwise noted, all share information and per share
data included in the prospectus and accompanying financial statements have been adjusted to reflect this share split and change in par value.
On
June 10, 2011, our ADSs began trading on the New York Stock Exchange under the ticker symbol "TAOM." We issued and sold a total of 7,187,500 ADSs, representing
143,750,000 ordinary shares, at an initial offering price of US$9.00 per ADS.
On
July 13, 2011, the underwriters of our initial public offering exercised their over-allotment option to purchase an additional 525,224 ADS from us at the
initial public offering price of US$9.00 per ADS, less the underwriting discount. With this exercise, we issued and sold a total of 7,712,724 ADSs, representing 154,254,480 ordinary
shares.
On
November 28, 2011, we announced a share repurchase plan to repurchase up to US$10 million worth of outstanding ADSs over a 12-month period. On
September 28, 2012, we extended the share repurchase plan for another 12 months from November 23, 2012 to November 23, 2013. As of December 31, 2012, we had
repurchased an aggregated of 585,552 ADSs, representing 11,711,040 ordinary shares on the open market for total cash consideration of US$2.3 million. All of the above repurchased
ordinary shares were subsequently cancelled.
In
the first quarter of 2012, Shanghai Taomee entered into an investment agreement of US$0.1 million with Guangzhou Chuangyou Information Technology Co., Ltd., or
Chuangyou, a
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company
principally engaged in the design and development of online games in China, to acquire 6.0% of Chuangyou's equity interest and a contingent call option to further subscribe 13.16% newly issued
equity interest for US$0.6 million. In September 2012, Shanghai Taomee exercised the call option and completed the further acquisition in January 2013. As a result, we have
acquired 19.16% equity interest in Chuangyou. Chuangyou is a related party of us, as one of Chuangyou's investors is our director and principle shareholder.
In
June 2012, we incorporated and obtained 95% of the equity interest in Guangdong Taomee, a PRC company which primarily focuses on the design and distribution of toys, trading
cards as well as other products based on our franchises.
In
September 2012, we obtained a minor equity interest in Gamespedia Holdings Limited, a Cayman Island company which operates its mini game portal website through its wholly owned
subsidiaries and VIEs in China, with total consideration of US$6.2 million.
In
December 2012, we entered into an investment agreement to acquire a minority equity interest in Voozclub Co., Ltd., or Voozclub, a Korea-based character and
animation studio with an established presence in global brand licensing, online games, publishing and theme parks, for US$1.4 million in cash. In January 2013, we paid the whole
consideration to Voozclub.
In
December 2012, we incorporated Shanghai Xinsheng Information Technology Co., Ltd., a PRC company wholly owned by Shanghai Shengran which focuses on software
development.
In
March 2013, Shanghai Taomee entered into an agreement to set up a new online game development company with five third-party individuals, of which Shanghai Taomee will hold a
40% equity interest for a consideration of US$0.3 million.
Our
principal executive offices are located at 16/F, Building No. A-2, No. 1528 Gumei Road, Xuhui District, Shanghai 200233, People's Republic of China. Our
telephone number at this address is (86-21) 6128-0056 and our fax number is (86-21) 3367-4012. Our registered office in the Cayman Islands is at the
offices of Maples Corporate Services Limited, PO Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands.
Investor
inquiries should be directed to us at the address and telephone number of our principal executive offices set forth above. Our corporate information website is located at
www.taomee.com. The information contained on our corporate information website is not part of this annual report. Our agent for service of process in the United States is CT Corporation System
located at 111 Eighth Avenue, New York, NY 10011.
B.
Business Overview
We are one of the leading children's entertainment and media companies in China. We attribute our market leading position to our content development capabilities
that leverage our innovative culture, experience in the children's entertainment market in China, and knowledge of virtual worlds and online entertainment to create enduring and iconic characters,
images and story lines that attract a loyal following among children of the targeted age groups. Our success in developing branded entertainment experiences across online and mobile platforms has
translated into growing demand for our franchises offline. We are committed to delivering exceptional entertainment to children and families and leveraging our cross-media platform and child-centric
culture.
We
have a proven track record in creating branded franchises popular with children and their families through our cross-media platforms comprised of virtual worlds, print media, film,
television, live events, online video streaming sites, mobile applications, and social networking sites. As a confirmation of our positive and significant influence on children, we were awarded in
2012 by China's Ministry of Culture the "National Culture Industries Demonstration Base," a specially designated
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business
classification which the central government grants to Chinese cultural and media-related enterprises with leading influence in this filed.
Established
in 2007 in Shanghai as the first children's entertainment company in China, we launched our first online product Mole's World in September 2008, which became a leading
popular brand among children and families. With encouraging participation and feedback from users, we successfully launched several online virtual worlds and other entertainment products in the
following years, including our major franchises of Seer, Flower Fairy and Gongfupai. To further strengthen our leading market position, we established our publishing and licensing businesses in 2010,
and expanded into merchandise licensing, film and cartoon animation. As of December 31, 2012, we had launched four films featuring Mole's World and Seer. To further promote our brand we have
produced over 150 episodes of cartoon animation broadcasted over more than 100 TV channels throughout mainland China and Taiwan. In October 2011, we also expanded into mobile
front by releasing the mobile version of Mole's World, which is our first mobile game. Since then, we have released additional mobile games
and applications, and our accumulated mobile downloads on Apple iOS and Android platforms had increased to over 15.4 million as of December 31, 2012.
Our
success is in part due to our efforts to reinforce parental trust by creating a safe and enjoyable entertainment environment with wholesome, age-appropriate content and
standard-setting security safeguards. We believe we were the first children's entertainment company in China to launch a separate online monitoring portal, "Taomee MaMa," which we believe increases
online safety for children through parental engagement.
We
have achieved substantial growth since we launched our first virtual world, Mole's World, in September 2008. Our net revenues grew from US$7.1 million in 2009 to
US$36.0 million in 2010, and amounted to US$45.4 million in 2011 and US$40.2 million in 2012. For 2010, 2011 and 2012, 93.6%, 88.8% and 80.0% of our net revenues, respectively,
were generated primarily from subscription fees that allow users to access premium features and from sales of virtual items, and the remaining 6.4%, 11.2% and 20.0% of our net revenues, respectively,
were generated primarily from royalties, license fees, film box office sharing, and sales of interactive toys from our offline business. Our gross profit grew from US$5.1 million in 2009 to
US$30.1 million in 2010, and amounted to US$37.7 million in 2011 and US$30.2 million in 2012. Our net income grew from US$1.3 million in 2009 to US$21.6 million in
2010, and was US$19.5 million in 2011 and US$8.9 million in 2012.
Our Franchises
We have created and developed branded entertainment franchises, including our major franchises of Mole's World, Seer, Flower Fairy and
Gong Fu Pai. In addition, we have also obtained from Voozclub Co., Ltd., or Voozclub, a character development company incorporated in Korea, the exclusive license to operate the
franchise of Canimals in Mainland China and additional three franchises for our future pipeline. Our brands and franchises have expanded into various online and offline platforms including the virtual
worlds, video streaming site, mobile applications, social networking, and merchandising.
Mole's World
Introduced in September 2008, Mole's World is our first and one of our most popular franchises. This franchise features a
community of cuddly red-nosed moles living in a variety of settings and landscapes, and who collaborate and interact in many social activities that promote wholesome family values,
friendships, and happiness.
We
have launched virtual worlds including Mole's World and Mole Hero based on this franchise, and also introduced mobile games such as Mole Kart and Mole's Baby. We plan to launch other
virtual worlds and mobile games based on this franchise in the future. The Mole's World virtual world has
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received
several awards including the "Best Virtual World" in 2008 from Baidu, China's most popular search engine.
Certain
animated characters of our Mole's World franchise, including Princess Momo, Uncle Bodhi, and Professor Kevin, have become highly popular among children in China. We license these
characters to publishers, makers of consumer products in areas such as clothing, toys and food and beverages. In 2011 and 2012, we further introduced the franchise to television and film. The movie
Mole's World
II
received the "Monkey King Award" for best writing in 2012. During the China Animation Committee's Annual Meeting. Mole's World animation
series was ranked the sixth most beloved domestic cartoon animation in 2012 by the China Animation Association.
Seer
Introduced in September 2009, Seer is one of our most popular franchises. The Seer franchise primarily appeals to boys between
six and 14 with a theme of space exploration and adventure. Virtual worlds and games in the Seer franchise offer a sci-fi adventure experience which fosters children's interest in
science and environmental protection. For example, in the Seer virtual world, users travel through 34 different planets in search for new energy sources and often have to form teams with other
users to defend against attacks launched by space pirates who seek to monopolize energy reserves in outer space.
We
believe the Seer virtual world encourages strong teamwork and high levels of interaction among users. The Seer virtual world integrates mini-challenges that encourage
children to explore, discover and learn about physics, chemistry and mathematics. Our users often interact with classmates, parents and teachers to solve challenges.
In
November 2011, we launched a sequel virtual world Seer II and plan to launch other virtual worlds and mobile games based on this franchise in the future.
Certain
animated characters of our Seer franchise, including Mechanic Xixi, Captain Roger and Elf Rey, have become highly popular among children in China and we license these characters
to publishers, as well as makers of consumer products, such as clothing, toys and food and beverages. In 2011 and 2012, we launched a film and an animated television series based on
this franchise.
The
Seer franchise has received several awards, including being ranked the second most beloved domestic cartoon animation in 2012 by the China Animation Association, the Golden Dragon
Award for "Best Animated Feature Film" in 2011 for the Movie,
Seer: The Search for the Sacred Phoenix
and the "Most Influential Virtual Worlds" from
Baidu in 2010 for the Seer virtual world. The term "Seer" was the top search term on Baidu, during the weekends from January to May 2010.
Flower Fairy
We introduced Flower Fairy, our first franchise appealing to younger girls from ages five to 10, in June 2010. In the Flower
Fairy virtual world, each user chooses from a variety of fairy attributes and flower worlds to create a dream-like fairytale storyline. The user's fairy is in charge of tending her own
garden, cultivating various flowers and plants, and decorating her homes. The storyline promotes artistic expression, happiness, creativity, responsibility and cooperation. Certain animated
characters, including Princess Wisdom and Princess Benevolence, have become highly popular among children in China. We have integrated many of the aforementioned attributes that promote healthy
development of children into the franchise.
Gong Fu Pai
We introduced Gong Fu Pai in September 2010 as our first martial art-themed franchise, and a franchise appealing to
users slightly older than our existing franchises at the time. The Gong Fu Pai
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virtual
world allows users to learn, explore and discover by interacting with other characters. Players select and adopt a character, including Monkey Paipai, Rabbit Yier, Panda Big Bamboo and Dragon
Aotian. By attending a martial arts academy, they learn wholesome values and skills to embark in a
series of fantasy adventures. The Gong Fu Pai franchise currently appeals to boys primarily between the ages eight to 15.
Other Franchises
Canimals
In 2012, we have obtained from Voozclub the exclusive license to operate the franchise of Canimals in Mainland China. Voozclub,
incorporated in Korea, is a character development and animation studio that produces merchandise concepts and style guides, digital applications and animation, and also licenses the content and
characters to global partners. The characters produced by Voozclub differ from our own set of characters, therefore they further help strengthen and diversify our platform franchises. Canimals
includes the alien animal characters of Ato, Nia, Fizzy, Mimi, Uly and Oz, and is a franchise appealing to tweener and teenagers, primarily girls between the ages nine to 12. We have also launched
Canimals mobile applications and animations produced by Voozclub. Furthermore, our licensing relationship with Voozclub provides us with the right to operate additional three franchises developed by
Voozclub for our future pipeline.
Our Business Segments
We provide a diverse portfolio of services and products through two business segments: online business, and offline business.
Online Business
The online business includes developing and operating online virtual worlds, other online entertainment services as well as mobile
applications. Our online business achieved significant scale through the strength of our robust technology platform and targeted distribution network. Our reliable and flexible proprietary technology
platform, coupled with our experienced
research and development team, allows us to quickly expand our user base, enhance the online experience of our users and shorten development cycles. Our platform is supported by a national
distribution network spanning 130,000 retail outlets that are primarily located near schools or other places frequented by target users in over 2,800 towns and cities across China as of
December 31, 2012.
Since our inception in 2007, we have successfully launched over ten virtual worlds featuring our core franchises including Mole's
World, Seer series, Flower Fairy and Gong Fu Pai for children between the age of five and 15. In our virtual worlds, all of which are all accessible through our online community,
www.61.com
, children adopt avatars and participate in interactive games and activities set in fantasy landscape with evolving story lines. We have also licensed several
third-party games hosted on our servers and have links on our website to third-party hosted games. We believe our virtual worlds have a market overseas as well, and we have licensed the content to
partners throughout Asia and Europe. Our current international expansion strategy is to leverage our content and technology platform by establishing brand recognition and an active online community
through virtual worlds, online games, and mobile applications. Depending on geography, market and other factors, we also intend to strengthen our brand presence and monetization of our franchises
overseas through offline channels, including films, live events, and merchandise licensing.
We
believe all our virtual worlds provide a safe and educational entertainment experience for children. We have adopted a number of safety measures to protect our young users and
reassure their
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parents
by providing them with a certain level of family supervision through our uniquely designed monitoring system, Taomee MaMa, for example, is a website dedicated to parents and caregivers to
assist in the finding, reviewing, sharing and monitoring of children's entertainment websites, applications and products targeting the parenting community. See "Online security features."
Our virtual worlds also encourage the development of positive morals and values in children by rewarding acts of diligence, social responsibility and teamwork. From time to time, we design virtual
worlds that focus on fostering children's interest in science and the environment through interactive playing with our NPCs and other users.
The
premium features of our virtual worlds are only available to users who pay for a 30-day subscription. These users enjoy additional capabilities and special privileges,
such as having a higher upper limit for the total number of friends that the users can have and access to
exclusive online parties. For example, in Mole's World, only users who pay for subscription can fly a dragon or host gatherings at their virtual homes.
In
addition to generating revenues through subscriptions, we also have an item-based revenue stream. Our virtual world currency, the Mibi, can purchase coveted items such as
special edition clothing, accessories, and upgrades, which cannot be redeemed by virtual rewards from the in-community experience. For instance, with the Mibi, a user can upgrade his or
her standard virtual home into a two-story home or a castle, and furnish the virtual homes with chandeliers, drum sets, televisions, aquariums and other unique and exclusive items.
To further build our franchises and animated characters, we expanded into mobile platforms and have launched a diversified product and
applications portfolio offering over 20 mobile games and applications.
Since
the release of our first mobile game, Mole's World iOS version in October 2011, we have further expanded our mobile game portfolio to include Mole Kart and Seer.
Our
mobile applications include the mobile version of Taomee MaMa launched in March 2012, over 10 e-books released in 2012 which feature the Mole's World
franchise, and Seer and Mole's World animation application on Apple's iOS platform. Many of these products have been ranked the "most downloaded" applications on several application platforms in
mainland China, Hong Kong and Taiwan.
All
of our mobile games and applications can be downloaded onto iPhones and iPads through Apple's App Store, and some games can also be downloaded onto Android-based mobile devices. Some
games such as Mole's World are free to download and have an in-application purchase system for virtual items, while other games such as Seer charge a fee to download and also have an
in-application purchase system for virtual items. As of December 31, 2012, the number of downloads for the mobile applications operated by the Company has reached approximately
15.4 million on Apple iOS and Android platforms collectively.
We
remain focused on further developing and expanding our mobile game and applications offerings as we see more users interacting with our characters and franchises from
mobile devices.
In January 2012, in cooperation with a number of China's leading online video websites that have obtained the audio/video
program transmission licenses, we launched v.61.com, a website that offers animation series based on our franchises, such as Seer and Mole's World, as well as other content from these websites. By the
end of 2012, we had over 4,200 cartoon animation series available online, including one of the most popular animations in China, Seer, which has exceeded 100 million total
page views.
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In
November 2012, we jointly developed with Turner Broadcasting System Asia Pacific (the parent company of Cartoon Network) ben10.61.com, a dedicated Chinese online zone
for Ben 10 fans featuring videos, online games, wallpaper downloads, e-comics and character profiles.
We plan to release approximately two to three virtual worlds every year, and to increase our product development capabilities into more
interactive online entertainment and games in order to expand our audience and to satisfy our users as they mature and grow older. We also plan to release the Android version of mobile games, and will
develop fully-connected mobile games for both IOS and Android platforms. In our offline business, we will continue to invest in films, animation series, and TV programming including the release of our
third movie based on the Seer franchise in the summer of 2013.
Development of digital entertainment products (including our virtual worlds and
other online services)
We believe that rapid development of high-quality digital entertainment, including virtual worlds, online and mobile
services, and online community products as
well as timely updates are critical to our long term success and to the development of popular entertainment franchises. Today, our product development teams are organized by studio. Each studio
consists of programming, design, and graphic functions, and staffed with writers, virtual world architects, animation and graphical designers, and other creative talents. For example, to create our
virtual worlds, they collaborate to produce virtual communities with thematic fantasy landscapes, iconic and enduring characters, vivid images, child-friendly language and intriguing story lines. As
of December 31, 2012, we had 368 product development personnel and 118 online services personnel. We have in-house capabilities that allow us to develop digital
entertainment products, including virtual worlds, online services, and mobile applications rapidly and in response to constantly changing market demands and trends. Our product development cycle from
initial design concept to commercial launch has decreased to approximately nine months for our most recent virtual worlds.
We
have a systematic and organized development process for creating, developing and operating digital entertainment products. In summary, the process incorporates three stages:
(i) pre-development stage; (ii) development stage; and (iii) operational stage. Our management has also developed similar processes for development of other online
services, and we are actively developing our system for content creation for offline purposes.
-
-
In pre-development stage, our design department takes the lead in selecting and aggregating product
development ideas, often leveraging information gathered about the latest trends in children's entertainment. Our staff of writers contribute to the creative process, and we also encourage all of our
employees to provide creative ideas and concepts for product development. Upon management's approval, detailed proposals are submitted covering all aspects including preliminary story lines,
characters, cost estimates, and target demographics. Next, prototypes and storyboards are developed for submission to management. Each of our virtual worlds are created to cater to district market
segments and to grow our overall user base rather than merely shifting users from one virtual world to another.
-
-
Development stage includes a technical review of the prototypes. A project team is assembled consisting of our programming
staff, design staff and graphics artists. Milestones are formulated, and collaboration begins across the organization integrating the creative talents of our writers, architects, artists and designers
who determine the story and define the product environments. Meanwhile, our program developers develop server-end software and user-end software modules. Management reviews the
prototypes upon completion of each milestone, collecting feedback
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from
our testing department. Throughout the development stage we interact with our users and their parents to obtain feedback.
-
-
For our online virtual worlds, the operational stage entails closed beta testing, open beta testing, commercial launch and
operation. We conduct closed beta testing to remedy any technical issues and address technical problems. Open beta testing is typically a three to nine month process to achieve consistency, stability
and reliability of a virtual world in an open market environment. During commercial launch and operation, we continue to closely review and evaluate our operations, user experience, and user
engagement. Newly developed features and updates are typically released weekly, and are programmed based on information gathered about trends in user tastes and preferences, and evolving
market trends.
Our online technology platform
Leading product development team.
We have a team experienced in developing sophisticated Flash-based or HTML5-based digital
entertainment
including interactive virtual worlds, online products and services, and mobile applications.
Flexible and secure software platform.
Leveraging our programming and operating capabilities in the frontend, we operate our backend
server programs
on the Linux operating system. We utilize open source management tools to monitor and maintain the stable operation of our servers. Our software solution greatly reduces our development and
maintenance cost and at the same time supports our frequent product updates both cost-effectively and securely.
Scalable hardware infrastructure.
Our advanced server technology enables us to support over a million users interacting online
simultaneously. Our
physical servers on the infrastructure network are installed in five independent data centers in Shanghai, Beijing, Tianjin, Foshan and Suzhou. We are able to serve our growing user base through
parallel server expansion. Through advanced platform architecture, we are able to lower our server and bandwidth unit cost.
Anti-malicious software technology.
We have a combination of hardware and software solutions to both prevent malicious software from
attacking our virtual worlds and immediately disable and remove the malicious attack if a security breach occurs.
Advanced data warehouse.
In August 2010, we established a scalable data warehouse to help us measure the popularity of themes,
features and
virtual items. This helps our product development team to develop data analytics tools and to identify user preferences and develop content that enhances user experience and creates better
monetization potential.
We have established a system of stringent protection mechanisms which employ a number of different approaches to improve child safety
and facilitate parental supervision. Our security features include powerful content and language filters, restrictions on advertisements and access time, as well as a separate parental community and
monitoring site, "Taomee MaMa." We believe these measures reinforce parental trust, promote the healthy use of our virtual worlds in moderation at a young age, and protect children from inappropriate
content online.
Recognizing
the importance of protecting children's privacy online, we take extensive measures to safeguard our users' identities. Our weekly newsletters and user notifications remind
users not to share personal information online. We encourage children to use a series of pre-designed phrases to communicate with others within our fantasy world. While we allow online
chatting to foster our user communication, we also have powerful content and language filters to prevent the sharing of telephone numbers or other personal information and screen out language that may
be inappropriate for children.
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Chats
are also monitored by our staff moderators to prevent the use of abusive language and other inappropriate behavior, and we impose bans of varying length on users who are found to have engaged in
inappropriate behavior. We encourage users to report potential offenses to us in an online "neighborhood watch" program.
In
addition, we aim to create a healthy online environment suitable for children playing our self-developed virtual worlds and games. There is daily server downtime between
the hours of 00:00 and 06:00 in Mainland China to encourage children to form healthy Internet usage habits. For every 45 minutes of continued access, children receive a visual reminder
and after two hours of continued access, users will experience a decrease in the rate of virtual reward accumulation. These measures encourage our users to develop moderate and sustainable
usage habits.
We
launched our website for parents and caregivers, "Taomee MaMa," in January 2010, as a monitoring and communications channel for parents and guardians. We put in place a
sophisticated monitoring system, through which email addresses and cell phones registered by parents and guardians are tied to their children's user accounts to closely track children's time spent in
our virtual worlds. Parents can also send inquiries and suggestions to our staff and communicate with other parents on Taomee MaMa's discussion board.
Through
cooperation with the Children and Internet Laboratory at Fudan University's Media Research Center, we developed the first set of guidelines in China for families that want to
understand the influence of Internet use on children. The guidelines address concerns over safety, security and educational value of Internet usage for children in China.
To access our interactive virtual worlds, a user must register an account by setting up a unique account number. Once registered, the
user may access all of the interactive virtual worlds in our online entertainment community with their unique account number. Once the user accesses his or her account, the user may view information
on Mibi account balance, payment history and recharge the Mibi account.
Pricing, payment and distribution
Pricing
We offer the basic functions of our virtual worlds to users for free, and we charge a RMB10 (US$1.6) 30-day subscription
fee per virtual world for accessing premium features in each of our virtual worlds. Premium features significantly enhance user experience by providing users with more in-community credit
and virtual items. Our virtual items include props, clothing, home decor and accessories. We have generally maintained stable pricing for subscriptions to premium features of our virtual world and
in-community items since their launch.
Users conduct all of the transactions on the www.61.com interactive community with our own virtual currency, the Mibi. Users may
recharge their Mibi accounts through prepaid cards or other third-party payment channels.
Users
can purchase our prepaid cards through various distribution channels. Each of our prepaid cards contains a unique access code and password that enables users to recharge their Mibi
account. Our prepaid cards are offered in denominations of RMB10 (US$1.6) and RMB30 (US$4.8), to provide flexibility to users. Our prepaid cards expire two years from the date of issuance. We offer
both physical cards and cards in virtual form which are sold online through a third-party vendor.
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We sell our physical prepaid cards through a network of third-party distributors. We typically collect payment from our distributors
upon delivery of our prepaid cards. We sell the prepaid cards to our distributors at a pre-negotiated discount on the face value of the cards. Our distribution agreements also contain
pre-set sales targets and offer a volume rebate to distributors if they achieve certain pre-set sales targets. The rebate is provided to these distributors in the form of free
prepaid cards. The pre-negotiated discount rate is generally more favorable to wholesale distributors with higher sales volume. Our distribution agreements generally have a term between
half a year and one year, which can be renewed through the agreement of both parties. We require our distributors to distribute prepaid cards in designated geographical areas. We also require that
each distributor work closely with our marketing team and support its activities. As of December 31, 2012, these distributors resell the cards to sub-distributors who, in turn,
distribute the cards to over 130,000 retail outlets, such as newsstands and convenience stores, in over 2,800 towns and cities across China, many of which are strategically located near
schools and other places frequented by target users.
Our
virtual prepaid cards are sold via third-party online distributors and via SMS through telecom operators. We also offer the distributors of our virtual cards a
pre-negotiated discount on the face value of the cards and a volume rebate.
Users
may purchase the Mibi at the www.61.com payment center, where they can directly charge their account. We also accept online payment from a variety of payment channels popular in
China, such as debit cards, Shanda game cards, China Mobile recharge cards and Alipay, among others. We pay a processing fee to banks and other third-party payment channels in connection with
such payments.
Offline Business
Our offline business focuses on merchandise licensing, publishing, as well as the development of media and entertainment products, such
as films, and self-branded TV shows.
Due to the growing popularity of the Taomee brand and our many franchises, in 2009, we began licensing characters and images to third
parties and have achieved significant growth since then. We believe there is significant demand to license our content, but we seek to selectively enter into licensing arrangements in order to ensure
the quality and integrity of our brand and franchises when they are associated with third-party content, products and services. Therefore, we have only licensed our characters and images to companies
which are leaders in their respective sectors, such as traditional print, film, television media, manufacturing and select retailers of consumer merchandise such as toys, apparel, beverages and
electronic devices. While we currently leverage our franchises developed for virtual worlds for our offline franchising, our goal is to develop original content for our offline business as well. Our
coverage in offline business aims not only to diversify our revenues but also to raise our brand profile and extend our corporate reach as a leading children's entertainment and media company
in China.
We
develop and popularize children's books and magazines featuring our franchises and characters in conjunction with third-party publishers. We typically license our franchises to
publishers and earn royalties from these licenses.
We
license our franchises to leading brands in China, such as "P&G" and "ZTE" and other consumer goods makers in categories such as apparel, toys, accessories, stationery, consumer
electronics, and food
and beverages. As of December 31, 2012, we licensed our franchises to companies operating in major consumer product categories including apparel, accessories, toys, stationery, consumer
electronics, food, beverage, books, theme parks, live shows, and carnivals.
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Our
license fees are usually based on a fixed percentage of the wholesale or retail selling price of the products with a guaranteed minimum payment for a given year. Terms of our license
agreements are generally between one to two years.
We have invested in the development of animated film and television content in China due to the growing popularity of our franchise and
characters. Our investments include the development of animation films based on our Mole's World franchise and Seer franchise. In addition, we have set up a dedicated team that focuses on content
development for film, which work with experienced producers of films and televisions series.
We
have co-produced and invested in four featured films, based on our "Mole's World" and "Seer" franchises. Our two animated movies based on our franchises,
Seer: The Search for the Sacred Phoenix
and
Legend of the MolesThe Frozen Horror
, were
released in theaters across China in July and August 2011 respectively, which collectively have been watched by over 2.1 million audiences in mainland China and Taiwan, according to the
public information provided by EntGroup.cn. As a follow up to those successful movies, we launched two sequels nationwide; Seer II and Mole's World II, on June 28, 2012 and July 5, 2012,
respectively. The two new movies have been collectively watched by more than 1.7 million audiences according to the public information provided by EntGroup.cn.
To
further promote our franchise and brand, we have also co-produced and invested in animation series of over 150 episodes combined based on our "Mole's World" and
"Seer" franchises, which have been broadcasted on over 100 channels including China Central Television, major satellite channels, China's leading cartoon networks and our website v.61.com.
On
February 1, 2013, we launched a new self-branded children's television show called
Taomee Dream School
on major
cartoon channels and TV stations across China. The television show,
which also can be seen at
http://dream.61.com/
, serves as the designated television platform for premiering our original animation content.
We also procure and sell interactive toys featuring our franchise. In the second quarter of 2012, we established Guangdong Taomee
Animation Technology Co., Ltd. or Guangdong Taomee, a company incorporated in Guangzhou, Guangdong, China which primarily focuses on the design and distribution of toys, trading cards as
well as other products based on our franchises. Our products also offer unique promotional and interactive features that allow our customers to explore our online platform. As we continue to gain
experience in our offline business, we are always seeking new offline business and marketing opportunities to expand our portfolio and to attract users to our online community.
As our franchises are our valuable assets, we focus on the protection of these franchises through careful selection of leading and
reputable merchandising partners and other licensees, and through enforcing the implementation, primarily through contract terms and through our course of dealings and active monitoring mechanisms, of
procedures on the branding of our franchise assets. These include stringent production quality measures, standards on the portrayal or presentation of our franchises in different media formats and in
merchandises, and strict pre-approval processes. For films and television productions, we control the development of each story line, including the shooting scripts; for books, we have
approval rights on the plot lines and character presentations; for merchandise, our approval is often required during the development of prototypes and packaging and, under most circumstances, we also
have the right to conduct onsite inspections and to request modifications of displays.
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Leveraging
the extensive user base of our online entertainment community, we also employ in-community market surveys to analyze user demand and preferences before licensing
our franchises for specific commercial productions of our licensed franchises, which we believe improves the success of the products that bear our franchise assets.
Seasonality
Our quarterly results of operations may be affected by seasonal trends caused by user behavior and demand for our online and offline
offerings. We expect our net revenues from online business to be higher during winter and summer vacations when there are more active users and children have more online playtime during these
non-school days, which usually falls in the first and third quarters of each calendar year. For instance, there are more non-school days in the first quarter and third quarter
of 2012. Decreases in our net revenues from online business, if any, as a result of seasonality may be most visible from the third quarter to the fourth quarter of each year, as the fourth quarter has
less than half of the non-school days compared to the third quarter, and from the first quarter to the second quarter as well, not only because the decrease in non-school days
in the second quarter as compared to the first quarter, but also because children are generally given extra pocket money during Chinese New Year in the first quarter of each year. These
seasonality trends generally manifest themselves more clearly with respect to more mature virtual worlds and less clearly during periods of high growth that accompany the introductory stages of a
highly popular virtual world. For example, as a result of the seasonality effect discussed above, our revenues from online business was higher in the first quarter of 2012 as compared to the second
quarter of 2012 and we expect a similar decrease in revenue from online business in the second quarter of 2013 as compared to the first quarter of 2013.
Seasonality
of our offline business is affected by the different consumption patterns influencing different media formats or product categories for our licensed franchises and the mix of
media formats and product categories. For instance, sales of certain toys and stationery sold near primary schools may decrease during winter and summer vacations, while sales of clothing may increase
during such periods.
Competition
As a leading children's entertainment and media company, we face competition from both online and offline players who seek to develop
brands and franchises through the licensing or creation of content for children. Currently, our offline competitors are primarily companies that produce, license, or distribute entertainment content
and merchandise to similar target groups in China. Meanwhile, the children's online entertainment industry in China is characterized by relatively low capital requirements and barriers to entry. There
are a number of existing competitors in the children's online entertainment industry and we expect more entrants to offer a range of virtual worlds and digital contents targeting children in China in
a relatively short period of time. We believe our principal competitor in online children's entertainment in China is Tencent Holdings Limited, or Tencent, the developer of Roco Kingdom. Our other
competitors include BaitianInfo Co., Ltd., the developer of Aobi Island. Potential competitors also include major Internet portal operators, other domestic and foreign virtual world
developers and operators, media companies focused on children's entertainment and alliances between our existing and new competitors. We also face competition on the mobile front with respect to
mobile applications, as there is an increasing number of Internet
companies in China tapping into the mobile market with applications and services targeting children. Some of our competitors, especially major foreign and China-based publicly listed media and virtual
world operators, have significantly greater financial and marketing resources and name recognition than we have. Our competitors may adopt loss-leading pricing or other tactics or business
models to attract our users. See "Item 3. Key InformationD. Risk FactorsRisks Related to Our BusinessWe may not be able to maintain our revenues and
profitability as we operate in a competitive industry and compete against many companies."
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We
believe we compete primarily on the basis of our innovative culture and proven content development capabilities, our understanding of children and the industry, our brand recognition,
our advanced technology platform and our strong commitment to online safety.
Customer Services
As of December 31, 2012, our dedicated customer service team had 77 employees, mostly serving our online users. From our
inception, we have focused on catering to the needs of children and their parents and this focus is reflected in all major aspects of our service.
All
members of our customer service team receive training on how to communicate with children and their parents. Our call center functions as an extension to users' online experience.
For instance, unlike most call centers where customer support is identified by a numeric ID, each member of our customer service team is assigned a unique nickname. Users can reach our customer
service by telephone, email or our online bulletin board. Periodic reports based on these feedbacks are provided to our management and operational team. We frequently hold "Taomee Superdays" when we
invite children and parents to visit our office and meet our creative team.
Marketing and Promotion
We believe user referral is a significant and effective medium for promoting our franchises among children as they share their
experiences with friends and schoolmates.
We
also leverage the large user base of our online community to engage in effective and targeted cross-selling of our online and offline products and services. We publicize the launch of
new franchises through promotion campaigns in our existing virtual worlds, online services and mobile applications. We also embed promotional messages in our digital products for certain licensed
products sold offline. We believe such cross-selling through our online community is one of the most effective means for promoting online and offline services to our users. We also place
advertisements on search engines and popular casual game portals in China to reach new users. Our distributors, who cover over 130,000 retail outlets in over 2,800 towns and cities as of
December 31, 2012, are obligated to promote our prepaid cards according to the terms of our distribution agreements with them.
We
believe the films and television series based on our franchises, such as the films and television series based on Mole's World and Seer that premiered in 2011 and 2012, are an
important part our effort to build brand awareness and promote our franchises to a broader audience within a short time. We have co-produced and invested in over 150 episodes of
animation series and four feature films, based on our "Mole's World" and "Seer" franchises. Our animated television series have been broadcasted on over 100 channels including China Central
Television, major satellite channels, and China's leading cartoon networks. Two animated movies based on our franchises,
Seer: The Search for the Sacred
Phoenix
and
Legend of the MolesThe Frozen Horror
, were released in theaters across China in July and
August 2011 respectively, which collectively have been watched by over 2.1 million audiences in mainland China and Taiwan, according to the public information provided by EntGroup.cn. As
a follow up to those successful movies, we launched two sequels nationwide; Seer II and Mole's World II, on June 28, 2012 and July 5, 2012, respectively. The two new movies have been
collectively watched by more than 1.7 million audiences according to the public information provided by EntGroup.cn.
For
a number of our licensed products, such as trading cards and books, we bundle the products with labels and promotion materials containing redemption codes for virtual items to
promote cross-selling of our online and our licensees' products.
We
also attend animation and toy exhibitions and expos, such as the Chinajoy Digital Entertainment Expo and Conference that usually attract a large number of children and their parents
to reach more potential users.
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Intellectual Property
We regard our copyrights, trademarks, trade secrets and similar intellectual property as critical to our success, and rely on trademark
and copyright law, trade secret protection and confidentiality and/or license agreements with our employees, suppliers and others to protect our proprietary rights. All of our research and development
personnel have entered into confidentiality and proprietary information agreements or contract clauses with us. These agreements address intellectual property protection issues and require our
employees to assign to us all of the inventions, designs, and technologies they develop during their employment with us.
As
of December 31, 2012, we received approval for 211 and seven trademark registrations in China and Taiwan respectively and are in the process of applying for registration of
187 trademarks in China. In addition, we have obtained 48 copyright registrations for software we developed, two of which were jointly developed and owned by us and other parties
unrelated to us, three copyright registrations for Mole's World and Seer animation series and 356 copyright registrations for artworks which were produced by our employees and owned by us. We
also registered 30 domain names, including www.61.com, our primary operation website, and www.taomee.com, our corporate information website.
Under
the contractual arrangements we enter into with producers of film and television series, we either wholly own or jointly own the intellectual property rights for newly created
characters in the television series and films we help develop.
While
we actively take steps to protect our proprietary rights, such steps may not be adequate to prevent the infringement or misappropriation of our intellectual property. This is
particularly the case in China where the laws may not protect our proprietary rights as fully as in the United States. Infringement or misappropriation of our intellectual property could
materially harm our business.
Employees
We had 70, 233, 484, 575 and 640 employees as of December 31, 2008, 2009, 2010, 2011 and 2012, respectively. The
following table sets forth the number of our employees categorized by areas of operations as of December 31, 2012:
|
|
|
|
|
|
|
|
Function
|
|
Number of
Employees
|
|
Percentage of
total
|
|
Online operations
|
|
|
118
|
|
|
18.4
|
%
|
Offline operations
|
|
|
35
|
|
|
5.5
|
%
|
Product development
|
|
|
368
|
|
|
57.5
|
%
|
Sales and marketing
|
|
|
54
|
|
|
8.4
|
%
|
General and administrative
|
|
|
65
|
|
|
10.2
|
%
|
|
|
|
|
|
|
Total
|
|
|
640
|
|
|
100.0
|
%
|
|
|
|
|
|
|
Our
success depends on our ability to attract, retain and motivate qualified personnel. We believe we offer our employees competitive compensation packages, and we have generally been
able to attract and retain qualified personnel and maintain a stable core management team. For a description of the
employment agreement we signed with some members of our senior management, see "Item. 6. Directors, Senior Management and EmployeesC. Board PracticesEmployment Agreements."
Substantially
all of our employees are based in the PRC. In accordance with PRC laws, we participate in employee benefit plans organized by municipal and provincial governments,
including pension, work-related injury benefits, maternity insurance, medical insurance, unemployment benefit and housing fund plans. We are required under PRC laws to make contributions
to the employee benefit plans at specified percentages of the salaries, bonuses and certain allowances of our employees, up to a maximum amount specified by the local government. A labor union of our
employees was established to represent employees with respect to labor disputes and other employee matters. We
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believe
that we maintain a good working relationship with our employees and we have not experienced any significant labor disputes or disputes with the labor department of the PRC government since
our inception.
Facilities
We are headquartered in Shanghai and have leased an aggregate of approximately 8,890 square meters of offices in Shanghai from
independent third parties and do not own any real property.
We
believe that our leased facilities are adequate to meet our needs for the foreseeable future, and that we will be able to obtain adequate facilities, principally through leasing of
additional properties, to accommodate our future expansions.
Insurance
We do not maintain any property insurance other than insurance for our vehicles. Consistent with customary industry practice in China,
we do not maintain business interruption insurance or key employee insurance for our executive officers. Uninsured damage to any of our equipment or buildings or a significant product liability claim
could have a material adverse effect on our results of operations. See "Item 3. Key InformationD. Risk FactorsRisks Related to Our BusinessWe have a
limited insurance coverage which could expose us to significant costs and business disruption."
Legal and Administrative Proceedings
We are currently not a party to, and we are not aware of any threat of, any legal, arbitral or administrative proceedings, which, in
the opinion of our management, is likely to have a material and adverse effect on our business, financial condition or results of operations. We may from time to time become a party to various legal,
arbitral or administrative proceedings arising in the ordinary course of our business.
Regulations Related to Our Business
Our online and offline business are subject to various PRC laws and regulations relating to the telecommunications, Internet
information services, information security and censorship, online games and media industries, and are regulated by various PRC government authorities,
including:
-
-
the Ministry of Industry and Information Technology, or MIIT (formerly the Ministry of Information Industry,
or MII);
-
-
the Ministry of Culture, or MOC;
-
-
the General Administration of Press and Publication, or GAPP;
-
-
the State Administration of Radio Film and Television, or the SARFT;
-
-
the Ministry of Public Security, or MPS;
-
-
the People's Bank of China, or PBOC;
-
-
the Ministry of Commerce, or MOFCOM;
-
-
the State Administration of Industry and Commerce, or SAIC;
-
-
the State Administration of Foreign Exchange, or SAFE; and
-
-
the National Copyright Administration, or NCAC.
According
to the
Proposal on the Institutional Reform and Functional Transformation of the State Council
promulgated by the State Council
on March 10, 2013, among the other things, GAPP and SARFT are integrated to form the State General Administration for Press, Publication, Radio, Film and Television. The foregoing proposal was
approved by the National People's Congress according to
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the
Decision of the First Session of the 12
th
National People's Congress on the Proposal on the Institutional Reform and Functional Transformation of the
State Council
promulgated by the National People's Congress on March 14, 2013.
New
laws and regulations may be adopted from time to time to address new and developing issues in the Internet information service and other industries, and such laws and regulations may
require licenses and permits in addition to those we currently have. As a result, uncertainties may exist with respect to the interpretation and implementation of current and any future PRC laws and
regulations applicable to our business.
Restrictions on Foreign Ownership of Telecommunications services
Among all of the applicable laws and regulations, the
Telecommunications Regulations of the
PRC
, or the Telecom Regulations, implemented on September 25, 2000, are the primary regulations governing our online business activities. The Telecom Regulations set
forth extensive guidelines on various aspects of telecommunications operations in China and draw a distinction between "basic telecommunications services" and "value-added telecommunications
services." The
Catalog of Telecommunications Business
, which was amended on February 21, 2003 and became effective on April 1, 2003, and
issued as an attachment to the Telecom Regulations, provides that Internet information services are value-added telecommunications services. Under the Telecom Regulations, a telecommunication business
operator in China must obtain an operating license from MII or its provincial-level counterparts.
According
to the
Administrative Regulations on Foreign-Invested Telecommunications Enterprises
issued by the PRC State Council on
December 11, 2001 and amended on September 10, 2008, foreign-invested value-added telecommunications enterprises must be in the form of a Sino-foreign equity joint venture.
The regulations restrict the ultimate capital contribution percentage held by foreign investor(s) in a foreign-invested value-added telecommunication enterprise to 50% or less. In July 2006,
the MII issued the
Circular of the Ministry of Information Industry on
Strengthening
the Administration of Foreign Investment in
Value-added Telecommunication Business
, according to which, a foreign investor in the telecommunication service industry of China must establish a foreign invested enterprise
and apply for a telecommunication businesses operation license. On March 1, 2009, the MIIT promulgated the
Administrative Measures for Telecommunications Business
Operating License
, or the Telecom License Measures, effective from April 10, 2009, which set forth the types of licenses required to provide telecommunication services
in China and the procedures and requirements for obtaining such licenses. The licenses for foreign invested telecommunications business operators must be sought from the MIIT.
In
order to comply with foreign ownership restrictions, we conduct our operations in China primarily through Shanghai Taomee via a series of contractual arrangements that were entered
into with it and its shareholders. We exercise effective control through these arrangements and receive economic benefits generated from them. See "Item 4. Information on the
CompanyC. Organizational Structure."
Internet information services
The Internet information services are regulated by the
Administrative Measures on Internet Information
Services
, or the ICP Measures, issued on September 25, 2000 by the State Council. The ICP Measures define "Internet information services" as services that provide
information to online users through the Internet. Internet information services are divided into commercial services and non-commercial services. According to the ICP Measures, the
Internet information commercial service providers are required to obtain an operating license, or an ICP license, from the MIIT or the relevant provincial counterparts while the Internet information
non-commercial service providers are required to undertake the filing procedures with the MIIT or the relevant provincial counterparts. We obtained the ICP license from the Shanghai branch
of the MIIT in 2009.
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The
PRC government has promulgated measures relating to Internet information service specifically prohibiting Internet activities that result in the publication of any content which is
found to, among other things, propagate obscenity, gambling or violence, instigate crimes, undermine public morality or the cultural traditions of the PRC, or compromise state security or secrets.
When an Internet information service provider finds that information falling within the above scope is transmitted on its website, it must terminate the transmission of such information or delete such
information immediately, maintain records and report to relevant authorities. If an ICP license holder violates these measures, the PRC government may revoke its ICP license and shut down
its websites.
Internet publication and culture activities
GAPP and the MII jointly promulgated the
Tentative Measures for Internet Publication
Administration
, or Internet Publication Measures, on June 27, 2002, which took effect on August 1, 2002 and imposed a license requirement for any company that
intends to engage in Internet publishing, defined as any act by an Internet information service provider to select, edit and process content or programs and to make such content or programs publicly
available on the Internet. Since the provision of online games is deemed an Internet publication activity, an online game operator must obtain an Internet publishing license in order to directly offer
its online games to the public in the PRC. We have been approved by the MIIT to conduct Internet publication activities.
We
obtained the Internet publishing license from GAPP in December 2010. Prior to obtaining an Internet publishing license from GAPP, we worked with third party publishers to
publish Mole's World, Seer, Flower Fairy, Magic Haqi and Gong Fu Pai. If this practice is later challenged by the GAPP, we may be subject to various penalties. See "Item 3. Key
InformationD. Risk FactorsRisks Related to Doing Business in ChinaThe laws and regulations governing virtual worlds and online games in China are developing and
are subject to future changes. If we or the third-party publishers we work with fail to obtain or maintain all applicable permits and approvals, our business and operations would be materially and
adversely affected." In the future, after we receive an Internet publishing license from GAPP, we would be able to apply for GAPP pre-approval for our virtual worlds. For more information
on the pre-approval by the GAPP, see "Online games administration measures."
On
May 10, 2003, the MOC promulgated the
Provisional Regulations for the Administration of Internet Culture
, or the Internet
Culture Measures, which were revised in July 2004 and February 2011 respectively. The Internet Culture Measures apply to entities engaging in the provision of "Internet culture products"
and the relevant services. The term "Internet culture products" refers to the culture products produced and disseminated via the Internet, further divided into two categories, (1) culture
products specifically produced for Internet, such as online audio-video entertainment, online games, online plays, online performance, online works of art and online cartoons, and so forth;
(2) culture products such as audio-video entertainment, games, plays, performance, works of art and cartoons, and so forth, reproduced onto Internet by technical measures. According to the
Internet Culture Measures, commercial entities are required to apply for, in addition to the ICP license, an Internet culture operation license from the MOC, if they engage in any of the following
types of activities: the production, duplication, importation, distribution or broadcasting of Internet culture products; the dissemination of Internet culture product on the Internet or transmission
thereof to computers, fixed-line or mobile phones, radios, television sets or gaming consoles for the purpose of browsing, reading, using or downloading such products; or the exhibition or
holding of contests related to Internet culture products. We obtained the ICP license and Internet culture operation license in 2009.
Online games administration measures
The Provisional
Administration Measures of Online Games
, or the Online Games
Administration Measures, were promulgated by the Ministry of Culture on June 3, 2010 and became effective as of August 1, 2010. The Online Games Administration Measures govern the
activities in respect of online
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game
development and operations, issuance of virtual currency, and provision of virtual currency exchange service. In addition, it provides that the MOC will be responsible for the censorship of
imported online games and record-filing of domestic online games. Record-filing procedures for domestic online games, which include the virtual worlds we develop, will be carried out with the MOC
within 30 days from the date such online games begin to be operated online, and in the case of material change, within 30 days from the date when the relevant alteration
takes effect.
All
operators of online games, issuers of virtual currencies, and virtual currency exchange service providers (collectively, "Online Game Business Operators") are required to obtain the
abovementioned Internet culture operation license. An online cultural operating permit is valid for three years, and an application of renewal should be filed 30 days before the permit expires
in order to renew the permit. As to Online Game Business Operators, they must (1) request a valid identity certificate of game users for real name registration, and save their information;
(2) make the information public 60 days ahead when they terminate online games or transfer the franchising to operate online games, and return the unused virtual currencies and the
currently effective game services to the users by legal money or other means accepted by users; and they must not: (1) set compulsory battles between users without their consents in games;
(2) promote and propagandize games with any aforementioned prohibited content; and (3) induce game users to devote legal money or virtual currencies in exchange for game products and
services, by any incidental means such as random draw. It is also provided that the state culture activity administration will be responsible to promulgate the requisite terms of a standard online
game service agreement, which must be incorporated in the services agreement of each online game operator. The game operators' services agreement cannot contravene these requisite terms.
On
July 11, 2008, the General Office of the State Council issued the
Regulation on Main Functions, Internal Organization and Staffing of the PRC General
Administration of Press and Publication
, or the Regulation on Three Provisions. On September 7, 2009, the Central Organization Establishment Commission issued the
corresponding interpretation, or the Interpretation on Three Provisions, collectively as the Regulation on Three Provisions and Interpretation thereof. The Regulation on Three Provisions and
Interpretation thereof authorized the MOC with overall jurisdiction to regulate the online gaming industry, while granting GAPP the authority to grant approvals for the Internet publication of online
games, by expressly stating that (1) administration over online games (other than
pre-examination and approval before Internet publication of online games) is granted to the MOC; (2) subject to MOC's overall administration, GAPP is responsible for the
pre-examination and approval for Internet publication of online games; and (3) once games are launched online, the online games will be only administrated and regulated by MOC. As
of the date hereof, We have obtained 12 approvals from the GAPP in total, covering the Internet publications of all the virtual worlds which are developed by us and have been commercially
launched, including the above-mentioned five franchises of Mole's World, Seer, Magic Haqi, Flower Fairy and Gong Fu Pai. We used to work with third party publishers for the publication of such
franchises prior to our obtaining of the Internet publishing license.
On
September 28, 2009, the GAPP together with several other governmental authorities jointly published the
Notice Regarding the Consistent Implementation
of the "Regulation on Three Provisions" of the State Council and the Relevant Interpretations of the State Commission Office for Public Sector Reform and the Further Strengthening of the
Administration of Pre-examination and Approval of Online Games and the Examination and Approval of Imported Online Games
, or the GAPP Notice. The GAPP Notice is
issued for the purpose of consistent implementation of the Regulation on Three Provisions and Interpretation thereof. However, Article IV of the GAPP Notice prohibits foreign investors from
controlling or participating in online game operating businesses directly or indirectly via wholly owned, equity joint venture or cooperative joint venture investments in China, or via contractual or
technical support arrangements, or the Contractual Arrangements. As to the implementation of Article IV of the GAPP Notice, please see "Item 3. Key InformationD. Risk
FactorsRisks Related to Our Corporate StructureIf the PRC government determines that our ownership structure does not comply with the
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restrictions
contained in the GAPP Notice, we could be subject to severe penalties" and "Item 3. Key InformationD. Risk FactorsRisks Related to Doing Business in
ChinaThe laws and regulations governing virtual worlds and online games in China are developing and are subject to future changes. If we, as the developer of our mobile games, are
required to obtain applicable permits and licenses, or if we are required to obtain approval for the release of our e-books on mobile platforms, it may materially and adversely affect our
business results and future growth."
Virtual currency
We issue virtual currency to our users, in the form of a prepaid charge card and prepaid points that function as virtual exchange
instruments, in exchange for services in our virtual worlds. On February 15, 2007, the MOC, the SAIC and other relevant governmental authorities jointly issued the
Circular on Further Strengthening the Administration of
Internet Cafes and Online
Games
, or the Internet Cafes Circular. Under the Internet Cafes Circular, the SAIC is directed to strengthen the administration of virtual currency in online games to avoid any
adverse impact on the PRC economy and financial system. The Internet Cafes Circular provides that, (i) the total amount of virtual currency issued by online game operators and the amount
purchased by individual game players should be strictly limited; (ii) a strict and clear division between virtual transactions and real transactions carried out by way of electronic commerce
must be observed, in that virtual currency should only be used for purchasing virtual items and services within the online games and not for purchasing tangible or physical products; (iii) in
case the virtual currency is redeemed, the value of the payment cannot be more than the original purchase price; and (iv) the resale for a profit (i.e., scalping) of virtual currency is
prohibited. Such prohibition provided by the Internet Cafes Circular in 2007 is for the purpose of preventing an adverse impact on financial stability caused by the issuance of virtual currency.
On
June 4, 2009, the MOC and the Ministry of Commerce jointly issued the
Notice on Strengthening the Administration of Virtual Currency in Online
Games
, or the Virtual Currency Notice, which is designed to standardize the issuance and exchange service of virtual currency, or VCOG, in online games through establishing a
market access threshold for the issuance and exchange of virtual currency in online games, as well as to strengthen the management of the relevant qualifications for market players. The Virtual
Currency Notice requires that enterprises issuing virtual currency or providing virtual currency exchange services must meet the relevant requirements for setting up a commercial Internet culture
enterprise and must apply for an Internet culture operation license from the MOC.
The
Virtual Currency Notice further requires VCOG exchange service enterprises to (i) require a VCOG seller to register in its real name and be associated with a domestic bank
account registered with the same registration information, and retain all transaction and accounting records for no less than 180 days; (ii) develop recovery systems and technologies to
detect illegal VCOG transactions and examine the exchange information it receives to prevent illegal transactions; (iii) promptly delete the improper transaction information and stop providing
service once the VCOG exchange service enterprise is aware of or has confirmed after receiving notice that the VCOG was illegally obtained; and (iv) not provide service to underage game
players. We do not believe our business involves VCOG exchange services, which is the provision of a marketplace or platform to exchange VCOG among users.
Pursuant
to the Online Games Administration Measures, game operators who issue virtual currencies are required to ensure: (1) the virtual currencies can only be exchanged for the
online game services and products provided by themselves, but not for the purchase of services and products that are provided by other game operators; (2) the prepaid money of users for
purchase of virtual currencies shall not be misappropriated; (3) the game operators will keep purchase records of users for at least 180 days since the last time they receive services;
(4) the game operators will file the category, price, amount, and so forth, with the provincial culture administration which they register with.
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Information security and censorship
Internet content in China is also regulated and restricted from a state security standpoint. The Standing Committee of National
People's Congress enacted a decision on December 28, 2000 that makes it unlawful to: (i) gain improper entry into a computer or system of strategic importance; (ii) disseminate
politically disruptive information; (iii) leak state secrets; (iv) falsify or disseminate false commercial information that influences trading of stock exchange or future exchanges or
disrupts financial orders; or (v) infringe intellectual property rights. The MPS has promulgated measures that prohibit the use of the Internet in ways which, among other things, result in a
release of State secrets or a distribution of socially destabilizing content. The MPS has supervision and inspection rights in this regard, and we may be subject to the jurisdiction of the local
security bureaus. If an ICP operator violates these measures, the PRC government may revoke its ICP license and shut down its websites.
On
May 14, 2004, the MOC issued the
Notice Regarding the Strengthening of Network Game Censorship
. This notice mandates that all
imported and domestic online games are required to be filed with the MOC. We have made such filings for all of our existing virtual worlds. The filings of Mole's World, Seer and Flower Fairy have been
completed, and the filings of other virtual worlds are being reviewed as of the date of this annual report.
On
July 12, 2005, the MOC and the MII promulgated the
Opinions on the Development and Administration of Online Game
reflecting the
PRC government's intent to foster and control the development of the online game industry in China. In addition, the MOC will censor online games that threaten state security, disturb the social
order, or contain obscenity or violence.
Privacy Protection
PRC law does not prohibit Internet content providers from collecting and analyzing personal information for their own use. We require
our users to accept a user agreement whereby they agree to provide certain personal information to us. PRC law prohibits Internet content providers from disclosing to any third parties any information
transmitted by users through their networks unless otherwise permitted by law. If an Internet content provider violates these regulations, the MIIT or its local bureaus may impose penalties and the
Internet content provider may be liable for damages caused to its users.
Addiction prevention and identity verification system
In April 2007, GAPP and several other governmental authorities issued a circular requiring the implementation of an addiction
prevention and the identity verification system by all PRC online game operators, in an effort to curb addictive online game play behaviors in minors under 18. Game operators are required to reduce
in-game gains or benefits after three hours of continuous play and eliminate in-game gains or benefits after five or more hours of continuous play.
To
identify whether a game player is a minor and thus subject to the addiction prevention system, an identity verification system is also adopted, which requires online game players to
register their real identity information before they play online games and requires us to submit the identity information of game players to the public security authority for verification. We have
implemented addiction prevention programs for all of our virtual worlds and have established the identity verification system in all of our virtual worlds as one of the ways for registration. Please
see "Item 3. Key InformationRisk FactorsRisks Related to Doing Business in ChinaUncertainties in PRC government policies and regulations regarding virtual
worlds and online games and children's Internet use in China may adversely affect our business."
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Internet infringement
The
Tort Law of the PRC
, which was promulgated by the Standing Committee of National
People's Congress on December 26, 2009, became effective on July 1, 2010. According to the Tort Law, an Internet user or an Internet service provider who infringes upon the civil rights
or interests of others through the use of the Internet will assume tort liability. Where an Internet user infringes upon the civil rights or interests of another through the use of the Internet, the
infringee will be entitled to notify and request the Internet service provider whose Internet services are facilitating the infringement to take necessary measures including the deletion, blocking or
disconnection of an Internet link. If, after being notified, the Internet service provider fails to take necessary measures in a timely manner to end the infringement, it will be jointly and severally
liable for any additional harm caused by its failure to act. Under the Tort Law, civil rights and interests will include the personal rights and rights of property, such as the right to life, right to
health, right to name, right to reputation, right to honor, right of portraiture, right of privacy, right of marital autonomy, right of guardianship, right to ownership, right to usufruct, right to
security interests,
copyright, patent right, exclusive right to use trademarks, right to discovery, right to equity interests and right of heritage.
Regulations on Television and Film Industry
We have expanded into film and television production through the co-production of, or investments in, two animation series
and two feature films, based on our "Mole's World" and "Seer" franchises. On July 19, 2004, SARFT promulgated the
Administration Rules on the Production and Operation of
Broadcasting Television Programs
, pursuant to which an entity that plans to produce and operate television and broadcast programs in China is required to obtain the License for
Producing and Operating Television and Broadcast Programs. On July 11, 2006, SARFT issued
Provisional Regulations on Filing and Publicity of Domestic Television
Animations
, stipulating that registrations for domestic television animations must be filed with, and be publicly displayed by SARFT prior to their production. On
February 14, 2008, SARFT promulgated the
Notice of the State Administration of Radio, Film and Television on Strengthening the Administration of the Broadcasting of
Domestic Animation Series
and later on May 14, 2010, SARFT further promulgated
Regulations on Content of Television
Series
, pursuant to which for each domestic television animation completed, the animation production entity is required to obtain the Domestic Animation Publication License
prior to the broadcast of such domestic television animation to the public. On December 25, 2001, the State Council promulgated
Regulations on the Administration of
Movies
, according to which, an entity other than film production entities that intends to independently engage in movie production shall report to SARFT for approval and obtain
an One-Time Film Production License for each single film to be produced from SARFT. We cooperate with third parties with the requisite qualifications and licenses in the production and
distribution of the animation series and film based on our Mole's World franchise and the film based on our Seer franchise. Shanghai Taomee Animation Co., Ltd. has obtained
(i) the license for the production and broadcasting of radio and television program, and the license for the broadcasting of Seer I, Seer II and Mole's World III animation series, and
(ii) one-time film production license for the third film based on our Seer franchise.
Policies to Foster Growth of Domestic Animation Industry
Since 2004, several circulars have been issued to encourage the development of the still nascent animation industry in China. On
April 20, 2004, SARFT promulgated
Several Opinions on Developing Domestic Animation and Film Industry
, which restricts foreign animation content
by putting a time limit on total hours allowed to be broadcast in television stations in China. SARFT issued the
Circular on Further Regulating the Broadcasting of
Animations
in 2006, and the
Circular on Strengthening the Regulation on the Broadcasting of Animations
in 2008, effectively
prohibiting the broadcasting of foreign animation content by nationwide television stations from 17:00 to 21:00 every day. In 2006 and 2008, circulars were issued by various governmental
departments including the Ministry of Finance and MOC,
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supporting
domestic animation industry and promoting the animation production industrial chain. Furthermore, on July 17, 2009, the Ministry of Finance and State Administration of Taxation
jointly promulgated the
Circular on Tax Policy to Support Animation Industry
, which provides domestic animation producers a series of preferential tax
treatment with regard to their self-developed products.
Regulation on Broadcasting Audio/Video Programs through the Internet
On July 6, 2004, the SARFT promulgated the Rules for the Administration of Broadcasting of Audio/Video Programs through the
Internet and Other Information Networks, or the Audio/Video Broadcasting Rules. The Audio/Video Broadcasting Rules apply to the opening, broadcasting, integration, transmission or download of
audio/video programs via the Internet and other information networks. Anyone who wishes to engage in Internet broadcasting activities must first obtain an audio/video program transmission license,
with a term of two years, issued by the SARFT and operate pursuant to the scope as provided in such license. Foreign-invested enterprises are not allowed to engage in the above business.
On
December 20, 2007, the SARFT and the MIIT jointly issued the Rules for the Administration of Internet Audio and Video Program Services, commonly known as Document 56, which
came into effect as of January 31, 2008. Document 56 reiterates the requirement set forth in the Audio/Video Broadcasting Rules that online audio/video service provider must obtain a
license from the SARFT. Furthermore, Document 56 requires all online audio/video service providers to be either wholly state-owned or state-controlled. According to relevant official answers to
press questions published on the SARFT's website dated February 3, 2008, officials from the SARFT and the MIIT clarified that online audio/video service providers that already had been
operating lawfully prior to the issuance of Document 56 may re-register and continue to operate without becoming state-owned or controlled, provided that such providers have not
engaged in any unlawful activities. This exemption will not be granted to online audio/video service providers established after Document 56 was issued.
In
January 2012, in cooperation with a number of China's leading online video websites which have obtained the audio/video program transmission licenses, we launched v.61.com, a
website that offers animation series based on our franchises, such as Seer and Mole's World, as well as other content from these websites. If the governmental authorities determine that our online
website falls within Document 56, we may not be able to obtain the audio/video program transmission license, and we may become subject to significant penalties, fines, legal sanctions or an order to
suspend our online website.
In
November 2012, we jointly developed with Turner Broadcasting System Asia Pacific (the parent company of Cartoon Network) ben10.61.com, a dedicated Chinese online zone
for Ben 10 fans featuring videos, online games, wallpaper downloads, e-comics and character profiles.
Regulations on E-Books
On October 9, 2010, GAPP have promulgated
The Opinions of GAPP on the Development of E-Books
Industry
, which came into effect on the same day, according to which enterprises engaging in e-book industries are subject to approvals and administration from
relevant governmental authorities. In addition, enterprises engaging in the creation, editing and publication of e-books or in the operation of platform where the e-book
resources are delivered to users are deemed as e-book publisher and are subject to approvals for the publication of e-books. We have released over ten e-books in
the middle of 2012 which featured the Mole's World franchise, and Seer animation application on Apple's iOS platform. Since there is no official or public interpretation on the definition of
e-book publication, we are not sure whether our release of e-books on mobile platforms will be deemed as publication and therefore be subject to the approval of GAPP.
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Regulations Related to Intellectual Property Rights
The State Council and the NCAC have promulgated various rules and regulations relating to the protection of software in China. Under
these rules and regulations, software owners, licensees and transferees may register their rights in software with the NCAC or its local branches and obtain software copyright registration
certificates. Although such registration is not mandatory under PRC law, software owners, licensees and transferees are encouraged to go through the registration process to enjoy better protections of
registered software rights.
On
March 5, 2009, the MIIT promulgated the
Administrative Measures on Software Product
s, or the Software Measures, which replaced
the original
Administrative Measures on Software Measures
promulgated by MII in October 2000, to regulate software products and promote the
development of the software industry in China. Pursuant to the Software Measures, software products which are
developed in China and registered with the local provincial government authorities in charge of the information industry and filed with MIIT may enjoy the relevant encouragement policies. Software
developers or producers are may sell or license their registered software products independently or through agents. Upon registration, the software products will be granted registration certificates.
Each registration certificate is valid for five years and may be renewed upon expiration.
The
PRC Trademark Law
, adopted in 1982 and revised in 2001, with its implementation rules adopted in 2002, protects registered trademarks.
The PRC Trademark Office of the SAIC handles trademark registrations and grants a protection term of ten years to registered trademarks.
The
MII amended its
Administrative Measures on China Internet Domain Names
in 2004. According to these measures, the MII is in charge of
the overall administration of domain names in China. The registration of domain names in PRC is on a "first apply-first-registration" basis. A domain name applicant will become the domain name holder
upon the completion of the application procedure.
Regulations Related to Employment
On June 29, 2007, the Standing Committee of the National People's Congress adopted the
Employment
Contract Law
, or ECL, which became effective as of January 1, 2008. The ECL was further amended by the Standing Committee of the National People's Congress on
December 28, 2012. The ECL requires employers to provide written contracts to their employees, restricts the use of temporary workers, and aims to give employees long-term
job security.
Pursuant
to the ECL, employment contracts lawfully concluded prior to the implementation of the ECL and continuing as of the date of its implementation will continue to be performed.
Where an employment relationship was established prior to the implementation of the ECL but no written employment contract was concluded, a contract must be concluded within one month after the
ECL's implementation.
Regulations Related to Foreign Currency Exchange and Dividend Distribution
Foreign currency exchange
The principal regulations governing foreign currency exchange in China are the
Foreign Exchange Administration
Regulations
, as amended in August 2008. Under this regulation, the RMB is freely convertible for current account items, including the trade and service-related foreign
exchange transactions and other current exchange transactions, but not for capital account items, such as direct investments, loans, repatriation of investments and investments in securities, unless
the prior approval of SAFE is obtained and prior registration with SAFE is made.
Pursuant
to the
Administration Rules of the Settlement, Sale and Payment of Foreign Exchange
promulgated on June 20, 1996 by the
PBOC, foreign-invested enterprises in China may purchase or remit foreign currency for settlement of current account transactions without the approval of the SAFE.
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Foreign
currency transactions under the capital account are still subject to limitations and require approvals from, or registration with, the SAFE and other relevant PRC governmental authorities.
In
October 2005, the SAFE issued the
Circular on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Return
Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies
, or Circular 75, which became effective as of November 1, 2005. This
was further supplemented by an implementing notice issued by SAFE on November 24, 2005. Circular 75 suspends the implementation of two prior regulations promulgated in January and April
of 2005 by SAFE. Circular 75 states that PRC residents, whether natural or legal persons, must register with the relevant local SAFE branch prior to establishing or taking control of an
offshore entity established for the purpose of overseas equity financing involving onshore assets or equity interests held by PRC residents. The term "PRC legal person residents" as used in
Circular 75 refers to those entities with legal person status or other economic organizations established within the territory of the PRC. The term "PRC natural person residents" as used in
Circular 75 includes all PRC citizens and all other natural persons, including foreigners, who habitually reside in China for economic benefit. Under Circular 75, PRC residents are
required to complete amended registrations with the local SAFE branch upon (i) injection of equity interests or assets of an onshore enterprise into an offshore entity, or
(ii) subsequent overseas equity financing by such offshore entity. PRC residents are also required to complete amended registrations or filings with the local SAFE branch within 30 days
of any material change in the shareholding or capital of the offshore entity, such as changes in share capital, share transfers and long-term equity or debt investments, and providing
security. PRC residents who have already incorporated or gained control of offshore entities that have made onshore investment in the PRC before Circular 75 was promulgated are required to
register their shareholding in the offshore entities with the local SAFE branch on or before March 31, 2006. The guidance issued by the SAFE in May 2011 allows PRC residents to register
with the relevant local SAFE branch after the
establishment of the offshore entity on stringent conditions, but such PRC residents will be subject to penalties for their non-compliance of the PRC foreign exchange control regime,
if any.
Under
the Circular 75, PRC residents are further required to repatriate to the PRC all of their dividends, profits or capital gains obtained from their shareholdings in the
offshore entity within 180 days of their receipt of such dividends, profits or capital gains. The registration and filing procedures under the Circular 75 are prerequisites for other
approval and registration procedures necessary for capital inflow from the offshore entity, such as inbound investments or shareholders loans, or capital outflow to the offshore entity, such as the
payment of profits or dividends, liquidating distributions, equity sale proceeds, or the return of funds upon a capital reduction. All our individual shareholders who are subject to Circular 75
have obtained registration with regards to the establishment of our company and the later changes of their shareholding in our company as required under Circular 75. Please see "Item 3.
Key InformationRisk FactorsRisks Related to Doing Business in ChinaWe may be subject to penalties, including restriction on our ability to inject capital into
our PRC subsidiary and our PRC subsidiary's ability to distribute profits to us, if our PRC resident shareholders or beneficial owners fail to comply with relevant PRC foreign exchange rules."
On
February 15, 2012, SAFE promulgated the
Notice regarding Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Option
Plan of Overseas-Listing Companies
, which substitutes the
Application Procedure of Foreign Exchange Administration for Domestic Individuals
Participating in Employee Stock Holding Plan or Stock Option Plan of Overseas-Listed Companies
promulgated by SAFE on March 28, 2007. Under the Stock Option Rule, the
domestic individuals as defined under the
Foreign Exchange Administration Regulations
who are granted stock options or other incentive alternatives by
an overseas publicly listed company are required, through a PRC agent or PRC subsidiary of such overseas publicly listed company, to register with SAFE and complete certain other procedures.
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Dividend distribution
The principal regulations governing distribution of dividends of foreign holding companies include the
Foreign
Investment Enterprise Law
issued in 1986 and amended in 2000, and the
Implementation Rules under the Foreign Investment Enterprise
Law
issued in 1990 and amended in 2001. Under these regulations, foreign investment enterprises in the PRC may pay dividends only out of their accumulated profits, if any,
determined in accordance with PRC accounting standards and regulations. In addition, foreign investment enterprises in the PRC are required to allocate at least 10% of their respective accumulated
profits each year, if any, to fund certain reserve funds unless these
reserves have reached 50% of the registered capital of the enterprises. Funds held in these reserves are not distributable as cash dividends.
Regulations Related to Taxation
On March 16, 2007, the National People's Congress, the PRC legislature, passed the new
Enterprise Income
Tax Law
, or the new EIT Law which became effective on January 1, 2008. On December 6, 2007, the State Council approved and promulgated the Implementation
Rules of PRC Enterprise Income Tax
Law
, which took effect simultaneously with the new EIT Law.
The
new EIT Law applies a uniform 25% Enterprise Income Tax rate to both foreign-invested enterprises and domestic enterprises and eliminates many of the preferential tax policies
afforded to foreign investors. Furthermore, dividends out of post-2007 earnings paid by a foreign-invested enterprise to a non-resident shareholder are now subject to a
withholding tax of 10%, which may be reduced under any applicable bi-lateral tax treaty between the PRC and the jurisdiction where the non-resident shareholder resides.
According to the
Administrative Measures for Non-residents Enjoying Tax Treaty Benefits (Trial Implementation)
issued by the State
Administration of Taxation on August 24, 2009, which became effective on October 1, 2009, an applicant seeking a preferential withholding tax rate under a bilateral tax treaty must apply
to the competent PRC tax authorities for recognition of eligibility for such treaty benefits. According to the
Circular of the SAT on How to Understand and Identify "Beneficial
Owner" under Tax Treaties
, which became effective on October 27, 2009, or Circular 601, the PRC tax authorities must evaluate whether an applicant for treaty
benefits with respect to dividends, interest and royalties qualifies as a "beneficial owner" on a case-by-case basis, and must follow the "substance over form" principle.
Circular 601 sets up criteria to identify a "beneficial owner" and provides that an applicant that does not carry out substantial business activities, an agent or a conduit company, will not be
regarded as a "beneficial owner" and therefore cannot enjoy treaty benefits.
Pursuant
to the
Arrangement between Mainland of the PRC and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and Prevention of
Fiscal Evasion with respect to Taxes on Income
signed on August 21, 2006, which in Hong Kong, applies to income derived in any year of assessment commencing on or after
April 1, 2007, and in the PRC, in any year commencing on or after January 1, 2007, a company incorporated in Hong Kong will be subject to withholding income tax at a rate of 5% on
dividends it receives from its PRC subsidiaries if it is deemed the beneficial owner by PRC tax authorities and holds a 25% or more equity interest in that particular PRC subsidiary at the time of the
distribution, or 10% if it holds less than a 25% equity interest in that subsidiary or is not the beneficial owner of the income.
An
enterprise registered under the laws of a jurisdiction outside the PRC may be deemed a PRC tax resident if its place of effective management is in the PRC. According to the
implementation rules, an enterprise's place of effective management may be deemed to be in the PRC if the PRC is the location of its "de facto management bodies", which are defined as the bodies that
have substantial and overall
management and control over such aspects as the production and the business, personnel, accounts and properties of the enterprise.
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In
addition, under the new EIT Law, foreign shareholders could become subject to a 10% income tax on any gains they realized from the transfer of their shares, if such gains are regarded
as income derived from sources within the PRC, and the enterprise in which their shares invested is considered a "tax resident enterprise" in the PRC. Once a non-PRC company is deemed to
be a PRC tax resident by following the "place of effective management" concept and any dividend distributions from such company are regarded as income derived from sources within the PRC, PRC
withholding income tax may be imposed and applied to dividend distributions from the deemed PRC tax resident to its foreign shareholders, and dividends distributed by its PRC subsidiaries to such
deemed PRC tax resident would be exempt from PRC tax if certain requirement are met.
Pursuant
to the
PRC Individual Income Tax Law
, or the Individual Income Tax Law, adopted on December 29, 2007 and amended on
June 30, 2011, individuals who are domiciled in the PRC or who are not domiciled but have resided in the PRC for at least one year are required to pay Individual Income Taxes in accordance with
the Individual Income Tax Law on income derived from sources in and outside the PRC. For those individuals who are neither domiciled in nor residents of the PRC, or who are not domiciled and reside
for less than one year in the PRC, are required to pay Individual Income Taxes in accordance with this law on income derived from sources within the PRC.
Pursuant
to the PRC Provisional Regulations on Business Tax, taxpayers providing taxable services falling under the category of service industry in China are required to pay a business
tax at a normal tax rate of 5% of their revenues. In November 2011, the Ministry of Finance and the SAT promulgated the Pilot Plan for Imposition of Value-Added Tax to Replace Business Tax.
Pursuant to this pilot plan and relevant notices, from January 1, 2012, VAT will replace business tax in the transport and shipping industry and some of the modern service industries in
Shanghai. In July 2012, the Ministry of Finance and the SAT promulgated the Circular concerning Implementing the Pilot Plan for Imposition of Value-Added Tax to Replace Business Tax for
Transport and Shipping Industry and Certain Modern Service Industries in Eight Provinces and Municipalities (including Beijing), which expanded the pilot regions to other eight provinces and
municipalities including Beijing, Tianjin, and Shenzhen. Under the pilot plan, a VAT rate of 6% applies to certain modern service industries. Most of our consolidated affiliated entities are located
in these pilot regions, and the revenues recognized from part of our businesses operated by Shanghai Shengran and Shanghai Taomee are subject to VAT at a rate of 6%, while other part of our business
are still subject to PRC business tax at a statutory tax rate of 5%. If this plan is extended to apply to other part of our business, we may be subject to VAT rate which is higher than the business
tax rate, which could harm our financial condition and results of operations.
Regulations Related to M&A and Overseas Listings
On August 8, 2006, six PRC regulatory agencies, including the Ministry of Commerce, the State-owned Assets Supervision and
Administration Commission, the State Administration of Taxation, the SAIC, the CSRC and SAFE, jointly issued the
Regulations on Mergers and Acquisitions of Domestic Enterprises
by Foreign Investors
, or the New M&A Rules, which became effective on September 8, 2006 and was amended by the Ministry of Commerce on June 22, 2009. The
New M&A Rules, among other things, require that (i) PRC entities or individuals obtain MOFCOM approval before they establish or control a special purpose vehicle, or SPV, overseas,
provided that they intend to use the SPV to acquire their equity interests in a PRC company at the consideration of newly issued share of the SPV, or Share Swap, and list their equity interests in the
PRC company overseas by listing the SPV in an overseas market; (ii) the SPV obtains MOFCOM's approval before it acquires the equity interests held by the PRC entities or PRC individual in the
PRC company by Share Swap; and (iii) the SPV obtains CSRC approval before it lists overseas. Please see "Item 3. Key InformationD. Risk FactorsRisks Related to
Doing Business in ChinaThe approval of the China Securities Regulatory Commission, or the CSRC, may be required in connection with the initial public offering under a PRC regulation. The
regulation also establishes more complex procedures for acquisitions conducted by foreign investors that could make it more difficult for us to grow through acquisitions."
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C.
Organizational Structure
The following diagram illustrates our corporate structure and the place of incorporation of each of our significant subsidiaries and significant VIE as of
December 31, 2012.
-
(1)
-
Shanghai
Taomee is our VIE in China and is 30% owned by Mr. Jason Liqing Zeng, our chairman, 23.75% owned by Mr. Benson Haibing Wang, our
co-founder, director and chief executive officer, 17.375% owned by Mr. Crow Zhen Wei, our co-founder, director and chief technology officer, 15.75% owned by
Mr. Roc Yunpeng Cheng, our co-founder, director and president, 8.125% owned by Mr. Bin Wang and 5% owned by Mr. Yuliang Feng.
We
have entered into contractual arrangements with Shanghai Taomee and its shareholders, through which we exercise effective control over operations of Shanghai Taomee and receive
economic benefits generated from it. As a result of these contractual arrangements, under U.S. GAAP, we are considered the primary beneficiary of Shanghai Taomee and thus consolidate its
results in our consolidated financial statements. However, these contractual arrangements may not be as effective in providing us with control over the VIE as direct ownership of it. In addition, the
VIE or its shareholders may breach the contractual arrangements with us. In such cases, we would have to rely on legal remedies under PRC law, which may not always be effective, particularly in light
of uncertainties in the PRC legal system. See "Item 3. Key InformationD. Risk FactorsRisks Related to Our Corporate StructureIf the PRC
government determines that the contractual arrangements that establish the structure for operating our business do not comply with applicable PRC laws and regulations, we could be subject to severe
penalties" and "Item 3. Key InformationD. Risk Factors
65
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Risks
Related to Our Corporate StructureIf the PRC government determines that our ownership structure does not comply with the restrictions contained in the GAPP Notice, we could be
subject to severe penalties."
Contractual Arrangements with Shanghai Taomee and its Shareholders
Our relationships with Shanghai Taomee and its shareholders are governed by a series of contractual arrangements. Under PRC laws, each
of Shanghai Taomee and Shanghai Shengran is an independent legal person and neither of them is exposed to liabilities incurred by the other party. Other than pursuant to the contractual arrangements
between Shanghai Taomee and Shanghai Shengran, Shanghai Taomee is not required to transfer any funds generated from its operations to Shanghai Shengran.
Loan Agreement.
Certain shareholders of Shanghai Taomee, namely Messrs. Jason Liqing Zeng, Benson Haibing Wang, Crow Zhen Wei, Roc
Yunpeng
Cheng and Bin Wang entered into a loan agreement with Shanghai Shengran, under which Shanghai Shengran provided an interest-free loan of RMB2.5 million (US$0.4 million) to
these shareholders, solely for their respective contributions to the increased capital of Shanghai Taomee. The loan has a term of ten years, which can be extended if mutually agreed by the parties.
Shanghai Shengran has the right to determine the method of loan repayment, including requiring the shareholders to transfer all of their respective equity interest in Shanghai Taomee to Shanghai
Shengran and/or its designee.
Option Agreement.
Shanghai Taomee's shareholders have entered into an option agreement with Shanghai Shengran, under which each
shareholder of
Shanghai Taomee granted Shanghai Shengran an exclusive option to purchase or have its designee purchase his equity interest in Shanghai Taomee at the purchase price equal to the lowest price permitted
by the PRC laws, and agreed to assist Shanghai Shengran in obtaining all necessary government approvals as may be then required in connection with the purchase. Shanghai Shengran may exercise such
option at any time to the extent permitted by the PRC laws. In addition, Shanghai Taomee and its shareholders agree that without Shanghai Shengran's prior written consent, they will not engage in
certain actions including transferring or otherwise disposing of the equity interest in Shanghai Taomee.
Proxy Agreement.
Shanghai Taomee and its shareholders have entered into a proxy agreement with Shanghai Shengran, under which each
shareholder of
Shanghai Taomee granted an irrevocable power of attorney to Shanghai Shengran that authorizes Shanghai Shengran to vote as the shareholder's attorney-in-fact on all of the
matters of Shanghai Taomee requiring shareholders' approval, including the appointment of board members and senior management members.
Business Operation Agreement.
Shanghai Taomee and its shareholders have entered into a business operation agreement with Shanghai
Shengran, under
which each of the shareholders agrees that, without the prior written consent of Shanghai Shengran or its designee, Shanghai Taomee will not conduct any transactions which might substantially affect
its assets, businesses, personnel, obligations, rights or operations confirmed by Shanghai Shengran. Shanghai Taomee and its shareholders agree to fully comply with the advices in connection with its
business operation and financial management provided by Shanghai Shengran from time to time and to elect directors and officers of Shanghai Taomee in consistence with the direction of Shanghai
Shengran. In addition, the shareholders agree to unconditionally transfer to Shanghai Shengran, without any consideration, any dividends or other proceeds received from Shanghai Taomee in their
capacity as shareholders of Shanghai Taomee.
Commercial Cooperation Agreement.
Under the commercial cooperation agreement between Shanghai Taomee and Shanghai Shengran, Shanghai
Shengran agrees
to place certain game updates and value-added components developed by it, or the objects, on Shanghai Taomee's platform for operation. Shanghai Shengran will provide routine maintenance, updates,
technical support and
66
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debugging
for the operation of the objects, and Shanghai Taomee will provide platform servers, broadband resources and customer services. Unless Shanghai Shengran directs otherwise and subject to
applicable laws, any intellectual property in relation to the objects will belong to Shanghai Shengran and cannot be used by Shanghai Taomee beyond the agreed scope of uses. Shanghai Shengran will
enjoy the profits generated from this operation after the deduction of a reasonable portion thereof by Shanghai Taomee. The rate for the deduction will be determined through negotiation by both
parties based on the principles of arm's-length pricing.
Shares Pledge Agreement.
Shanghai Taomee and its shareholders have entered into an equity interest pledge agreement with Shanghai
Shengran, under
which the shareholders of Shanghai Taomee pledged all of their equity interests in Shanghai Taomee to Shanghai Shengran to secure their and Shanghai Taomee's obligations under certain agreements above
and as collateral for all of the amounts payable by Shanghai Taomee to Shanghai Shengran under those agreements. If any event of default as defined under this agreement occurs, Shanghai Shengran, as
the pledgee, will be entitled to dispose of the pledged equity interests. In addition, any equity proceeds (including but not limited to any dividend or profit) from Shanghai Taomee will be further
pledged in favor of Shanghai Shengran excepted otherwise agreed by Shanghai Shengran in writing.
D.
Property, Plant and Equipment
Our principal executive offices are located at 16/F, Building No. A-2, No. 1528 Gumei Road, Xuhui District, Shanghai 200233, People's
Republic of China. Our telephone number at this address is (86-21) 6128-0056 and our fax number is (86-21) 3367-4012. We are headquartered in Shanghai
and have leased an aggregate of approximately 8,890 square meters of offices in Shanghai from independent third parties and do not own any real property.
We
believe that our leased facilities are adequate to meet our needs for the foreseeable future, and that we will be able to obtain adequate facilities, principally through leasing of
additional properties, to accommodate our future expansions.
ITEM 4A. UNRESOLVED STAFF COMMENTS
None.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our
audited consolidated financial statements and the related notes included elsewhere in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties. Our
actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under
"Risk Factors" and elsewhere in this annual report.
A.
Operating Results
Overview
We are one of the leading children's entertainment and media companies in China. Our success online has translated into growing demand
for our content offline in print media, merchandising, television and film. In our virtual worlds, children adopt avatars and learn through interactive games and group activities set in imaginative
landscapes with evolving story lines of exploration and adventure.
We
work with publishers to offer a wide range of children's books and magazines, featuring iconic characters, story lines and images we have developed and popularized. We license our
franchises to leading brands in toys and other consumer products for children in China. We have also developed
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content
for animation film and television, which we released in 2012. We refer to these other businesses as our offline business.
We
generate revenues from our online business primarily through the sales of subscriptions and virtual items, which users pay for primarily in the form of virtual currency purchased with
prepaid cards. Our prepaid cards are distributed in over 130,000 retail outlets in over 2,800 towns and cities in China. We generate revenues from our offline business mainly from
license fees and royalties based on contracts with book publishers, makers of consumer products and other licensees.
For
2010, 2011 and 2012, approximately 93.6%, 88.8% and 80.0%, respectively, of our net revenues were generated from online business, and approximately 6.4%, 11.2% and 20.0%,
respectively, of our net revenues were generated from offline business.
Our
net revenues were US$36.0 million in 2010, US$45.4 million in 2011, and US$40.2 million in 2012. Our gross profit was US$30.1 million in 2010,
US$37.7 million in 2011, and US$30.2 million in 2012. Our net income was US$21.6 million in 2010,US$19.5 million in 2011, and US$8.9 million in 2012. The
number of active paying accounts, in our online entertainment community were 2.4 million in the three months ended December 31, 2010, 1.7 million in the three months ended
December 31, 2011 and 1.2 million in the three months ended December 31, 2012, and per paying account average gross revenues from the operation of our virtual communities in
China, or ARPU, increased from approximately US$3.9 to US$4.7 and US$4.8 in the same periods.
Factors Affecting Our Results of Operations
Our results of operations are affected by the factors described in more details in the "Descriptions of Certain Statement
of Operations ItemsNet revenues" as well as the general and specific factors, including:
-
-
overall economic growth in China, which has resulted in increases in disposable income and discretionary consumer
spending;
-
-
urbanization rate, which has led to the development of a sophisticated consumer market and a greater concentration of
children in urban centers with ready access to the Internet;
-
-
discretionary spending on and by children on media and entertainment, which has increased considerably as a result of
Chinese families' growing affluence as well as population control policies of the Chinese government;
-
-
demand for online entertainment among children, which has grown as a result of rapidly increasing popularity of Internet
use among children.
-
-
government policies that restrict the operation by foreign content developers and operators. See "Item 4.
Information on the CompanyB. Business OverviewRegulations Related to Our BusinessOnline games administration measures";
-
-
the stability and quality of our management and employees;
-
-
competition in the children's entertainment and media industry, which is characterized by rapid change, converging
technologies, relatively low capital requirements and barriers to entry. See "Item 3. Key InformationD. Risk FactorsRisks Related to Our BusinessWe
may not be able to maintain our revenues and profitability as we operate in a competitive industry and compete against many companies"; and
-
-
our ability to achieve a high level of production and operation efficiency.
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Table of Contents
Descriptions of Certain Statement of Operations Items
Net revenues
We generate revenues from two sources: (i) online business through the operation of our virtual worlds and provision of other
online services and products, including royalties for licensing our virtual worlds, and (ii) offline business.
Our
revenues from online business grew rapidly since we commercially launched our first virtual world, Mole's World, in September 2008. Our revenues from offline business also
grew rapidly since 2009, when we first leveraged our online business to enter into arrangements to license our franchises to makers of consumer products and publishers of children's books. Since the
fourth quarter of 2011, our net revenues from online business decreased together with the decrease of the active paying accounts. We believe the decrease is primarily due to competition and our
strategy to temporarily decelerate monetization to attract new users and increase user stickiness, which is evidenced by increased active accounts in 2012. Our net revenues from offline business have
increased in both amount and percentage in 2011 and 2012 as a result of our strategy to build our cross-media entertainment platforms. The following table sets forth a breakdown of our net revenues
from the periods indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2010
|
|
2011
|
|
2012
|
|
|
|
US$
|
|
%
|
|
US$
|
|
%
|
|
US$
|
|
%
|
|
|
|
(in thousands, except percentages)
|
|
Net revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Online business
|
|
|
33,683
|
|
|
93.6
|
|
|
40,331
|
|
|
88.8
|
|
|
32,169
|
|
|
80.0
|
|
Offline business
|
|
|
2,290
|
|
|
6.4
|
|
|
5,066
|
|
|
11.2
|
|
|
8,039
|
|
|
20.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenues
|
|
|
35,973
|
|
|
100.0
|
|
|
45,397
|
|
|
100.0
|
|
|
40,208
|
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our net revenues from online business amounted to US$33.7 million, US$40.3 million and US$32.2 million in 2010,
2011 and 2012, respectively.
Our
net revenues from online business are net of discounts and rebates granted to our distributors, as well as business taxes or VAT and related surcharges incurred in connection with
our operations. Each of Shanghai Shengran and Shanghai Taomee is subject to PRC business tax at a statutory tax rate of 5% or VAT at a rate of 6% and surcharges related to urban construction and
education, which we deduct from our gross online business revenues.
We
generate revenues from our online business primarily through two revenue streamstime-based and item-based. While users can access our virtual
worlds for free, users may choose to pay a RMB10 (US$1.6) fee per virtual world to access premium features and gain privileges within each of our virtual worlds for 30 days. Users who pay the
subscription fee enjoy additional capabilities, special privileges, such as having a higher upper limit for the total number of friends that the users can have and access to exclusive online parties.
In addition, users pay a fee for each virtual item within our virtual worlds. For more details on revenue recognition, see "Critical Accounting Policies and EstimatesRevenue
Recognition." Starting from June, 2011, we began to generate online business revenues from licensing our virtual worlds outside of China. Starting from the second half of 2010, we also began to
operate third-party online casual games on our platform and generate revenues from such licensing arrangements.
Users
can purchase subscriptions and virtual items using our virtual currency, the Mibi, which in turn can be purchased from different distribution channels, such as our prepaid cards,
third-party
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prepaid
cards, online payment channels and cellular telecom operators. We sell the prepaid cards to our distributors at a pre-negotiated discount on the face value of the cards and offer a
volume rebate to distributors if they meet a pre-set sales requirement. Net proceeds from distributors are initially recorded as advances from customer. Upon activation or charge of the
prepaid cards or the Mibi, these advances from customers are transferred to deferred revenues. The proceeds received from sales of the Mibi directly to users through third-party payment channels are
recorded as deferred revenues. For more details on our distribution agreements and payment systems, see "Item 4. Information on the CompanyB. Business
OverviewOur Business SegmentsOnline BusinessPricing, payment and distribution."
Our
physical prepaid cards will expire on the expiration date printed thereon, which is generally two years after the date of card production. The proceeds from the expired physical
prepaid cards that have not been activated are recognized as other operating income upon expiration of the cards. In 2010, 2011 and 2012, we recognized US$41,801, US$546,360 and US$1,867,626,
respectively, as other operating income due to expiration of prepaid cards.
The
following table sets forth the number of active accounts, the number of active paying accounts and ARPU for each period indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Periods Ended
|
|
|
|
2010
|
|
2011
|
|
2012
|
|
|
|
March 31
|
|
June 30
|
|
September 30
|
|
December 31
|
|
March 31
|
|
June 30
|
|
September 30
|
|
December 31
|
|
March 31
|
|
June 30
|
|
September 30
|
|
December 31
|
|
Active Accounts (in thousands)(1)
|
|
|
30,344
|
|
|
33,989
|
|
|
36,213
|
|
|
25,967
|
|
|
27,329
|
|
|
24,046
|
|
|
37,126
|
|
|
27,009
|
|
|
42,267
|
|
|
43,680
|
|
|
57,348
|
|
|
34,401
|
|
Active Paying Accounts (in thousands)(2)
|
|
|
2,961
|
|
|
3,274
|
|
|
3,062
|
|
|
2,415
|
|
|
2,741
|
|
|
2,207
|
|
|
2,129
|
|
|
1,677
|
|
|
1,899
|
|
|
1,817
|
|
|
1,716
|
|
|
1,213
|
|
ARPU (in US$)(3)
|
|
|
2.3
|
|
|
3.0
|
|
|
3.3
|
|
|
3.9
|
|
|
4.6
|
|
|
5.1
|
|
|
5.2
|
|
|
4.7
|
|
|
5.0
|
|
|
4.8
|
|
|
4.6
|
|
|
4.8
|
|
-
(1)
-
The
number of active accounts for each quarter prior to June 30, 2010 was based on monthly active accounts, as adjusted to eliminate double-counting
of the same accounts that accessed multiple virtual worlds during the relevant months and as extrapolated for quarterly presentation. No such adjustment was made after June 30, 2010, when we
upgraded our operating data collection system.
-
(2)
-
The
number of active paying accounts for each quarter is the number of active accounts that paid subscription fees to access premium features of our virtual
worlds or purchased virtual items in the relevant quarter.
-
(3)
-
Includes
gross revenues from online business, and excludes gross revenues from the licensing of our virtual worlds to third-parties.
We believe net revenue from our online business is primarily affected by the following factors:
-
-
Our ability to maintain and expand our user base
which depends on the
continued growth of the number of children who use the Internet, our ability to bring appealing content and entertainment experiences to our users, coverage of mobile and new online platforms, use
effective promotion to reach new users, expand our user base in second and third-tier cities in China, and maintain and enhance our reputation among children and their parents. We will
also develop new virtual worlds and other services on our community, which may appeal to age groups and demographics that we have yet to reach and increase our revenues as a result. From time to time,
we may adopt the strategy of trying to gain market share and increase user stickiness and temporarily decelerate monetization. The operating results of 2012 have bolstered our confidence in such
strategy to prioritize market share expansion as we foster the growth of our user base and user stickiness.
-
-
Our ability to increase item-based revenue stream.
We generate
revenues primarily through the sales of subscriptions to access premium features and gain privileges in our interactive communities and the sales of virtual items. The increase in sales depends on our
ability to frequently enhance and update our virtual items and premium features to cater to children's changing preferences and attract more sales. As we already have a large and stable base of users
who pay subscription fees, we expect one of the key drivers of future growth to be increased spending on virtual items.
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-
-
Our ability to increase our ARPU by:
-
-
effectively pricing our subscription fees and virtual items and utilizing
bundling.
We price our subscription fees and virtual items to be attractive and affordable for our users and to reflect market trend. While we do not foresee
near-term increase in per account subscription fee, we expect greater flexibility in pricing virtual items.
-
-
optimizing revenue mix.
We have built and will continue to build a
portfolio of diverse virtual worlds that appeal to children of different age, gender and interests. As children of different gender and age groups exhibit different ARPUs, and as virtual worlds with
different themes or at different life stages exhibit different ARPUs, our revenues will be affected by the mix of virtual worlds and other services and communities we offer. Our ability to continue to
launch virtual worlds to create a portfolio with various target users and life cycles is critical to our sustained growth.
-
-
Our ability to expand the distribution network and negotiate favorable rebates and discounts with
distributors.
We maintain an extensive distribution system for our physical prepaid cards that reached approximately 130,000 retail outlets in over 2,800 towns
and cities around China, as of December 31, 2012. Since many children have limited access to online payment channels, we rely on payment through the physical prepaid cards for a substantial
amount of our revenues. We need to identify additional retail outlets that are located near our target users and expand our distribution network to more second and third-tier cities in
China. In addition, our ability to negotiate favorable discount and rebate rates with more distributors and continue to optimize our distribution structure is important to our future
revenue growth.
-
-
Seasonality in user behavior.
Our quarterly results of operations may be
affected by seasonal trends caused by user behavior and demand for our online and offline offerings. We expect our net revenues from online business to be higher during winter and summer vacations
when there are more active users and children have more online playtime during these non-school days, which usually falls in the first and third quarters of each calendar year. For
instance, there are more non-school days in the first quarter and third quarter of 2012. Decreases in our net revenues from online business, if any, as a result of seasonality may be most
visible from the third quarter to the fourth quarter of each year, as the fourth quarter has less than half of the non-school days compared to the third quarter, and from the first quarter
to the second quarter as well, not only because the decrease in non-school days in the second quarter as compared to the first quarter, but also because children are generally given extra
pocket money during Chinese New Year in the first quarter of each year. These seasonality trends generally manifest themselves more clearly with respect to more mature virtual worlds and less
clearly during periods of high growth that accompany the introductory stages of a highly popular virtual world. For example, as a result of the seasonality effect discussed above, our revenues from
online business was higher in the first quarter of 2012 as compared to the second quarter of 2012 and we expect a similar decrease in revenue from online business in the second quarter of 2013 as
compared to the first quarter of 2013.
-
-
Our ability to operate in a competitive industry.
We operate in the
competitive children's online entertainment industry. See "Factors Affecting Our Results of Operations." Our ability to maintain our competitive edge in attracting and retaining users, to
quickly respond to market trends and user preferences and to strategically promote our brands and services are crucial to our growth.
-
-
Our ability to expand cooperation with online game developers.
Starting
from the second half of 2010, we began to operate third-party online casual games on our platform and generate revenues from such licensing arrangements. We plan to continue to enter into licensing
arrangements to operate third-party online casual games on our platform.
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Table of Contents
Our net revenues from offline business amounted to US$2.3 million, US$5.1 million and US$8.0 million in 2010, 2011
and 2012, respectively.
Our
revenues from offline business mostly consisted of publishing royalties, film and merchandise licensing fees generated from licensing our content in the PRC. In addition to licensing
our franchises, we also design and sell interactive toys that bear images of our franchises, and sometimes books featuring our franchises. We take the associated inventory risks in connection with
such sales. See "Cost of ServicesOffline business."
We
invested in the production of, or licensed our franchise to producers of four feature films, based on our "Mole's World" and "Seer" franchises, which we released in 2011 and 2012, and
generated revenues through box office sharing proceeds and distribution of films on television and website.
Our
results of operations will be significantly affected by our ability to grow our offline business by leveraging our brand name and the popularity of our franchise assets and content
creation capabilities. We believe net revenue from our offline business is primarily affected by the following factors:
-
-
Our ability to engage additional licensees in more media formats and product
categories.
Currently, we are working with licensees in key categories of consumer goods, such as apparel, accessories, toys, stationery, consumer electronics, food, beverage,
books, theme parks, live shows, and carnivals, including many brands well-known in China. We plan to increase our offline revenues by identifying additional media formats and/or product
categories for the license of our franchises and number of licensees in each media format or product category;
-
-
Our ability to generate more content and offerings for offline business.
As of December 31, 2012, our content for our offline business had been based on our franchises developed for our virtual worlds. We expect our offline revenues to grow as we develop more
franchises or develop original content for the offline business;
-
-
Our ability to negotiate favorable royalty rates with our licensees.
We
believe as we further enhance our brand recognition, we may be able to negotiate more favorable royalty rates;
-
-
Our ability to engage in cross-marketing and promotions between online and offline
media.
We expect our revenues from offline business to increase as the awareness of our brands grows, as we promote our offline business in our large online community and as we
tie the offline products and services to our popular online virtual worlds or other offerings, such as placing a redemption code in licensed children's books and toys that allows readers to redeem
coveted virtual items; In addition, we also promoted our brands and franchise assets through TV animations. As of December 31, 2012, we have produced over 150 episodes of cartoon
animations and broadcasted on over 100 TV channels throughout mainland China and Taiwan;
-
-
Seasonality of our offline business
is affected by the different
consumption patterns influencing different media formats or product categories for our licensed franchises and the mix of media formats and product categories. For instance, sales of certain toys and
stationery sold near primary schools may decrease during winter and summer vacations, while sales of clothing may increase during such periods.
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Table of Contents
Cost of Services
The following table sets forth a breakdown of our cost of services and as a percentage of total cost of services for the periods
indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2010
|
|
2011
|
|
2012
|
|
|
|
US$
|
|
%
|
|
US$
|
|
%
|
|
US$
|
|
%
|
|
|
|
(in thousands, except percentages)
|
|
Cost of services:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Online business
|
|
|
5,166
|
|
|
88.3
|
|
|
6,035
|
|
|
78.5
|
|
|
6,950
|
|
|
69.5
|
|
Offline business
|
|
|
685
|
|
|
11.7
|
|
|
1,653
|
|
|
21.5
|
|
|
3,048
|
|
|
30.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of services
|
|
|
5,851
|
|
|
100.0
|
|
|
7,688
|
|
|
100.0
|
|
|
9,998
|
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our cost of services relating to our online business primarily consists of bandwidth and server hosting costs, salaries and benefits of
our operations staff, production costs for prepaid cards, amortization of upfront licensing fees, depreciation and amortization of equipment and software purchased from third-parties, and other
direct costs.
Our
bandwidth costs represent the fees we pay to bandwidth vendors, which are typically telecommunications operators such as China Telecom and China Unicom, or independent third parties
that purchase bandwidth from major telecommunications operators in China. We also purchase servers from which we incur depreciation expenses and rental expenses for storing our servers. In the
foreseeable future, we expect our bandwidth costs and server-related depreciation and rental expenses to continue to increase in absolute amount given the anticipated increase in the volume of our
website traffic. We expect this increase in absolute terms to be partially offset to the extent we are able to achieve better economies of scale as a result of increased sales volume and continued
technological improvements that optimize bandwidth and server usage.
Salaries
and benefits (including share-based compensation) cost for our online business primarily comprise compensation to operations support staff, including employees responsible for
database and user system maintenance, bandwidth and server monitoring and maintenance, prepaid card and billing system maintenance, online security, technical support and customer service. We expect
costs associated with salaries and benefits to increase as we continue to expand our operations and hire more staff. Our operations staff for online business decreased from 132 as of
December 31, 2010 to 115 as of December 31, 2011, and increased to 118 as of December 31, 2012.
Our
production costs include the cost of manufacturing and transporting physical prepaid cards to our distributors around China. Such production costs may increase in absolute amount as
we continue to expand our operations and enter into distribution agreements with city level distributors. However, we do not expect production costs of the prepaid card to comprise a material part of
our cost of services going forward.
Cost of services relating to our offline business is primarily comprised of compensation to our operations employees, film production
cost and merchandise cost, which is the inventory costs of our interactive toys and the cost involved in producing labels for the verification of the authenticity of our licensed products.
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Table of Contents
Operating Expenses
Our operating expenses consist of product development expenses, sales and marketing expenses and general and administration expenses.
The following table sets forth a breakdown of our operating expenses in terms of amount and as a percentage of our total net revenues for the periods indicated. As we continue to expand both our
online and offline business, we expect our operating expenses to increase in absolute amount, and we aim to maintain or enhance our operating efficiency when our business further scales up.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2010
|
|
2011
|
|
2012
|
|
|
|
US$
|
|
%
|
|
US$
|
|
%
|
|
US$
|
|
%
|
|
|
|
(in thousands, except percentages)
|
|
Total net revenues:
|
|
|
35,973
|
|
|
100
|
|
|
45,397
|
|
|
100
|
|
|
40,208
|
|
|
100
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product development expenses
|
|
|
4,649
|
|
|
12.9
|
|
|
10,304
|
|
|
22.7
|
|
|
12,318
|
|
|
30.6
|
|
Sales and marketing expenses
|
|
|
1,570
|
|
|
4.4
|
|
|
6,255
|
|
|
13.8
|
|
|
9,966
|
|
|
24.8
|
|
General and administrative expenses
|
|
|
5,729
|
|
|
15.9
|
|
|
7,965
|
|
|
17.5
|
|
|
10,078
|
|
|
25.1
|
|
Other operating (income)
|
|
|
(278
|
)
|
|
(0.8
|
)
|
|
(1,734
|
)
|
|
(3.8
|
)
|
|
(5,512
|
)
|
|
(13.7
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
11,670
|
|
|
32.4
|
|
|
22,790
|
|
|
50.2
|
|
|
26,850
|
|
|
66.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our product development expenses consist primarily of salaries and benefits, including share-based compensation, for personnel engaged
in concept generation, community function development and design, story line development, website structure and content development and design, graphic and audio design, quality control and testing of
our virtual worlds and other online services. Product development expenses accounted for approximately 12.9%, 22.7% and 30.6% of our total net revenues in 2010, 2011 and 2012, respectively. Our
product development expenses increased in recent years primarily due to our hiring additional writers, engineers, development staff, animation and graphic artists. We expect that our product
development expenses will further increase in absolute amount in the future as we continue to devote resources to improve our interactive communities and the overall user experience and to create new
virtual worlds and develop wireless products, and as we incur higher share-based compensation expenses.
Our sales and marketing expenses primarily consist of advertising and promotional expenses, film promotion and animation related
expenses, salaries and benefits, including share-based compensation, and other overhead expenses incurred by our sales and marketing personnel. Sales and marketing expenses accounted for approximately
4.4%, 13.8% and 24.8% of our total net revenues in 2010, 2011 and 2012, respectively. Our sales and marketing expenses increased in the absolute amount in recent years, primarily due to the growth of
our sales and marketing team as well as an expansion of our marketing efforts. We expect that our sales and marketing expenses will increase in absolute amount as we further promote our virtual worlds
in future periods on search engines, web portals and casual game websites and produce more TV animations featured in our franchises.
Our general and administration expenses primarily consist of salaries and benefits, including share-based compensation, for our general
and administration, finance and human resources personnel, office rentals, depreciation and amortization expenses relating to property and equipment used in general and
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Table of Contents
administrative
functions, professional service fees and other expenses incurred in connection with general corporate purposes. General and administration expenses accounted for approximately 15.9%,
17.5% and 25.1% of our total net revenues in 2010, 2011 and 2012, respectively. We expect our general and administration expenses to increase in absolute amount as we incur additional expenses in
connection with the expansion of our business, our investment activities and our operations as a publicly traded company, which include hiring more staff for our general and administrative team,
expenses related to improving and maintaining our internal control over financial reporting and complying with our reporting obligations, and as we incur higher share-based compensation expenses.
However, we expect our general and administration expenses to stay relatively stable or decrease as a percentage of our total net revenues in the future as we expect our revenue growth will keep pace
with the increase in our general and administration expenses.
Our other operating income consists of PRC government subsidies granted to our operating subsidiary and significant VIE in China and
income recognized as a result of expiration of prepaid cards. Other operating income amounted to US$0.3 million in 2010, US$1.7 million in 2011 and US$5.5 million in 2012. We
received government subsidies in 2010, 2011 and 2012. However, the amount we receive may vary depending on government policy, our business operations and other factors. In 2012, we recognized an
amount of US$1.9 million as other operating income due to the expiration of prepaid cards.
Share of Profits/Loss in Equity Method Investments
In December 2009, we obtained a minority interest in Elyn Corporation and its wholly owned subsidiary Taiwan
Taomee Co., Ltd., of which 20% equity interests was initially held through a related party, as consideration, in exchange for a three-year exclusive right to operate certain
of our virtual worlds in Taiwan, Hong Kong and Macau. As we have the ability to exercise significant influence over Elyn Corporation, we account for this investment using the equity method
of accounting.
On
February 25, 2011, we entered into an agreement to effectively sell a 10.5% equity interest in Elyn Corporation that had been indirectly held by the related party on our
behalf. Of the 10.5% equity interest in Elyn Corporation, 9.14% was sold to Qiming Funds which are our existing shareholders and 1.36% was sold to a third party investor for US$3.4 million and
US$0.5 million, respectively, in cash. A gain of US$3.7 million was recognized in share of profit in equity method investments in the consolidated statement of operations. In
addition, the nominee shareholding agreement was terminated with the related party and we held all of our 29.5% equity in Elyn Corporation directly, and continued to account for this investment using
the equity method.
On
August 12, 2011, our equity interest in Elyn Corporation was diluted from 29.5% to 28.8% as a result of Elyn Corporation's issuing shares to its employees.
In
November 2011, Taiwan Taomee went through a reorganization and contemporaneously issued new ordinary shares to existing shareholders and certain employees. As a result of such
transactions, our equity interest in Taiwan Taomee was changed from 28.8% interest held through Elyn Corporation to a 27.6% effective interest which was held through (1) 29.50% in Elyn
Corporation, which held 72.09% of Taiwan Taomee, and (2) 28.77% in Joy Children Technology Co., Ltd., or Joy Children, a shell company with no operations, which
owned 21.86% of Taiwan Taomee after the reorganization. The change in equity interest reflected a dilution resulting from shares issued to Taiwan Taomee's employees, which
were accounted for by Taiwan Taomee as stock compensation. In addition, we paid total consideration of US$668,992 in cash for the newly issued shares of Taiwan Taomee through Joy Children,
which was recorded as an increase in equity method investment.
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Table of Contents
In
July 2012, our aggregated equity interest through Elyn and Joy Children in Taiwan Taomee was diluted from 27.6% to 27.1%, i.e. (1) 29.50% in Elyn, which holds 70.88% of
Taiwan Taomee and (2) 28.77% in Joy Children, which holds 21.49% of Taiwan Taomee. The dilution was mainly due to the issue of new ordinary shares by Taiwan Taomee from capital surplus and
appropriations of 2011 earnings to certain existing shareholders and employees.
Our
equity in profit 2010, 2011 and 2012 was US$0.5 million, US$1.0 million and US$0.5 million of Elyn Corporation and nil, US$7,757 and US$0.2 million of Joy
Children, respectively, and was recognized as share of profit in equity investment in the consolidated statements of operations.
In
October 2010, pursuant to an equity investment agreement which we entered into with Shenzhen Decent Investment Limited and two individuals unrelated to us, Shenzhen Ruigao was
formed in the PRC for the purpose of developing console games. We obtained a 17.65% equity interest in Shenzhen Ruigao for total cash consideration of US$1.0 million which was paid in two
installments, with the first payment being made in October 2010 and the remaining payment of US$0.5 million being paid in the first quarter of 2011. As we have the ability to exercise
significant influence over Shenzhen Ruigao, we account for this investment using the equity method of accounting. In May 2012, a third party investor obtained 7.5% equity interest in Shenzhen
Ruigao through capital injection, and our equity interest in Shenzhen Ruigao was reduced to 15.61%. In July 2012, Shanghai Taomee transferred all its equity interest in Shenzhen Ruigao for
US$1.0 million and recorded a gain of US$0.3 million. Our share of losses in equity investment in Shenzhen Ruigao was US$0.05 million in 2010 and US$0.4 million in 2011,
and our share of profits was US$0.2 million in 2012.
In
the first quarter of 2012, Shanghai Taomee entered into an investment agreement of US$0.1 million with Guangzhou Chuangyou Information Technology Co., Ltd., or
Chuangyou, a company principally engaged in the design and development of online games in China, to acquire 6.0% of Chuangyou's equity interest and a contingent call option to further subscribe 13.16%
newly issued equity interest for US$0.6 million. In September 2012, Shanghai Taomee exercised the call option and completed the further acquisition in January 2013. As a result,
we have acquired 19.16% equity interest in Chuangyou. Chuangyou is a related party of us, as one of Chuangyou's investors is our director and principle shareholder. As we have the ability to exercise
significant influence over Chuangyou, we account for this investment using the equity method of accounting. Our equity in loss in 2012 was US$35,310 in Chuangyou.
Taxation
Cayman Islands
We are incorporated in the Cayman Islands. Under the current law of the Cayman Islands, we are not subject to income or capital gains
tax. In addition, payment of dividends by us to our shareholders is not subject to withholding tax in the Cayman Islands.
Hong Kong
Our subsidiary in Hong Kong is subject to profits tax at the rate of 16.5% on assessable profits determined under relevant Hong Kong
tax legislation.
Under
the new EIT Law, the dividends paid by a foreign invested enterprise, or a FIE, to its immediate holding company outside the PRC are subject to withholding tax at a rate of 10% or
a lower rate if such foreign investor's jurisdiction of incorporation has a tax treaty with the PRC. According 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 Income signed in August, 2006, or the Tax Treaty, dividends payable by a FIE to a Hong Kong
resident company which directly owns at least 25.0% of the equity interest in that FIE will be subject to withholding tax at a lower rate of 5%.
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Table of Contents
Taomee HK, a company incorporated in Hong Kong in November 2008, currently holds all the equity interest in Shanghai Shengran. However, according to
Circular 124 issued by the SAT, which came into effect on October 1, 2009, the 5% withholding tax rate for dividends under the Tax Treaty does not apply automatically and Taomee HK needs
to obtain an approval from the competent local tax authority before it can enjoy such a preferential tax rate. According to Circular 81 issued by the SAT in February 2009, a key
condition for a foreign investor to enjoy the preferential withholding tax rate for dividends payable by a FIE is that such foreign investor is the "beneficial owner" of such dividends.
Circular 601 issued by the SAT on October 27, 2009 further clarifies that, generally the "beneficial owner" shall engage in substantive business operations such as manufacturing,
distribution or management and, among others, the fact that the immediate offshore holding company does not have any other business operations except holding property or rights generated from dividend
income from the FIE would adversely affect such offshore shareholder in the determination of its "beneficial owner" status by the tax authority.
In
respect of financial years 2010, 2011 and 2012, Taomee HK recorded a loss and therefore did not apply for approval to enjoy the 5% preferential tax rate under the Tax Treaty. Given
that Taomee HK is not engaged in substantive business operations and it does not have any other business operations except for its holding in Shanghai Shengran, Taomee HK may be subject to the 10.0%
withholding tax rate if it is not regarded as the "beneficial owner" of the dividends.
Dividends
paid by Taomee HK to its shareholder is not subject to any withholding tax in Hong Kong.
China
PRC Enterprise Income Tax, or EIT
Prior to January 1, 2008, companies established in China were generally subject to state and local EIT at statutory rates of 30%
and 3% respectively. On March 16, 2007, the National People's Congress of China enacted a new enterprise income tax law, i.e. the PRC Enterprise Income Tax Law, which took effect
beginning January 1, 2008. On December 6, 2007, the State Council also adopted the Implementing Rules for the Enterprise Income Tax Law, or the Implementing Rules, which also took effect
beginning January 1, 2008. Under the PRC Enterprise Income Tax Law, foreign invested enterprises, or FIEs, and Chinese domestic companies are subject to EIT at a uniform rate of 25%. On
February 22, 2008, the Ministry of Finance and the State Administration of Taxation, or the SAT, promulgated the Notice on Several Preferential Policies in Respect of Enterprise Income Tax, or
Notice No. 1 2008, reiterating the policy that a software enterprise newly established within China may, upon determination, be exempted from income taxes for its first two profit-making years
and shall be subject to the income tax at half the standard rate for the next three years. On April 24, 2009, the Ministry of Finance and SAT promulgated the Notice on Several Issues Relevant
to the Implementation of the Preferential Policies on Enterprise Income Tax, which states that, software enterprises established prior to the end of 2007 may, upon certification, enjoy the
preferential policies on the EIT reductions and exemptions within specified periods as provided in the Notice No. 1 2008. Our VIE, Shanghai Taomee, which was established in 2007 and qualified
as a "software enterprise" in 2009, enjoys a full exemption from EIT in 2009 and 2010 and a reduced EIT rate of 12.5% from 2011 to 2013. Shanghai Taomee's tax holiday period was approved by relevant
tax authorities in May 2010. In addition, our wholly-owned subsidiary, Shanghai Shengran, which was established in 2009 and qualified as a "software enterprise" in 2010 and was informed in
April 2011 that the full EIT exemption would apply retroactively in 2009 and 2010, and 50% reduction in EIT rate will apply from 2011 to 2013.In May 2012, Shanghai Shengran further
received a written approval from local tax authorities, according to which Shanghai Shengran was entitled to the full EIT exemption for 2010 and 2011, and 50% reduction in EIT rate, i.e. EIT
rate of 12.5%, from 2012 to 2014, which resulted in an adjustment of US$2.1 million as a one-time tax benefit in 2012. Continued qualification as a "software enterprise" is however
subject to
77
Table of Contents
an
annual assessment by the relevant government authorities in China. See "Item 3. Key InformationD. Risk FactorsRisks Related to Doing Business in
ChinaWe may be classified as a "resident enterprise" for PRC enterprise income tax purposes, which could result in our global income becoming subject to 25% PRC enterprise
income tax."
Under
the PRC Enterprise Income Tax Law and the Implementing Rules, dividends generated from the business of our PRC subsidiary after January 1, 2008 and payable to us may be
subject to a withholding tax rate of 10% if we are considered a non-resident enterprise incorporated outside of the PRC unless there is an applicable tax treaty with China that provides
for a different withholding arrangement and we are deemed to be entitled to such favorable treatment. Distributions of earnings generated before January 1, 2008 are exempt from PRC
withholding tax.
The
PRC Enterprise Income Tax Law provides that enterprises established outside China whose "effective management" is located in China are considered "resident enterprises" and will
generally be subject to the uniform 25% EIT rate as to their global income. Under the implementation regulations, "effective management" is defined as substantial and overall management and control
over such aspects as the production and business, personnel, accounts and properties of an enterprise. The risk that we may be deemed to be a PRC resident enterprise under the PRC Enterprise Income
Tax Law and be subject to the PRC enterprise income tax at the rate of 25% on our worldwide income is disclosed in "Risk FactorsRisks Related to Doing Business in ChinaWe may
be classified as a "resident enterprise" for PRC enterprise income tax purposes, which could result in our global income becoming subject to 25% PRC enterprise income tax."
Share-Based Compensation Expenses
In May 2009, we adopted our 2009 Employee Stock Option Plan, or the 2009 Plan. We reserved 45,000,000 shares for grants
under the 2009 Plan. As of December 31, 2012, options to purchase 25,496,360 ordinary shares were outstanding, 11,285,980 ordinary shares were exercised and
8,217,660 ordinary shares were available for future grants under the 2009 Plan. We did not grant any options prior to 2009.
On
June 24, 2009, we granted options to purchase a total of 10,500,000 ordinary shares at the price of US$0.0400 per share to certain of our employees under the 2009 Plan.
These options are subject to vesting over four years, starting from June 24, 2009, and were valued at the estimated fair value on the date of the award.
In
June 2010, we adopted our 2010 Share Incentive Plan, or the 2010 Plan. We reserved 55,000,000 shares for grants under the 2010 Plan. As of the date December 31,
2012, options to purchase 21,425,000 ordinary shares were outstanding, 8,649,648 restricted shares were outstanding and 21,344,980 ordinary shares were available for future grants
under the 2010 Plan.
On
June 7, 2010, we granted options to purchase a total of 35,175,000 ordinary shares at the price of US$0.0700 per share to certain of our directors, executive officers
and employees under the 2009 Plan. These options are subject to vesting over four years, starting from June 7, 2010, and were valued at the estimated fair market value on the date of
the award.
On
January 4, 2011, we granted options to our employees and a third-party consultant to purchase 16,665,000 and 2,500,000 of ordinary shares of the Company, respectively, at an
exercise price of US$0.3600 per share. These options vest over a four-year requisite service period, with 25% of the options to vest on each anniversary after the grant date. The fair
value of the stock options as of the grant date was US$3,605,856 in the aggregate, or US$0.1881 per share. The options granted to the third-party consultant was subsequently forfeited in
September 2011 as the contract was terminated.
On
May 24, 2011, we granted options to purchase a total of 20,175,000 ordinary shares at the initial public offering price and a total of 4,500,000 restricted shares
to our independent director
78
Table of Contents
appointees,
executive officers and certain employees under the 2010 Plan. The options granted to the independent director appointees are subject to vesting over three years, and the rest are subject
to vesting over four years, starting from May 24, 2011.
On
November 21, 2011, we granted options to an employee of us to purchase up to 150,000 shares under the 2010 Plan. The exercise price of the options is $0.2600 per share.
These options vest over a four-year requisite service period, with 25% of the options to vest on each anniversary after the grant date.
On
February 28, 2012, our compensation committee approved a share option exchange program that offered our eligible directors and employees the right to exchange vested and
unvested outstanding share options to purchase our ordinary shares granted under the 2010 Share Incentive Plan between January 2011 to May 2011 for our restricted shares at the ratio of
3:1. The exchange ratio was determined based on the fair value of replacement restricted shares so that the fair value of the
replacement restricted shares to be issued upon exchange would be approximately equivalent to the fair value of the share options surrendered by an individual on the date of exchange. These
replacement restricted shares are subject to substantially the same vesting schedule as the options that are validly tendered in the exchange offer. A total of 102 directors and employees
accepted the offer, and tendered options to purchase an aggregate of 28,790,000 ordinary shares, including 14,090,000 shares granted on January 4, 2011 and
14,700,000 shares granted on May 24, 2011, in exchange for an aggregate of 9,596,718 restricted shares at a ratio of 3:1, which were granted on March 30, 2012. The exchange
of the share option for restricted shares was accounted for as a modification of share-based award, which involves a cancellation of the original award and an issuance of a new award, with no
incremental compensation cost recognized as the fair value of the restricted shares was not more than the fair value of the options given up on the date of exchange.
On
July 16, 2012, we granted options to employees and directors to purchase up to a total of 19,840,000 ordinary shares under our 2010 Plan. The exercise price of the
options is US$0.2395 per share. These options vest over a four-year period, each with a graded vesting schedule, all commencing on July 16, 2012. We also granted to employees and
directors to purchase up to a total of 400,000 restricted shares for no consideration under the 2010 Plan. These non-vested restricted shares vest over a four-year
requisite service period, with 25% of the options to vest on each anniversary after the grant date.
On
July 20, 2012, we granted options to directors to purchase up to a total of 3,600,000 ordinary shares under our 2010 Plan. The exercise price is US$0.1960 per share.
These options vest over a three year period, each with a graded vesting schedule, all commencing on July 20, 2012.
In
July 2012, we adopted our 2012 Share Incentive Plan, or the 2012 Plan. We reserved 30,000,000 shares for grants under the 2012 Plan. As of December 31, 2012,
there were no options or restricted shares granted under the 2012 Plan.
We
recognize the share grants as compensation for the relevant employees' services to us and recorded share-based compensation expenses. Our share-based compensation expenses amounted to
approximately US$0.2 million, US$2.0 million and US$2.2 million in 2010, 2011 and 2012, respectively.
As
of December 31, 2012, we had US$2.5 million in unrecognized compensation expenses related to non-vested share-based compensation awards, which we expect to
recognize over a weighted average period of 3.1 years, and we had US$3.7 million of total unrecognized compensation expenses related to non-vested restricted shares granted
under the 2010 Plan, which we expect to recognize over a weighted average period of 2.3 years.
We
are required to estimate the grant-date fair value of the share options and other share-based awards that we grant to our employees. The grant date fair value of the share
options granted in the years ended December 31, 2009, 2010 and 2011 was estimated using the Black-Scholes-Merton option-
79
Table of Contents
pricing
model, and the grant date fair value of the share options granted in the year ended December 31, 2012 was estimated using binomial option-pricing model. The fair value of
non-vested restricted shares was computed based on the fair value of our ordinary shares on the grant date. We estimated the expected term based on option terms related to vesting schedule
and expected option expiration date. The volatility rate estimation is developed based on the volatility of the comparable companies within the expected term commensurate with the expected time period
modified to reflect ways in which currently available information indicates that the future of the subject company is reasonably expected. The risk-free interest rate is selected based on
the yield of Chinese International Government Bond, which is denominated in U.S. dollars, with duration closest to the expected term.
In
May 2009, we repurchased 5,000,000 ordinary shares from a shareholder for total cash proceeds of US$160,000. We cancelled the repurchased shares immediately after such
transfer. This repurchase resulted in a compensation charge of US$61,560, which was the difference between the cash consideration paid and the US$0.0214 per share fair value of the ordinary shares on
the repurchase date.
On
November 28, 2011, we announced a share repurchase plan to repurchase up to US$10 million worth of outstanding ADSs over a 12-month period. On
September 28, 2012, we extended the share repurchase plan for another 12 months from November 23, 2012 to November 23, 2013. As of December 31, 2012, we had
repurchased an aggregated of 585,552 ADSs, representing 11,711,040 ordinary shares on the open market for total cash consideration of $2.3 million. All of the above repurchased
ordinary shares were subsequently cancelled.
Since
the completion of our initial public offering, we determined the fair value of the ordinary shares for the above option awards based on the closing price of our ADSs traded on the
NYSE on the grant day. The table below sets forth certain information concerning the options and restricted shares awarded to our directors and executive officers and other individuals as a group on
the dates indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Grant Date/Award Date
|
|
Options
|
|
Restricted
Shares
|
|
Exercise
Price/
Purchase
Price (US$)
|
|
Fair Value of
Ordinary
Shares (US$)
|
|
June 24, 2009
|
|
|
10,500,000
|
|
|
|
|
|
0.0400
|
|
|
0.0214
|
|
June 7, 2010
|
|
|
35,175,000
|
|
|
|
|
|
0.0700
|
|
|
0.0700
|
|
January 4, 2011
|
|
|
19,165,000
|
|
|
|
|
|
0.3600
|
|
|
0.3600
|
|
May 24, 2011
|
|
|
20,175,000
|
|
|
|
|
|
0.4500
|
|
|
0.5000
|
(1)
|
|
|
|
|
|
|
4,500,000
|
|
|
nil
|
|
|
0.5000
|
(1)
|
November 21, 2011
|
|
|
150,000
|
|
|
|
|
|
0.2600
|
|
|
0.2600
|
(2)
|
July 16, 2012
|
|
|
19,840,000
|
|
|
|
|
|
0.2395
|
|
|
0.2395
|
(3)
|
|
|
|
|
|
|
400,000
|
|
|
nil
|
|
|
0.2395
|
(3)
|
July 20, 2012
|
|
|
3,600,000
|
|
|
|
|
|
0.1960
|
|
|
0.1960
|
(4)
|
-
(1)
-
Estimated
based on the mid-point of the estimated public offering price set forth on the front cover of the preliminary prospectus dated
May 24, 2011.
-
(2)
-
Determined
based on the closing price of our ADSs trade on the NYSE on November 21, 2011.
-
(3)
-
Determined
based on the closing price of our ADSs trade on the NYSE on July 16, 2012.
-
(4)
-
Determined
based on the closing price of our ADSs trade on the NYSE on July 20, 2012.
Critical Accounting Policies and Estimates
We prepare our financial statements in conformity with U.S. GAAP, which requires us to make judgments, estimates and assumptions
that affect the reported amounts of assets and liabilities,
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revenues
and expenses, and the disclosure of our contingent assets and liabilities. We continually evaluate these judgments, estimates and assumptions based on the most recently available information,
our own historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about matters that are
not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates.
An
accounting policy is considered critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time such estimate is
made, and if different accounting estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could material impact our
consolidated financial statements. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements. The following
descriptions of critical accounting policies, judgments and estimates should be read in conjunction with our consolidated financial statements and other disclosures included in this
annual report.
When
reviewing our financial statements, you should consider (i) our selection of critical accounting policies, (ii) the judgment and other uncertainties affecting the
application of such policies, and (iii) the sensitivity of reported results to changes in conditions and assumptions.
Revenue Recognition
We earn revenues through developing and operating proprietary online virtual worlds. We provide such services to children via an online
entertainment platform pursuant to a time-based revenue model and an item-based revenue model. Since our inception, we have not licensed or otherwise marketed any of our
proprietary software to third parties except in one instance which was immaterial.
Time-based model
Users pay RMB10 (US$1.6) for a 30-day subscription per virtual world to access
premium features in each of our virtual worlds. We recognize revenue generated from subscription fees ratably over the users' subscription period.
Item-based model
Users purchase our in-game virtual items under this model. Revenues are recognized
over the estimated lives of the in-game virtual premium items purchased or as the virtual premium items are consumed. For the virtual premium items that are immediately consumed, we
recognize revenue upon consumption. For the virtual premium items with no predetermined expiration or permanent items, we recognize revenue ratably over the estimated average lives of the permanent
items (i.e. estimated period paying players play our games), which range from one year to one and a half years. The amount of the unamortized permanent items and unconsumed items are recognized
as deferred revenue. We recognized US$13.0 million, US$21.2 million and US$16.3 million gross revenue from virtual premium items accounted for under the item-based
model for the years ended December 31, 2010, 2011 and 2012, respectively. We estimate the average lives of our permanent items based on an assessment of our historical data and user behavior
patterns, including the average period that users typically stay in our virtual worlds, the age group of our target users, and the number of active paying users in our virtual worlds, and the
promotional events we launched, with reference to industry research data. We assess the estimated lives of our permanent items periodically. If there are indications of any significant changes to the
estimated lives of these permanent items, the revised estimates would be applied prospectively in the period of change. Prior to June 30, 2010, we did not have sufficient historical data from
our virtual worlds to estimate the useful life of the permanent items, and used the industry
research data and peer company information in developing the estimate of the average life of permanent items, which was determined to be one year for all our virtual worlds. Effective July 1,
2010, we changed the accounting estimate of the useful life of our permanent items in Mole's World from one year to 18 months based on an analysis of the life of the virtual world and user
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behavior
patterns using historical user data since the launch of Mole's World in September 2008, and applied such change prospectively. The effect of the change in accounting estimate on the
results of operations for the year ended December 31, 2010 was immaterial. In 2011 and 2012, we did not make changes to the useful life of any of our virtual worlds. We will continue to monitor
the user behavior patterns of each of our virtual worlds and will utilize such information to update the estimates of the useful lives of permanent items.
We
record revenues net of sales discounts and rebates paid to our distributors. The cost of providing free virtual items as a result of promotional activities was immaterial for each of
the three years presented.
Users
pay subscription fees and purchase virtual items using our virtual currency, which can be purchased via various distribution channels, such as our prepaid cards, third-party
prepaid cards, online payment channels, and via short messages, or SMS, through cellular telecom operators. Under both the time-based and the item-based revenue models,
proceeds we receive directly from end users for sales of online points are recorded as deferred revenues, while proceeds we receive from sales of online points to parties in the distribution channel
and from sales of prepaid cards are initially recorded as advances from customers. As we do not have control over and generally do not know the ultimate selling price of the prepaid cards or online
points sold by the distributors, we record net proceeds from the distributors as advances from customers. Upon activation of prepaid cards or purchase of online points, advances from customers are
immediately transferred to deferred revenues.
Prepaid
cards expire on the expiration date printed thereon, which is generally two years after the date of card production. Proceeds from expired prepaid cards that have not been
activated are recognized as other operating income upon expiration of the cards. We recognized US$41,801, US$0.5 million and US$1.9 million in other operating income in connection with
expired prepaid cards for the years ended December 31, 2010, 2011 and 2012, respectively.
Licensing and royalty fee revenue
revenues from our offline business
include licensing income and royalty fees for licensing our proprietary cartoon figures to merchandisers and book publishers Most of the revenues generated under merchandise licensing income and
royalty fees are recognized at the end of each month and calculated at the contractual royalty rate times the sales of the licensed merchandise product for the month. The sales of the licensed product
are derived from the monthly sales reports provided by the licensee.
In
certain of the merchandise licensing arrangements, we receive a guaranteed base fee and additional royalty fees that are contingent on sales volume. Proceeds from minimum guaranteed
royalties in excess of royalties earned are generally recognized as revenues at the end of the contract term. In a small number of our merchandise licensing arrangements, we receive a fixed royalty
fee from the licensee over the contract period. We recognize this type of royalty revenue ratably over the contract period.
Film revenue
we recognize revenue from the distribution of our films when the film is exhibited in theaters, provided that no
significant obligations remain, amounts can be accurately estimated, and collection is reasonably assured.
Revenue
from the distribution of the film on television and websites is recognized when the production is made available for exhibition and when other contractual obligations or
conditions are met.
Merchandise sales revenue
revenues from selling interactive toys, books and merchandise are recognized when persuasive
evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured.
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Table of Contents
Share-based payment transactions with employees, such as share options and non-vested restricted shares, are measured based
on the grant-date fair value of the equity instrument. We recognize share-based compensation costs net of a forfeiture rate on a straight line basis over the requisite service period of
the award, which is generally the same as the vesting period of the award. We adjust the estimated forfeiture rate over the requisite service period to the extent that actual forfeitures differ, or
are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the
amount of share-based compensation costs to be recognized in future periods.
We
are required to estimate the grant-date fair value of the share options and other share-based awards that we grant to our employees. The grant date fair value of the share
options granted in the years ended December 31, 2009, 2010 and 2011 was estimated using the Black-Scholes-Merton option-pricing model, and the grant date fair value of the share options granted
in the year ended December 31, 2012 was estimated using binomial option-pricing model. We estimated the expected term based on option terms related to vesting schedule and expected option
expiration date. The volatility rate estimation was developed based on the volatility of the comparable companies within the expected term commensurate with the expected time period modified to
reflect ways in which currently available information indicates that the future of the subject company is reasonably expected. The risk-free interest rate was selected based on the yield
of Chinese International Government Bond, which is denominated in U.S. dollars, with duration closest to the expected term.
Before
we completed the initial public offer, when we were a private company, we determined the fair value of our ordinary shares as of the grant date of the share-based awards by making
complex and highly subjective judgments and assumptions about our projected financial and operating results. We were also required to make other assumptions such as our weighted average cost of
capital, general market and macroeconomic conditions, nature and prospects of the children's entertainment and media industry, nature and stage of development of our company, comparable companies, and
our business risks. These assumptions were inherently uncertain. Changes in these assumptions could significantly affect the valuation results and the amount of share-based compensation expenses we
recognized in our consolidated financial statements.
The
fair value of our Company's ordinary shares underlying the share options granted prior to our completion of the initial public offering in June, 2011 was estimated by determining the
equity value of our Company and then allocating the equity value into the various classes of shares and options using the option-pricing method, which is one of the generally accepted valuation
methodologies. Firstly, the total equity value was developed by using the discounted cash flow approach and the guideline companies approach, which incorporated certain assumptions including the
market performance of comparable listed companies, as well as the our forecasted financial results and growth trends. We checked the results obtained under the discounted cash flow approach against
the results obtained from the guideline companies approach and found no material discrepancies. Then, equity value was
allocated using the option pricing method under three scenarios, namely liquidation scenario, redemption scenario and IPO scenario (based on the terms of the preferred shares, share options and
management's expectation on an IPO event) to determine the fair value of our ordinary shares. Under the option-pricing method, each class of equity is modeled as a call option with a distinct claim on
the enterprise value of our company. The main inputs to this model included equity value of our company, exercise price, expected volatility, expected term, expected dividend yield and
risk-free interest rate. With regard to the share options and restricted shares that were awarded on May 24, 2011, we used the mid-point of the price range set forth in
the preliminary prospectus of IPO as the estimated fair value of ordinary shares.
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Table of Contents
For
the purpose of determining the estimated fair value of our share options prior to our initial public offering, we believed that the expected volatility is the most sensitive
assumptions since we had limited trading histories at the date we granted our options. Changes in the volatility assumption could significantly impact the estimated fair values of the options
calculated by the Black-Scholes option pricing model. Expected volatility was estimated based upon the average stock price volatility of the comparable companies over a period commensurate with the
expected term of the options. When estimating expected volatility of the share price of a nonpublic entity, historical volatility of other companies in a similar industry group was considered.
Determining
the value of our share-based compensation expense in future periods required the input of highly subjective assumptions, including estimated forfeitures. We estimated the
forfeitures of our share options based on past employee retention rates and our expectations of future retention rates, and we will prospectively revise our forfeiture rates based on actual history.
Our share based compensation expense may change based on changes to our actual forfeitures.
Since
the completion of our initial public offering, we determined the fair value of the ordinary shares for the above option awards based on the closing price of our ADSs traded on the
NYSE on the date of grant.
Our
actual share-based compensation expense may be materially different from our current expectations. As of December 31, 2012, we had US$2.5 million of unrecognized
compensation expense related to unvested options granted under the option plans, which we expect to recognize over a weighted-average period of 3.1 years. As of December 31, 2012, we
also had US$3.7 million of total unrecognized compensation expense related to non-vested restricted shares granted under the 2010 Plan, which is expected to be recognized over a
weighted-average period of 2.3 years.
In
arriving at the equity value of our company, we applied a discount for lack of marketability, or DLOM, of 33.0% for the June 2009 grant, 21.0% for the June 2010 grant
and 7.0% for the January 2011 grant, respectively, to reflect the fact that, at the time of the grants, we were a closely-held company and there was no public market for our
ordinary shares. We used the put option method to estimate the DLOM, taking into consideration factors like the timing of liquidity event such as an IPO and estimated volatility of our ordinary
shares. The decrease in the DLOM was primarily because we were approaching our initial public offering, as the closer the valuation date was from the offering, the lower the put option value was, and
thus the lower the implied DLOM. For the determination of the fair value of the options granted on each of the grant dates prior to the initial public offering and the fair value of the underlying
ordinary shares of our company prior to the initial public offering, we also considered retrospective valuations conducted by an independent appraiser.
Other
general assumptions used in deriving the fair value of the ordinary shares transferred and our total equity value include the following: (i) there will be no material
changes in the existing political, legal, fiscal and economic conditions in China; (ii) there will be no material changes in tax law in China and the tax rates applicable to our subsidiary and
VIE; (iii) exchange rates and interest rates will not differ materially from currently prevailing rates, (iv) the availability of finance will not be a constraint on the future growth of
the Company, (v) the Company will retain and have competent management, key personnel and technical staff to support its ongoing operation, and (vi) there will be no material deviation
in industry trends and market conditions from economic forecasts.
Income taxes
We provide for current income taxes in accordance with the laws of the relevant tax authorities. We recognize deferred income taxes
when temporary differences exist between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements. Net operating loss carry forwards and credits are
applied using enacted statutory tax rates applicable to future years. We reduce deferred tax assets by a valuation allowance when, in the opinion of our management, it is
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Table of Contents
more-likely-than-not
that a portion of or all of our deferred tax assets will not be realized. The components of the deferred tax assets and liabilities are
individually classified as current and non-current based on their characteristics.
We
consider positive and negative evidence when determining whether some portion or all of our deferred tax assets will not be realized. This assessment considers, among other matters,
the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carry-forward periods, our historical results of operations, and our
tax planning strategies. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become
deductible. Based upon the level of our historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, we believe it is
more-likely-than-not that we will realize all the benefits of the deductible differences as of December 31, 2009 and 2010. As of December 31, 2012, we
believe it is more-likely-than-not that Shanghai Animation will not realize the deferred tax assets resulted from the tax loss carried forward in the future
periods. Thus, a full valuation allowances are provided for the deferred tax assets of Shanghai Animation. The amount of the deferred tax assets considered realizable, however, could be reduced in the
near term if estimates of future taxable income during the carry forward periods are reduced. Such reduction of deferred tax asset could increase our income tax expense and adversely affect our
results of operations in the period in which an allowance is recorded.
We
recognize the impact of uncertain income tax positions at the largest amount that is more-likely-than-not to be sustained upon audit by the
relevant tax authority. For a tax position that meets the more-likely-than-not recognition threshold, we initially and subsequently measure the tax benefit as the
largest amount that we judge to have a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority. Our liability associated with unrecognized tax benefits is
adjusted periodically due to changing circumstances, such as the progress of tax audits, case law developments and new or emerging legislation. Such adjustments are recognized entirely in the period
in which they are identified. Our effective tax rate includes the net impact of changes in the liability for unrecognized tax benefits and subsequent adjustments as considered appropriate by our
management. We classify interest and/or penalties related to uncertain tax positions in income tax expense.
Consolidation of VIEs
PRC laws and regulations currently prohibit or restrict foreign ownership of Internet-related business. In order to comply with these
foreign ownership restrictions, we operate our online entertainment community through Shanghai Taomee. We have entered into a series of contractual arrangements with Shanghai Taomee and its equity
owners. As a result of these contractual arrangements, we have the ability and intention to exercise control over the entities and the right and obligation to absorb substantially all of their profits
and losses. Therefore, we have concluded that we are the primary beneficiary of Shanghai Taomee and have consolidated the entities since the date of execution of the contractual arrangements. This
conclusion is predicated on the assumption that the contractual arrangements are legally enforceable, which we have determined based on the advice of our PRC legal counsel. However, there are
substantial uncertainties regarding the interpretation and application of current and future PRC laws and regulations. Any changes in PRC laws and regulations that affect our ability to control
Shanghai Taomee might preclude us from consolidating Shanghai
Taomee in the future. See "Item 3 Key InformationRisks Related to Our Corporate Structure.
85
Table of Contents
Results of Operations
The following table sets forth a summary of our consolidated results of operations for the periods indicated both in absolute amount
and as a percentage of our total net revenues.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For Years Ended December 31,
|
|
|
|
2010
|
|
2011
|
|
2012
|
|
|
|
US$
|
|
%
|
|
US$
|
|
%
|
|
US$
|
|
%
|
|
|
|
(in thousands, except percentages)
|
|
Net revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Online business
|
|
$
|
33,683
|
|
|
93.6
|
|
$
|
40,331
|
|
|
88.8
|
|
$
|
32,169
|
|
|
80.0
|
|
Offline business
|
|
|
2,290
|
|
|
6.4
|
|
|
5,066
|
|
|
11.2
|
|
|
8,039
|
|
|
20.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenues
|
|
|
35,973
|
|
|
100.0
|
|
|
45,397
|
|
|
100.0
|
|
|
40,208
|
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of services:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Online business
|
|
|
(5,166
|
)
|
|
(14.4
|
)
|
|
(6,035
|
)
|
|
(13.3
|
)
|
|
(6,950
|
)
|
|
(17.3
|
)
|
Offline business
|
|
|
(686
|
)
|
|
(1.9
|
)
|
|
(1,653
|
)
|
|
(3.6
|
)
|
|
(3,048
|
)
|
|
(7.6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
30,122
|
|
|
83.7
|
|
|
37,709
|
|
|
83.1
|
|
|
30,210
|
|
|
75.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product development expenses
|
|
|
(4,649
|
)
|
|
(12.9
|
)
|
|
(10,304
|
)
|
|
(22.7
|
)
|
|
(12,318
|
)
|
|
(30.6
|
)
|
Sales and marketing expenses
|
|
|
(1,570
|
)
|
|
(4.4
|
)
|
|
(6,255
|
)
|
|
(13.8
|
)
|
|
(9,966
|
)
|
|
(24.8
|
)
|
General and administrative expenses
|
|
|
(5,729
|
)
|
|
(15.9
|
)
|
|
(7,965
|
)
|
|
(17.5
|
)
|
|
(10,078
|
)
|
|
(25.1
|
)
|
Other operating income
|
|
|
278
|
|
|
0.8
|
|
|
1,734
|
|
|
3.8
|
|
|
5,512
|
|
|
13.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
(11,670
|
)
|
|
(32.4
|
)
|
|
(22,790
|
)
|
|
(50.2
|
)
|
|
(26,850
|
)
|
|
(66.8
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
18,452
|
|
|
51.3
|
|
|
14,919
|
|
|
32.9
|
|
|
3,360
|
|
|
8.4
|
|
Interest income, net
|
|
|
240
|
|
|
0.7
|
|
|
1,410
|
|
|
3.1
|
|
|
2,647
|
|
|
6.6
|
|
Other income (expenses), net
|
|
|
(115
|
)
|
|
(0.3
|
)
|
|
667
|
|
|
1.5
|
|
|
859
|
|
|
2.1
|
|
Income before income taxes and share of profit in equity method investments
|
|
|
18,577
|
|
|
51.7
|
|
|
16,996
|
|
|
37.4
|
|
|
6,866
|
|
|
17.1
|
|
Income tax (expense)/benefit:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
(7
|
)
|
|
(0.0
|
)
|
|
(2,539
|
)
|
|
(5.6
|
)
|
|
1,279
|
|
|
3.2
|
|
Deferred
|
|
|
2,511
|
|
|
7.0
|
|
|
812
|
|
|
1.8
|
|
|
(424
|
)
|
|
(1.1
|
)
|
Total income tax (expenses)/benefits
|
|
|
2,504
|
|
|
7.0
|
|
|
(1,727
|
)
|
|
(3.8
|
)
|
|
855
|
|
|
2.1
|
|
Income before share of profit in equity method investments
|
|
|
21,081
|
|
|
58.6
|
|
|
15,269
|
|
|
33.6
|
|
|
7,721
|
|
|
19.2
|
|
Share of profit in equity method investments
|
|
|
494
|
|
|
1.4
|
|
|
4,224
|
|
|
9.3
|
|
|
1,140
|
|
|
2.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
21,574
|
|
|
60.0
|
|
|
19,493
|
|
|
42.9
|
|
|
8,861
|
|
|
22.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: Net loss attributable to non-controlling interest
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1
|
)
|
|
0.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income attributable to Taomee Holdings Limited
|
|
|
21,574
|
|
|
60.0
|
|
|
19,493
|
|
|
42.9
|
|
|
8,862
|
|
|
22.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deemed dividend on Series A convertible redeemable preferred shares
|
|
|
(469
|
)
|
|
(1.3
|
)
|
|
(200
|
)
|
|
(0.4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income attributable to holders of ordinary shares
|
|
$
|
21,105
|
|
|
58.7
|
|
$
|
19,293
|
|
|
42.5
|
|
$
|
8,862
|
|
|
22.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reportable Segments
For 2010, 2011 and 2012, we had two reportable segments: (i) online business and (ii) offline business. Segment revenues
from the online business segment and our offline business segment accounted for 93.6% and 6.4%, respectively, in 2010, 88.8% and 11.2%, respectively, in 2011, and 80.0% and 20.0%, respectively, in
2012. The online business segment comprises primarily the operation of the virtual worlds offered through our online virtual community and mobile games and applications. In 2011 and 2012, the offline
business segment comprised primarily of the licensing of our franchises to book publishers and makers of consumer products, as well as revenues from film series and interactive
86
Table of Contents
toys
featuring our cartoon figures. We do not allocate operating expenses to the segments. The following table sets forth our net revenues, gross profit and gross profit margin by segment for the
periods indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2010
|
|
2011
|
|
2012
|
|
|
|
Segment
Net
Revenues
|
|
Segment
Gross
Profit
|
|
Segment
Gross
Margin
|
|
Segment
Net
Revenues
|
|
Segment
Gross
Profit
|
|
Segment
Gross
Margin
|
|
Segment
Net
Revenues
|
|
Segment
Gross
Profit
|
|
Segment
Gross
Margin
|
|
|
|
US$
|
|
US$
|
|
%
|
|
US$
|
|
US$
|
|
%
|
|
US$
|
|
US$
|
|
%
|
|
|
|
(in thousands, except percentages)
|
|
Reportable Segments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Online business
|
|
|
33,683
|
|
|
28,517
|
|
|
84.7
|
|
|
40,331
|
|
|
34,295
|
|
|
85.0
|
|
|
32,169
|
|
|
25,220
|
|
|
78.4
|
|
Offline business
|
|
|
2,290
|
|
|
1,605
|
|
|
70.1
|
|
|
5,066
|
|
|
3,414
|
|
|
67.4
|
|
|
8,039
|
|
|
4,990
|
|
|
62.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
35,973
|
|
|
30,122
|
|
|
83.7
|
|
|
45,397
|
|
|
37,709
|
|
|
83.1
|
|
|
40,208
|
|
|
30,210
|
|
|
75.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2012 Compared to Year Ended December 31, 2011
Net Revenues.
Our net revenues decreased by 11.4% from US$45.4 million in 2011 to US$40.2 million in 2012. This
decrease was primarily
due to the decline in online revenues and was partially offset by the increase in offline revenues.
Online Business.
Net revenues generated from the online business decreased from US$40.3 million in 2011 to US$32.2 million in
2012. The
decrease was primarily due to the implementation of our strategy to focus less on short-term revenue growth and instead invest in long-term brand enhancement and platform
expansion to attract new users and increase user stickiness.
Offline Business.
Net revenues generated from our offline business increased by 58.7% to US$8.0 million in 2012 from approximately
US$5.1 million in 2011. This increase was primarily due to the increase in revenues generated from our co-branding and merchandise licensing, revenue-sharing arrangements for two
films based on the Mole and Seer franchises and revenue contributed by the interactive toy design and sales business.
Cost of Services.
Our cost of services increased from US$7.7 million in 2011 to US$10.0 million in 2012, primarily due
to the increased
costs related to the development of both online and offline businesses.
Online Business.
Cost of services relating to our online business increased by 15.2% to US$6.9 million in 2012 from
US$6.0 million in
2011. This increase was primarily due to an increase in personnel-related expenses, wireless products hosting cost as a result of the increased wireless revenue and amortization costs associated with
game licensing fees.
Offline Business.
Cost of services relating to our offline business increased by 84.5% to US$3.0 million in 2012 from
approximately
US$1.7 million in 2011. This significant increase was primarily due to the increase in personnel-related expenses, the film production costs, interactive toy inventory costs.
Gross Profit.
As a result of the foregoing, our gross profit decreased to US$30.2 million in 2012 from US$37.7 million
in 2011, and our
gross margin decreased to 75.1% in 2012 from 83.1% in 2011, as a result of the decreased net revenue and increased cost of services.
Operating Expenses.
Our operating expenses increased by 17.8% to US$26.8 million in 2012 from US$22.8 million in 2011.
The increase in
our operating expenses was primarily due to the increase in
87
Table of Contents
sales
and marketing expenses, and to a lesser extent, increase in product development expenses and general and administrative expenses.
-
-
Product Development Expenses.
Our product development
expenses increased by 19.5% from US$10.3 million in 2011 to US$12.3 million in 2012. The increase was primarily attributable to an increase in personnel-related expenses associated with
headcount expansion and partially offset by a decrease in outsourced R&D expenses, amortization costs and share-based compensation. We also hired new staffs for the development of new product and
services including approximately 35 new employees for the mobile application research team. The number of our product development staff increased from 342 as of December 31, 2011
to 368 as of December 31, 2012.
-
-
Sales and Marketing Expenses.
Our sales and marketing
expenses increased by 59.3% from US$6.3 million in 2011 to US$10.0 million in 2012. The increase was primarily attributable to the increase of personnel-related expenses, the increased
advertising and promotional activities, including the costs associated with the promotion for our new films, as well as an increase in animation production expenses.
-
-
General and Administrative Expenses.
Our general and
administrative expenses increased by 26.5% from US$8.0 million in 2011 to US$10.1 million in 2012. The increase was primarily due to the increased personnel-related expenses in
connection with new hires and share-based compensation, traveling expenses and daily office expenses, incremental expenses associated with being a listed company as well as increased investment
activities.
-
-
Other Operating Income.
We had other operating income of
US$5.5 million in 2012, a significant increase of 218.0% from US$1.7 million in 2011, as we received more government subsidies and recognized US$1.9 million of other operating
income as a result of the expiration of prepaid cards.
Income Tax Benefit/(Expense).
We had income tax benefit of US$0.9 million in 2012, compared to an income tax expense of
approximately
US$1.7 million in 2011. The change was primarily due to our recognition of a one-time income tax benefit of US$2.1 million as a result of governmental approval for tax
reduction for the year of 2011.
Interest Income, Net.
Our net interest income increased to approximately US$2.6 million in 2012 from approximately
US$1.4 million in
2011 primarily due to the increase in our cash balance.
Other Income (Expenses), Net.
Our other income increased to US$0.9 million in 2012 from approximately US$0.7 million
in 2011 primarily
due to exchange gains from our deposit denominated in RMB.
Share of Profit in Equity Method Investments.
Share of profit in equity investment was US$1.1 million in 2012, compared with
US$4.2 million in 2011. The decrease is mainly due to the gains on disposals, whereby in 2012 we disposed all our equity interest in Shenzhen Ruigao for US$1.0 million and recorded a
gain of US$0.3 million in 2012, compared with a gain of US$3.7 million recognized from the sale of 10.5% equity interest in Elyn Corporation in 2011.
Net Income.
As a result of the foregoing, our net income decreased from US$19.5 million in 2011 to US$8.9 million
in 2012.
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010
Net Revenues.
Our net revenues increased by 26.1% from US$36.0 million in 2010 to US$45.4 million in 2011. This
increase was primarily
due to increases in revenues from our online business and offline businesses.
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Table of Contents
Online Business.
Net revenues generated from the online business increased from US$33.7 million in 2010 to US$40.3 million in
2011. The
growth was driven by both the growth of our existing self-developed franchises as well as revenues from third-party developed games available to users on our platform. Our ARPU increased
from approximately US$3.9 in the three months ended December 31, 2010 to US$4.7 in the three months ended December 31, 2011, mainly as a result of increased virtual item sales. The price
we charged for our 30-day subscription of premium features and virtual items did not change between these two periods. In the fourth quarter of 2011, we decided to temporarily decelerate
monetization in an effort to attract new users and enhance user stickiness.
Offline Business.
Net revenues generated from our offline business increased significantly to US$5.1 million in 2011 from
approximately
US$2.3 million in 2010. This increase was primarily due to revenues generated from the our co-branding and merchandise licensing contracts, proceeds-sharing arrangements for the
film based on the Seer franchise and royalty received from publishers of children's books.
Cost of Services.
Our cost of services increased from US$5.9 million in 2010 to US$7.7 million in 2011, primarily due
to the expansion
of our online and offline operations.
Online Business.
Cost of services relating to our online business increased by 16.8% to US$6.0 million in 2011 from
US$5.2 million in
2010. This increase was primarily due to an increase in our salaries and benefits expenses related to our operational employees and an increase in share-based compensation.
Offline Business.
Cost of services relating to our offline business increased to US$1.7 million in 2011 from approximately
US$0.7 million in 2010. This increase was primarily due film and animations production costs as well as increases in the salaries and benefits payment to the newly-hired employees for the
offline business.
Gross Profit.
As a result of the foregoing, our gross profit increased substantially to US$37.7 million in 2011 from
US$30.1 million in
2010, and our gross margin decreased slightly to 83.1% in 2011 from 83.7% in 2010, as the growth in our cost of services slightly outpaced the growth in our net revenues.
Operating Expenses.
Our operating expenses increased by 95.3%, or US$11.1 million, to US$22.8 million in 2011 from
US$11.7 million in 2010. The increase in our operating expenses was primarily due to increases in product development expenses and sales and marketing expenses, and to a lesser extent,
increases in general and administrative expenses.
-
-
Product Development Expenses.
Our product development
expenses increased by 121.6% from US$4.6 million in 2010 to US$10.3 million in 2011. The increase was primarily attributable to an increase in salary and benefits expenses as additional
software engineers, development staff, and creative technicians including writers, virtual world architects, and graphic artists were hired. We also hired new staff for the development of new product
and services including mobile applications, platform services and online video. The number of our product development staff increased from 262 as of December 31, 2010 to 342 as of
December 31, 2011.
-
-
Sales and Marketing Expenses.
Our sales and marketing
expenses increased by 298.4% from US$1.6 million in 2010 to US$6.3 million in 2011. The increase was primarily attributable to higher advertising and promotional activities, including
those related to new product launches throughout 2011, as well as an increase in branding-related animation production expenses.
-
-
General and Administrative Expenses.
Our general and
administrative expenses increased by 39.0% from US$5.7 million in 2010 to US$8.0 million in 2011. The increase was primarily due to the increase in share base compensation and
incremental expenses as a listed company.
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Table of Contents
-
-
Other Operating Income.
We had other operating income of
US$1.7 million in 2011 as we received government subsidies in the third and fourth quarter of 2011 and recognized a small amount of other operating income as a result of the expiration of
prepaid cards.
Income Tax Benefit/(Expense).
We had income tax expenses of US$1.7 million in 2011, compared to an income tax benefit of
approximately
US$2.5 million in 2010, due to the changes in the corporate income tax rate eligibility of Shanghai Shengran and Shanghai Taomee in 2011. Shanghai Shengran obtained a software enterprise
certificate in 2010 and was informed in April 2011 that the full EIT exemption would apply retroactively in 2009 and 2010, and 50% reduction in EIT rate will apply from 2011 to 2013.In
May 2012, Shanghai Shengran further received a written approval from local tax authorities, according to which Shanghai Shengran was entitled to the full EIT exemption for 2010 and 2011, and
50% reduction in EIT rate, i.e. EIT rate of 12.5%, from 2012 to 2014, which resulted in an adjustment of US$2.1 million as a one-time tax benefit in 2012. Shanghai Taomee
obtained a software enterprise certificate in 2009 and is entitled to corporate income tax exemption in 2009 and 2010 and 50% tax reduction in the following three years from 2011 to 2013. Shanghai
Taomee's tax holiday period was approved by relevant tax authorities in May 2010. Shanghai Taomee was subject to a tax rate of 12.5% in 2011, compared to nil in 2010. Our effective tax rate was
18.2% in 2009, negative 13.1% in 2010, and 10.2% in 2011.
Interest Income, Net.
Our net interest income increased to approximately US$1.4 million in 2011 from approximately
US$0.2 million in
2010 as a result of higher interest income from our demand deposit as our cash balance increased which includes the proceeds we received from the initial public offering and as we received higher
interest rate on our deposits.
Other Income (Expenses), Net.
Our other income was US$0.7 million in 2011, compared to other expense of approximately
US$0.1 million in
2010 primarily due to exchange gains from our deposit denominated in RMB.
Share of Profit/Loss in Equity Method Investments.
Share of profit in equity investment was US$4.2 million in 2011,
compared with
US$0.5 million in 2010 mainly due to we sold 10.5% of equity interest in Elyn Corporation in February 2011 and recorded a gain of US$3.7 million.
Net Income.
As a result of the foregoing, our net income decreased from US$21.6 million in 2010 to US$19.5 million
in 2011.
B.
Liquidity and Capital Resources
The following table sets forth a summary of our cash flows for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended
December 31,
|
|
|
|
2010
|
|
2011
|
|
2012
|
|
|
|
(US$ in thousands)
|
|
Net cash provided by operating activities
|
|
|
37,012
|
|
|
22,386
|
|
|
7,162
|
|
Net cash provided by (used in) investing activities
|
|
|
(3,777
|
)
|
|
707
|
|
|
(7,731
|
)
|
Net cash provided by (used in) financing activities
|
|
|
(1,464
|
)
|
|
52,959
|
|
|
(1,667
|
)
|
Effect of exchange rate changes
|
|
|
481
|
|
|
1,540
|
|
|
128
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
32,252
|
|
|
77,592
|
|
|
(2,108
|
)
|
Cash and cash equivalents, beginning of the period
|
|
|
10,835
|
|
|
43,087
|
|
|
120,679
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of the period
|
|
|
43,087
|
|
|
120,679
|
|
|
118,571
|
|
|
|
|
|
|
|
|
|
To
date, we have financed our operations primarily through cash from operations and proceeds from our initial public offering. We did not have any short-term or
long-term bank borrowings
90
Table of Contents
outstanding
as of December 31, 2010, 2011 and 2012. As of December 31, 2011 and 2012, we had US$120.7 million and US$118.6 million in cash and cash equivalents,
respectively. The decrease of the cash and cash equivalents from 2011 to 2012 was primarily due to the cash used in making certain equity investments in 2012 and to a lesser extent the cash used in
financing activities, which were offset by the cash provided by operating activities. The decrease in cash provided by operating activities from 2011 to 2012 was primarily attributable to the decrease
in revenues of our online business, partially offset by the increases in our offline business revenues.
In
November 2010, we declared a cash dividend of US$10.0 million to be paid out of our current cash reserves to our shareholders who were record holders of ours as of
October 31, 2010, of which we paid US$1.05 million in December 2010 and an additional US$2.55 million in March 2011, and paid the rest in the second half of 2011. We
did not declare any dividend in 2012.
We
are a holding company, and we rely principally on dividends and other distributions from our subsidiary in China for our cash requirements. We receive economic benefits generated from
our significant VIE, Shanghai Taomee, through various contractual arrangements entered into by Shanghai Shengran, our PRC subsidiary, with Shanghai Taomee. Such contractual arrangements include
business operation agreement, commercial cooperation agreement and equity interest pledge agreement with Shanghai Taomee. Under these contractual arrangements, Shanghai Taomee will pay to Shanghai
Shengran its earnings in RMB in the form of services fees. Under China's existing foreign exchange regulations, our PRC subsidiary is able to make payments of current accounts, like dividends to its
offshore holding companies, in foreign currencies, without prior approval from the SAFE, after complying with certain procedural requirements. See "Item 3. Key InformationRisk
FactorsRisks Related to Doing Business in ChinaGovernmental control of currency conversion may affect the value of your investment" and "Item 3. Key
InformationRisk FactorsRisks Related to Doing Business in ChinaWe may be subject to penalties, including restriction on our ability to inject capital into our
PRC subsidiary and our PRC subsidiary's ability to distribute profits to us, if our PRC resident shareholders or beneficial owners fail to comply with relevant PRC foreign exchange rules."
In
addition, current PRC regulations permit our subsidiary to pay dividends to us only out of its accumulated profits, if any, determined in accordance with PRC accounting standards and
regulations. Each of our subsidiary and VIEs in China is required to set aside at least 10% of its after tax profits, as determined on a calendar year basis and in accordance with PRC GAAP, if any, to
fund a statutory reserve until such reserve reaches 50% of its registered capital. The registered capital of Shanghai Taomee and Shanghai Shengran are RMB10 million and US$2.5 million,
respectively. As of the date of this annual report, Shanghai Taomee and Shanghai Shengran have made allocations to the statutory reserve fund in compliance with the applicable PRC laws and
regulations. Each of Shanghai Taomee and Shanghai Shengran has made no allocations for the year ended December 31, 2012 because their statutory reserves have reached 50% of their registered
capital, the maximum amount required under the PRC regulations. These reserves are not distributable as cash dividends.
We
determine the amount of statutory reserves to be set aside each year in accordance with PRC regulations based the amount of accumulated profits of our subsidiary and VIEs in China as
determined under PRC GAAP. The differences in the amount of accumulated profits under PRC GAAP and the amount of retained earnings in our financial statements, prepared and presented in accordance
with U.S. GAAP, relate to the different methods of revenue recognition and accounting for share-based compensation under PRC GAAP and U.S. GAAP. After 2010, such differences between PRC
GAAP and U.S. GAAP will no longer be relevant as we do not expect our PRC VIEs and subsidiary to set aside additional amounts as statutory reserves after reaching the maximum amounts required
by the relevant PRC laws.
We
believe that our current levels of cash balances and cash flows from operations will be sufficient to meet our anticipated cash needs to fund our operations for at least the next
12 months.
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However,
we may need additional cash resources in the future if we experience adverse business conditions or other developments or if we find and wish to pursue opportunities for investment,
acquisitions, strategic cooperation or other similar actions.
Operating Activities
Our net cash provided by operating activities in 2012 was approximately US$7.2 million. This is based on our net income of
US$8.9 million in 2012, positively adjusted by a US$2.3 million increase in share-based compensation and US$0.6 million dividends received from Elyn Corporation and Joy Children.
This was partly offset primarily by a US$2.2 million adjustment in income tax recoverable, as well as a US$2.1 million decrease in advance from customers, a
US$0.9 million decrease in deferred revenue and a US$0.9 million decrease in accounts receivable which are attributable to the decrease of our revenues of 2012 compared to the revenue of
2011, and, to a lesser extent, by adjustment of accrued expenses, accounts payables, deferred income tax, prepayments and other assets.
Our
net cash provided by operating activities in 2011 was approximately US$22.4 million. This is based on our net income of US$19.5 million in 2011, positively adjusted by
a US$2.0 million increase in share-based compensation, a US$2.1 million increase in deferred revenues, a US$2.2 increase in income taxes payable, a US$1.5 million increase in
advance from customers as our online business segment grew from 2010 to 2011. This was partly offset by a US$1.0 million decrease in accounts receivable, a US$0.4 million decrease in
accrued expenses and other current liabilities, and a US$1.5 million adjustment to amounts due from related parties, accounts payable, amounts due to related parties, prepaid and other current
assets and deferred income taxes, and other assets. The change in accrued expenses and other current liabilities were largely due to an increase in unpaid professional fees.
Our
net cash provided by operating activities in 2010 was approximately US$37.0 million. This is based on our net income of US$21.6 million in 2010, positively adjusted by
an approximately US$8.9 million increase in deferred revenues and a US$5.2 million increase in advance from customers as our online business segment grew rapidly from 2009 to 2010. This
was partly offset by a US$3.7 million increase in accrued expenses and other current liabilities such as accruals for wages and bonuses as well as fees for professional services and a
US$2.7 million adjustment to decrease net income due to changes in trade receivables, prepaid and other current assets and deferred income taxes, and other assets. The changes in prepaid and
other current assets were due to increases in prepaid lease expenses, prepaid advertising expenses and advances to our employees for business purposes. The changes in other assets were due to an
increase in lease deposit.
Investing Activities
Our net cash used in investing activities in 2012 was approximately US$7.7 million, primarily due to US$7.0 million paid
to acquire equity investees, including the purchase of 8.02% equity interest in Gamespedia, US$1.4 million for the purchase of intangible assets such as Canimals franchise and additional three
franchises for our future pipeline from Voozclub, and the exclusive licensing right of two online games from our related parties, and to a lesser extent, US$0.3 million paid for the purchase of
property and equipment for our ordinary course of business. This was partly offset by US$1.0 million proceeds from the sale of all our equity interest in Shenzhen Ruigao.
Our
net cash provided by investing activities in 2011 was approximately US$0.7 million, primarily as a result of US$3.9 million from the proceeds from our sale of a 10.5%
equity interest in Elyn Corporation in February 2011, and partly offset by US$1.2 million payment to a third party game company as upfront licensing fee, US$1.1 million in
investment in an equity investee, and US$0.8 million in purchase of property and equipment.
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Our
net cash used in investing activities was US$3.8 million in 2010, of which US$3.0 million was used to purchase property and equipment, and the rest was used to make
loans to related parties and for an investment in the equity interest of Shenzhen Ruigao.
Financing Activities
Our net cash used in financing activities in 2012 was approximately US$1.7 million, resulting from US$1.7 million used in
repurchase of ordinary shares and US$0.3 million as issuance costs of our ordinary shares, and was offset by US$0.3 million received from exercise of share options.
Our
net cash provided by financing activities in 2011 was approximately US$53.0 million, resulting from the proceeds of US$69.4 million received from the initial public
offering, and was offset by US$9.0 million of cash dividends paid, US$6.9 million payment of initial public offering costs and US$0.6 million used to repurchase of ordinary
shares.
Our
net cash used in financing activities was US$1.5 million in 2010, of which US$1.05 million was used to pay a cash dividend declared in November 2010 and the rest
was used to pay expenses related to the initial public offering.
Capital Expenditures
We had capital expenditures of US$3.0 million, US$2.1 million and US$1.7 million for 2010, 2011 and 2012,
respectively. Our capital expenditures were used primarily for (i) purchase of computer hardware and equipment, (ii) purchase of intangible assets, and (iii) purchase of
franchises and online game licensing rights for our pipeline. Actual future capital expenditures may differ from the amounts indicated above.
Restricted Net Assets
Pursuant to laws applicable to entities incorporated in the PRC, our subsidiaries and the VIEs in the PRC must make appropriations from
after-tax profit to non-distributable reserve funds. These reserve funds include one or more of the following: (i) a general reserve, (ii) an enterprise expansion
fund and (iii) a staff bonus and welfare fund. Subject to certain cumulative limits, the general reserve fund requires annual appropriation of 10% of after tax profit (as determined
under accounting principles generally accepted in the PRC at each year-end) until the accumulative amount of such reserve fund reaches 50% of their registered capital; the other fund
appropriations are at the subsidiaries' discretion. These reserve funds can only be used for specific purposes of enterprise expansion and staff bonus and welfare and are not distributable as cash
dividends and amounted to US$2.0 million as of December 31, 2012. In addition, due to restrictions on the distribution of registered capital from our PRC subsidiaries, the PRC
subsidiaries' registered capital of US$10.3 million as of December 31, 2012, were considered restricted. As a result of these PRC laws and regulations, as of December 31, 2012,
approximately US$12.3 million, were not available for distribution to the Company by its PRC subsidiaries in the form of dividends, loans or advances.
C.
Research and Development, Patents and Licenses, etc.
We have created a proprietary engine for powering our virtual worlds. Our scalable hardware infrastructure allows us to cost-effectively accommodate
rapid growth in user base and traffic. The advanced modular architecture of our technology platform allows us to quickly update the content of our virtual worlds with new features, shorten development
cycles and rapidly roll out new virtual worlds and other services. The layering of more advanced features and functionalities afford us opportunities to increase the monetization of our user base. Our
reliable account and virtual currency management system and integrated prepaid card and online payment systems also allow us to analyze user spending patterns and quickly monetize any new virtual
worlds and services. Our research and development team
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possesses
extensive experience in Flash and HTML5 technologies and is credited with the creation of innovative and advanced features, such as the continuous side-scrolling action
scenes that deliver a superior and highly engaging user experience and add monetization values. Our technology platform also features a scalable data warehouse and advanced data and integrated data
analytical functions that help us measure the popularity of themes, features and virtual items. This
helps our product development team understand user preferences and develop content that enhances user experience and creates better monetization potential.
In
each of the three years ended December 31, 2010, 2011 and 2012, our research and development expenditures, including share-based compensation expenses for research and
development staff, were US$4.6 million, US$10.3 million and US$12.3 million, representing 12.9%, 22.7% and 30.6% of our total net revenues for 2010, 2011 and 2012, respectively.
Our research and development expenses consist primarily of payroll expenses, share-based compensation expenses and rental expenses. We have expensed all of the development costs for the research and
development of products.
Intellectual Property
We regard our copyrights, trademarks, trade secrets and similar intellectual property as critical to our success, and rely on trademark
and copyright law, trade secret protection and confidentiality and/or license agreements with our employees, suppliers and others to protect our proprietary rights. All of our research and development
personnel have entered into confidentiality and proprietary information agreements or contract clauses with us. These agreements address intellectual property protection issues and require our
employees to assign to us all of the inventions, designs, and technologies they develop during their employment with us.
As
of December 31, 2012, we received approval for 211 and seven trademark registrations in China and Taiwan respectively and are in the process of applying for registration of
187 trademarks in China. In addition, we have obtained 48 copyright registrations for software we developed, two of which were jointly developed and owned by us and other parties
unrelated to us, three copyright registrations for Mole's World and Seer animation series and 356 copyright registrations for artworks which were produced by our employees and owned by us. We
also registered 30 domain names, including www.61.com, our primary operation website, and www.taomee.com, our corporate information website.
Under
the contractual arrangements we enter into with producers of film and television series, we either wholly own or jointly own the intellectual property rights for newly created
characters in the television series and films we help develop.
While
we actively take steps to protect our proprietary rights, such steps may not be adequate to prevent the infringement or misappropriation of our intellectual property. This is
particularly the case in China where the laws may not protect our proprietary rights as fully as in the United States. Infringement or misappropriation of our intellectual property could
materially harm our business.
D.
Trend Information
Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events for the year ended
December 31, 2012 that are reasonably likely to have a material adverse effect on our net revenues, income, profitability, liquidity or capital resources, or that would cause the 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 financial guarantees or other commitments to guarantee the payment obligations of any third parties. In addition, we have not entered
into any derivative contracts
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that
are indexed to our own shares and classified as shareholder's equity, or that are not reflected in our consolidated financial statements. Furthermore, we 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. Moreover, we do not have any variable interest in any unconsolidated
entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.
F.
Contractual Obligations
The following table sets forth our operating lease obligations as of December 31, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
|
|
|
|
Less than
1 Year
|
|
1 - 3 Years
|
|
3 - 5 Years
|
|
More than
5 years
|
|
Total
|
|
|
|
(US$ in thousands)
|
|
Operating lease obligations
|
|
|
2,541
|
|
|
3,272
|
|
|
|
|
|
|
|
|
5,813
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
2,541
|
|
|
3,272
|
|
|
|
|
|
|
|
|
5,813
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our
operating lease obligations related to lease agreements for our corporate offices and Internet data centers.
In
December 2012, we entered into an investment agreement of US$1.4 million in Voozclub Co., Ltd., or Voozclub, a Korean animation studio and content
developer, to acquire 10% of its equity interest. The total consideration was paid in cash in January 2013.
In
December 2012, Shanghai Taomee entered into an agreement with a third party to obtain the exclusive license right of a cartoon style action game. As of December 31,
2012, Shanghai Taomee shall pay RMB5.0 million (approximately US$0.8 million) as license fee, and RMB5.0 million (approximately US$0.8 million) as minimum guarantee,
respectively in 2013, and an amount up to RMB7.0 million (approximately US$1.1 million) of operating premium in 2013 if certain revenue milestones are met.
Other
than the obligations set forth above, we did not have any long-term debt obligations, capital lease obligations, purchase obligations or other long-term
liabilities as of December 31, 2012.
G.
Safe Harbor
This annual report contains forward-looking statements that are based on our management's beliefs and assumptions and on information currently available to us.
These statements involve known and unknown risks, uncertainties and other factors, including those listed under "Risk Factors," which may cause our actual results, performance or achievements to be
materially different from those expressed or implied by the forward-looking statements.
In
some cases, you can identify these forward-looking statements by words or phrases such as "may," "will," "expect," "anticipate," "aim," "estimate," "intend," "plan," "believe,"
"potential," "continue," "is/are likely to" or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and
financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include, among other things,
statements relating to:
-
-
our business strategies and initiatives as well as our business plans;
-
-
our future business development, results of operations and financial condition;
-
-
expected changes in our revenues and certain cost or expense items;
-
-
our expectations with respect to increased revenue growth and our ability to sustain profitability;
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-
-
our services and products under development or planning;
-
-
our ability to attract users and further enhance our brand recognition; and
-
-
trends and competition in the children's entertainment and media market and industry, including those for online
entertainment.
This
annual report also contains data related to the children's online entertainment industry in China, including projections that are based on a number of assumptions. These market
data, including the public data from EntGroup.cn include projections that are based on a number of assumptions. The children's entertainment and media market and children's product market in China may
not grow at the rates suggested by the market data, or at all. The failure of the markets to grow at the projected rates may have a material adverse effect on our business and the market price of our
ADSs. In addition, the rapidly changing nature of the children's online entertainment industry in China subjects any projections or estimates relating to the growth prospects or future condition of
our market to significant uncertainties. If any one or more of the assumptions underlying the market data turns out to be incorrect, our actual results may differ from the projections based on these
assumptions.
You
should read thoroughly this annual report and the documents that we refer to in this annual report with the understanding that our actual results in the future may be materially
different from or worse than what we expect. We qualify all of our forward-looking statements by these cautionary statements. Other sections of this annual report include additional factors which
could adversely affect our business and financial performance. Moreover, we operate in an evolving environment. New risk factors and uncertainties emerge from time to time and it is not possible for
our management to predict all risk factors and uncertainties, nor can we assess the impact of all factors on our business or the extent to
which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
You
should not rely upon forward-looking statements as predictions of future events. We undertake no obligation to update or revise any forward-looking statements, whether as a result of
new information, future events or otherwise.
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A.
Directors and Senior Management
The following table sets forth information regarding our directors and executive officers as of the date of this annual report.
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|
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|
|
Directors and Executive Officers
|
|
Age
|
|
Position/Title
|
Jason Liqing Zeng
|
|
|
43
|
|
Chairman
|
Benson Haibing Wang
|
|
|
32
|
|
Co-Founder, Director and Chief Executive Officer
|
Crow Zhen Wei
|
|
|
37
|
|
Co-Founder, Director and Chief Technology Officer
|
Roc Yunpeng Cheng
|
|
|
35
|
|
Co-Founder, Director and President
|
JP Gan
|
|
|
41
|
|
Independent Director
|
Shengwen Rong
|
|
|
44
|
|
Independent Director
|
Ted Lai
|
|
|
42
|
|
Independent Director
|
Changtian Wang
|
|
|
47
|
|
Independent Director
|
George Kuan
|
|
|
39
|
|
Independent Director
|
Paul Keung
|
|
|
42
|
|
Chief Financial Officer
|
Frank Chenghua Zhu
|
|
|
34
|
|
Executive vice president
|
Tiffany Tiefeng Qiang
|
|
|
34
|
|
Vice president
|
Owen Quan Zhou
|
|
|
36
|
|
Vice president
|
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Mr. Jason Liqing Zeng
has served as our chairman since October 2008. Mr. Zeng founded Shenzhen Decent Investment
Limited, an investment company which focuses on high-technology investment, in May 2007 and has served as the chairman since its inception. Previously, Mr. Zeng
co-founded Tencent Holdings Limited, an Internet service company in China listed on the Hong Kong Stock Exchange, and served as its chief operating officer from 1999 to 2007. From 1993 to
1999, Mr. Zeng served as a manager in the Shenzhen Branch of China Telecom Corporation Limited, a company engaging in information service and wired telecommunications and broadband services in
China and listed on the Hong Kong Stock Exchange and the New York Stock Exchange. Mr. Zeng is also an independent director of A8 Digital Music Holdings Limited, an integrated
digital music company listed on the Hong Kong Stock Exchange, a director of Shenzhen Ruigao, a director of Chuangyou, a director of Shenzhen Taole Internet Technology Co., Ltd, a
director of Shenzhen Kuaibo Technology Co., Ltd. and a director of several private companies. Mr. Zeng received his EMBA degree from China Europe International Business School in
China in 2007 and his bachelor's degree in computer communication from Xi'an Electronic Technology University in 1993.
Mr. Benson Haibing Wang
is one of the founders and the creative architect of many of our franchises. Mr. Wang is also our
chief executive officer and has served as our director since October 2008. Prior to co-founding our company, Mr. Wang worked as a project manager at Tencent Technology
(Shenzhen) Company Limited, a subsidiary of Tencent Holdings Limited, from 2004 to 2007. Mr. Wang is also a director of Shenzhen Ruigao, a director of Gamespedia Holdings Limited, and a
director of Chuangyou. Mr. Wang has approximately seven years of experience in the development of online products in China and has formulated our current strategy and led our rapid growth.
Mr. Wang received
his bachelor's degree in electrical engineering and his master's degree in computer science from Huazhong University of Science and Technology in 2001 and 2004, respectively.
Mr. Crow Zhen Wei
is one of our founders and our chief technology officer. Mr. Wei has served as our director since
October 2008. Prior to co-founding our company, Mr. Wei worked as a software engineer at Novell China Inc., a company engaging in infrastructure software business,
from 2006 to 2007. Mr. Wei was a system architecture designer and project manager at Tencent Technology (Shenzhen) Company Limited from 2004 to 2006. Prior to that, Mr. Wei was a
software engineer at Huawei Technologies Co., Ltd., a China-based telecom solutions provider, from July 2003 to December 2003. Mr. Wei has approximately eight years
of experience in software and Internet technology. Mr. Wei received his bachelor's degree in chemistry and his master's degree in computer science from University of Science and Technology of
China in 1999 and 2003, respectively.
Mr. Roc Yunpeng Cheng
is one of our founders and our president. Mr. Cheng has served as our director since
October 2008. Prior to co-founding our company, Mr. Cheng worked as an assistant general manager of the advertising department of Tencent Technology (Shenzhen) Company
Limited from 2001 to 2007, primarily responsible for advertising business in East and South China. Mr. Cheng was a sales manager in the Shenzhen Branch of International Network Communications
(Shanghai) Co., Ltd., a company engaging in Internet portal and related business, from 1999 to 2001. Mr. Cheng has approximately ten years of experience in marketing and
operations. Mr. Cheng received his bachelor's degree in materials engineering from Harbin Institute of Technology in 1999.
Mr. JP Gan
has served as our director since May 2009 and is currently our independent director. Mr. Gan has been
serving as a managing director and a member of the investment committee of Qiming Venture Partners, a private equity firm affiliated to the Qiming Funds, since 2007. From 2005 to 2006, Mr. Gan
was the chief financial officer of Kongzhong Corporation, a Nasdaq listed wireless Internet company. Prior to joining Kongzhong, Mr. Gan was a director of the Carlyle Group responsible for
venture capital investments in the Greater China region from 2000 to 2005. Mr. Gan worked at the investment banking division of Merrill Lynch, in Hong Kong from 1999 to 2000, and worked at
PricewaterhouseCoopers LLP in the United States from 1994 to 1997. Currently, Mr. Gan is also a director of Ctrip.com International Limited and Jiayuan.com
International Ltd., both of which
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are
NASDAQ-listed companies, a director of Elyn Corporation, an affiliate of us, and Elyn Corporation's wholly-owned subsidiary, Taiwan Taomee Co., Ltd., and a director of several
private companies. Mr. Gan obtained his Masters of Business Administration from the University of Chicago Booth School of Business and his bachelor's degree in business administration from the
University of Iowa.
Mr. Shengwen Rong
has served as our independent director since June 2011. Mr. Rong has been the chief financial
officer of UCWeb Inc., a leading provider of mobile Internet software technology and application services. From April 2010 to January 2012, Mr. Rong was the chief financial
officer of Country Style Cooking Restaurant Chain Co., Ltd, a NYSE-listed company. Prior to that, Mr. Rong had been the chief financial officer of two privately held
education companies in China since April 2008. From 2000 to 2008, Mr. Rong held multiple financial management positions at Google, Inc. Solectron Corp., and Siebel Systems.
Mr. Rong also worked at PricewaterhouseCoopers as an auditor both in its Chicago and Beijing offices. Mr. Rong obtained a bachelor's degree in economics from Renmin University of China
in 1991, a master's degree in professional accountancy from West Virginia University in 1996 and an MBA from the Booth School of Business at the University of Chicago in 2000. Mr. Rong is a
certified public accountant in the United States.
Mr. Ted Lai
has served as our independent director since June 2012. Mr. Lai is currently the executive vice president
for Asia of BBC Worldwide, responsible for strategic development across the Asia region, driving growth through new brand, product and service initiatives. Mr. Lai also serves on the steering
committee of AngelVest, a China based angel investor organization. Before joining BBC, Mr. Lai spent more than a decade working for Time Warner with his last role being senior vice president of
Warner Bros. International TV. Previously, Mr. Lai was a business development and product management executive in the digital media industry, having worked in several high-profile
companies, including idealab's FreePC from inception to merger and initial public offering. Mr. Lai also developed strategic plans for theme parks and location-based entertainment centers for
the Walt Disney Company. Mr. Lai earned his MBA at Harvard Business School and master's and bachelor's degrees in engineering at Stanford University.
Mr. Changtian Wang
has served as our independent director since June 2012. Mr. Wang is the chairman and chief
executive officer of Beijing Enlight Media Co., Ltd., a company listed on the Shenzhen Stock Exchange. Mr. Wang has more than twenty years' experience in media industry. Before
founding Beijing Enlight Media Co., Ltd., Mr. Wang worked for some television channels and newspapers in China, such as Beijing Television. Mr. Wang is also director of
JinHua Changfeng Information and Technology Co., Ltd., a Zhejiang-based instant messaging and internet value-added service provider, and is also the chairman or director of several
companies which are affiliates or subsidiaries of Beijing Enlight Media Co., Ltd.. Mr. Wang earned his bachelor's degree in journalism from Fudan University.
Mr. George Kuan
has served as our independent director since June 2012. Mr. Kuan is currently in a sales leadership
role at Nike Inc. Greater China. Prior to joining Nike Inc. Greater China, Mr. Kuan worked at several well-known multinational corporations, including
Coca-Cola (China) Beverages, Ltd., SAP, Oracle Corporation and BMC Software Inc. Mr. Kuan earned his bachelor's degree in business administration in finance
from the University of Houston in 1996, his master of science in management and systems from New York University in 2004, and his Ph.D. in philosophy from the International School of Management
in 2011.
Mr. Paul Keung
has been our chief financial officer and executive vice president of investment department since
February 2011. Prior to joining us, Mr. Keung was a managing director of Oppenheimer Investments Asia since 2009, overseeing the firm's Asia research practice. Between 2000 and 2008,
Mr. Keung was the executive director of CIBC World Markets, where for the majority of his time, he was responsible for coverage of the Internet and Media sectors in the US and China.
From
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1998
to 2000, Mr. Keung was the chief information officer of Wyndham International, a global hospitality company. Between 1994 and 1998, he served in various investment banking and equity
research roles at Deutsche Morgan Grenfell, PaineWebber Securities, and Salomon Brothers. Mr. Keung currently serves as an Independent director of Jiayuan.com International Ltd., a
NASDAQ-listed company. Mr. Keung obtained his bachelor's degree in hotel administration from Cornell University and his master's degree in real estate from New York University.
Mr. Frank ChengHua Zhu
joined our company since January 2010, and is currently our executive vice president in charge of
branded entertainment business. Prior to joining our company, Mr. Zhu worked as a category manager at the China office of The Walt Disney Company, an international family entertainment and
media enterprise listed on the New York Stock Exchange, from 2005 to 2009. Mr. Zhu was a brand manager at the China office of Reckitt Benckiser Group plc., a company engaging in
the production of health and personal care products listed on the New York Stock Exchange, from 2004 to 2005. In 2003, Mr. Zhu worked as a brand supervisor at the China division of
Unilever, a company listed on the New York Stock Exchange. Mr. Zhu started his career as a marketing executive at the China office of Yum! Brands, Inc., a restaurant company based
in Louisville, Kentucky and listed on the New York Stock Exchange, from 2000 to 2002. Mr. Zhu has approximately 10 years of experience in brand management, entertainment and
licensing operation. Mr. Zhu received his bachelor's degree in business administration from Fudan University in 2000.
Ms. Tiffany Tiefeng Qiang
has been our vice president in charge of corporate strategy and development since June 2010. Prior
to joining our company, Ms. Qiang worked as a vice president of Qiming Venture Partners from 2007 to 2010, where she conducted a portfolio of investment projects in Internet and consumer
industry and managed the portfolio companies after investment. Prior to that, Ms. Qiang was a financial analyst in both industrial and capital divisions at General Electric Company, a company
providing technology, media and financial services listed on the New York Stock Exchange, from 2005 to 2007. Ms. Qiang received her bachelor's degree in electrical engineering from
Tsinghua University in 2001 and her master's degree in management science and engineering from Stanford University in 2005.
Mr. Owen Quan Zhou
has been our vice president in charge of human resources since July 2011. Prior to joining our company,
Mr. Zhou worked as a strategic manager of human resources and manager of human resources of wireless industry department of Tencent Technology Company Limited, from January 2004 to
July 2011. Mr. Zhou was the officer of human resources development and the manager of human resources of Ping An Insurance (Group) Company of China, Ltd., Henan branch, from
July 1997 to December 2003. Mr. Zhou has approximately 14 years of experience in human resources management. Mr. Zhou received his bachelor's degree in international
trade and commerce from Jiangxi University of Finance and Economics in 1997.
B.
Compensation of Directors and Executive Officers
In 2012, we paid an aggregate of approximately RMB2.9 million (US$0.5 million) in cash to our executive officers, and an aggregate of approximately
RMB0.5 million (US$0.1 million) in cash to our independent directors. For options granted to our executive officers, see "Share Incentive Plans."
We
have neither set aside nor accrued any amount of cash to provide pension, retirement or other similar benefits to our officers and directors. Our PRC subsidiary and VIE are required
by law to make contributions equal to certain percentages of each employee's salary for his or her retirement benefit, medical insurance benefits, housing funds, unemployment and other statutory
benefit. Our PRC subsidiary contributed an aggregate of RMB1.0 million (US$0.2 million) for retirement and similar benefits for our officers and directors in 2012.
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Share Incentive Plans
2009 Stock Option Plan
We have adopted our 2009 Stock Option Plan, or the 2009 Plan, to promote our success and to increase shareholder value by providing an
additional means, through the grant of awards, to attract, motivate, retain and reward selected employees and other eligible persons. The maximum number of shares which may be issued pursuant to all
awards under the 2009 Plan is 45,000,000. As of December 31, 2012, options to purchase an aggregate of 25,496,360 ordinary shares under the 2009 Plan were outstanding.
Types of Awards.
The 2009 Plan permits the grant of several kinds of awards, including among others, options, restricted shares and
restricted
share units.
Plan Administration.
Our board of directors, or one or more committees designated by our board of directors, will administer the 2009
Plan. The
administrator will determine the terms and conditions of each grant, including, without limitation, the eligibility of the persons, whether and to what extent awards are granted, the grant price, the
number of awards, the forms of the award agreements, limited amendment of terms of any outstanding award, the construction and interpretation of the 2009 Plan and any award agreements, and such other
action not inconsistent with the terms of the 2009 Plan as the administrator deems appropriate.
Award Agreements.
Options and other awards granted under the 2009 Plan are evidenced by a written award agreement that sets forth the
material terms
and conditions for each grant.
Eligibility.
We may grant awards to employees and directors of our company and consultants.
Term of the Option and Stock Appreciation Rights.
The term of each option and stock appreciation rights granted will not exceed
ten years.
Vesting Schedule.
In general, the option agreements specify the vesting schedules.
Amendment and Termination of the 2009 Plan.
Unless terminated earlier, the 2009 Plan will continue in effect for a term of ten years
from the date of
its approval by the board of directors. Our board of directors has the authority to amend, modify, suspend, or terminate the 2009 Plan subject to shareholder approval to the extent required by
applicable laws or if such amendment would lessen the shareholder approval requirements. However, no such action may impair the rights of any award recipient unless agreed by the recipient
in written.
2010 Share Incentive Plan
We have adopted our 2010 Share Incentive Plan, or the 2010 Plan. The maximum number of shares which may be issued pursuant to all
awards under the 2010 Plan is 55,000,000. As of December 31, 2012, options to purchase an aggregate of 21,425,000 ordinary shares and 8,649,648 restricted shares under the 2010
Plan were outstanding.
Types of Awards.
The 2010 Plan permits the grant of several kinds of awards, including among others, options, restricted shares,
restricted share
units and share appreciation rights.
Plan Administration.
The compensation committee of our board of directors will administer the 2010 Plan, and may delegate its
administrative
authority to a committee of one or more members of our board or one or more of our officers, subject to certain restrictions. Among other things, the compensation committee will designate the eligible
individuals who may receive awards, and determine the types and number of awards to be granted and terms and conditions of each award grant. The
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compensation
committee has the sole power and discretion to cancel, forfeit or surrender an outstanding award.
Award Agreements.
Options and other awards granted under the 2010 Plan will be evidenced by a written award agreement that sets forth
the material
terms and conditions for each grant.
Eligibility.
We may grant awards to the employees, consultants rendering bona fide services to us or our affiliated entities
designated by our
board, as well as our directors, provided that awards cannot be granted to consultants or non-employee directors who are resident of any country in the
European Union, and any other country which pursuant to applicable laws does not allow grants to non-employees.
Term of the Option and Stock Appreciation Rights.
The term of each option and stock appreciation rights granted will not exceed ten
years, and the
compensation committee may extend the term subject to certain limitation under relevant applicable regulations.
Acceleration of Awards upon Corporate Transactions.
The compensation committee may, in its sole discretion, upon or in anticipation of
a corporate
transaction, accelerate awards, purchase the awards from the holder or replace the awards.
Vesting Schedule.
In general, the compensation committee determines, or the option agreements specify the vesting schedules.
Amendment and Termination of the 2010 Plan.
The compensation committee may at any time amend, modify or terminate the 2010 Plan subject
to
shareholder approval to the extent required by laws. Additionally, shareholder approval will be specifically required to increase the number of shares available under the 2010 Plan, or to permit the
compensation committee to extend the term or the exercise period of an option or share appreciation right beyond ten years, or if amendments result in material increases in benefits or a change in
eligibility requirements. Any amendment, modification or termination of the 2010 Plan must not impair any rights or obligations under awards already granted without consent of the holder of such
awards. Unless terminated earlier, the 2010 Plan will expire and no further awards may be granted after the tenth anniversary of the shareholders' approval of the 2010 Plan.
2012 Share Incentive Plan
We have adopted our 2012 Share Incentive Plan, or the 2012 Plan. The maximum number of shares which may be issued pursuant to all
awards under the 2012 Plan is 30,000,000. As of December 31, 2012, there were no options or restricted shares granted under the 2012 Plan.
Types of Awards.
The 2012 Plan permits the grant of several kinds of awards, including among others, options, restricted shares,
restricted share
units and share appreciation rights.
Plan Administration.
The compensation committee of our board of directors will administer the 2012 Plan, and may delegate its
administrative
authority to a committee of one or more members of our board or one or more of our officers, subject to certain restrictions. Among other things, the compensation committee will designate the eligible
individuals who may receive awards, and determine the types and number of awards to be granted and terms and conditions of each award grant. The compensation committee has the sole power and
discretion to cancel, forfeit or surrender an outstanding award.
Award Agreements.
Options and other awards granted under the 2012 Plan will be evidenced by a written award agreement that sets forth
the material
terms and conditions for each grant.
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Eligibility.
We may grant awards to the employees, consultants rendering bona fide services to us or our affiliated entities
designated by our
board, as well as our directors, provided that awards cannot be granted to consultants or non-employee directors who are resident of any country in the European Union, and any other
country which pursuant to applicable laws does not allow grants to non-employees.
Term of the Option and Stock Appreciation Rights.
The term of each option and stock appreciation rights granted will not exceed ten
years, and the
compensation committee may extend the term subject to certain limitation under relevant applicable regulations.
Acceleration of Awards upon Corporate Transactions.
The compensation committee may, in its sole discretion, upon or in anticipation of
a corporate
transaction, accelerate awards, purchase the awards from the holder or replace the awards.
Vesting Schedule.
In general, the compensation committee determines, or the option agreements specify the vesting schedules.
Amendment and Termination of the 2012 Plan.
The compensation committee may at any time amend, modify or terminate the 2012 Plan subject
to
shareholder approval to the extent required by laws. Additionally, shareholder approval will be specifically required to increase the number of shares available under the 2012 Plan, or to permit the
compensation committee to extend the term or the exercise period of an option or share appreciation right beyond ten years, or if amendments result in material increases in benefits or a change in
eligibility requirements. Any amendment, modification or termination of the 2012 Plan must not impair any rights or obligations under awards already granted without consent of the holder of such
awards. Unless terminated earlier, the 2012 Plan will expire and no further awards may be granted after the tenth anniversary of the shareholders' approval of the 2012 Plan.
The
table below sets forth, as of December 31, 2012, the option and restricted share grants made to our directors and executive officers and other individuals as a group, under
our share incentive plans:
|
|
|
|
|
|
|
|
|
|
|
|
|
Name
|
|
Ordinary
Shares
Underlying
Outstanding
Options/
Restricted
Shares
|
|
Exercise Price/
Purchase Price
(US$/Share)
|
|
Grant Date/
Award Date
|
|
Expiration Date
|
|
Benson Haibing Wang
|
|
*
|
|
|
0.07
|
|
|
June 7, 2010
|
|
|
June 7, 2020
|
|
Roc Yunpeng Cheng
|
|
*
|
|
|
0.07
|
|
|
June 7, 2010
|
|
|
June 7, 2020
|
|
Crow Zhen Wei
|
|
*
|
|
|
0.07
|
|
|
June 7, 2010
|
|
|
June 7, 2020
|
|
Shengwen Rong
|
|
*
|
|
|
0.45
|
|
|
May 24, 2011
|
|
|
May 24, 2021
|
|
Qi Ji
|
|
*
|
|
|
0.45
|
|
|
May 24, 2011
|
|
|
May 24, 2021
|
|
Ted Lai
|
|
*
|
|
|
0.1960
|
|
|
July 20, 2012
|
|
|
July 20, 2022
|
|
Changtian Wang
|
|
*
|
|
|
0.1960
|
|
|
July 20, 2012
|
|
|
July 20, 2022
|
|
George Kuan
|
|
*
|
|
|
0.1960
|
|
|
July 20, 2012
|
|
|
July 20, 2022
|
|
JP Gan
|
|
*
|
|
|
0.1960
|
|
|
July 20, 2012
|
|
|
July 20, 2022
|
|
Paul Keung
|
|
*
|
|
|
0.45/nil
|
|
|
May 24, 2011
|
|
|
May 24, 2021
|
|
|
|
*
|
|
|
0.2395
|
|
|
July 16, 2012
|
|
|
July 16, 2022
|
|
Frank Chenghua Zhu
|
|
*
|
|
|
0.07
|
|
|
June 7, 2010
|
|
|
June 7, 2020
|
|
|
|
*
|
|
|
0.36
|
|
|
January 4, 2011
|
|
|
January 4, 2021
|
|
|
|
*
|
|
|
0.2395
|
|
|
July 16, 2012
|
|
|
July 16, 2022
|
|
102
Table of Contents
|
|
|
|
|
|
|
|
|
|
|
|
|
Name
|
|
Ordinary
Shares
Underlying
Outstanding
Options/
Restricted
Shares
|
|
Exercise Price/
Purchase Price
(US$/Share)
|
|
Grant Date/
Award Date
|
|
Expiration Date
|
|
Tiffany Tiefeng Qiang
|
|
*
|
|
|
0.07
|
|
|
June 7, 2010
|
|
|
June 7, 2020
|
|
|
|
*
|
|
|
0.36
|
|
|
January 4, 2011
|
|
|
January 4, 2021
|
|
|
|
*
|
|
|
0.2395
|
|
|
July 16, 2012
|
|
|
July 16, 2022
|
|
Quan Zhou
|
|
*
|
|
|
0.45/nil
|
|
|
May 24, 2011
|
|
|
May 24, 2021
|
|
|
|
*
|
|
|
0.2395
|
|
|
July 16, 2012
|
|
|
July 16, 2022
|
|
Directors and executive officers as a group
|
|
14,000,000
|
|
|
0.07
|
|
|
June 7, 2010
|
|
|
June 7, 2020
|
|
|
|
750,002
|
|
|
nil
|
|
|
January 4, 2011
|
|
|
January 4, 2021
|
|
|
|
4,708,335
|
|
|
nil
|
|
|
May 24, 2011
|
|
|
May 24, 2021
|
|
|
|
6,000,000
|
|
|
0.2395
|
|
|
July 16, 2012
|
|
|
July 16, 2022
|
|
|
|
3,600,000
|
|
|
0.1960
|
|
|
July 20, 2012
|
|
|
July 20, 2022
|
|
Other individuals as a group
|
|
2,784,040
|
|
|
0.04
|
|
|
June 24, 2009
|
|
|
June 24, 2019
|
|
|
|
8,712,320
|
|
|
0.07
|
|
|
June 7, 2010
|
|
|
June 7, 2020
|
|
|
|
2,703,783
|
|
|
0.36/nil
|
|
|
January 4, 2011
|
|
|
January 4, 2021
|
|
|
|
1,412,528
|
|
|
0.45/nil
|
|
|
May 24, 2011
|
|
|
May 24, 2021
|
|
|
|
10,900,000
|
|
|
0.2395
|
|
|
July 16, 2012
|
|
|
July 16, 2022
|
|
-
*
-
Ordinary
shares underlying the share options held by such person that are exercisable within 60 days after the date of this annual report comprise less
than 1% of our outstanding ordinary shares.
On
February 28, 2012, our compensation committee approved a share option exchange program that offered our eligible directors and employees the right to exchange vested and
unvested outstanding share options to purchase our ordinary shares granted under the 2010 Share Incentive Plan between January 2011 to May 2011 for our restricted shares at the ratio of
3:1. The exchange ratio was determined based on the fair value of replacement restricted shares so that the fair value of the replacement restricted shares to be issued upon exchange would be
approximately equivalent to the fair value of the share options surrendered by an individual. These replacement restricted shares are subject to substantially the same vesting schedule as the options
that were validly tendered in the exchange offer. A total of 102 directors and employees accepted the offer, and tendered options to purchase an aggregate of 28,790,000 ordinary shares,
including 14,090,000 shares granted on January 4, 2011 and 14,700,000 shares granted on May 24, 2011, in exchange for an aggregate of 9,596,718 restricted shares at
a ratio of 3:1, which were granted on March 30, 2012. The exchange of the share option for restricted shares was accounted for as a modification of share-based award, which involves a
cancellation of the original award and an issuance of a new award, with no incremental compensation cost recognized as the fair value of the restricted shares was not more than the fair value of the
options given up on the date of exchange. This exchange program is expected to provide additional incentive
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and
retention value. The replacement restricted shares to our directors, officers and employees as listed below:
|
|
|
|
|
|
|
|
|
|
Name
|
|
Number of
Restricted
Shares
Granted
|
|
Date of Grant of
Restricted Shares
|
|
Date of Grant of
Cancelled Option
|
|
Shengwen Rong
|
|
*
|
|
|
March 30, 2012
|
|
|
May 24, 2011
|
|
Qi Ji
|
|
*
|
|
|
March 30, 2012
|
|
|
May 24, 2011
|
|
Paul Keung
|
|
*
|
|
|
March 30, 2012
|
|
|
May 24, 2011
|
|
Frank Chenghua Zhu
|
|
*
|
|
|
March 30, 2012
|
|
|
January 4, 2011
|
|
Tiffany Tiefeng Qiang
|
|
*
|
|
|
March 30, 2012
|
|
|
January 4, 2011
|
|
Quan Zhou
|
|
*
|
|
|
March 30, 2012
|
|
|
May 24, 2011
|
|
Directors and executive officers as a group
|
|
*
|
|
|
March 30, 2012
|
|
|
January 4, 2011/
May 24, 2011
|
|
Other individuals as a group
|
|
*
|
|
|
March 30, 2012
|
|
|
January 4, 2011/
May 24, 2011
|
|
-
*
-
Beneficially
own less than 1.0% of our outstanding ordinary shares.
C. Board Practices
Board of Directors
Our board of directors consists of nine members. A director is not required to hold any shares in the company by way of qualification.
A director may vote with respect to any contract or transaction in which he or she is materially interested provided the nature of the interest is disclosed prior to its consideration and any vote on
such contract or transaction. The directors may exercise all the powers of the company to borrow money, mortgage its undertaking, property and uncalled capital, and issue debentures or other
securities whether outright or as security for any debt, liability or obligation of the company or of any third-party. None of our non-executive directors has a service contract with us
that provides for benefits upon termination of employment.
Committees of the Board of Directors
We have established three committees under the board of directors: the audit committee, the compensation committee and the corporate
governance and nominating committee, and adopt a charter for each of the committees. Each committee's members and functions are described below.
Audit Committee
Our audit committee consists of Mr. Shengwen Rong, Mr. Ted Lai and Mr. George Kuan. Mr. Rong,
Mr. Lai and Mr. Kuan satisfy the "independence" requirements of Section 303A of the Corporate Governance Rule of the New York Stock Exchange and
Rule 10A-3 under the Securities Exchange Act of 1934, as amended. Mr. Rong is the chairman of our audit committee and meets the criteria of an audit committee
financial expert as set forth under the applicable rules of the SEC. Mr. Rong, Mr. Lai and Mr. Kuan all have extensive knowledge and experience applying U.S. GAAP. From
April 2010 to January 2012, Mr. Rong was the chief financial officer of Country Style Cooking Restaurant Chain Co., Ltd, a NYSE-listed company which
prepares and presents its consolidated financial statements in accordance with U.S. GAAP, and also had experience applying U.S. GAAP at his previous positions at Google, Inc.,
Solectron Corp., and Siebel Systems. Prior to that, Mr. Rong worked at PricewaterhouseCoopers LLP in the United States and Beijing. Mr. Rong is a certified public
accountant in the United States. Mr. Kuan has served in various finance and accounting roles at BMC Software Inc., including serving as the regional finance manager based in
Australia and the
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Table of Contents
country
controller at BMC Japan. In BMC Software Inc., Mr. Kuan was a member of the corporate accounting team responsible for operating expenses management control. In BMC Japan,
Mr. Kuan served in the corporate accounting team responsible for revenue recognition accounting practice, in accordance with GAAP software policy. Mr. Lai has experience of reviewing
company financial statements related to his work with AngelVest, as well as with BBC Worldwide, Time Warner and the Walt Disney Company.
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:
-
-
selecting our independent registered public accounting firm and pre-approving all auditing and
non-auditing services permitted to be performed by our independent registered public accounting firm;
-
-
reviewing with the independent registered public accounting firm any audit problems or difficulties and management's
response;
-
-
reviewing and approving all proposed related-party transactions, as defined in Item 404 of
Regulation S-K under the Securities Act;
-
-
discussing the annual audited financial statements with management and our independent registered public
accounting firm;
-
-
annually reviewing and reassessing the adequacy of our audit committee charter;
-
-
meeting separately and periodically with management and our independent registered public accounting firms;
-
-
reporting regularly to the full board of directors; and
-
-
such other matters that are specifically delegated to our audit committee by our board of directors from time
to time.
Compensation Committee
Our compensation committee consists of Mr. JP Gan, Mr. Ted Lai and Mr. George Kuan. Mr. Gan, Mr. Tai
and Mr. Kuan satisfy the "independence" requirements of Section 303A of the Corporate Governance Rule of the New York Stock Exchange. Mr. Gan is the chairman of our
compensation committee. Our compensation committee assists the board of directors in reviewing and approving the compensation structure of our directors and executive officers, including all forms of
compensation to be provided to our directors and executive officers. Our chief executive officer may not be present at any committee meeting during which his compensation is deliberated. The
compensation committee is responsible for, among other things:
-
-
reviewing and recommending to the board with respect to the total compensation package for our four most senior
executives;
-
-
approving and overseeing the total compensation package for our executives other than the four most senior executives;
-
-
reviewing and making recommendations to the board of directors with respect to the compensation of our
directors; and
-
-
reviewing periodically and approving any long-term incentive compensation or equity plans, programs or similar
arrangements, annual bonuses, employee pension and welfare benefit plans.
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Table of Contents
Corporate Governance and Nominating Committee
Our corporate governance and nominating committee consists of Mr. Changtian Wang, Mr. JP Gan and Mr. Shengwen
Rong. Mr. Wang, Mr. Gan and Mr. Rong satisfy the "independence" requirements of Section 303A of the Corporate Governance Rule of the New York Stock Exchange.
Mr. Wang is the chairman of our corporate governance and nominating committee. The corporate governance and nominating committee assists our board of directors in identifying individuals
qualified to become our directors and in determining the composition of the board and its committees. The corporate governance and nominating committee is responsible for, among
other things:
-
-
identifying and recommending nominees for election or re-election to our board of directors, or for
appointment to fill any vacancy;
-
-
reviewing annually with our board of directors its current composition in light of the characteristics of independence,
age, skills, experience and availability of service to us;
-
-
identifying and recommending to our board the directors to serve as members of committees;
-
-
advising the board periodically with respect to significant developments in the law and practice of corporate governance
as well as our compliance with applicable laws and regulations, and making recommendations to our board of directors on all matters of corporate governance and on any corrective action to be
taken; and
-
-
monitoring compliance with our code of business conduct and ethics, including reviewing the adequacy and effectiveness of
our procedures to ensure proper compliance.
Duties of Directors
Under Cayman Islands law, our directors have a fiduciary duty to act honestly, in good faith and with a view to our best interests. Our
directors also have a duty to exercise the skill they actually possess and such care and diligence that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty
of care to us, our directors must ensure compliance with our memorandum and articles of association as may be amended from time to time. Our company has a right to seek damages against any director
who breaches a duty owed to us.
Terms of Directors and Officers
Pursuant to our memorandum and articles of association, our board of directors are designated into three classes, namely Class A
directors, Class B directors and Class C directors, who shall retire from office and be eligible for re-election at the first, second and third annual general meeting after
our initial public offering, respectively. Mr. Roc Yunpeng Cheng, Mr. Ted Lai and Mr. Changtian Wang have been designated as Class A directors. Mr. Crow Zhen Wei,
Mr. Shengwen Rong and Mr. George Kuan have been designated as Class B directors. Mr. Jason Liqing Zeng, Mr. Benson Haibing Wang and Mr. JP Gan have been
designated as Class C directors. At each subsequent annual general meeting after the third annual general meeting after our initial offering, the directors of the class who have been longest in
office shall retire and shall be eligible for re-election. A director may only be removed by the shareholders. Officers are elected by and serve at the discretion of the board
of directors.
Employment Agreements
We have entered into employment agreements with each of our executive officers. Under these agreements, each of our executive officers
is employed for a three-year period. We may terminate an executive officer's employment for cause, at any time, without notice or remuneration, for certain acts of the officer, including
but not limited to serious or persistent breach or non-observance of the employment terms or a conviction of a criminal offence. An executive officer may terminate his/her
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employment
at any time with one-month prior written notice. Furthermore, we may terminate the employment at any time without cause upon advance written notice and certain amount of
compensation payment.
Each
executive officer has agreed to hold, both during and after the employment agreement expires or is earlier terminated, in strict confidence and not to use, except for our benefit,
any confidential information of our company. In addition, the majority of our executive officers have agreed to be bound by non-competition restrictions which are set forth in his or her
employment agreement.
Board Observer
We have granted Saban Media Ventures, an affiliate of Saban Capital Group, a non-voting observer seat on our board of
directors for a period of eighteen months after the closing of the initial public offering, and our board of directors further renewed such period for another eighteen months to June 9, 2014.
Mr. Sumeet Jaisinghani has been designated by Saban as our board observer since July 2011, and he is a director of Saban Capital Group, responsible for Saban's principal investment
activities in Asia, and is head of the firm's Singapore office. In addition, Mr. Jaisinghani is a member of the Board of Directors of Partner Communications and Celestial Tiger Entertainment
(CTE), and also played a key role in Saban's investments in Partner, Media Nusantara Citra, MNC Sky Vision, CTE and us.
D. Employees
We had 70, 233, 484, 575 and 640 employees as of December 31, 2008, 2009, 2010, 2011 and 2012, respectively. The following table sets forth the
number of our employees categorized by areas of operations as of December 31, 2012:
|
|
|
|
|
|
|
|
|
|
Function
|
|
Number of
Employees
|
|
Percentage
of total
|
|
|
Online operations
|
|
|
118
|
|
|
18.4
|
%
|
|
Offline operations
|
|
|
35
|
|
|
5.5
|
%
|
|
Product development
|
|
|
368
|
|
|
57.5
|
%
|
|
Sales and marketing
|
|
|
54
|
|
|
8.4
|
%
|
|
General and administrative
|
|
|
65
|
|
|
10.2
|
%
|
|
|
|
|
|
|
|
|
Total
|
|
|
640
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
Our
success depends on our ability to attract, retain and motivate qualified personnel. We believe we offer our employees competitive compensation packages, and we have generally been
able to attract and retain qualified personnel and maintain a stable core management team. For a description of the employment agreement we signed with some members of our senior management, see
"Item. 6. Directors, Senior Management and EmployeesC. Board PracticesEmployment Agreements."
Substantially
all of our employees are based in the PRC. In accordance with PRC laws, we participate in employee benefit plans organized by municipal and provincial governments,
including pension, work-related injury benefits, maternity insurance, medical insurance, unemployment
benefit and housing fund plans. We are required under PRC laws to make contributions to the employee benefit plans at specified percentages of the salaries, bonuses and certain allowances of our
employees, up to a maximum amount specified by the local government. A labor union of our employees was established to represent employees with respect to labor disputes and other employee matters. We
believe that we maintain a good working relationship with our employees and we have not experienced any significant labor disputes or disputes with the labor department of the PRC government since
our inception.
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Table of Contents
E. Share Ownership
The following table sets forth information with respect to the beneficial ownership of our ordinary shares as of the date of this annual
report, by:
-
-
each of our directors and executive officers; and
-
-
each person known to us to own beneficially more than 5% of our ordinary shares.
The
total number of ordinary shares outstanding as of December 31, 2012 is 766,282,380, including ordinary shares represented by ADSs. As of December 31, 2012, we had
29,633,648 ordinary shares which were legally issued according to our share incentive plans, but were not deemed issued or outstanding from accounting perspective.
For
each person and group included in the following table, percentage of beneficial ownership is calculated by dividing the number of shares beneficially owned by such person or group
(which includes ordinary shares underlying share options held by such person or group that are exercisable within 60 days after the date of this annual report) by the sum of (i) the
number of ordinary shares outstanding as of the date of this annual report, (ii) the number of ordinary shares underlying share options held by such person or group that are exercisable within
60 days after the date of this annual report, and (iii) the
number of non-vested equity shares held by such person or group that will vest within 60 days after the date of this annual report.
Except
as otherwise noted, the business address of each person listed in the table is c/o Taomee Holdings Limited, 16/F, Building No. A-2, No. 1528 Gumei Road,
Xuhui District, Shanghai 200233, People's Republic of China.
|
|
|
|
|
|
|
|
|
|
Ordinary Shares
Beneficially Owned
|
|
|
|
Number
|
|
%
|
|
Directors and Executive Officers:
|
|
|
|
|
|
|
|
Jason Liqing Zeng(1)
|
|
|
146,500,000
|
|
|
19.1
|
|
Benson Haibing Wang(2)
|
|
|
89,392,592
|
|
|
11.7
|
|
Crow Zhen Wei(3)
|
|
|
76,742,593
|
|
|
10.0
|
|
Roc Yunpeng Cheng(4)
|
|
|
73,642,593
|
|
|
9.6
|
|
JP Gan(5)
|
|
|
125,000,000
|
|
|
16.3
|
|
Shengwen Rong(6)
|
|
|
*
|
|
|
*
|
|
Ted Lai
|
|
|
|
|
|
|
|
Changtian Wang
|
|
|
|
|
|
|
|
George Kuan
|
|
|
|
|
|
|
|
Paul Keung(7)
|
|
|
*
|
|
|
*
|
|
Frank Chenghua Zhu(8)
|
|
|
*
|
|
|
*
|
|
Tiffany Tiefeng Qiang(9)
|
|
|
*
|
|
|
*
|
|
Quan Zhou(10)
|
|
|
*
|
|
|
*
|
|
All Directors and Executive Officers as a Group(11)
|
|
|
515,361,112
|
|
|
67.3
|
|
108
Table of Contents
|
|
|
|
|
|
|
|
|
|
Ordinary Shares
Beneficially Owned
|
|
|
|
Number
|
|
%
|
|
Principal Shareholders:
|
|
|
|
|
|
|
|
Frontier Technology Holdings Limited(12)
|
|
|
135,000,000
|
|
|
17.6
|
|
Speednext Industrial Limited(13)
|
|
|
11,500,000
|
|
|
1.5
|
|
Qiming Venture Partners II, L.P.(14)
|
|
|
113,418,000
|
|
|
14.8
|
|
Qiming Venture Partners II-C, L.P.(15)
|
|
|
9,931,500
|
|
|
1.3
|
|
Qiming Managing Directors Fund II, L.P(16).
|
|
|
1,650,500
|
|
|
0.2
|
|
Joy Union Holdings Limited(17)
|
|
|
86,392,592
|
|
|
11.3
|
|
Universys Holdings Ltd.(18)
|
|
|
74,492,593
|
|
|
9.7
|
|
Charming China Limited(19)
|
|
|
71,392,593
|
|
|
9.3
|
|
-
*
-
Less
than 1%
-
(1)
-
Includes
6,750,000 ADSs representing 135,000,000 ordinary shares held by Frontier Technology Holdings Limited and 575,000 ADSs
representing 11,500,000 ordinary shares held by Speednext Industrial Limited, a British Virgin Islands company wholly-owned by Mr. Zeng.
-
(2)
-
Represents
12 ordinary shares and 86,392,580 ordinary shares represented by 4,319,629 ADSs held by Joy Union Holdings Limited, a
British Virgin Islands company wholly owned by Mr. Wang, and 3,000,000 ordinary shares issuable upon exercise of options within 60 days of the date of this annual report held by
Mr. Wang.
-
(3)
-
Represents
13 ordinary shares and 74,492,580 ordinary shares represented by 3,724,629 ADSs held by Universys Holdings Ltd., a
British Virgin Islands company wholly owned by Mr. Wei, and 2,250,000 ordinary shares issuable upon exercise of options within 60 days of the date of this annual report held by
Mr. Wei.
-
(4)
-
Represents
13 ordinary shares and 71,392,580 ordinary shares represented by 3,569,629 ADSs held by Charming China Limited, a British
Virgin Islands company wholly owned by Mr. Cheng, and 2,250,000 ordinary shares issuable upon exercise of options within 60 days of the date of this annual report held by
Mr. Cheng.
-
(5)
-
Represents
113,418,000 ordinary shares held by Qiming Venture Partners II, L.P., 9,931,500 ordinary shares held by Qiming Venture
Partners II-C, L.P., and 1,650,500 ordinary shares held by Qiming Managing Directors Fund II, L.P. Mr. Gan is a managing director of and participates on the
investment committee of Qiming Corporate GP II, Ltd. The business address of Mr. Gan is c/o Qiming Corporate GP II, Ltd., 11400 SE Sixth Street,
Suite 100 Bellevue, Washington 98004, USA.
-
(6)
-
Represents
ordinary shares issuable upon exercise of options and the non-vested equity shares that will vest within 60 days of the date
of this annual report held by Mr. Rong.
-
(7)
-
Represents
ordinary shares issuable upon exercise of options and the non-vested equity shares that will vest within 60 days of the date
of this annual report held by Mr. Keung.
-
(8)
-
Represents
ordinary shares issuable upon exercise of options and the non-vested equity shares that will vest within 60 days of the date
of this annual report held by Mr. Zhu.
-
(9)
-
Represents
ordinary shares issuable upon exercise of options and the non-vested equity shares that will vest within 60 days of the date
of this annual report held by Ms. Qiang.
-
(10)
-
Represents
ordinary shares issuable upon exercise of options and the non-vested equity shares that will vest within 60 days of the date
of this annual report held by Mr. Zhou.
109
Table of Contents
-
(11)
-
Represents
ordinary shares held by all of our directors and executive officers as a group and ordinary shares issuable upon exercise of options and the
non-vested equity shares that will vest within 60 days of the date of this annual report held by all of our directors and executive officers as a group.
-
(12)
-
Represents
6,750,000 ADSs representing 135,000,000 ordinary shares held by Frontier Technology Holdings Limited, a British Virgin Islands
company wholly owned by Mr. Jason Liqing Zeng. The registered address for Frontier Technology Holdings Limited is Trinity Chambers, P.O. Box 4301, Road Town, Tortola, British
Virgin Islands.
-
(13)
-
Represents
575,000 ADSs representing 11,500,000 ordinary shares held by Speednext Industrial Limited, a British Virgin Islands company wholly
owned by Mr. Jason Liqing Zeng. The registered address of Speednext Industrial Limited is Offshore Incorporations Limited, P.O Box 957, Offshore Incorporations Centre, Road Town,
Tortola, British Virgin Islands.
-
(14)
-
Represents
113,418,000 ordinary shares held by Qiming Venture Partners II, L.P. The general partner of both Qiming Venture Partners
II, L.P. and Qiming Venture Partners II-C, L.P. is Qiming GP II, L.P., a Cayman Islands exempted limited partnership, whose general partner is Qiming
Corporate GP II, Ltd., a Cayman Islands limited company which is also the general partner of Qiming Managing Directors Fund II, L.P. Voting and investment power of the shares held
by the Qiming Funds is exercised by the investment committee of Qiming Corporate GP II, Ltd., which consists of Duane Kuang, Gary Rieschel, JP Gan and Robert Headley. Each of
Duane Kuang, Gary Rieschel, JP Gan and Robert Headley disclaims beneficial ownership of the ordinary shares, except to the extent of such person's own pecuniary interest therein. The business address
of each of the Qiming Funds, Qiming GP II, L.P. and Qiming Corporate GP II, Ltd. is 11400 SE Sixth Street, Suite 100 Bellevue, Washington 98004, USA.
-
(15)
-
Represents
9,931,500 ordinary shares held by Qiming Venture Partners II-C, L.P. See also note (11) to this
table above.
-
(16)
-
Represents
1,650,500 ordinary shares held by Qiming Managing Directors Fund II, L.P. See also note (11) to this
table above.
-
(17)
-
Represents
12 ordinary shares and 86,392,580 ordinary shares represented by 4,319,629 ADSs held by Joy Union Holdings Limited, a
British Virgin Islands company wholly owned by Mr. Benson Haibing Wang. The registered address for Joy Union Holdings Limited is Trinity Chambers, P.O. Box 4301, Road Town,
Tortola, British Virgin Islands.
-
(18)
-
Represents
13 ordinary shares and 74,492,580 ordinary shares represented by 3,724,629 ADSs held by Universys Holdings Ltd., a
British Virgin Islands company wholly owned by Mr. Crow Zhen Wei. The registered address for Universys Holdings Ltd. is Trinity Chambers, P.O. Box 4301, Road Town, Tortola,
British Virgin Islands.
-
(19)
-
Represents
13 ordinary shares and 71,392,580 ordinary shares represented by 3,569,629 ADSs held by Charming China Limited, a British
Virgin Islands company wholly owned by Mr. Roc Yunpeng Cheng. The registered address for Charming China Limited is Trinity Chambers, P.O. Box 4301, Road Town, Tortola, British
Virgin Islands.
As
of the date of this annual report, to our knowledge, 611,982,342 ordinary shares were held by two record holders in the United States, including JPMorgan Chase Bank
N.A., the depositary of our ADS program. The number of beneficial owners of our ADSs in the United States is likely to be much larger than the number of record holders of our ordinary shares in
the United States. None of our existing shareholders has different voting rights from other shareholders. We are not aware of any arrangement that may, at a subsequent date, result in a change
of control of our company.
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Table of Contents
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. Major Shareholders
See "Item 6. Directors, Senior Management and EmployeesE. Share Ownership."
B. Related Party Transactions
Contractual Arrangements
PRC laws currently restrict foreign ownership of online virtual world businesses. To comply with PRC laws, we conduct our online
virtual world business through contractual arrangements with Shanghai Taomee and its shareholders. See "Item 4. Information on the CompanyC. Organizational Structure" for a
description of these contractual arrangements.
As
part of our contractual arrangements with Shanghai Taomee and certain of its shareholders, Mr. Jason Liqing Zeng, our chairman, Mr. Benson Haibing Wang, our
co-founder, director and chief executive officer, Mr. Crow Zhen Wei, our co-founder, director and chief technology officer, Mr. Roc Yunpeng Cheng, our
co-founder, director and president and Mr. Bin Wang, Shanghai Shengran entered into a loan agreement with these five persons, under which Shanghai Shengran lent an
interest-free loan of RMB2.5 million (US$0.4 million) to these persons, solely for their respective contributions to the increased capital of Shanghai Taomee, our
significant VIE.
Transactions with Certain Officers, Shareholders and Affiliates and Key Management Personnel
In June 2009, Shanghai Taomee entered into an agreement with Shenzhen ParaEngine Corporation, or Shenzhen ParaEngine, a company
significantly influenced by Mr. Jason Liqing Zeng, who is a director of Shenzhen ParaEngine's controlling entity, for developing and operating a 3-D online virtual world for
children. In August 2011, Shanghai Taomee entered into a supplement agreement with ParaEngine, pursuant to which Shanghai Taomee gave up its exclusive rights of this 3-D online
virtual world and increased the royalty percentage to be paid to ParaEngine. In May 2012, Shanghai Taomee entered into another 3-D online virtual world co-develop
agreement with ParaEngine. For the years ended December 31, 2010, 2011 and 2012, we paid US$31,208, US$173,281 and US$203,444 in royalty, and nil, nil, and US$0.2 million in licensing
fees to Shenzhen ParaEngine, respectively. As of December 31, 2012, we had approximately US$13,954 due to Shenzhen ParaEngine Corporation.
In
October 2010, pursuant to an equity investment agreement which Shanghai Taomee entered into with Shenzhen Decent Investment Limited and two third party individuals, Shenzhen
Ruigao was formed in the PRC for the purpose of developing console games. Shanghai Taomee obtained a 17.65% equity interest in Shenzhen Ruigao for total cash consideration of US$1.0 million
which was paid in two
installments, with the first payment being made in October 2010 and the remaining payment of US$0.5 million being paid in the first quarter of 2011. As we have the ability to exercise
significant influence over Shenzhen Ruigao, we account for this investment using the equity method of accounting. In May 2012, a third party investor obtained 7.5% equity interest in Shenzhen
Ruigao through capital injection, and our equity interest in Shenzhen Ruigao was reduced to 15.61%. In July 2012, Shanghai Taomee transferred all its equity interest in Shenzhen Ruigao for
US$1.0 million and recorded a gain of US$0.3 million. Our share of losses in equity investment in Shenzhen Ruigao was US$0.05 million in 2010 and US$0.4 million in 2011,
and our share of profits was US$0.2 million in 2012.
In
June 2011, Shanghai Shengran entered into an agreement with Taiwan Taomee for the license to Taiwan Taomee of certain operating rights of an online game developed and owned by
Shanghai Shengran. Shanghai Shengran also entered into agreement with Taiwan Taomee for the license of certain offline products which are derived from the online game images. In 2012, Shanghai
Shengran licensed Taiwan Taomee two additional online games. Revenues generated from Taiwan Taomee were
111
Table of Contents
US$245,015
and US$240,160 for online licensing and offline licensing respectively for the year ended December 31, 2011, and US$127,644 and US$175,500 respectively for the year ended
December 31, 2012. As of December 31, 2012, we had an amount due from Taiwan Taomee of US$185,053. In January 2013, Shanghai Shengran further granted Taiwan Taomee the exclusive
right of two additional games at a license fee of US$0.1 million and will share the royalty at a certain agreed percentage.
On
February 25, 2011, we entered into an agreement to effectively sell a 10.5% equity interest in Elyn Corporation that had been indirectly held by a related party on our behalf.
Of the 10.5% equity interest in Elyn Corporation, 9.14% was sold to Qiming Funds, which are our existing shareholders and 1.36% was sold to an investor, an independent third party who was not
affiliated with us or the Series A shareholders, for a consideration of approximately US$3.4 million and US$0.5 million in cash, respectively, at the same price per share. In
addition, the nominee shareholding agreement was terminated with the related party and we currently hold 29.5% equity in Elyn Corporation directly.
On
August 12, 2011, our equity interest in Elyn Corporation was diluted from 29.5% to 28.8% as a result of Elyn Corporation's issuing shares to its employees.
In
November 2011, Taiwan Taomee went through a reorganization and contemporaneously issued new ordinary shares to existing shareholders and certain employees. As a result of such
transactions, our equity interest in Taiwan Taomee was changed from 28.8% interest held through Elyn Corporation to a 27.6% effective interest which was held through (1) 29.50% in Elyn
Corporation, which held 72.09% of Taiwan Taomee, and (2) 28.77% in Joy Children Technology Co., Ltd., or Joy Children, a shell company with no operations, which owned 21.86% of
Taiwan Taomee after the reorganization. The change in
equity interest reflected a dilution resulting from shares issued to Taiwan Taomee's employees, which were accounted for by Taiwan Taomee as stock compensation. In addition, we paid total
consideration of US$668,992 in cash for the newly issued shares of Taiwan Taomee through Joy Children, which was recorded as an increase in equity method investment.
In
July 2012, our aggregated equity interest through Elyn and Joy Children in Taiwan Taomee was diluted from 27.6% to 27.1%, i.e. (1) 29.50% in Elyn, which holds 70.88% of
Taiwan Taomee and (2) 28.77% in Joy Children, which holds 21.49% of Taiwan Taomee. The dilution was mainly due to the issue of new ordinary shares by Taiwan Taomee from capital surplus and
appropriations of 2011 earnings to certain existing shareholders and employees.
Our
equity in profit in 2010, 2011 and 2012 was US$546,437, US$965,959 and US$506,644 of Elyn Corporation and nil, $7,757 and US$191,381 of Joy Children, respectively, and was recognized
as share of profit in equity investment in the consolidated statements of operations.
In
July 2012, Shanghai Taomee entered into an operating agreement with Guangzhou Chuangyou Information Technology Co., Ltd., or Chuangyou, a company principally
engaged in the design and development of online games in China, and a related party of us, as one of Chuangyou's investors is our director and principle shareholder. According to such operating
agreement, Chuangyou granted to Shanghai Taomee the operating rights of an online game developed and owned by Chuangyou. For the year ended December 31, 2012, Shanghai Taomee had paid
US$150,000 as licensing fee to Chuangyou, and recorded as amount due from Chuangyou.
In
November 2012, Shanghai Shengran provided an interest-free loan of US$76,366 to Chuangyou, and Chuangyou paid off the loans in December 2012.
In
the first quarter of 2013, Shanghai Animation entered into an agreement with a related party to jointly invest in the production and distribution of an animation film with our cartoon
figures. According to the agreements, Shanghai Animation will invest RMB13.0 million (approximately US$2.1 million) in this project.
112
Table of Contents
Employment Agreement
See "Item 6. Directors, Senior Management and EmployeesC. Board PracticesEmployment Agreements."
Share Incentives
See "Item 6. Directors, Senior Management and EmployeesB. Compensation of Directors and Executive
OfficersShare Incentive Plan."
C. Interests of Experts and Counsel
Not applicable.
ITEM 8. FINANCIAL INFORMATION
A. Consolidated Statements and Other Financial Information
We have appended consolidated financial statements filed as part of this annual report.
Legal Proceedings
We are not currently a party to any material litigation or other legal proceeding and are not aware of any pending or threatened
litigation or other legal proceeding that may have a material adverse impact on our business or operations.
Dividend Policy
Our board of directors has complete discretion over whether to pay dividends on our ordinary shares. If our board of directors decides
to pay dividends on our ordinary shares, 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.
On
May 6, 2009, we issued 125,000,000 shares of Series A convertible redeemable preferred shares for aggregate cash proceeds of US$4,948,718, net of direct and
incremental equity issuance costs of US$51,282 to new investors. As the Series A preferred shares were negotiated with independent third-party investors, the cash proceeds received represented
the fair value of the issued Series A preferred shares. The accretion to the redemption value was calculated over the period from the issuance date to the earliest redemption date using the
effective interest method and reflected as a reduction to net income to arrive at net income attributable to the ordinary shareholders in the accompanying consolidated statements of operations and
amounted to US$468,580, US$200,601 and nil in 2010, 2011 and 2012, respectively. These amounts were considered deemed dividends for the years ended December 31, 2010, 2011 and 2012.
In
November 2010, we declared a cash dividend of US$10.0 million to be paid out of our current cash reserves to our shareholders who were record holders of ours as of
October 31, 2010, of which we paid US$1.05 million in December 2010 and an additional US$2.55 million in March 2011, and paid the rest in the second half
of 2011.
We
intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business. If we pay any dividends, the depositary will pay our ADS holders
the dividends it receives on our ordinary shares, after deducting its fees and expenses as provided in the deposit agreement. Cash dividends on our ordinary shares, if any, will be paid in
U.S. dollars.
113
Table of Contents
We
are a holding company incorporated in the Cayman Islands. We rely principally on dividends from our subsidiary in China for our cash requirements, including any payment of dividends
to our shareholders. Current PRC regulations permit our PRC subsidiary to pay dividends to us only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards
and regulations. In addition, each of our subsidiary and VIEs in China is required to set aside a certain amount of its after-tax profits each year, if any, to fund certain statutory
reserves. These reserves are not distributable as cash dividends. Furthermore, if our subsidiary or VIEs in China 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.
B. Significant Changes
Except as disclosed elsewhere in this annual report, we have not experienced any significant changes since the date of our audited consolidated financial
statements included in this annual report.
ITEM 9. THE OFFER AND LISTING
A. Offer and Listing Details
We completed the initial public offering of 7,187,500 ADSs, each representing 20 ordinary shares of par value US$0.00002 per share, on
June 10, 2011. On June 8, 2011, we listed our ADSs on the NYSE under the ticker symbol "TAOM".
The
following table provides the high and low trading prices for our ADSs on the NYSE for the periods shown.
|
|
|
|
|
|
|
|
|
|
Sales Price
|
|
|
|
High
|
|
Low
|
|
Annual Highs and Lows
|
|
|
|
|
|
|
|
Fiscal Year ended December 31, 2011 (from June 8, 2011)
|
|
|
17.90
|
|
|
3.95
|
|
Fiscal Year ended December 31, 2012
|
|
|
6.50
|
|
|
3.15
|
|
Quarterly Highs and Lows
|
|
|
|
|
|
|
|
Second Quarter ended June 30, 2011 (from June 8, 2011)
|
|
|
11.34
|
|
|
7.24
|
|
Third Quarter ended September 31, 2011
|
|
|
17.90
|
|
|
5.88
|
|
Fourth Quarter ended December 31, 2011
|
|
|
7.33
|
|
|
3.95
|
|
First Quarter ended March 31, 2012
|
|
|
6.50
|
|
|
4.50
|
|
Second Quarter ended June 30, 2012
|
|
|
5.75
|
|
|
3.74
|
|
Third Quarter ended September 31, 2012
|
|
|
4.89
|
|
|
3.25
|
|
Fourth Quarter ended December 31, 2012
|
|
|
3.84
|
|
|
3.15
|
|
First Quarter ended March 31, 2013
|
|
|
5.29
|
|
|
3.54
|
|
Monthly Highs and Lows
|
|
|
|
|
|
|
|
October 2012
|
|
|
3.84
|
|
|
3.37
|
|
November 2012
|
|
|
3.66
|
|
|
3.21
|
|
December 2012
|
|
|
3.59
|
|
|
3.15
|
|
January 2013
|
|
|
4.17
|
|
|
3.54
|
|
February 2013
|
|
|
5.29
|
|
|
3.95
|
|
March 2013
|
|
|
4.10
|
|
|
3.75
|
|
April 2013 (through April 15, 2013)
|
|
|
4.55
|
|
|
4.01
|
|
B. Plan of Distribution
Not applicable.
114
Table of Contents
C. Markets
Our ADSs, each representing 20 ordinary shares, have been listed on the NYSE since June 8, 2011. Our ADSs are traded under the symbol "TAOM."
D. Selling Shareholders
Not applicable.
E. Dilution
Not applicable.
F. Expenses of the Issue
Not applicable.
ITEM 10. ADDITIONAL INFORMATION
A. Share Capital
Not applicable.
B. Memorandum and Articles of Association
We are a Cayman Islands company and our affairs are governed by our memorandum and articles of association and the Companies Law of the Cayman Islands, which is
referred to as the Companies Law below. We incorporate by reference into this annual report the description of our third amended and restated memorandum and articles of association contained in our
F-1 registration statement (File No. 333-174293) originally filed with the SEC on May 18, 2011.
C. Material Contracts
We have not entered into any material contracts other than in the ordinary course of business and other than those described in "Item 4. Information on the
Company" or elsewhere in this annual report on Form 20-F.
D. Exchange Controls
See "Item 4. Information on the CompanyB. Business OverviewRegulations Related to Our BusinessRegulation related to
Foreign Currency Exchange and Dividend Distribution".
E. Taxation
The following summary of the material Cayman Islands, PRC and United States federal income tax consequences of an investment in our ADSs or ordinary shares
is based upon laws and relevant interpretations thereof in effect as of the date of this annual report, all of which are subject to change. This summary does not deal with all possible tax
consequences relating to an investment in our ADSs or ordinary shares, such as the tax consequences under state, local and other tax laws.
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 or withholding tax applicable to us or to any holder of our ADSs and ordinary shares. There are no other taxes likely to be material to
us levied by the Government of the Cayman Islands except for stamp
115
Table of Contents
duties
which may be applicable on instruments executed in, or after execution brought within the jurisdiction of the Cayman Islands. No stamp duty is payable in the Cayman Islands on transfers of
shares of Cayman Islands companies, except those which hold interests in land in the Cayman Islands. The Cayman Islands is not party to any double tax treaties which are applicable to payments made by
or to our company. There are no exchange control regulations or currency restrictions in the Cayman Islands.
Pursuant
to Section 6 of the Tax Concessions Law (1999 Revision) of the Cayman Islands, we have obtained an undertaking from the
Governor-in-Council:
-
(1)
-
that
no law which is enacted in the Cayman Islands imposing any tax to be levied on profits or income or gains or appreciation shall apply to us or our
operations; and
-
(2)
-
that
the aforesaid tax or any tax in the nature of estate duty or inheritance tax shall not be payable on our shares, debentures or other obligations.
The
undertaking for us is for a period of twenty years from August 10, 2010.
People's Republic of China Taxation
If the PRC tax authorities determine that our Cayman Islands holding company is a "resident enterprise" for PRC enterprise income tax
purposes, a withholding tax of 10% for our non-PRC enterprise shareholders or potentially 20% for non-PRC individual shareholders may be imposed on dividends they receive from
us and a 10% (20% in the case of non-PRC individual shareholders) income tax may be imposed on gains they recognize from transferring our shares or ADSs. See "Item 3. Key
InformationD. Risk FactorsRisks Related to Doing Business in ChinaWe may be classified as a "resident enterprise" for PRC enterprise income tax purposes, which
could result in our global income becoming subject to 25% PRC enterprise income tax" and "Item 3. Key InformationD. Risk FactorsRisks Related to Doing Business
in ChinaIf we are classified as a "resident enterprise" for PRC enterprise income tax purposes, you may be subject to PRC withholding tax on dividends from us and to PRC income tax on
gain realized on the transfer of our ADSs or ordinary shares."
United States Federal Income Taxation
The following discussion describes the material U.S. federal income tax consequences to U.S. Holders (as defined
below) under current law of an investment in the ADSs or ordinary shares. This discussion applies only to U.S. Holders that hold the ADSs or ordinary shares as capital assets within the meaning
of Section 1221 of the United States Internal Revenue Code of 1986, as amended (generally, property held for investment), and that have the U.S. dollar as their functional
currency. This discussion is based on the tax laws of the United States as of the date of this annual report and on U.S. Treasury regulations in effect or, in some cases, proposed, as of
the date of this annual report, as well as judicial and administrative interpretations thereof available on or before such
date. All of the foregoing authorities are subject to change, which change could apply retroactively and could affect the tax consequences described below.
The
following discussion neither deals with the tax consequences to any particular investor nor describes all of the tax consequences applicable to persons in special tax situations
such as:
-
-
banks, insurance companies and other financial institutions;
-
-
regulated investment companies;
-
-
real estate investment trusts;
-
-
broker-dealers;
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-
-
traders that elect to use a mark-to-market method of accounting;
-
-
U.S. expatriates;
-
-
tax-exempt entities;
-
-
persons liable for alternative minimum tax;
-
-
persons holding ADSs or ordinary shares as part of a straddle, hedging, conversion or integrated transaction;
-
-
persons that actually or constructively own 10% or more of the total combined voting power of all classes of our
voting stock;
-
-
persons who acquired ADSs or ordinary shares pursuant to the exercise of any employee share option or otherwise as
compensation; or
-
-
partnerships or pass-through entities, or persons holding ADSs or ordinary shares through
such entities.
INVESTORS ARE URGED TO CONSULT THEIR TAX ADVISORS REGARDING THE APPLICATION OF THE U.S. FEDERAL TAX RULES TO THEIR PARTICULAR CIRCUMSTANCES AS WELL AS THE
STATE, LOCAL, NON-U.S. AND OTHER TAX CONSEQUENCES TO THEM OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF ADSs OR ORDINARY SHARES.
For
purposes of the discussion below of the U.S. federal income tax consequences to "U.S. Holders," you are a U.S. Holder if you are a beneficial owner of ADSs or
ordinary shares and you are, for U.S. federal income tax purposes,
-
-
an individual who is a citizen or resident of the United States;
-
-
a corporation (or other entity taxable as a corporation for U.S. federal income tax purposes) created or
organized in the United States or under the laws of the United States, any State thereof or the District of Columbia;
-
-
an estate, the income of which is subject to U.S. federal income taxation regardless of its source; or
-
-
a trust that (1) is subject to the primary supervision of a court within the United States and the control
of one or more U.S. persons for all substantial decisions or (2) has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person.
If
you are a partner in a partnership (or other entity taxable as a partnership for U.S. federal income tax purposes) that holds ADSs or ordinary shares, your tax treatment
will generally depend on your status and the activities of the partnership. If you are a partner in such a partnership, you should consult your tax advisor.
The
discussion below assumes the representations contained in the deposit agreement are true and the obligations in the deposit agreement and any related agreement have been and will be
complied with in accordance with their terms. If you own ADSs, you should be treated as the owner of the underlying ordinary shares represented by those ADSs for U.S. federal income
tax purposes.
The
U.S. Treasury has expressed concerns that intermediaries in the chain of ownership between the holder of a depositary share and the issuer of the security underlying the
depositary share may be taking actions that are inconsistent with the beneficial ownership of the underlying security (which may include, for example, pre-releasing ADSs to persons that do
not have the beneficial ownership of the securities underlying the ADSs). Accordingly, the creditability of any PRC taxes, or the availability of the reduced tax rate for any dividends received by
certain non-corporate U.S. Holders, including individual U.S. Holders (discussed below), could be affected by actions taken by intermediaries in the
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chain
of ownership between the holders of ADSs and our company if as a result of such actions the holders of ADSs are not properly treated as beneficial owners of underlying ordinary shares.
Passive Foreign Investment Company
Based on the market price of our ADSs and the composition of our income and assets, we believe we were a PFIC for U.S. federal
income tax purposes for our taxable year ended December 31, 2012. A non-U.S. corporation will be a PFIC for U.S. federal income tax purposes for any taxable year
if either:
-
-
at least 75% of its gross income for such year is passive income; or
-
-
at least 50% of the value of its assets (based on an average of the quarterly values of the assets) during such year is
attributable to assets that produce passive income or are held for the production of passive income.
For
this purpose, passive income generally includes dividends, interest, royalties and rents (other than royalties and rents derived in the active conduct of a trade or business and not
derived from a related person). In addition, we will be treated as owning our proportionate share of the assets and earning our proportionate share of the income of any other corporation in which we
own, directly or indirectly, at least 25% (by value) of the stock.
A
separate determination must be made after the close of each taxable year as to whether we were a PFIC for that year. Because the value of our assets for purposes of the PFIC test will
generally be determined, in part, by reference to the market price of our ADSs and ordinary shares, our PFIC status will depend in large part on the market price of the ADSs and ordinary shares, which
may fluctuate significantly.
If
we were treated as a PFIC for our taxable year ended December 31, 2012 and you held ADSs or ordinary shares during such year, we generally will continue to be treated as a PFIC
with respect to you for all succeeding years during which you hold ADSs or ordinary shares, unless we cease to be a PFIC and you make a "deemed sale" election with respect to the ADSs or ordinary
shares. If such election is made, you will be deemed to have sold ADSs or ordinary shares you hold at their fair market value on the last day of the last taxable year in which we were a PFIC and any
gain from such deemed sale would be subject to the rules described in the following two paragraphs. After the deemed sale election, your ADSs or ordinary shares with respect to which the deemed sale
election was made will not be treated as shares in a PFIC unless we subsequently become a PFIC.
For
each taxable year we are treated as a PFIC with respect to you, you will be subject to special tax rules with respect to any "excess distribution" you receive and any gain you
recognize from a sale or other disposition (including a pledge) of the ADSs or ordinary shares, unless you make a "mark-to-market" election as discussed below. Distributions
you receive in a taxable year that are greater than 125% of the average annual distributions you received during the shorter of the three preceding taxable years or your holding period for the ADSs or
ordinary shares will be treated as an excess distribution. Under these special tax rules:
-
-
the excess distribution or recognized gain will be allocated ratably over your holding period for the ADSs or ordinary
shares;
-
-
the amount allocated to the current taxable year, and any taxable years in your holding period prior to the first taxable
year in which we were a PFIC, will be treated as ordinary income; and
-
-
the amount allocated to each other taxable year will be subject to the highest tax rate in effect for individuals or
corporations, as applicable, for each such year and the interest charge generally applicable to underpayments of tax will be imposed on the resulting tax attributable to each such year.
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The
tax liability for amounts allocated to taxable years prior to the year of disposition or excess distribution cannot be offset by any net operating losses for such years, and gains
(but not losses) realized on the sale or other disposition of the ADSs or ordinary shares cannot be treated as capital, even if you hold the ADSs or ordinary shares as capital assets.
If
we are treated as a PFIC with respect to you for any taxable year, to the extent any of our subsidiaries are also PFICs or we make direct or indirect equity method investments in
other entities that are PFICs, you may be deemed to own shares in such lower-tier PFICs that are directly or indirectly owned by us in that proportion which the value of the ADSs or
ordinary shares you own bears to the value of all of our ADSs or ordinary shares, as applicable, and you may be subject to the adverse tax consequences described in the preceding two paragraphs with
respect to the shares of such lower-tier PFICs that you are deemed to own. You should consult your tax advisors regarding the application of the PFIC rules to any of our subsidiaries.
A
U.S. Holder of "marketable stock" in a PFIC may make a mark-to-market election for such stock to elect out of the PFIC rules described above regarding
excess distributions and recognized gains. For this purpose, "marketable stock" is stock that is regularly traded on a qualified exchange or other market, as defined in applicable U.S. Treasury
regulations. Our ADSs, but not our ordinary shares, are listed on the New York Stock Exchange, which is a qualified exchange or other market for these purposes. Consequently, if the ADSs are
listed on the New York Stock Exchange and are regularly traded, and you are a holder of ADSs, we expect the mark-to-market election would be available to you.
If
you make a mark-to-market election for the ADSs, you will include in income for each year we are a PFIC an amount equal to the excess, if any, of the fair
market value of the ADSs as of the close of your taxable year over your adjusted basis in such ADSs. You will be allowed an ordinary deduction for the excess, if any, of the adjusted basis of the ADSs
over their fair market value as of the close of the taxable year. However, deductions will be allowable only to the extent of any net mark-to-market gains on the ADSs included
in your income for prior taxable years. Amounts included in your income under a mark-to-market election, as well as gain on the actual sale or other disposition of the ADSs,
will be treated as ordinary income. Ordinary loss treatment will also apply to the deductible portion of any mark-to-market loss on the ADSs, as well as to any loss realized on
the actual sale or other disposition of the ADSs, to the extent the amount of such loss does not exceed the net mark-to-market gains previously included for such ADSs. Your
basis in the ADSs will be adjusted to reflect any such income or loss amounts. If you make a mark-to-market election, any distributions we make would generally be subject to
the rules discussed below under "Taxation of Dividends and Other Distributions on the ADSs or Ordinary Shares," except the lower tax rate applicable to qualified dividend income would not
apply. Because a mark-to-market election cannot be made for equity interests in any lower-tier PFICs that we own, a U.S. Holder may continue to be subject to
the PFIC rules with respect to its indirect interest in any investments held by us that are treated as an equity interest in a PFIC for U.S. federal income tax purposes. You should consult your
tax advisors as to the availability and desirability of a mark-to-market election, as well as the impact of such election on interests in any lower-tier PFICs.
Alternatively,
if a non-U.S. corporation is a PFIC, a holder of shares in that corporation may avoid taxation under the PFIC rules described above regarding excess
distributions and recognized gains by making a "qualified electing fund" election to include in income its share of the corporation's income on a current basis. However, you may make a qualified
electing fund election with respect to
your ADSs or ordinary shares only if we agree to furnish you annually with certain tax information, and we currently do not intend to prepare or provide such information.
Unless
otherwise provided by the U.S. Treasury, each U.S. Holder of a PFIC is required to file an annual report containing such information as the U.S. Treasury may
require. Since we believe we were
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a
PFIC for our taxable year ended December 31, 2012, you should consult your tax advisor regarding any reporting requirements that may apply to you.
You
are strongly urged to consult your tax advisor regarding the application of the PFIC rules to your investment in the ADSs or ordinary shares.
Taxation of Dividends and Other Distributions on the ADSs or Ordinary Shares
Subject to the PFIC rules discussed above, the gross amount of any distributions we make to you with respect to the ADSs or ordinary
shares (including the amount of any taxes withheld therefrom) generally will be includible in your gross income as dividend income on the date of receipt by the depositary, in the case of ADSs, or on
the date of receipt by you, in the case of ordinary shares, but only to the extent the distribution is paid out of our current or accumulated earnings and profits (as determined under
U.S. federal income tax principles). Any such dividends will not be eligible for the dividends-received deduction allowed to corporations in respect of certain dividends received from
U.S. corporations. To the extent the amount of the distribution exceeds our current and accumulated earnings and profits (as determined under U.S. federal income tax principles),
such excess amount will be treated first as a tax-free return of your tax basis in your ADSs or ordinary shares, and then, to the extent such excess amount exceeds your tax basis in your
ADSs or ordinary shares, as capital gain. We currently do not and we do not intend to calculate our earnings and profits under U.S. federal income tax principles. Therefore, you should expect
any distribution we make to you will be reported as a dividend even if such distribution would otherwise be treated as a non-taxable return of capital or as capital gain under the rules
described above.
With
respect to certain non-corporate U.S. Holders, including individual U.S. Holders, any dividends may be taxed at the lower capital gains rate applicable to
"qualified dividend income,"
provided (1) either (a) our ADSs or ordinary shares, as applicable, are readily tradable on an established securities market in the United States, or (b) we are eligible
for the benefits of a qualifying income tax treaty with the United States that includes an exchange of information program, (2) we were neither a PFIC nor treated as such with respect to
you for the taxable year in which the dividend was paid and the preceding taxable year (discussed below), and (3) certain holding period requirements are met. Under U.S. Internal Revenue
Service authority, ADSs are considered for purposes of clause (1) above to be readily tradable on an established securities market in the United States if they are listed on the
New York Stock Exchange, as our ADSs (but not our ordinary shares) are. Based on existing guidance, it is not entirely clear whether dividends you receive with respect to the ordinary
shares may qualify as qualified dividend income because the ordinary shares are not themselves listed on a U.S. exchange. In addition, as discussed above in "Passive Foreign
Investment Company," we believe we were a PFIC for our taxable year ended December 31, 2012. If we are treated as a "resident enterprise" for PRC tax purposes under the PRC EIT Law, we may be
eligible for the benefits of the income tax treaty between the United States and the PRC. You should consult your tax advisors regarding the availability of the lower tax rate applicable to
qualified dividend income for any dividends we pay with respect to the ADSs or ordinary shares, as well as the effect of any change in applicable law after the date of this annual report.
Any
dividends we pay with respect to the ADSs or ordinary shares will constitute foreign source income for foreign tax credit limitation purposes. If any such dividends are taxed as
qualified dividend income (as discussed above), the amount of the dividend taken into account for purposes of calculating the foreign tax credit limitation will in general be limited to the
gross amount of the dividend, multiplied by the reduced tax rate applicable to qualified dividend income and divided by the highest tax rate normally applicable to dividends. The limitation on foreign
taxes eligible for credit is calculated separately with respect to specific classes of income. For this purpose, any dividends we pay with respect to the ADSs or ordinary shares will generally
constitute "passive category income" but could, in the case of certain U.S. Holders, constitute "general category income."
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If
PRC withholding taxes apply to any dividends paid to you with respect to our ADSs or ordinary shares (see "Item 5. Operating and Financial Review and
ProspectsA. Operating ResultsTaxationChina"), the amount of the dividend would include the withheld PRC taxes and, subject to certain conditions and limitations,
such PRC withholding taxes would be treated as foreign taxes eligible for credit against your U.S. federal income tax liability. The rules relating to the determination of the foreign tax
credit are complex, and you should consult your tax advisors regarding the availability of a foreign tax credit in your particular circumstances.
Taxation of Disposition of ADSs or Ordinary Shares
Subject to the PFIC rules discussed above, you will recognize taxable gain or loss on any sale, exchange or other taxable disposition
of ADSs or ordinary shares equal to the difference between the amount realized for the ADSs or ordinary shares and your tax basis in the ADSs or ordinary shares. The gain or loss generally will be
capital gain or loss. If you are a non-corporate U.S. Holder, including an individual U.S. Holder, that has held the ADSs or ordinary shares for more than one year, you may
be eligible for reduced U.S. federal income tax rates. The deductibility of capital losses is subject to limitations. Any gain or loss you recognize on a disposition of ADSs or ordinary shares
will generally be treated as U.S. source income or loss for foreign tax credit limitation purposes. However, if we are treated as a "resident enterprise" for PRC tax purposes, we may be
eligible for the benefits of the income tax treaty between the United States and the PRC. In such event, if PRC tax were to be imposed on any gain from the disposition of the ADSs or ordinary
shares (see "Item 5. Operating and Financial Review and ProspectsA. Operating ResultsTaxationChina"), a U.S. Holder that is eligible for the
benefits of the income tax treaty between the United States and the PRC may elect to treat the gain as PRC source income for foreign tax credit purposes, in which case, subject to certain
conditions and limitations, such PRC tax would be eligible for credit against the holder's U.S. federal income tax liability. You should consult your tax advisors regarding the proper treatment
of gain or loss in your particular circumstances, including the effects of any applicable income tax treaties.
Information Reporting and Backup Withholding
Any dividend payments with respect to ADSs or ordinary shares and proceeds from the sale, exchange or other taxable disposition of ADSs
or ordinary shares may be subject to information reporting to the U.S. Internal Revenue Service and backup withholding, unless the U.S. Holder is an exempt recipient. Backup withholding
will not apply, however, to a U.S. Holder that furnishes a correct taxpayer identification number and makes any other required certification on U.S. Internal Revenue Service
Form W-9. U.S. Holders that are exempt from backup withholding may be required to complete U.S. Internal Revenue Service Form W-9 to avoid
possible erroneous backup withholding. U.S. Holders should consult their tax advisors regarding the application of the information reporting and backup withholding rules.
Backup
withholding is not an additional tax. Amounts withheld as backup withholding may be credited against your U.S. federal income tax liability, and you may obtain a refund of
any excess amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the U.S. Internal Revenue Service and furnishing any required information in a
timely manner.
Additional Reporting Requirements
Certain U.S. Holders who are individuals are required to report information relating to an interest in our ADSs or ordinary
shares, subject to certain exceptions (including an exception for ADSs and ordinary shares held in accounts maintained by certain financial institutions). U.S. Holders should consult their tax
advisors regarding the effect, if any, of these rules on their ownership and disposition of the ADSs or ordinary shares.
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F. Dividends and Paying Agents
Not Applicable.
G. Statement by Experts
Not Applicable.
H. Documents on Display
We previously filed with the SEC our registration statement on Form F-1 (Registration Number 333-174293), as amended and
prospectus under the Securities Act of 1933, with respect to our ordinary shares represented by the ADSs. We also filed with the SEC a related registration statement on Form F-6
(Registration Number 333-174441) with respect to the ADSs. We have also filed with the SEC our registration statements on Form S-8 (Registration
Number 333-176920) with respect to our securities to be issued under our 2009 Stock Option Plan, 2010 Share Incentive Plan and 2012 Share Incentive Plan.
We
are subject to periodic reporting and other informational requirements of the Exchange Act as applicable to foreign private issuers. Accordingly, we are required to file reports,
including annual reports on Form 20-F, and other information with the SEC. All documents filed by us with the SEC can be inspected and copied at the public reference facilities
maintained by the SEC at 100 F Street, N.E., Washington, D.C. 20549. You can request copies of these documents, upon payment of a duplicating fee, by writing to the SEC. Please call the
SEC at 1-800-SEC-0330 for further information on the operation of the public reference rooms. 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.
We
intend to furnish JPMorgan Chase Bank, N.A., the depositary of our ADSs, with all notices of shareholders' meeting and other reports and communications that are made generally
available to our shareholders. The depositary will make such notices, reports and communications available to holders of ADSs and, upon our written request, will mail to all record holders of ADSs the
information contained in any notice of a shareholders' meeting received by the depositary from us.
In
accordance with NYSE Rules 203.01, we will post this annual report on Form 20-F on our website at
http://ir.taomee.com/phoenix.zhtml?c=243417&p=irol-sec. In addition, we will provide hard copies of our annual report free of charge to shareholders and ADS holders upon request.
I. Subsidiary Information
For a listing of our subsidiaries, see "Item 4Information on the CompanyC. Organizational Structure," as well as
Exhibit 8.1 filed herewith.
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ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Exchange Risk
Our revenues and purchases are generally denominated in Renminbi. Our assets and liabilities are also denominated in Renminbi, except
for cash held in other currencies, which included approximately US$19.6 million as of December 31, 2012. As a result, fluctuations in the exchange rates between the U.S. dollar
and Renminbi will affect our results of operations and financial condition. Such fluctuations will also affect us with respect to the translation of the net proceeds that we will receive from the
initial public offering into Renminbi. The Renminbi's exchange rate with the U.S. dollar is affected by, among other things, changes in China's political and economic conditions and
China's foreign exchange policies. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under this policy,
the Renminbi was permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. For almost two years after reaching a high against the U.S. dollar in
July 2008, the Renminbi traded within a narrow band against the U.S. dollar, remaining within 1% of its July 2008 high. As a consequence, the Renminbi fluctuated sharply since
July 2008 against other freely traded currencies, in tandem with the U.S. dollar. In June 2010, the PRC government announced that it would increase the Renminbi exchange rate
flexibility and since that time the Renminbi has gradually appreciated against the U.S. dollar. However, it remains unclear how this flexibility might be implemented. There remains significant
international pressure on the PRC government to adopt a more flexible currency policy, which could result in greater fluctuation of the Renminbi against the U.S. dollar.
To
the extent that we need to convert U.S. dollars that we have on hand or receive from future financing activities into the Renminbi for our operations or other uses within the
PRC, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we would receive from the conversion. On the other hand, a decline in the value of
the Renminbi against the U.S. dollar could reduce the U.S. dollar equivalent amounts of our financial results, the value of your investment in our company and the dividends we may pay in
the future, if any, all of which may have a material adverse effect on the prices of ADSs. As of December 31, 2012, we had U.S. dollar-denominated cash balances of
US$19.6 million. Assuming we had converted the US$1.0 million into the Renminbi at the exchange rate of US$1.00 for RMB6.2301 as of December 31, 2012, this cash balance
would have been RMB122.4 million. Assuming a 5% appreciation of the RMB against the U.S. dollar, this cash balance would have decreased to RMB116.3 million as of
December 31, 2012.
Interest Rate Risk
Our exposure to interest rate risk primarily relates to finance income generated by excess cash invested in demand deposits with
original maturities of three months or less. We have not used any derivative financial instruments to manage our interest risk exposure. We have not been exposed, nor do we anticipate being exposed,
to material risks due to changes in interest rates. However, our future finance income may be lower than expected due to changes in market interest rates.
Inflation Risk
In recent years, inflation has not had a material impact on our results of operations. According to the National Bureau of Statistics
of China, the change in China's Consumer
Price Index decreased by 0.7% in 2009, increased by 3.3% in 2010, and 5.4% in 2011, and 2.6% in 2012. If inflation rises, it may materially and adversely affect our business.
Credit Risk
As of December 31, 2010, 2011 and 2012, substantially all of our cash and cash equivalents were held by financial institutions
that we believe to have high credit quality such as large state-owned
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enterprises.
Therefore, we believe we are not exposed to unusual risks. We have not experienced any losses on deposits of cash and cash equivalents. Due to the limited availability of online payment
systems in China and the limited access children have to online payment channels, users pay for our online business primarily through purchase of our prepaid cards, which distributed through a network
of third-party distributors. Before 2010, a majority of our prepaid cards were sold through Guangzhou New Fanlian Digital Technology Co., Ltd., our then national distributor. In
2010, we diversified our distributor network and our top three distributors contributed to 25.9%, 9.2% and 9.1% of the sales of our prepaid cards in 2010, 10.3%, 8.5% and 8.4% in 2011, and 9.8%, 8.9%
and 7.2% 2012. We collect payment from distributors upon delivery of the prepaid cards, which helps reduce our accounts receivable. We have not experienced any significant bad debts with respect to
our accounts receivable. We made no allowance for doubtful accounts in 2010 and 2012. We wrote off RMB1.0 million (US$155,171) in bad debt to an independent third party in 2011.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
A. Debt Securities
Not applicable.
B. Warrants and Rights
Not applicable.
C. Other Securities
Not applicable.
D. American Depositary Shares
Fees and Charges Our ADS holders May Have to Pay
ADS holders will be required to pay the following service fees to the depository:
|
|
|
Service
|
|
Fee
|
Issuance of ADSs
|
|
Up to US$0.05 per ADS issued
|
Cancellation of
ADSs
|
|
Up to US$0.05 per ADS canceled
|
Distribution of cash
dividends or other cash distributions
|
|
Up to US$0.05 per ADS held
|
Distribution of ADSs pursuant
to stock dividends, free stock distributions or exercise of rights
|
|
Up to US$0.05 per ADS held
|
Distribution of securities
other than ADSs or rights to purchase additional ADSs
|
|
Up to US$0.05 per ADS held
|
Depositary
services
|
|
Up to US$0.05 per ADS held on the applicable record date(s) established by the depositary
|
Transfer of
ADSs
|
|
US$1.50 per certificate presented for transfer
|
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 ADRs 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
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(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, by any party depositing or withdrawing shares or by any party surrendering ADSs 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 ADRs or the deposited securities or a distribution of ADSs),
whichever is applicable:
-
-
a fee of up to US$1.50 per ADR or ADRs for transfers of certificated or direct registration ADRs;
-
-
a fee of up to US$0.05 per ADS for any cash distribution made pursuant to the deposit agreement;
-
-
a fee of up to US$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 holders of ADRs 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);
-
-
reimbursement of such fees, charges and expenses as are incurred by the depositary and/or any of the depositary's agents
(including, without limitation, the custodian and expenses incurred on behalf of holders in connection with compliance with foreign exchange control regulations or any law or regulation relating to
foreign investment) in connection with the servicing of the shares or other 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 charge shall be assessed on a proportionate basis against 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 holders or by deducting such charge from one or more cash dividends or other cash distributions);
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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 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 holders entitled thereto;
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stock transfer or other taxes and other governmental charges;
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cable, telex and facsimile transmission and delivery charges incurred at your request in connection with the deposit or
delivery of shares;
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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
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expenses of the depositary in connection with the conversion of foreign currency into U.S. dollars.
We
will pay all other charges and expenses of the depositary and any agent of the depositary (except the custodian) pursuant to agreements from time to time between us and the
depositary. The charges described above may be amended from time to time by agreement between us and the depositary.
Our
depositary has agreed to reimburse us for certain expenses we incur that are related to establishment and maintenance of the ADR program, including investor relations expenses and
exchange application and listing fees. Neither the depositary nor we can determine the exact amount to be made available to us because (i) the number of ADSs that will be issued and
outstanding, (ii) the
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of fees to be charged to holders of ADSs and (iii) our reimbursable expenses related to the ADR program are not known at this time. The depositary collects its fees for issuance and
cancellation of ADSs directly from investors depositing shares or surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them. The depositary collects fees for making
distributions to investors by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees. The depositary may collect its annual fee for
depositary services by deduction from cash distributions, or by directly billing investors, or by charging the book-entry system accounts of participants acting for them. The depositary
will generally set off the amounts owing from distributions made to holders of ADSs. If, however, no distribution exists and payment owing is not timely received by the depositary, the depositary may
refuse to provide any further services to holders that have not paid those fees and expenses owing until such fees and expenses have been paid.
At
the discretion of the depositary, all fees and charges owing under the deposit agreement are due in advance and/or when declared owing by the depositary.