UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
(Mark One)
o | REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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o | SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number: 000-51116
Ku6 Media Co., Ltd. |
(Exact name of Registrant as specified in its charter) |
Securities registered or to be registered pursuant to Section 12(b) of the
* Not for trading, but only in connection with the listing on the NASDAQ Global Market of American Depositary Shares, each representing 100 Ordinary Shares
Securities registered or to be registered pursuant to Section 12(g) of the
Securities for which there is a reporting obligation pursuant to Section 15(d) of the
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes x No
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 o Yes x No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow. o Item 17 o Item 18
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by
o Yes o No
Except where the context otherwise requires and for purposes of this annual report on Form 20-F only:
· “ADSs” refers to our American depositary shares, each of which represents 100 ordinary shares;
· “Cayman Companies Law” refers to the Companies Law
· “China” and the “PRC” refer to the People’s Republic of China, excluding, for the purposes of this annual report on Form 20-F only, Taiwan and the special administrative regions of Hong Kong and Macau; ·“Huzhong” refers to Huzhong Advertising (Shanghai) Ltd., an independent third party;
· “Ku6 Holding” refers to Ku6 Holding Limited and its subsidiaries, affiliates and predecessor entities;
· “Mr. Xu” refers to Xudong Xu, our largest shareholder;
· “New Shengyue” refers to Shanghai Shengyue Advertising Co., Ltd., an independent third party, with respect to our agreements with it on or after April 1, 2014;
· “Old Shengyue” refers to Shanghai Shengyue Advertising Co., Ltd., then wholly owned by Shanda Interactive, with respect to our agreements with it on or prior to March 31, 2014;
· “ordinary shares” refers to our ordinary shares, par value $0.00005 per share;
· “our consolidated affiliated entities” refers to Ku6 (Beijing) Information Technology Co., Ltd., or Ku6 Information Technology, Tianjin Ku6 Zheng Yuan Information Technology Co., Ltd., or Tianjin Ku6 Zheng Yuan, Ku6 (Beijing) Cultural Media Co., Ltd., or Ku6 Cultural, and Tianjin Ku6 Network Communication Technology Co., Ltd., or Tianjin Ku6 Network;
· “our PRC subsidiaries” refers to Ku6 (Beijing) Technology Co., Ltd., or Beijing WFOE, WeiMoSanYi (Tianjin) Technology Co., Ltd., or Tianjin WFOE, and Kusheng (Tianjin) Technology Co., Ltd., or Tianjin Ku6 Network WFOE;
· “Qinhe” refers to Shanghai Qinhe Internet Technology Software Development Co., Ltd., a company controlled by Mr.
· “RMB” and “Renminbi” refer to the legal currency of China;
· “Shanda Interactive” refers to Shanda Interactive Entertainment Limited, a Cayman Islands company;
· “Shanda Media” refers to Shanda Media Group Limited, a wholly owned subsidiary of Shanda Interactive; ·“Share Purchase Transaction” refers to the purchase of 1,938,360,784 of our ordinary shares by Mr. Xu from Shanda Media, our then controlling shareholder,
· “we,” “us,” “our company” and “our” refer to Ku6 Media Co., Ltd. and its subsidiaries, consolidated affiliated entities and predecessor entities.
This annual report on Form 20-F contains forward-looking statements that are based on our current expectations, assumptions, estimates and projections about us and our industry. All statements other than statements of historical fact in this form are forward-looking statements. These forward-looking statements can be identified by words or phrases such as “may,” “will,” “expect,” “anticipate,” “estimate,” “plan,” “believe,” “is/are likely to” or other similar expressions. The forward-looking statements included in this form relate to, among others:
· our goals and strategies;
· our future business development, financial condition and results of operations;
· our projected revenues, earnings, profits and other estimated financial information;
· expected changes in our margins and certain costs or expenditures;
· expected continued acceptance of our content;
· our plans to expand and diversify the sources of our revenues;
· expected changes in the respective shares of our revenues from particular sources;
· our plans for staffing, research and development and marketing;
· our plans to launch new products and services;
· our plans for strategic partnerships with other businesses;
· our acquisition and divestiture strategy, and our ability to successfully integrate past or future acquisitions with our existing operations and complete planned divestitures;
· competition in the PRC online video industry;
· the outcome of ongoing, or any future, litigation or arbitration;
· changes in PRC governmental preferential tax treatment and financial incentives we currently qualify for and expect to qualify for; and
· PRC governmental policies relating to media and the Internet and Internet content providers and to the provision of advertising over the Internet.
These forward-looking statements involve various risks and uncertainties. Although we believe that our expectations expressed in these
Item 1.Identity of Directors, Senior Management and Advisors
Not Applicable.
Item 2. Offer Statistics and Expected Timetable
Not Applicable.
A.Selected Financial Data
The following table presents certain selected consolidated financial information for our business. You should read the following information in conjunction with our audited consolidated financial statements, the notes thereto and Item 5. “Operating and Financial Review and Prospects” included elsewhere in this annual report on Form 20-F. The data as of December 31,
In May 2010, we sold all of our 51% interest in Beijing Huayi Brothers Music Co., Ltd., or Huayi Music, to Huayi Brothers Media Corporation. In August 2010, we completed the disposal of our remaining wireless value-added services, or WVAS, and recorded music businesses to Shanda Interactive and also acquired from Shanda Interactive the control of Shanghai Yisheng Network Technology Co., Ltd., or Yisheng, an online audio business. The initial acquisition of the online audio business from Shanda Interactive was accounted for as an acquisition under common control and the disposal of the WVAS and recorded music businesses, including Huayi Music, was accounted for as discontinued operations in accordance with U.S. GAAP in our consolidated financial statements. In August 2011, we disposed of a significant interest in Yisheng and retained a 20% interest. The disposal gain was recognized as an increase in additional paid-in capital for the year ended December 31, 2011.
The audited consolidated financial statements included in this annual report on Form 20-F were prepared on the basis of a going concern which contemplates that we will be able to realize assets and discharge liabilities in the normal course of business. However, substantial doubt exists as to our ability to continue as a going concern. The audited consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties. See Item 5.B. “Liquidity and Capital Resources—Liquidity and Going Concern,” Item 3.D. “Risk Factors—Risks Related to our Business—There is substantial doubt as to our ability to continue as a going concern” and notes 1 and 2 to our audited consolidated financial statements included elsewhere in this annual report on Form 20-F.
Exchange Rate Information
We present our historical consolidated financial statements in U.S. dollars. Certain contractual amounts in Renminbi described in this annual report are translated into U.S. dollar amounts solely for the convenience of the reader. Except as otherwise specified, these amounts are translated at a rate of
The following table sets forth information regarding exchange rates between Renminbi and U.S. dollars for the periods indicated:
Source: Federal Reserve H.10 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 were 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.
Risks Related to Our Business There is substantial doubt as to our ability to continue as a going concern.
Substantial doubt exists as to our ability to continue as a going concern. See Item 5.B. “Liquidity and Capital Resources—Liquidity and Going Our new business models may not be able to generate sufficient revenues and operating cash flows.
Historically, we derived substantially all of our revenues from online advertising services, for which we collect service fees from advertisers through our advertising agencies. From April 2011 to March 2014, we relied on Old Shengyue, an affiliate wholly owned by Shanda Interactive during that period, as our primary advertising agency, which managed our sales to, and collected payments from, substantially all of our advertisers. Our advertising agency agreement with Old Shengyue In April 2014, we entered into a new advertising agency agreement with New Shengyue, which is no longer owned by Shanda Interactive and is an independent third party. In August 2014, we terminated this agreement with New Shengyue and entered into another new advertising agency agreement with Huzhong, an independent third party. We generated advertising revenue of $0.5 million in 2014 from New Shengyue. Pursuant to our agreement with Huzhong, Huzhong will act as our exclusive advertising agency for standard media resources and non-exclusive advertising agency for highly-interactive advertising resources. Under this agreement, we guarantee a certain amount of web traffic per day for webpages on which Huzhong posts advertisements, and in return, Huzhong guarantees to us a minimum amount of advertising revenues per day. If we fail to meet the web traffic target, the minimum amount guaranteed by Huzhong will be proportionally adjusted for the shortfall. Huzhong agreed to prepay 50% of the minimum guaranteed amounts within five business days prior to the beginning of each month and settle the balance within five business days after the end of each month. This advertising agency agreement with Huzhong will expire on December 31, 2017. We generated revenue of $2.8 million under our agreement with Huzhong from August 29, 2014 to December 31, 2014. Going forward, we will continue to rely on third party advertising agencies like Huzhong for our advertising services and we cannot assure you that we will maintain our relationship with them and generate sufficient revenues from these sources. In addition, we explored new revenue models in cooperation with Qinhe, a company controlled by Mr. Xu, our largest Our cooperation with Qinhe is relatively new and subject to
As our revenue models for our advertising and marketing services are still relatively new and constantly changing, we cannot assure you that these arrangements will be successful or that we will be able to generate sufficient revenue and cash flows from these revenue models in the future. If either Qinhe or
Our online advertising business had benefited significantly from Shanda Interactive’s brand name and strong market position in China prior to the Share Purchase Transaction. From April 2011 to March 2014, we relied on Old Shengyue, an affiliate wholly owned by Shanda Interactive during that period, as our sole advertising agency, which managed our sales to, and collected payments from, substantially all of our advertisers.
We have
In addition, we have relied and will continue to rely on Mr. Xu to operate our business and to finance our capital needs. In April 2014, as a result of our management’s review and adjustment of our business strategies after the Share Purchase Transaction, we adopted new revenue models in cooperation with Qinhe, a company controlled by Mr. Xu. In March 2015, we obtained loans from Mr. Xu, our largest shareholder, in the amount of RMB30.0 million. We cannot assure you that we will be able to continue to obtain additional financings from Mr. Xu under terms acceptable to us or at all in the future. Our cooperation arrangements with Qinhe are subject to considerable uncertainties.
Historically, we derived substantially all of our revenues from online advertising services, for which we collect service fees from advertisers through our advertising agencies. In April 2014, as a result of our management’s review and adjustment of our business strategies after the Share Purchase Transaction, we adopted new revenue models in cooperation with Qinhe, a company controlled by Mr. Xu, our largest
As a result, revenues we generate under these agreements will depend on the performance of the iSpeak platform
Our history with Qinhe is very short and the form of cooperation between Qinhe and us continues to change. The level of information that is available for Qinhe, a privately held company, is highly limited. Therefore, it is very difficult to effectively assess our future prospects with respect to our cooperation with Qinhe. You should consider our business and prospects in light of the risks and considerable uncertainties with respect to such arrangements. We require a significant amount of cash to fund our operations. We cannot assure you that we can meet our working capital requirements or other capital needs through improved operating results.
The operation of an online user-generated content, or UGC, video business requires continuous, substantial investment in content, technology, talent and infrastructure. In order to implement our development strategies to expand our infrastructure and optimize our services across Internet-enabled devices, and further expand and diversify our revenue sources, we may incur additional capital needs in the future. We will also need to fund our research and development activities in order to remain competitive on cost and technology. We cannot assure you that we will be able to generate sufficient cash flows or otherwise As of December 31,
We cannot assure you that we can meet our working capital requirements or other capital needs through additional financings in amounts or on terms acceptable to us, or at all.
If we cannot meet our liquidity needs through improved operating results, we may need to obtain financings from financial institutions or issue debt securities. We cannot assure you that we will be able to obtain any future financings if required under commercially reasonable terms, or at all. In addition, we may have to issue and sell additional equity securities to meet our liquidity needs, but our ability to sell our equity securities is not assured. Any additional issuance of equity securities would dilute the ownership of our shareholders and ADS holders. Our ability to obtain additional financings in the future is subject to a number of uncertainties, including:
· our future business development, financial condition and results of operations;
· changes in financial market conditions or our business condition that could limit our access to existing credit facilities or make new financings more costly or even unfeasible;
· changes in China’s currency exchange control regulations that could limit our ability to access cash in China to meet liquidity requirements for our operations in China or elsewhere;
· general market conditions for financing activities by companies in our industry; and
· macroeconomic, political and other conditions in China and elsewhere.
In the past, Shanda Interactive and Mr. Xu provided debt and equity financings for us in various situations. In March 2015, we obtained loans from Mr. Xu, our largest shareholder, in the amount of RMB30.0 million. However, we may not receive any support from Shanda Interactive and Mr. Xu in the future. See “—We may not be able to continue to receive support from If we cannot obtain sufficient funding to meet our working capital requirements or other capital expenditure needs, our business, financial condition and prospects may be materially and adversely affected. We have a history of losses, and we may be unable to achieve or sustain profitability.
We incurred net losses in each of the fiscal years from
· growth or decline of the online video industry;
· the transition from long-form professional content to short-form UGC;
· the continued growth and maintenance of our user base;
· our ability to control our costs and expenses and effectiveness of our cost reduction plans;
· our ability to provide new advertising services to meet the demands of our advertising customers;
· growth or decline of the online advertising market in China; and
· brand advertisers’ allocation of more budgets to online video industry.
Our ability to achieve profitability also depends on the success of our new business models, including our cooperation arrangements with Qinhe, which
Despite our cost reduction measures, The report of our independent registered public accounting firm expresses substantial doubt about our ability to continue as a going concern.
Our
We may implement further restructuring of our business, including through strategic acquisitions,
In order to improve our business operations, we may implement further restructuring of our business in the future, including through strategic acquisitions. There could be a material adverse effect on our business, results of operations and prospect if we fail to successfully execute any such restructuring plans and acquisitions, or if the contemplated benefits from any such restructuring or acquisitions do not materialize.
In addition, the success of any acquisition, if any, will depend upon a number of factors, including:
· our ability to acquire businesses on a cost-effective basis;
· our ability to obtain necessary financings for such acquisition;
· our ability to integrate acquired personnel, operations, products and technologies into our organization effectively; and
· our ability to retain and motivate key personnel and to retain the clients of acquired firms.
Any such restructuring or strategic acquisition may require a significant commitment of management time, capital investment and other resources. Our business operation may also be severely disrupted by any such transactions. We may be unable to consummate such transactions, we may not be able to effectively integrate an acquired business or we may be required to incur significant expenses to complete a transaction. We may also experience increased employee turnovers in our existing workforce. As a result, our business, financial condition and results of operations may be materially and adversely affected. In addition, if we use debts to finance any such restructuring or acquisition, we may become highly leveraged. If we use our equity securities as consideration for transactions, the value of your ADSs may be substantially diluted.
In addition, according to the amendments to Schedule 13D filed by Shanda Interactive on April 1, 2014 and the Schedule 13D filed by Mr. Xu on April 9, 2014, under the share purchase agreement relating to the Share Purchase Transaction, Shanda Media, a wholly owned subsidiary of Shanda Interactive, has agreed that if we propose to acquire Sky Profit Limited, a company controlled by Mr. Xu, our largest shareholder, and such transaction is recommended to the shareholders for approval by our board of directors and any special committee of disinterested directors, Shanda Media shall vote all its shares in line with such recommendation. Sky Profit Limited controls Qinhe, which operates iSpeak, a social platform that allows users to engage in real-time online group activities through voice, text and video. Shanda Media has a right under this share purchase agreement to subscribe to equity or equity-linked securities issued by affiliates of Mr. Xu for an amount up to
We operate in a highly competitive market and we may not be able to compete successfully against our competitors.
We face significant competition, primarily from those companies that operate online video websites in China, which our management estimates to currently number over one hundred. A large number of independent online video sites, such as Youku Tudou and iQiyi.com, compete against us. In addition, Chinese Internet portals, including Sina.com, Sohu.com and Baidu.com, and some of China’s major TV networks, such as China Central Television, or CCTV, Phoenix Satellite TV and Hunan Satellite TV, which have longer operating histories and more experience in attracting and retaining users and managing customers than we do, have launched their own video businesses. We also face competition from Internet video streaming platforms based on the P2P technology, such as PPS and PPTV. We compete with these companies for users and advertisers. Our competitors may compete with us in a variety of ways, including by conducting brand promotions and other marketing activities and making acquisitions. In addition, certain online video websites may continue to derive their revenues from providing content that infringes third-party copyright and may not monitor their websites for any such infringing content. As a result, we may be placed at a disadvantage to some of these websites that do not incur similar costs as we do with respect to content monitoring. Some of our competitors have a longer operating history and significantly greater financial resources than we do, and in turn may be able to attract and retain more users and advertisers. If any of our competitors achieves greater market acceptance than we do or is able to offer more attractive online video content, our user traffic may decrease and our market share may decrease, which may result in a loss of advertisers and have a material and adverse effect on our business, financial condition and results of operations.
In addition, Internet streaming of content represents only one of many existing and potential new technologies for viewing video. Many users maintain simultaneous relationships with multiple video providers and can easily shift from one provider to another. For example, users may subscribe to cable, buy a DVD, and download a movie from Apple iTunes or other sources, or some combination thereof. New competitors may be able to launch new businesses at a relatively low cost.
We also face competition from other types of advertising media, such as newspapers, magazines, yellow pages, billboards and other forms of outdoor media, television and radio. Most large companies in China allocate, and will likely continue to allocate, most of their marketing budgets to traditional advertising media and only a small portion of their budgets to online marketing and other forms of advertising media. If these companies do not devote a larger portion of their marketing budgets to online marketing services provided by our online video business, or if our existing customers reduce the amount they spend on online marketing, our results of operations and future growth prospects could be adversely affected. The online video industry in China and user acceptance of our online video content may not grow as quickly as expected, which may adversely affect our revenues and business prospects.
Our business prospects depend on the continuing development of the online video industry in China. As an emerging industry, China’s online video industry has experienced substantial growth in recent years in terms of both users and content. We cannot assure you, however, that the online video industry will continue to grow as rapidly as it has in the past. With the development of technology, new forms of media may emerge and render online video websites less attractive to users. Growth of the online video industry is affected by numerous factors, such as users’ general online video experience, technological innovations, development of Internet and Internet-based services, regulatory changes, especially regulations affecting copyrights, and the macroeconomic environment. If the online video industry in China does not grow as quickly as expected or if we fail to benefit from such growth by successfully implementing our business strategies, our user traffic may decrease and our business and prospects may be adversely affected. We operate in a rapidly evolving industry. If we fail to keep up with the technological developments and users’ changing requirements, our business, results of operations and prospects may be materially and adversely affected.
The online video industry is rapidly evolving and subject to continuous technological changes and changes in industry standards. Our success will depend on our ability to keep up with the changes in technology and user behavior resulting from the technological developments. For example, the development of broadband enabled the enjoyment of high definition videos online. In addition, the number of people accessing the Internet via devices other than personal computers, including mobile phones and other hand-held devices, has increased in recent years. With the rapid development of 3G and 4G mobile communication services in China, we expect this trend to continue. If we do not adapt our products and services to such changes in an effective and timely manner, we may suffer from a decreased user traffic, which may result in a reduced number of advertisers using our online advertising services. Furthermore, changes in technologies may require substantial capital expenditures in product development as well as in modification of products, services or infrastructure. Failure in keeping up with technological development may result in our products and services being less attractive, which in turn, may materially and adversely affect our business, results of operations and prospects.
If we fail to continue to provide attractive products and services, we may not be able to generate sufficient user traffic to remain competitive.
Our success depends on our ability to generate sufficient user traffic through provision of attractive products and services. To attract and retain users and compete against our competitors, we must maintain high-quality UGC that provides our users with a satisfactory online video experience. With UGC, users can upload and share their own videos and spend a longer time on our website, and we believe a “community-like” environment will enhance users’ loyalty to our website and such network effect broadens advertisers’ reach of audience. Previously, we purchased the licensing rights to some popular UGC and shared advertising revenues with individual users whose number of uploads exceed certain thresholds. We also had a revenue sharing program to reward users for contents they uploaded in order to encourage more users to upload UGC to our website. In April 2014, in connection with the change of our business models after the Share Purchase Transaction, we announced a suspension of this revenue sharing program from May 1, 2014. We may not be able to continue to anticipate user preferences.
Based on the feedback on our website design and our statistics regarding users’ watching behavior, we keep developing new website features that appeal to users, such as designing more user-friendly content searching tools, creating additional interactive social functions or offering better website compatibility with new Internet-enabled devices. We need to continuously anticipate user preferences and industry changes and respond to such changes in a timely and effective manner. If we fail to cater to the needs and preferences of our users and, as a result, fail to deliver satisfactory user experience, we may suffer from reduced user traffic and our business and results of operations may be materially and adversely affected. We may not be able to maintain and enhance our brand.
We may not be able to maintain and enhance our Ku6 brand You may not be able to rely on our quarterly operating results as an indication of our future performance because our quarterly operating results may be subject to significant fluctuations.
We may experience significant fluctuations in our quarterly operating results due to a variety of factors, many of which are beyond our control. Significant fluctuations in our quarterly operating results could be caused by many factors, including, but not limited to:
· our ability to retain existing users, attract new users at a steady rate and maintain user satisfaction;
· the creation of new content by our users and the popularity of such content;
· technical difficulties, system downtime or Internet failures for our websites;
· the amount and timing of operating costs and capital expenditures relating to expansion of our business, operations and infrastructure;
· the adoption of new, or changes to existing, governmental regulations; and
· economic conditions in general and specific to the online video industry in China.
As a result, you should not rely on quarter-to-quarter or
We may be subject to administrative actions by PRC regulatory authorities and other liabilities because of advertisements shown on our website.
Under PRC advertising laws and regulations, we are obligated to monitor the advertising content shown on our website to ensure that such content is true, accurate and in full compliance with applicable laws and regulations. In addition, where a special government review is required for specific types of advertisements prior to website posting, such as advertisements relating to pharmaceuticals, medical instruments, agrochemicals and veterinary pharmaceuticals, we are obligated to confirm that such review has been performed and approval has been obtained from competent governmental authority, which is generally the local branch of the State Administration for Industry and Commerce, or the SAIC. Violation of these laws and regulations may subject us to penalties, including fines, confiscation of our advertising income, orders to cease dissemination of the advertisements and orders to publish an announcement correcting the misleading information. In circumstances involving serious violations, such as posting a pharmaceutical product advertisement without approval, or posting an advertisement for fake pharmaceutical products, PRC governmental authorities may force us to terminate our advertising operation or revoke our licenses. Furthermore, advertisers, advertising operators or advertising distributors, including us, may be subject to civil liability if they infringe on the legal rights and interests of third parties.
Substantially all of the advertisements shown on our website are provided to us by our advertising agency on behalf of advertisers. We cannot assure you that all the content contained in such advertisements is true and accurate as required by the advertising laws and regulations, especially given the uncertainty in the application of these laws and regulations. For example, Article 38 of the Advertisement Law provides that an advertisement operator who knows or should have known the posted advertisement is false or fraudulent will be subject to joint and several liabilities. However, for the determination of the truth and accuracy of the advertisements and the actual or constructive knowledge of the website, there are no implementing rules or official interpretations, and such a determination is at the sole discretion of the relevant local branch of the SAIC, which results in uncertainty in the application of these laws and regulations.
If we are found to be in violation of applicable PRC advertising laws and regulations in the future, we may be subject to penalties and our reputation may be harmed, which may have a material and adverse effect on our business, financial condition, results of operations and prospects. See Item 4.B. “Business Overview—Government Regulation—Regulations on Advertisements.”
We rely on the efficient and uninterrupted operation of complex information technology applications, systems and networks to operate our business. Our ability to provide users with a high-quality online video experience depends on the continuous and reliable operation of our systems. We cannot assure you that we will be able to procure sufficient bandwidth in a timely manner or on acceptable terms or at all. Failure to do so may significantly impair user experience on our website and decrease the overall effectiveness of our website to both users and advertisers. Disruptions, failures, unscheduled service interruptions or a decrease in connection speeds could hurt user experience and our reputation, causing our users and advertisers to switch to our competitors’ websites. Our systems and proprietary video content delivery network, or CDN, are vulnerable to damage or interruption as a result of fires, floods, earthquakes, power losses, telecommunications failures, cyber-attacks, undetected errors in software, computer viruses, hacking and other attempts to harm our systems. We have experienced service interruptions in the past which typically were caused by (i) overload of our servers, (ii) unexpected overflow of user traffic, and (iii) service malfunction of the telecommunications operators, such as power outage of Internet data centers or network transmission congestion. We may continue to experience similar interruptions in the future despite our continuous efforts to improve our systems. Since we host our servers at third-party Internet data centers, any natural disaster or unexpected closure of Internet data centers operated by third-party providers may result in lengthy service interruptions. If we experience frequent or persistent service disruptions, whether caused by failures of our own systems or those of third-party service providers, our users’ experience may be negatively affected, which in turn, may have a material and adverse effect on our reputation. We cannot assure you that we will be successful in minimizing the frequency or duration of service interruptions. In addition, the risks of cyber-attacks have increased significantly recently. Some of these attacks may originate from well organized, highly skilled organizations. Any such attack could result in a loss of our intellectual property, the release of commercially sensitive information, customer or employee personal data. Failures to protect the privacy of customer and employee confidential data against breaches of network security could result in damage to our reputation.
Undetected programming errors could adversely affect user experience and the market acceptance of our video programs, which may materially and adversely affect our business and results of operations.
The video programs, including advertising video programs, on our website may contain programming errors that may only become apparent after their release. We receive user feedback in connection with programming errors affecting their user experience from time to time, and such errors may also come to our attention during our monitoring process. We generally have been able to resolve such programming errors in a timely manner. However, we cannot assure you that we will be able to detect and resolve all these programming errors effectively. Undetected audio or video programming errors or defects may adversely affect user experience and cause our advertisers to reduce their use of our services, any of which could materially and adversely affect our business and results of operations. Our operations depend on the performance of the Internet infrastructure and telecommunications networks in China and third-party service providers.
Our products and services depend on the ability of our users to access the Internet. Therefore, the successful operation of our business depends on the performance of the Internet infrastructure and telecommunications networks in China. Almost all access to the Internet is maintained through state-owned telecommunications operators under the administrative control and regulatory supervision of China’s Ministry of Industry and Information Technology, or the MIIT. Moreover, we have entered into contracts with various subsidiaries of a limited number of telecommunications service providers in each province and rely on them to provide us with data communications capacity through local telecommunications lines and Internet data centers to host our servers. We have limited access to alternative networks or services in the event of disruptions, failures or other problems with China’s Internet infrastructure or the telecommunications networks provided by telecommunications service providers. Our Ku6.com website regularly serves a large number of users and advertisers. With the expansion of our business, we may be required to upgrade our technology and infrastructure to keep up with the increasing traffic on our websites. However, we have no control over the costs of the services provided by telecommunications service providers. If the prices we pay for telecommunications and Internet services rise significantly, our results of operations may be materially and adversely affected. If Internet access fees or other charges to Internet users increase, our user traffic may decline and our business may be hurt. Our servers, which are partly hosted at third-party Internet data centers, are vulnerable to break-ins, sabotage and vandalism. The occurrence of a natural disaster or a closure of an Internet data center by a third-party provider without adequate notice could result in lengthy service interruptions. Moreover, the agreements we have entered into with domestic telecommunications carriers to host our servers typically have terms of approximately one year and are renewable subject to early termination. If we are not able to renew such hosting services agreements with the telecommunications carriers when they expire and are not able to enter into agreements with alternative carriers at commercially reasonable terms or at all, the quality and stability of our services may be adversely affected. In addition, our domain names are resolved into Internet protocol (IP) addresses by systems of third-party domain name registrars and registries. Any interruptions or failures of those service providers’ systems, which are beyond our control, could significantly disrupt our own services.
If we experience frequent or persistent system failures on our websites, whether due to interruptions and failures of our own information technology and communications systems or those of third-party service providers we rely upon, our reputation and brand could be permanently harmed. The steps we take to increase the reliability and redundancy of our systems are expensive, may reduce our operating margin and may not be successful in reducing the frequency or duration of service interruptions.
We also depend significantly on relationships with leading technology providers and the licenses that the technology providers have granted to us. Our competitors may establish the same relationships as we have, which may adversely affect us. We may not be able to maintain these relationships or replace them on commercially attractive terms. We have been and expect to continue to be exposed to intellectual property infringement and other claims, including claims based on content posted on our website.
Our success depends, in large part, on our ability to operate our business without infringing third-party rights, including third-party intellectual property rights. Internet companies, technology and media industries own, and are seeking to obtain, a large number of patents, copyrights, trademarks and trade secrets, and they are frequently involved in litigation based on allegations of infringement or other violations of intellectual property rights or other related legal rights. There may be patents issued or pending that are held by others that cover significant aspects of our technologies, products, business methods or services.
We have been and may continue to be subject to claims for defamation, negligence, infringement of third-party copyright and other rights, such as privacy and image rights, or other claims based on the nature or content of videos or other information provided by
Due to the significant number of videos uploaded by users, which currently amounts to an average of approximately
It could be time-consuming and costly to defend these claims, which, with or without merit, may cause us to incur significant costs and liabilities and could materially and adversely affect our business, and also result in diversion of the attention of our management and our financial resources and negative publicity on our brand and reputation. The failure to successfully defend any of them may result in substantial damage awards and/or court orders that may prevent us from continuing to provide certain of our existing services. We may not be able to adequately protect our intellectual property rights, and any failure to protect our intellectual property rights could adversely affect our revenues and competitive position.
We believe that trademarks, trade secrets, patents, copyrights and other intellectual property we use are important to our business. We rely on a combination of trademark, copyright, patent and trade secret protection laws in China and other jurisdictions, as well as confidentiality procedures and contractual provisions to protect our intellectual property and our brand. We have invested significant resources to develop our own intellectual property and acquire licenses to use and distribute the intellectual property of others for our online video site; failure to maintain or protect these rights could harm our business. In addition, any unauthorized use of our intellectual property by third parties may adversely affect our current and future revenues and our reputation.
The validity, enforceability and scope of protection available under intellectual property laws with respect to the Internet industry in China are uncertain and still evolving. Implementation and enforcement of PRC intellectual property-related laws have historically been deficient and ineffective. Accordingly, protection of intellectual property rights in China may not be as effective as in the United States or other western countries. Furthermore, policing unauthorized use of proprietary technology is difficult and expensive, and we may need to resort to litigation to enforce or defend copyrights issued to us or our other intellectual property or to determine the enforceability, scope and validity of our proprietary rights or those of others. Such litigation and an adverse determination in any such litigation, if any, could result in substantial costs and diversion of resources and management attention.
Complexity, uncertainties and changes in government policies or regulations of Internet industry may have a material and adverse effect on our business, financial condition, results of operations and prospects.
Our online video business is subject to strict government regulations in China. The PRC government extensively regulates the Internet industry, including foreign ownership of, and the licensing and permit requirements pertaining to, companies in the Internet industry. Under the PRC regulatory scheme, a number of regulatory agencies, including the State Administration of Press, Publication, Radio, Film and Television, or SAPPRFT, including its predecessor ministries, the
We believe that we have obtained the licenses and permits essential for our business operations. However, given the Internet-related laws and regulations are relatively new and rapidly evolving in China, their interpretation and enforcement involve significant uncertainty. As a result, in certain circumstances it may be difficult to determine what actions or omissions may be deemed to violate applicable laws and regulations. The permits, licenses or approvals that we hold may be subject to challenge, we may fail to obtain permits or licenses that may be deemed necessary for our operations, or we may not be able to renew certain permits or licenses. We may also need to apply for additional permits or licenses when we enter new sectors of the Internet industry. For example, we may need to apply for the Internet News Information Service Permit issued by the SCIO or the Internet Publication License issued by SAPPRFT, in connection with the current events channel on our website. We may also need to expand the scope of our audio/video program transmission licenses to cover more categories of audio/video services. If we fail to maintain any of the required permits, licenses or approvals, we may be subject to various penalties, including fines and discontinuation of, or restriction on, our operations. Any such disruption of our business operations may have a material adverse effect on our business, financial condition, results of operations and prospects.
In addition, actions by the PRC government, including the interpretation, re-interpretation and application of existing PRC laws, regulations and policies and promulgation of new laws, regulations or policies relating to the Internet industry, may create substantial uncertainties regarding the legality of existing and future foreign investments in the Internet industry in China. Any such actions may have a material adverse effect on our business, financial condition, results of operations and prospects. For example, in December 2012, the GAPP published a proposed rule relating to Internet publication which, among other things, seeks to clarify the meaning of the “Internet publication service” and “Internet publication” as well as modify the application procedures for the relevant license. We plan to apply for the required license once the final rule is issued. However, we cannot assure you that such application would be approved by the relevant governmental agencies in a timely manner or at all. If we fail to obtain the license, we may be subject to various administrative penalties, including fines and confiscation of our income or assets, and we may be forced to discontinue our business and our website may be blocked.
We have limited business insurance coverage.
Insurance companies in China currently do not offer as extensive an array of insurance products as insurance companies do in more developed economies. We do not have any business liability or disruption insurance to cover our operations. We have determined that the costs of insuring for these risks and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. Any uninsured occurrence of business disruption may result in our incurring substantial costs and the diversion of resources, which could have an adverse effect on our results of operations and financial condition.
Regulation and censorship of information disseminated over the Internet in China may adversely affect our business and subject us to liability for information displayed on or linked to our websites.
The PRC government has adopted 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 reactionary, obscene, superstitious, fraudulent or defamatory. Furthermore, Internet content providers are also prohibited from displaying content that may be deemed by relevant government authorities as “socially destabilizing” or leaking “state secrets” of the PRC. Failure to comply with these requirements may result in administrative penalties, such as fines, the revocation of licenses to provide Internet content and other licenses and the closure of the concerned websites. In the past, failure to comply with such requirements has resulted in the closure of certain websites. The website operator may also be held liable for such censored information displayed on or linked to the website.
In addition, the MIIT has published regulations that subject website operators to potential liability for content displayed on their websites and the actions of users and others using their systems, including liability for violations of PRC laws and regulations 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 to block any Internet website at its sole discretion. From time to time, the Ministry of Public Security has stopped the dissemination over the Internet of information that it believes to be socially destabilizing. The State Secrecy Bureau is also 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. Furthermore, we are required to report any suspicious content to relevant governmental authorities, and to undergo computer security inspections. If we fail to implement the relevant safeguards against security breaches, our websites may be shut down and our business and ICP licenses may be revoked.
Although we attempt to monitor the content on our websites, we are not able to control or restrict the content of other Internet content providers linked to or accessible through our websites, or content uploaded to, or generated or placed on, our websites by our users. To the extent that PRC regulatory authorities find any content displayed on our websites objectionable, they may require us to limit or eliminate the dissemination of such information on our websites. If third-party websites linked to or accessible through our website operate unlawful activities such as online gambling on their websites, PRC regulatory authorities may require us to report such unlawful activities to relevant authorities and to remove the links to such websites, or they may suspend or shut down the operation of such websites. PRC regulatory authorities may also temporarily block access to certain websites for a period of time for reasons beyond our control. Any of these actions may reduce our user traffic and adversely affect our business. In addition, we may be subject to penalties for violations of those regulations arising from information displayed on or linked to our websites, including a suspension or shutdown of our online operations.
Concerns about collection, use and security of personal data could damage our reputation and deter current and potential users from using our services.
We have an extensive user base for our video platform, from which we collect personal data about our registered users. Under our privacy policy, without our users’ prior consent, we may not provide any of our users’ personal data to any unrelated third party. While we strive to comply with our privacy policies and other applicable data protection laws and regulations, any failure or perceived failure of compliance may result in proceedings or actions against us by our users, government authorities or other parties, and could damage our reputation. User and regulatory attitudes toward privacy are evolving, and their concerns about the extent to which personal data may be recorded, used or shared may adversely affect our ability to record, use or share such data, which may limit our advertising capabilities and the effectiveness of the marketing efforts of our advertising agencies.
In addition, concerns about the security of personal data could also lead to a decline in general Internet usage, which could lead to lower user traffic on our platform.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud.
We are subject to reporting obligations under the U.S. securities laws. The Securities and Exchange Commission, or the SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, adopted rules requiring every public company to include a management report on the effectiveness of such company’s internal control over financial reporting in its annual report. Our management concluded that our internal control over financial reporting was effective as of December 31,
We believe that we were a passive foreign investment company (“PFIC”) for taxable years 2006, 2007, 2008 and 2009 and it was not clear whether we were a PFIC for taxable year 2011. Although we believe we were not a PFIC for taxable year
We will be a PFIC for U.S. tax purposes for a taxable year if either (a) 75% or more of our gross income for such taxable year is passive income or (b) 50% or more of the average quarterly value, generally determined by fair market value, of our assets during such taxable year consists of assets that either produce passive income or are held for the production of passive income. For such purposes, if we directly or indirectly own 25% or more of the shares of another corporation, we generally will be treated as if we (a) held directly a proportionate share of the other corporation’s assets and (b) received directly a proportionate share of the other corporation’s income. We believe that we were a PFIC for taxable years 2006, 2007, 2008 and 2009, and it was not clear whether we were a PFIC for taxable year 2011. The determination of our PFIC status is subject to uncertainty because the treatment of the contractual arrangements between our PRC subsidiaries and our consolidated affiliated entities for purposes of the PFIC rules is uncertain. If we were a PFIC for 2006, 2007, 2008, 2009 and 2011, and you held ordinary shares or ADSs during any such taxable years, we would continue to be treated as a PFIC with respect to those ordinary shares or ADSs for all succeeding years during which you hold them. Our PFIC status for any taxable year will not be determinable until after the end of the taxable year and will depend on the composition of our income and assets and the market value of our assets for such taxable year, which may be, in part, based on the market price of our ordinary shares or ADSs (which may be especially volatile). For these reasons, and because of the uncertainties regarding the treatment of our contractual arrangements with our consolidated affiliated entities, there can be no assurance that we will not be a PFIC for any taxable year. Such characterization could result in adverse U.S. federal income tax consequences to a U.S. investor. In general, if we are a PFIC, then “excess distributions” to a U.S. investor and any gain realized by a U.S. investor on the sale or other disposition of our ordinary shares or ADSs will be allocated ratably over the U.S. investor’s holding period for the ordinary shares or ADSs; the amount allocated to the taxable year of receipt of the proceeds of such distribution or disposition and any year prior to our becoming a PFIC will be taxed as ordinary income; and the amount allocated to each other taxable year will be subject to tax at the highest rate in effect for the applicable class of taxpayer for that year. Additionally, an interest charge will be imposed with respect to the resulting tax attributable to each such other taxable year and the U.S. investor will be subject to U.S. tax reporting requirements. Alternatively, if we are a PFIC and if our ADSs are “regularly traded” on a “qualified exchange,” a U.S. investor could make a mark-to-market election that would result in tax treatment different from the general tax treatment for PFICs described above.
Given the complexity of the issues regarding our classification as a PFIC, U.S. investors are urged to consult their own tax advisors for guidance as to the U.S. federal, state and local and other tax consequences of our status as a PFIC in light of their particular circumstances, as well as the availability of, and procedures for making, a mark-to-market or other available election. For further discussion of the adverse U.S. federal income tax consequences of our classification as a PFIC, see Item 10.E. “Taxation—U.S. Federal Income Taxation” below.
Risks Related to Our Corporate Structure
If the PRC government finds that the agreements that establish the structure for operating our businesses in China do not comply with PRC governmental restrictions on foreign investment in Internet business, we could be subject to severe penalties or be forced to relinquish our interests in those operations.
Current PRC laws and regulations place certain restrictions on foreign ownership of companies that engage in Internet business, including the provision of online video and online advertising services. Specifically, foreign ownership in an Internet content provider or other value-added telecommunication service providers may not exceed 50%. Moreover, a foreign investor must have certain track record in the value-added telecommunication business or advertisement business before it can obtain direct equity interests in a PRC company that operates in these industries. Since we are a Cayman Islands company without any track-record of value-added telecommunication service or advertisement operations, neither we nor our PRC subsidiaries are eligible to hold a license to operate our website or our advertisement business in China. As a result, we conduct our operations in China principally through contractual arrangements among our PRC subsidiaries, our consolidated affiliated entities, and their respective shareholders. These contractual arrangements enable us to exercise effective control over these entities and hence treat them as our consolidated affiliated entities and consolidate their results. For a detailed discussion of these contractual arrangements, see Item 4.C. “Organizational Structure.”
PRC laws and regulations governing the validity of these contractual arrangements are uncertain and the relevant government authorities have broad discretion in interpreting these laws and regulations. Although we believe we are in compliance with current PRC regulations, we cannot assure you that the PRC government would hold the same view with us or these contractual arrangements comply with regulations or policies that may be amended or adopted in the future.
On July 13, 2006, the MIIT issued the Notice of the MIIT on Intensifying the Administration of Foreign Investment in Value-added Telecommunications Services. This notice prohibits domestic telecommunication services providers from leasing, transferring or selling telecommunications business operating licenses to any foreign investor in any form, or providing any resources, sites or facilities to any foreign investor for their illegal operation of a telecommunications business in China. According to this notice, either the holder of a value-added telecommunication business operating license or its shareholders must legally own the domain names and trademarks used by such license holders in their provision of value-added telecommunication services. The notice further requires each license holder to have the necessary facilities, including servers, for its approved business operations and to maintain such facilities in the regions covered by its license. In addition, all In January 2015, MOFCOM published on its website for public comment on a draft Foreign Investment Law of the PRC, or the draft FIL. The draft FIL is believed to strengthen the regulation of PRC companies, such as our VIEs, which have contractual arrangements with foreign investors or foreign invested companies. Under the draft FIL, a company controlled by foreign investors through contractual arrangements is considered to be a foreign invested enterprise and as a result is explicitly subject to restrictions on foreign investment. If the current version of the draft FIL becomes effective, our VIEs could fall within the scope of foreign invested companies and be subject to restrictions on foreign investment in the telecommunication service industry including online video business, and the related contractual arrangements between our VIEs and us could be challenged. Under the draft FIL, it is unclear how “control” would be determined for such purpose, and the draft FIL is silent as to the enforcement actions that might be taken against existing companies, such as our VIEs, that operate in restricted industries. Ku6 Information Technology, one of our consolidated affiliated entities, holds the licenses and permits necessary to conduct our online video, online advertising and related businesses in China. However, the related trademarks are owned by Beijing WFOE, one of our wholly owned PRC subsidiaries. If the MIIT strictly enforces the notice, we may be required to transfer those trademarks from Beijing WFOE to Ku6 Information Technology. If the PRC government determines that we do not comply with the currently applicable laws and regulations or policies that may be adopted in the future such as the proposed Draft FIL, it could revoke our business and operating licenses, including our value-added telecommunication license and ICP license, require us to discontinue or restrict our operations, restrict our right to collect revenues, block our website, require us to restructure our operations, impose additional conditions or requirements with which we may not be able to comply, or take other regulatory or enforcement actions against us that could be harmful to our business. The imposition of any of these penalties would result in a material and adverse effect on our ability to conduct our business.
Substantial uncertainties exist with respect to the enactment timetable, interpretation and implementation of the draft Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations. In January 2015, MOFCOM published the draft FIL aiming to, upon its enactment, replace the existing laws regulating foreign investment in the PRC, namely, the Sino-foreign Equity Joint Venture Enterprise Law, the Sino-foreign Cooperative Joint Venture Enterprise Law and the Wholly Foreign-invested Enterprise Law. The draft FIL is believed to embody a PRC regulatory trend to rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic investments. MOFCOM is currently soliciting comments on the draft FIL and substantial uncertainties exist with respect to its enactment timetable, interpretation and implementation. The draft FIL, if enacted as proposed, may materially impact the viability of our current corporate structure, corporate governance and business operations in many aspects. Among other things, the draft FIL expands the definition of foreign investment and introduces the principle of “actual control” in determining whether a company is considered a foreign-invested enterprise, or an FIE. The draft FIL specifically provides that entities established in the PRC but “controlled” by foreign investors will be treated as FIEs, whereas an entity set up in a foreign jurisdiction would nonetheless be, upon market entry clearance by MOFCOM, treated as a PRC domestic investor provided that the entity is “controlled” by PRC entities and/or citizens. “Control” is broadly defined in the draft FIL to cover the following categories: (i) holding, directly or indirectly, not less than 50% of shares, equities, share of voting rights or other similar rights of the subject entity; (ii) holding, directly or indirectly, less than 50% of the voting rights of the subject entity but having the power to secure at least 50% of the seats on the board or other equivalent decision making bodies, or having the voting power to materially influence the board, the shareholders’ meetings, or other equivalent decision making bodies; or (iii) having the power to exert decisive influence, via contractual or trust arrangements, over the subject entity’s operations, financial matters or other key aspects of business operations. Once an entity is determined to be an FIE, it will be subject to the foreign investment restrictions or prohibitions set forth in a catalogue of “special administrative measures” to be separately issued by the State Council, which will classify industries into the “catalogue of prohibitions” and the “catalogue of restrictions.” Foreign investors are not allowed to invest in any sector set forth in the catalogue of prohibitions. The “variable interest entity” structure, or the VIE structure, has been adopted by many PRC-based companies, including us, to obtain necessary licenses and permits in the industries that are currently subject to foreign investment restrictions in China. Under the draft FIL, variable interest entities that are controlled through contractual arrangements could also be deemed FIEs if they are ultimately “controlled” by foreign investors. If MOFCOM takes this position, our VIEs may be deemed FIEs and we may be deemed to operate FIEs in industries listed in the “catalogue of restrictions” based on the current catalogue relating to foreign investment, and our current corporate structure may be challenged. The draft FIL has not taken a position on what actions shall be taken with respect to the existing companies with a VIE structure and MOFCOM is soliciting comments from the public on this point. Moreover, it is uncertain whether the industry in which our variable interest entities operate will be subject to the foreign investment restrictions or prohibitions set forth in the “catalogue of special administrative measures” to be issued. We cannot assure you that the Foreign Investment Law and the final “catalogue of special administrative measures,” if enacted, will not mandate further actions to be completed by companies with an existing VIE structure like us or that we will be able to comply with such requirements within reasonable time, on commercially acceptable terms, or at all. The draft FIL, if enacted as proposed, may also materially impact our corporate governance practices and increase our compliance costs. For instance, the draft FIL imposes stringent ad hoc and periodic information reporting requirements on foreign investors and the applicable FIEs. Aside from an investment information report required at each investment, and investment amendment reports, which shall be submitted upon changes to investments, it is mandatory for entities established by foreign investors to submit an annual report, and large foreign investors meeting certain criteria are required to report on a quarterly basis. Any company found to be non-compliant with these reporting obligations may potentially be subject to fines and/or administrative or criminal liabilities, and the persons directly responsible may be subject to criminal liabilities.
Our existing contractual arrangements with our consolidated affiliated entities and their shareholders may be subject to national security review by MOFCOM, and the failure to pass the national security review could have a material adverse effect on our business, results of operations and reputation.
In August 2011, the Ministry of Commerce, or MOFCOM, promulgated the Rules of Ministry of Commerce on Implementation of Security Review System of Merger and Acquisition of Domestic Enterprises by Foreign Investors, or the MOFCOM Security Review Rules, to implement the Notice of the General Office of the State Council on Establishing the Security Review System for Merger and Acquisition of Domestic Enterprises by Foreign Investors promulgated on February 3, 2011, or Circular 6. The MOFCOM Security Review Rules became effective on September 1, 2011. Under the MOFCOM Security Review Rules, a national security review is required for certain mergers and acquisitions by foreign investors raising concerns regarding national defense and security. Foreign investors are prohibited from circumventing the national security review requirements by structuring transactions through proxies, trusts, indirect investments, leases, loans, control through contractual arrangements or offshore transactions. The application and interpretation of the MOFCOM Security Review Rules remain unclear. If MOFCOM or other PRC regulatory agency subsequently determines that we need to submit our existing contractual arrangements with our affiliated PRC entity and its shareholders for national security review by interpretation, clarification or amendment of the MOFCOM Security Review Rules or by any new rules, regulations or directives promulgated after the date of this report, we may face sanctions by MOFCOM or other PRC regulatory agency. These sanctions may include revoking the business or operating licenses of our PRC subsidiaries or our consolidated affiliated entities and its subsidiaries, discontinuing or restricting our operations in China, confiscating our income or the income of our PRC subsidiaries or our consolidated affiliated entities, requiring us to undergo a costly and disruptive restructuring such as forcing us to transfer our equity interest in our PRC subsidiaries to a domestic entity or invalidating the agreements that our PRC subsidiaries have entered into with our consolidated affiliated entities and their respective shareholders, and taking other regulatory or enforcement actions that could be harmful to our business. Any of these sanctions could cause significant disruption to our business operations, including rendering us unable to access cash and other assets of, exercise our ownership rights in and consolidate the results of operations of our affiliated entities in China, which would have a material adverse effect on our business, results of operations and reputation.
We rely on contractual arrangements with our consolidated affiliated entities in China and their shareholders for our operations, which may not be as effective as direct ownership in providing operational control.
Since PRC laws restrict foreign equity ownership in companies engaged in online video and advertising businesses in China, we rely on contractual arrangements with our consolidated affiliated entities and their respective shareholders to operate our business in China. If we had direct ownership of Ku6 Information Technology, Tianjin Ku6 Zheng Yuan, Ku6 Cultural and Tianjin Ku6 Network, we would be able to: (i) exercise our rights as a shareholder to effect changes in the board of directors of these entities, which in turn could effect changes at the management level, subject to any applicable fiduciary obligations, and (ii) derive economic benefits from the operations of these entities by causing them to declare and pay dividends. However, under the current contractual arrangements, we rely on our consolidated affiliated entities and their respective shareholders’ performance of their contractual obligations to exercise effective control. In general, neither our consolidated affiliated entities nor their respective shareholders may terminate the contracts prior to the expiration date. However, the shareholders of Ku6 Information Technology, Tianjin Ku6 Zheng Yuan, Ku6 Cultural or Tianjin Ku6 Network may not act in the best interests of our company or may not perform their obligations under these contracts, including the obligation to renew these contracts when their initial terms expire. Such risks exist throughout the period in which we intend to operate our business through the contractual arrangements with our consolidated affiliated entities. However, if any dispute relating to these contracts remains unresolved, we will have to enforce our rights under these contracts through the operations of PRC law and courts and therefore will be subject to uncertainties in the PRC legal system. See “—Any failure by our consolidated affiliated entities or their respective shareholders to perform their obligations under our contractual arrangements with them may have a material adverse effect on our business” below. Therefore, these contractual arrangements may not be as effective as direct ownership in providing us with control over these consolidated affiliated entities.
Any failure by our consolidated affiliated entities or their respective shareholders to perform their obligations under our contractual arrangements with them may have a material adverse effect on our business.
Our consolidated affiliated entities and their respective shareholders may fail to take certain actions required for our business or follow our instructions despite their contractual obligations to do so. If they fail to perform their obligations under their respective agreements with us, we may have to rely on legal remedies under PRC law, including seeking specific performance or injunctive relief, which may not be effective.
All of our contractual arrangements with them are governed by PRC law and provide for the resolution of disputes through arbitration in China. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in China is not as developed as in certain other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements, which may make it difficult to exert effective control over our consolidated affiliated entities, and our ability to conduct our business may be adversely affected.
Contractual arrangements with our consolidated affiliated entities may result in adverse tax consequences to us.
Under applicable PRC tax laws and regulations, arrangements and transactions among related parties may be subject to audit or scrutiny by the PRC tax authorities within ten years after the taxable year when the arrangements or transactions are conducted. We could face material and adverse tax consequences if the PRC tax authorities were to determine that the contractual arrangements among our PRC subsidiaries, our consolidated affiliated entities in China and their respective shareholders were not entered into on an arm’s-length basis and therefore constituted unfavorable transfer pricing arrangements. Unfavorable transfer pricing arrangements could, among other things, result in an upward adjustment to our tax liability. In addition, the PRC tax authorities may impose interest on late payments on our consolidated affiliated entities for the adjusted but unpaid taxes. Our results of operations may be materially and adversely affected if our consolidated affiliated entities’ tax liabilities increase significantly or if they are required to pay interest on late payments. On March 18, 2015, the State Administration of Taxation promulgated the Announcement of the State Administration of Taxation on Issues Relating to Enterprise Income Tax on Expenses Paid by an Enterprise to its Overseas Affiliated Party, or Circular 16, which took effect as of the date of promulgation. Under Circular 16, any expense paid by an enterprise to its overseas affiliated party shall be in compliance with the “arm’s length principle.” Otherwise, the PRC tax authorities may adjust our tax liability in a manner that is unfavorable to us. According to Circular 16, any expense paid by an enterprise to its overseas affiliated party, which fails to perform functions, bear risks or conduct substantial business activities, shall not be deducted in calculating corporate income tax. When an enterprise pays expenses to its overseas affiliated party for the services rendered thereby, such services shall help the enterprise gain directly or indirectly economic interests. The expenses paid by an enterprise to its overseas affiliated party for the following services shall not be deducted in calculating corporate income tax: (i) services irrelevant to the risks that the enterprise bears or businesses that the enterprise carries out, (ii) services such as control, management and supervision conducted by the affiliated party over the enterprise for the purpose of protecting the nterests of direct or indirect investors in the enterprise, (iii) services rendered by the affiliated party that the enterprise has purchased or carried out by itself, (iv) specific services carried out by the affiliated party within the group specially for the enterprise, although the enterprise has gained extraneous earnings due to the affiliation to a group, (v) services that have been compensated in other affiliated transactions; and (vi) other services that cannot bring about direct or indirect economic interests to the enterprise. When an enterprise needs to pay royalties to its overseas affiliated party for using an intangible asset provided thereby, it shall determine the economic interests to which each affiliated party is entitled by taking into account the degree of contribution made by each affiliated party to the value of the intangible asset. If the royalties paid by the enterprise to the affiliated party, which only owns the legal ownership of the intangible asset but does not contribute to the value thereof, are not in compliance with the arm’s length principle, such royalties shall not be deducted in computing the corporate income tax payable by the enterprise. Where an enterprise establishes an overseas holding company or financing company for the purpose of financing for going public, the royalties paid to its overseas affiliated party for the carried interests generated from the activities of financing for going public, shall not be deducted in calculating corporate income tax. WeareaholdingcompanyincorporatedoutsideofthePRCandanypotentialincomewouldbebasedonthedividends,servicefees,royaltiesorotherdistributionsfromourPRCsubsidiariesandourconsolidatedaffiliatedentities.WemayneedtorelyonourPRCsubsidiariesandourconsolidatedaffiliatedentitiestofundourcashandfinancingrequirementsthroughcertainofthetransactionsdescribedinCircular16.Therefore,Circular16maysignificantlyincreaseourtaxliabilityifwedecidetocarryonanyofsuchtransactionsinthefuture.
The shareholders of our consolidated affiliated entities may have potential conflicts of interest with us, which may materially and adversely affect our business.
We conduct substantially all of our operations, and generate substantially all of our revenues, through our consolidated affiliated entities. Our control over these entities is based upon contractual arrangements with our consolidated affiliated entities and their shareholders that provide us with the substantial ability to control these entities. We provide no incentives to any of the shareholders of our consolidated affiliated entities for the purpose of encouraging them to act in the best interest of our company in such capacity. These shareholders may breach their contractual arrangements, or cause our consolidated affiliated entities to breach their contractual arrangements, with us or cause these contracts to be amended in a manner contrary to the interest of our company, if they believe such action furthers their own interest, or if they otherwise act in bad faith. We cannot assure you that, when conflicts arise, these shareholders will act in the best interest of our company or that conflicts will be resolved in our favor. If we cannot resolve any conflicts of interest or disputes between us and any of these shareholders, we would have to rely on legal proceedings, which may be expensive, time-consuming and disruptive to our operations. There is also substantial uncertainty as to the outcome of any such legal proceedings.
We rely on our PRC subsidiaries and our consolidated affiliated entities to fund our cash and financing requirements. Any limitation on the ability of our PRC subsidiaries and our consolidated affiliated entities to transfer funds to us could have a material adverse effect on our ability to grow or otherwise fund our cash and financing requirements.
We are a holding company and our operations are principally conducted through our PRC subsidiaries and our consolidated affiliated entities. As a result, the ability of our company to pay dividends and to finance debts depends upon the service fees and license fees paid by our consolidated affiliated entities to our PRC subsidiaries and dividends and other distributions paid by our PRC subsidiaries to our company. If any of our subsidiaries or consolidated affiliated entities incurs debt on its own behalf, the instruments governing the debt may restrict its ability to pay service fees or dividends directly or indirectly to our company.
Under PRC laws and regulations, our PRC subsidiaries and our consolidated affiliated entities may pay dividends only out of their retained earnings as determined in accordance with PRC accounting standards and regulations. There is no significant difference between retained earnings as determined in accordance with PRC accounting standards and in accordance with U.S. GAAP. In addition, our PRC subsidiaries and our consolidated affiliated entities are required to set aside at least 10% of their after-tax net income each year, if any, to fund certain statutory reserves, which are not distributable as cash dividends, until the aggregate amount of such funds reaches 50% of their respective registered capital. As of December 31,
Any limitation on the ability of our PRC subsidiaries to pay dividends or make other distributions to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends, or otherwise fund and conduct our business.
We may be unable to collect long-term loans extended to the shareholders of our consolidated affiliated entities.
As of December 31,
The
Under the equity pledge agreements among our PRC subsidiaries, certain of our consolidated affiliated entities and the shareholders of our consolidated affiliated entities, the shareholders of our consolidated affiliated entities have pledged all of their equity interests in these entities to our relevant subsidiaries by recording the pledge on the shareholder registers of the respective entities. According to the PRC Property Rights Law,
Our major shareholders will have substantial influence on the outcome of shareholder actions in our company that might not be beneficial to you as a holder of our ADSs.
As of
We may have conflicts of interest with our major shareholders or their respective affiliates,
As of
· Our board members or executive officers may have conflicts of interest. Mr. Xu currently serves as the chairman of our board of directors,
· Agreements with Mr. Xu and its affiliates. The various agreements that we entered into with Qinhe, a company controlled by Mr. Xu, including the interactive entertainment marketing cooperation agreement and the game marketing cooperation agreement, may be less favorable to us than would be the case if they were negotiated with third parties. Moreover, Mr. Xu may leverage his substantial influence over us to prevent us from bringing a legal claim against him or his affiliates in the event of a contractual breach, notwithstanding our contractual rights under the agreements and any other agreement we may enter into with Mr. Xu and his affiliates from time to time.
· Business opportunities. Business opportunities may arise that we, Mr. Xu and Shanda Interactive find attractive, and which would complement our respective businesses. Due to the substantial influence of Mr. Xu and Shanda Interactive, we may not be able to pursue these business opportunities effectively if Mr. Xu or Shanda Interactive decides to take advantage of such opportunities.
We may not be able to resolve any potential conflicts, and even if we do so, the resolution may be less favorable to us than if we were dealing with an unaffiliated shareholder. Even if all of the parties seek to transact business on terms intended to approximate those that could have been achieved among unaffiliated parties, this may not succeed in practice.
Risks Related to Doing Business in China
Substantially all of our assets are located in China and substantially all of our revenues are derived from our operations in China. Accordingly, our business, financial condition, results of operations and prospects are subject, to a significant extent, to economic, political and legal conditions and developments in China.
The PRC legal system embodies uncertainties which could limit the legal protections available to you and could also adversely affect our ability to operate our business.
The PRC legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases have little precedential value. Although legislation in China over the past 20 years has significantly improved the protection afforded to various forms of foreign investment and contractual arrangements in China, these laws, regulations and legal requirements are relatively new and their interpretation and enforcement involve uncertainties, which could limit the legal protection available to us, and foreign investors, including you. In addition, the PRC government may enact new laws or amend current laws that may be detrimental to our current contractual arrangements with respect to our consolidated affiliated entities, which may in turn have a material adverse effect on our ability to operate our business.
PRC regulations relating to the establishment of offshore special purpose vehicles, or SPVs, by PRC residents may subject our PRC resident beneficial owners or our PRC subsidiaries to liability or penalties, limit our ability to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to increase their registered capital or distribute profits to us, or may otherwise adversely affect us.
It is unclear how SAFE Circular 37 and any future regulation concerning offshore or cross-border transactions will be interpreted, amended and implemented by the relevant government authorities. We cannot predict how these regulations PRC regulation of loans to, and direct investment in, PRC entities by offshore holding companies and governmental control of currency
As the offshore holding company of our PRC subsidiaries, we have historically financed, and may continue to finance, our PRC subsidiaries by extending loans or making additional capital contributions to them. Any loans to our PRC subsidiaries are subject to PRC regulations. For example, loans by us to finance the operations of any PRC subsidiary which is a foreign-invested enterprise may not exceed statutory limits and are required to be registered with SAFE. We may also need to increase the registered capital of our PRC subsidiaries or finance them through capital contributions. Such changes and capital contributions must be approved by MOFCOM or its local branches. In August
In light of the various requirements imposed by PRC regulations on loans to and direct investment in PRC entities by offshore holding companies, including SAFE circulars referred to above, we cannot assure you that we will be able to complete the necessary government registrations or obtain the necessary government approvals on a timely basis, if at all, with respect to future loans or capital contributions by us to our PRC subsidiaries and conversion of such loans or capital contributions into Renminbi. If we fail to complete such registrations or obtain such approvals, our ability to capitalize or otherwise fund our PRC operations may be negatively affected, which could adversely affect our ability to fund and expand our business.
On February 15, 2012, SAFE issued the Notices on Issues concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly-Listed Company, or Circular 7, which replaced the Operating Procedures for Administration of Domestic Individuals Participating in the Employee Stock Ownership Plan or Stock Option Plan of an Overseas Listed Company issued by SAFE on March 28, 2007. According to Circular 7, domestic individuals, which include PRC residents and non-PRC residents who reside in China for a continuous period of not less than one year other than foreign diplomatic personnel and representatives of international organizations, are required to register with SAFE and complete certain other procedures if such individuals participate in an employee stock ownership plan or a stock option plan in a publicly listed overseas company. These participants should retain a PRC agent, which can be a subsidiary of the overseas listed company in China, to handle various foreign exchange matters associated with these plans. They must also retain an overseas entrusted institution to handle matters in connection with their exercise of stock options and their purchase and sale of stocks. The PRC agent of a PRC domestic individual participant must apply for the approval of an annual allowance if such participant needs to use funds in China in connection with the stock incentive plan. The PRC agent is also required to submit a filing form with respect to the stock incentive plan at the beginning of each quarter. The foreign exchange proceeds received by the PRC domestic individual participants from the sale of shares under the stock option plans granted by the overseas listed companies must be remitted into the bank accounts in China opened by their employers or PRC agents. We and our PRC domestic individual employees who have been granted share options will be subject to these rules. While we have completed the required registration of our 2010 Equity Compensation Plan, or the 2010 Plan, with the Tianjin Branch of SAFE in November 2012, we cannot assure you that all future participants will register with SAFE in a timely manner, or at all. Any failure to comply with such regulations may subject us and the participants of our equity compensation plans who are PRC citizens to fines and legal sanctions and prevent us from being able to grant equity compensation to our personnel which is currently a significant component of the compensation of many of our PRC employees, as a result of which our business operations may be adversely affected.
In addition, the State Administration for Taxation has issued circulars concerning employee share options or restricted shares. Under these circulars, employees working in the PRC who exercise share options (i.e. our existing equity compensation plans), or whose restricted shares vest, will be subject to PRC individual income tax. The PRC subsidiaries of an overseas listed company have obligations to file documents related to employee share options or restricted shares with relevant tax authorities and to withhold individual income taxes of those employees related to their share options or restricted shares. Although we currently withhold income tax from our PRC employees in connection with their exercise of options and the vesting of their restricted shares, if the employees fail to pay, or the PRC subsidiaries fail to withhold, their income taxes according to relevant laws, rules and regulations, the PRC subsidiaries may face sanctions imposed by the tax authorities or other PRC government authorities. The PRC tax authorities’ enhanced scrutiny of PRC enterprise income tax on offshore equity transfers may have a negative impact on your investment in our ADSs.
In
The State Administration of Taxation subsequently released public notices to clarify issues relating to Circular 698, including the Announcement on Several Issues Concerning the Enterprise Income Tax on the Indirect Transfers of Properties by Non-Resident Enterprises, or SAT Notice 7, which became effective on February 3, 2015. SAT Notice 7 abolished the compulsory reporting obligations originally set out in Circular 698. Under SAT Notice 7, if a non-resident enterprise transfers its shares in an overseas holding company that directly or indirectly owns PRC taxable properties, including shares in a PRC company, via an arrangement without reasonable commercial purpose, such transfer shall be deemed a direct transfer of the underlying PRC taxable properties. Accordingly, the transferee shall be deemed a withholding agent with the obligation to withhold and remit the income tax to the competent PRC tax authorities. SAT Notice 7 also establishes safe harbors for the “reasonable commercial purpose” test. There is limited guidance and practical experience regarding the application of Circular 698 and the related SAT notices. We, our non-PRC resident enterprise subsidiaries and our PRC subsidiaries may be subject to these regulations for our previous and future restructuring or disposal of shares in our offshore subsidiaries, in which case we may have disputes with tax authorities and need to incur expenses to establish that we are not
We may be deemed a PRC resident enterprise under the EIT Law and be subject to PRC taxation on our worldwide income.
The PRC Enterprise Income Tax Law, or the EIT Law, includes a provision specifying that legal entities organized outside China will be considered residents for PRC income tax purposes if their place of effective management or control is within China. If legal entities organized outside China were considered residents for PRC income tax purposes, they would be subject to the 25% enterprise income tax imposed by the EIT Law on their worldwide income. The implementation rules to the EIT Law provide that non-resident legal entities will be considered China residents if substantial and overall management and control over the manufacturing and business operations, personnel, accounting, properties, etc. reside within China. Although substantially all of our operational management is currently based in China, it is uncertain whether our company and our offshore intermediate holding company would be deemed as PRC tax resident enterprises under the EIT Law and other related PRC laws and regulations. If our company and our offshore intermediate holding company were deemed as PRC tax resident enterprises and have earned income other than dividends from our PRC subsidiaries, a 25% enterprise income tax on our global income could increase our tax burden and negatively affect our financial condition and results of operations.
Dividends that we receive from our PRC subsidiaries are subject to PRC withholding tax.
In accordance with the EIT Law and its implementation rules, dividends which arise from profits of foreign invested enterprises earned after January 1, 2008 are subject to a 10% withholding tax. As of December 31,
The enforcement of the PRC labor contract law may materially increase our costs and
The PRC National People’s Congress promulgated the Labor Contract Law and its implementation rules, both of which became effective on January 1, 2008. Compared to previous labor laws, the Labor Contract Law and its implementation rules provides stronger protection for employees and imposes more stringent obligations on employers with regard to, among others, minimum wages, severance payments upon permitted termination of 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. Compliance with the Labor Contract Law and its implementation rules may increase our operating expenses, in particular our personnel expenses. In the event that we decide to terminate some of our employees or otherwise change our employment or labor practices, the Labor Contract Law and its implementation rules may also limit our ability to effect those changes in a manner that we believe to be cost-effective or desirable, and could result in a material decrease in our profitability. In addition, pursuant to the Labor Contract Law and its amendments, dispatched employees are intended to be a supplementary form of employment, and the fundamental form should be direct employment by enterprises and organizations that require employees. Further, it is expressly stated in the Interim Provisions on Labor Dispatch, which became effective on March 1, 2014, that the number of dispatched employees and employer uses may not exceed 10% of its total labor force and the employer has a two-year transition period to comply with such requirement. A significant number of our employees are contracted through third-party human resources companies that are responsible for managing, among others, payrolls, social insurance contributions and local residency permits of these employees. We may be held jointly liable if such human resources companies fail to pay such employees their wages and other benefits or otherwise become liable to these employees for labor law violations.
As the
Restrictions on currency exchange may limit our ability to utilize our revenues effectively.
Substantially all of our revenues and operating expenses are denominated in Renminbi. The PRC government imposes controls on currency conversion between Renminbi and foreign currencies and, in certain cases, the remittance of currency out of and into China. Under existing PRC foreign exchange regulations, payments of current account items, including payment of dividends, interest payments and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior SAFE approval by complying with certain procedural requirements. Our PRC subsidiaries may also retain foreign exchange in their current accounts, subject to a ceiling approved by SAFE, to satisfy foreign exchange liabilities or to pay dividends. In addition, approval of the appropriate governmental authorities is required if Renminbi is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of offshore bank loans denominated in foreign currencies. However, we cannot assure you that the relevant PRC governmental authorities will not limit or eliminate our ability to purchase and retain foreign currencies in the future. Under our current corporate structure, the income of our company will be primarily derived from dividend payments from our PRC subsidiaries. Shortages in the availability of foreign currency may restrict the ability of our PRC subsidiaries to remit sufficient foreign currency to pay dividends to us, or otherwise satisfy its foreign currency-dominated obligations.
Our business, financial condition and results of operations could be materially and adversely affected by a severe and prolonged global economic downturn and a corresponding slowdown of the PRC economy.
Recent global market and economic conditions have been unprecedented and challenging and have caused persisting recession in most major economies in 2008 and 2009 and significant market volatility since 2010. Continued concerns about the systemic impact of a potentially long-term and widespread recession, energy costs, geopolitical issues and the availability and cost of credit have contributed to increased market volatility and diminished expectations for economic growth around the world. The difficult economic outlook has negatively affected business and consumer confidence and contributed to volatility at unprecedented levels. The PRC economy also faces challenges. In 2014, China’s gross domestic product expanded by only 7.4%, which was its slowest rate in the past 20 years and below the PRC government’s growth target. Since we derive substantially all of our revenues in China, any prolonged slowdown in the growth of the PRC economy could have a material adverse effect on our business, financial condition and results of operations. Disruptions of the financial markets could also significantly restrict our ability to obtain financing in the capital markets or from financial institutions.
Changes in China’s political and economic policies could harm our business.
The economy of China has historically been a planned economy subject to governmental plans and quotas and has, in certain aspects, been transitioning to a more market-oriented economy. Although we believe that the economic reform and the macroeconomic measures adopted by the PRC government have had a positive effect on the economic development of China, we cannot predict the future direction of these economic reforms or the effects these measures may have on our business, financial position or results of operations. In addition, the PRC economy differs from the economies of most countries belonging to the Organization for Economic Cooperation and Development, or OECD. These differences include:
· economic structure;
· level of government involvement in the economy;
· level of development;
· level of capital reinvestment;
· control of foreign exchange;
· methods of allocating resources; and
· balance of payments position.
As a result of these differences, our business may not develop in the same way or at the same rate as might be expected if the PRC economy were similar to those of the OECD member countries.
Inflation in China and measures to contain inflation could negatively affect our profitability and growth.
While the PRC economy has experienced rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas of the country. Rapid economic growth can lead to growth in the money supply and rising inflation. If prices for our advertising services rise at a rate that is insufficient to compensate for the rise in our costs, our business may be materially and adversely affected. In order to control inflation in the past, the PRC government has imposed controls on bank credits, limits on loans for fixed assets and restrictions on state bank lending. Such austerity measures can lead to a slowing of economic growth. A slowdown in the PRC economy could also materially and adversely affect our business and prospects.
Auditors of companies This lack of PCAOB inspections in China prevents the PCAOB from
Any occurrence of pandemic avian influenza, Ebola or other widespread public health problem, or any recurrence of severe acute respiratory syndrome, or SARS, could adversely affect our business and results of operations.
An outbreak of pandemic avian influenza or other widespread public health problem, or a renewed outbreak of SARS in China, where most of our revenues are derived, and in Beijing, where our operations are headquartered, could have a negative effect on our operations. There have been recent reports of outbreaks of an avian flu caused by the H7N9 virus, including confirmed human cases, in China. In 2014, the outbreak of Ebola fever in West Africa received considerable worldwide media attention. Experts warn that China is at serious risk of Ebola because of the large numbers of travelers from Africa as well as poor hospital standards. Our operations may be affected by a number of health-related factors, including the following:
· quarantines or closures of some of our offices which would severely disrupt our operations,
· the sickness or death of our key officers and employees, and
· a general slowdown in the PRC economy caused by any public health problems.
Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our business and results of operations.
Risks Related to Our ADSs If we fail to meet continued listing standards of NASDAQ, our ADSs may be delisted, which could have a material adverse effect on the liquidity of our ADSs. Our ADSs are currently traded on the Nasdaq Global Market. The NASDAQ Stock Market LLC has requirements that a company must meet in order to remain listed on NASDAQ Global Market, including maintain a minimum bid price of $1.0 per share of our ADSs and a minimum $50.0 million market value of our company. If we fail to meet any continued listing requirement, our ADSs could be subject to delisting procedures. If our ADSs were to be delisted, the liquidity of our ADSs would be adversely affected and the market price of our ADSs could decrease. Recently, the bid price of our ADSs frequently fell below $1.0 per share and the total market value of our company frequently fell below $50.0 million. There can be no assurance that we will be able to continue to meet the minimum requirements for listing in the future or that, had we failed to do so, we will be able to regain compliance within the period prescribed by NASDAQ.
The price of our ADSs has been volatile historically and may continue to be volatile, which may make it difficult for holders to resell the ADSs when desired or at attractive prices.
The trading price of our ADSs has been and may continue to be subject to wide fluctuations. The sale price of our ADSs on the NASDAQ Global Market ranged from
Our ADS price may fluctuate in response to a number of events and factors, including among other factors:
· announcements of technological or competitive developments;
· regulatory developments in our target markets affecting us, our customers or our competitors;
· announcements of share repurchase program;
· actual or anticipated fluctuations in our quarterly operating results;
· changes in financial estimates by securities research analysts;
· changes in the economic performance or market valuations of our website;
· addition or departure of our executive officers and key research personnel; and
· sales or perceived sales of additional ordinary shares or ADSs.
In addition, the financial markets in general, and the market prices for Internet-related companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of such companies. These broad market and industry fluctuations may adversely affect the price of our ADSs, regardless of our operating performance.
Future sales or perceived sales of substantial amounts of our ordinary shares or ADSs by our major shareholders could adversely affect the price of our ADSs.
If any of our major shareholders sells, or is perceived as intending to sell, substantial amounts of our ordinary shares or ADSs, including those issued upon the exercise of our outstanding stock options, the market price of our ADSs could fall. Such sales, or perceived potential sales, by any of our major shareholders might make it more difficult for us to issue new equity or equity-related securities in the future at a time and place we deem appropriate. If any of our major shareholders sells a substantial amount of ordinary shares it currently holds, the prevailing market price for our ADSs could be adversely affected.
As a foreign private issuer with ADSs listed on the NASDAQ Global Market, we follow home country corporate governance practices instead of certain NASDAQ requirements.
As a foreign private issuer whose ADSs are listed on the NASDAQ Global Market, we are permitted to follow home country corporate governance practices instead of certain NASDAQ requirements. A foreign private issuer that elects to follow its home country practice must submit to the NASDAQ Stock Market LLC a written statement from an independent counsel in such issuer’s home country certifying that the issuer’s practices are not prohibited by the home country’s laws. In addition, a foreign private issuer must disclose in its annual reports filed with the SEC each NASDAQ requirement with which it does not comply followed by a description of its applicable home country practice.
As a company incorporated in the Cayman Islands with ADSs listed on the NASDAQ Global Market, we intend to follow our home country practice instead of NASDAQ requirements that mandate that:
· our board of directors be comprised of a majority of independent directors;
· our directors be selected or nominated by a majority of the independent directors or a nomination committee comprised solely of independent directors;
· our board adopt a formal written charter or board resolution addressing the director nominations process and such related matters as may be required under the U.S. federal securities laws;
· the compensation of our executive officers be determined or recommended by a majority of the independent directors or a compensation committee comprised solely of independent directors; and
· issuances of securities in connection with equity-based compensation of officers, directors, employees or consultants be approved by shareholders.
As we are a Cayman Islands company, our shareholders may face difficulties in protecting their interests, and our ability to protect our rights through the U.S. federal courts may be limited.
Our corporate affairs are governed by our memorandum and articles of association, by the Cayman Companies Law and the common law of the Cayman Islands. The rights of shareholders to take action against the directors, actions by minority shareholders, and the fiduciary 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 in the Cayman Islands is derived in part from comparatively limited judicial precedents in the Cayman Islands as well as from English common law, the decisions of whose courts are of persuasive authority but are not binding on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law in this area may not be as clearly established as they would be under statutes or judicial precedents in existence in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities laws as compared to the United States, and some states, such as Delaware, have more developed and judicially interpreted bodies of corporate laws. Moreover, under the Cayman Companies Law, for mergers and consolidations involving two Cayman Islands companies or a Cayman Islands company and an overseas company, dissenting shareholders have the right to be paid the fair value of their shares (which, if not agreed to by the parties, will be determined by the Cayman Islands court) if they follow the required procedures, subject to certain exceptions, and such rights may not be comparable to the appraisal rights that would ordinarily be available to dissenting shareholders of a U.S. company. Finally, Cayman Islands companies may not have standing to initiate shareholder derivative actions before any federal court of the United States. As a result, our shareholders may have more difficulties in protecting their interests in the face of actions by our management, directors or major shareholders than would shareholders of a public company incorporated in a jurisdiction in the United States.
Our shareholders may have difficulties in enforcing judgments obtained against us.
We are a Cayman Islands company and substantially all of our assets are located outside of the United States. Substantially all of our current operations are conducted in China. In addition, most of our directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons are located outside the United States. As a result, it may be difficult for our shareholders to effect service of process within the United States upon these persons. It may also be difficult for our shareholders to enforce judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents in the United States and the substantial majority of whose assets are located outside of the United States.
There is uncertainty as to whether the courts of 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 due to the lack of reciprocal treaty in the PRC providing statutory recognition of judgments obtained in the United States. Furthermore, it is uncertain whether such PRC courts would be competent to hear original actions brought in the PRC against us or such persons who reside outside the United States predicated upon the securities laws of the United States or any state.
Although there is some uncertainty as to the enforcement in the Cayman Islands, in original actions or in actions for enforcement of judgments of United States courts, of liabilities predicated upon U.S. federal securities laws, a final and conclusive judgment in personam of a competent foreign court, including a competent United States court, against our company based upon the agreements under which a definite sum of money is payable other than a sum payable in respect of taxes or other charges of a like nature of a fine or other similar penalty, may be the subject of enforcement proceedings in the Grand Court of the Cayman Islands under the common law doctrine of obligation by action on the debt evidenced by the judgment of such competent foreign court. A final opinion as to the availability of this remedy should be sought when the facts surrounding the foreign court’s judgment are known, but, on general principles, it would be expected that such proceedings would be successful provided that (a) the court which gave the judgment was competent to hear the action in accordance with private international law principles as applied in the Cayman Islands and (b) the judgment is not contrary to public policy in Cayman Islands, has not been obtained by fraud or in proceedings contrary to natural justice and is not based on an error in Cayman Islands law.
Anti-takeover provisions in our organizational documents may discourage our acquisition by a third party, which could limit your opportunity to sell your shares at a premium.
Our memorandum and articles of association include provisions that could limit the ability of others to acquire control of us, modify our structure or cause us to engage in change of control transactions, including, among other things, provisions that authorize our board of directors, without action by our shareholders, to issue preferred shares and to issue additional ordinary shares, including ordinary shares represented by ADSs.
These provisions could have the effect of depriving you of an opportunity to sell your ADSs at a premium over prevailing market prices by discouraging third parties from seeking to acquire control of us in a tender offer or similar transactions.
The voting rights of holders of ADSs are limited by the terms of the deposit agreement.
A holder of our ADSs may only exercise the voting rights with respect to the underlying ordinary shares in accordance with the provisions of the deposit agreement. Upon receipt of voting instructions of a holder of ADSs in the manner set forth in the deposit agreement, the depositary will endeavor to vote the underlying ordinary shares in accordance with these instructions. Under our memorandum and articles of association and Cayman Islands law, the minimum notice period required for convening a general meeting is five days. When a general meeting is convened, you may not receive sufficient notice of a general meeting to permit you to withdraw your ordinary shares to allow you to cast your vote with respect to any specific matter. In addition, the depositary and its agents may not be able to send voting instructions to you or carry out your voting instructions in a timely manner. We will make all reasonable efforts to cause the depositary to extend voting rights to you in a timely manner, but we cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote your shares. Furthermore, the depositary and its agents will not be responsible for any failure to carry out any instructions to vote, for the manner in which any vote is cast, or for the effect of any such vote. As a result, you may not be able to exercise your right to vote and you may lack recourse if your ordinary shares are not voted as you requested.
We may be required to withhold PRC income tax on the dividends we pay you (if any), and any gain you realize on the transfer of our ordinary shares and ADSs may also be subject to PRC tax if we are treated as a PRC resident enterprise.
Pursuant to the EIT Law, we may be treated as a PRC resident enterprise for PRC tax purposes. See “—Risks Related to Doing Business in China—We may be deemed a PRC resident enterprise under the EIT Law and be subject to PRC taxation on our worldwide income” above. If we were so treated by the PRC tax authorities, we would be obligated to withhold PRC income tax on payments of dividends on our ordinary shares and ADSs to investors that are non-resident enterprises, provided that such dividends are deemed as China-sourced income. A non-resident enterprise is an enterprise that does not have an establishment or place of business in China or that has such establishment or place of business but its income is not effectively connected with the establishment or place of business. In addition, any gain realized by investors that are non-resident enterprises from the transfer of our ordinary shares or ADSs may be deemed as China-sourced income and generally be subject to PRC tax. Such dividends and gains to investors that are non-resident enterprises would generally be subject to a 10% PRC withholding tax, unless a reduced tax rate is provided by any applicable tax treaty and the holders have completed the relevant procedures prescribed by the PRC tax authorities to prove their beneficial owner status.
Moreover, under the PRC Individual Income Tax Law, or the IITL, if we are treated as a PRC resident enterprise, non-resident individual investors would be subject to PRC individual income tax on dividends paid to such investors and any capital gains realized from the transfer of our ordinary shares and ADSs, provided that such dividends and gains are deemed as China-sourced income. A non-resident individual is an individual who has no domicile in China and does not stay within China or has stayed within China for less than one year. Pursuant to the IITL and its implementation rules, for purposes of the PRC capital gains tax, the taxable income will be based on the total income obtained from the transfer of our ordinary shares or ADSs after deducting all the costs and expenses that are permitted under PRC tax laws to be deducted from the income. If we were considered a PRC resident enterprise and dividends paid with respect to our ordinary shares and ADSs and the gains realized from the transfer of our ordinary shares and ADSs were considered China-sourced income by relevant PRC tax authorities, such dividends and gains earned by non-resident individuals would generally be subject to PRC tax at a rate of 20%, unless a reduced tax rate is provided by any applicable tax treaty and the holders have completed the relevant procedures prescribed by the PRC tax authorities to prove their beneficial owner
The foregoing PRC taxes may reduce your investment return on our ordinary shares and ADSs and may also affect the price of our ordinary shares and ADSs.
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 books at any time or from time to time when it deems expedient in connection with the performance of its duties. The depositary may close its books for a number of reasons, including in connection with corporate events such as a rights offering, during which time the depositary needs to maintain an exact number of ADS holders on its books for a specified period.
Your right as a holder of ADSs to participate in any future rights offerings may be limited, which may cause dilution to your holdings.
We may from time to time distribute rights to our shareholders, including rights to acquire our securities. However, we cannot make rights available to our ADS holders in the United States unless we register the rights and the securities to which the rights relate under the Securities Act or an exemption from the registration requirements is available. In addition, the deposit agreement provides that the depositary bank will not make rights available to you unless the distribution to ADS holders of both the rights and any related securities are either registered under the Securities Act or exempted from registration under the Securities Act. We are under no obligation to file a registration statement with respect to any such rights or securities or to endeavor to cause such a registration statement to be declared effective nor is it our current intention to do so. Moreover, we may not be able to rely on an exemption from registration under the Securities Act. Accordingly, ADS holders may be unable to participate in future rights offerings, if any, and may experience dilution in their holdings. In addition, if the depositary is unable to sell rights that are not exercised or not distributed or if the sale is not lawful or reasonably practicable, it will allow the rights to lapse, in which case you will receive no value for these rights.
In December 2012, the SEC In January 2014, the In February 2015, the four PRC-based accounting firms each agreed to a censure and to pay a fine to the SEC to settle the dispute and avoid suspension of their ability to practice before the SEC and audit U.S.-listed companies. The settlement required the firms to follow detailed procedures and to seek approval from the CSRC to provide the SEC with access to such firms’ audit documents in response to future document requests by the SEC made through the CSRC. If the Big Four PRC-based accounting firms, including our independent registered public accounting firm, fail to comply with the document production procedures that are in the settlement agreement or if there is a failure of the process between the SEC and CSRC, the SEC retains authority to impose a variety of additional remedial measures on the accounting firms, such as imposing penalties on such firms and restarting the proceedings against such firms, depending on the nature of the failure. The principal auditor of our financial statements, PricewaterhouseCoopers Zhong Tian LLP, is one of the Chinese affiliates of the “Big Four” global networks of accounting firms and is subject to the proceedings and the initial decision.
Item 4. Information on the Company
A.History and Development of the Company
We became an independent company in September 1999 when we were spun-off from UT Starcom Inc., a NASDAQ-listed company that manufactures telecommunication equipment in China. In April 2002, we established a new holding company, Hurray! Holding Co., Ltd., in the Cayman Islands. In
In
On March 31, 2014, Mr. Xu entered into a share purchase agreement with our then controlling shareholder, Shanda Media,
Our principal executive offices are located at Building 6, Zhengtongchuangyi Centre, No. 18, Xibahe Xili, Chaoyang District, Beijing 100028, People’s Republic of China. Our telephone number is +86 10 5758-6813. Our agent for service of process in the United States is Puglisi & Associates, located at 850 Library Ave, Suite 204, Newark, DE 19711.
B.Business Overview
Introduction
We currently operate and focus on our online video business. Through our online brand Ku6 and our online video website www.ku6.com, we provide video information services and entertainment to viewers in China. As an online video portal, www.ku6.com offers news, reports and interactive entertainment programs and also provides a video platform for video-sharing and watching UGC.
Our online video business focuses on UGC and community-based
Our marketing solutions present customers with a complete range of advertisement creation, matching, placement and presentation. Our online marketing services include in-video, display, sponsorship and other forms. Historically, we derived substantially all of our revenues from online advertising services, for which we collect service fees from advertisers through our advertising agencies. In April 2014, as a result of our management’s review and adjustment of our business strategies after the Share Purchase Transaction, we
Due to PRC legal restrictions on foreign ownership and investment in value-added telecommunications services and advertising businesses in China, we operate our business primarily through our consolidated affiliated entities in China. We do not hold equity interests in our consolidated affiliated entities. However, through a series of contractual arrangements with these consolidated affiliated entities and their respective shareholders, we effectively control, and are able to derive substantially all of the economic benefits from, these consolidated affiliated entities.
Our Video Platform
Our Website
In 2011, we moved our content focus from long-form videos to short-form videos. Users can access our website for short-form videos, including hot news and reports, first-hand information and entertainment videos, which can be provided by users or our content partners or produced in-house.
Our website has a series of user-friendly functions such as search tools and recommendations. We also help users navigate our database and find videos of interest by creating popularity ranking indices and interest-based video channels, such as ent.ku6.com for entertainment and sports.ku6.com for sports. We provide social features, such as community web pages and video sharing and commenting tools. We also offer a search history for frequent visitors to help them quickly locate recently viewed video clips. We present a chat box alongside videos so that users viewing the same video at the same time can have live, online chats. Users may create a playlist based on their preferences so that the requested video will be broadcast continuously. Registered visitors may upload video clips easily to our website and comment on each video clip to share their opinions. We believe all these features help provide an enhanced user experience and reinforce user loyalty.
In addition, users can download our proprietary P2P software, “Speed Ku6,” and install it on their personal computers to enhance their viewing experience with high-quality videos and smooth connections. We also provide an application, “Upload Speed,” for users to upload video clips from their personal computers. We also have ChannelMe, a product that gives our priority value creating users/units, or VCUs, a unique identity and provide additional features for them to customize their homepage. It also allows users to interact with our priority VCUs online, such as sending virtual gifts to their favorite priority VCUs.
In January 2012, we entered into an agreement with YouTube, a renowned international video-sharing website owned by Google, which allowed our international users to view original videos from China on a new channel on YouTube’s website. In March 2012, we established a partnership arrangement with Channel V, a music video entertainment TV channel, to bring its content to our users on our website.
Mobile Platform
We significantly expanded our product portfolio for mobile platforms in
Our Content
UGC (User-Generated Content)
Our website allows Internet users to easily upload, watch and share UGC video clips. We offer creative talents, particularly the younger Chinese generation, channels for artistic expression outside the traditional mainstream content formats such as television. Our UGC covers a wide range of subject matters from entertainment to news, comedies, sports, finance, fashion and beyond. UGC is well embraced by Internet users, particularly young Internet users, given its sharing and interactive qualities.
Our editorial team is responsible for communicating with users on the types of UGC we believe are popular and well demanded.
Previously, we purchased the licensing rights to some popular UGC and shared advertising revenues with individual users whose number of uploads exceed certain thresholds. We also had a revenue sharing program to reward users for contents they uploaded in order to encourage more users to upload UGC to our website. In April 2014, in connection with the change of our business models after the Share Purchase Transaction, we announced a suspension of this revenue sharing program from May 1, 2014. This program has not been resumed and may not be resumed in the future. Historically, contracted users contributed approximately 50% of all the videos on our website. As a result of the suspension of this revenue sharing program, the quality and quantity of our UGC may deteriorate in the future, which, in turn, may materially and adversely affect our business, results of operations and prospects. See Item 3.D. “Risk Factors—Risks Related to Our Business—If we fail to continue to provide attractive products and services, we may not be able to generate sufficient user traffic to remain competitive.”
In-house Developed Content
In addition to UGC, our content includes in-house developed content that we produce from time to time, such as online talk shows, celebrity interviews and reality shows to our viewers. We select the types of content to be produced generally based on our assessment of users’ preferences and information gathered by us from analyzing user data collected through our video platform. We typically cooperate with third parties engaged in in-house production, taking advantage of talents of local production teams and their relatively low production costs. In
Licensed Content
In June 2011, we ceased purchasing copyrights of movies and TV dramas from professional studios and their distributors. Previously purchased movies and TV drama will be shown on ku6.com through the end of their license periods.
Our Users
We have an extensive user base for our video platform. Our users visit our website from direct navigation, organic search results or third-party website links connecting to us. Our user base consists primarily of young urban educated users, between ages 18 and 44, which is a particularly attractive demographic to advertisers. Online viewers in China also represent a more affluent and better-educated segment of the population in China. We have tracked and maintained extensive user data, including viewing history and information voluntarily provided by registered users. We use sophisticated statistical tools to analyze user data, to better understand users’ viewing preference and habits. This greatly facilitates our efforts in providing service to our advertising customers.
Marketing Services and Customers
Our online marketing services include in-video, display, sponsorship and other forms of advertisements. In-video advertisements appear at certain times during the playback of a video. These video advertisements can be pre-roll, post-roll, mid-roll or pause advertisements. Display advertisements can be delivered alongside a video and may take the form of graphic banners or text hyperlinks. Other forms of advertisements include product placements in our in-house produced web video series or sponsored live events. Our marketing solutions present opportunities to combine the visual impact and engagement of traditional television-like multimedia formats with the interactivity and precise targeting capabilities of the Internet.
· Innovative Targeting. Some targeting solutions are unique to the online video platform and cannot be transplanted into other media platforms. We are able to track and monitor an advertiser’s campaign on a real-time basis and can make adjustments to enhance its effectiveness within parameters specified by the advertiser upfront. Our targeting strategies enable advertisers to reach targeted users based on any or a combination of standards, including the demographic information about the user, the nature of the video’s content, the geographic location of the user, the time of day at which a video is being watched, or the keywords associated with the video. Our video channels also help segregate videos based on users’ interested content, which allows us to deliver advertisements tailored to the viewers of different channels; and
· Product Placements. As an online video provider with a permit for radio and television program production and operation, we are able to produce web-based content, such as web serial dramas, interviews and variety shows, with embedded product placements. If a program’s storyline is consistent with a brand’s or product’s marketing initiatives, a product placement can have strong branding effects on viewers.
Advertising Sales
We have an advertising tracking system which records and maintains the traffic statistics and other data relating to the effectiveness of advertisements. Our system tracks the reach, delivery duration and frequency, targeting and quantity of advertisements delivered by our website. It supports monitoring of our advertising efforts by enabling retrieval of real-time advertisement delivery data using certain system application interfaces. We have also introduced an advertising results forecasting system that is used in an increasing number of large advertising campaigns on our website. This system is designed to help optimize our advertisers’ strategy by forecasting the results of a given campaign, factoring in the covered audience and the frequency and reach of such campaign. After the broadcasting of a customer’s advertisement, we will provide them with a report of advertising effectiveness either prepared in-house or by an independent research firm upon their request.
The list prices of our advertising services depend on various factors, including the form of advertising, specific targeting requirements, duration of the time slot purchased and popularity of the content that the advertisements would be associated with. Prices for the aggregate time slots purchased by each advertiser or advertising agency are fixed under sales contracts, typically at a discount to our list prices. We review the list prices quarterly. In addition, we employ a cost per 1,000 impressions (CPM)-based model for our in-video advertisements. This approach is similar to that of traditional television in that the advertisements are priced based in part on the user reach and viewing frequency. It allows advertisers to better compare the online and offline advertising services at their disposal. It also enables us to better monetize our growing user base and provide measurable results to our advertisers.
We engage in advertising sales primarily through advertising agencies.
In Pursuant to We expect to continue to engage third party advertising agencies for our advertising sales in the future.
Marketing Cooperation
In April 2014, as a result of our management’s review and adjustment of our business strategies after the Share Purchase Transaction, we
Our cooperation with Qinhe is relatively new and subject to
As the revenue models under our cooperation with Qinhe are relatively new, there is also no assurance that they would generate sufficient revenues and operating cash flows in the future. See Item 3.D. “Risk Factors—Risks Related to Our Business—Our new business models may not be able to generate sufficient revenues and operating cash flows.”
Marketing and Brand Promotion
We have initiated various marketing activities to further promote our brand awareness among existing and potential users and customers, which include:
· Direct Advertising. We engage in direct advertising in print, radio and TV media to market and promote our online video products. We believe that direct advertising is one of the most effective ways to market and promote our services to Internet users.
· Online Advertising. We engage in online advertising on other websites with user bases similar to our own or likely to watch online videos.
· Promotional Events. We organize and run a number of online promotional events which we believe help create brand awareness by associating the Ku6 brand with well-known and respected organizations and events in China.
· We also market our products and services by displaying our name and logo in Ku6 media player screens when users embed our content on third-party websites.
Technology and Infrastructure
We believe our proprietary technologies and infrastructure are critical to our success. With a dedicated research and development department, we have made significant investments in developing a proprietary, scalable technology platform that differentiates our online video distribution system.
Architecture
Since 2011, we have invested significantly in CDN infrastructure to support faster delivery of our online video content. As a pioneer in implementing this technology, we have established a more stable and scalable CDN and gained valuable CDN operations experience.
Our CDN technology utilizes distributed data storage to maintain copies of popular content at the “edge” of the network, which enables end-users to more quickly access that content. CDN technology facilitates faster responses to users’ requests for content, avoids buffering and associated delays caused by low bandwidth and user congestion of Internet traffic, and is therefore critical to the success of online video providers.
By hosting our Internet data centers along the major nodes of the transmission backbones operated by the local subsidiaries of China’s telecommunications carriers, we seek to maintain high standards in terms of delivery quality and speed as video content is transmitted from our servers to users throughout China. We have established a large number of servers nationwide, which contribute significantly to our fast streaming speeds and reliable viewing experience. Our servers are located at service sites of the local subsidiaries of the major domestic telecommunications carriers, which provide a stable power supply and maintenance for our servers.
Content Monitoring and Copyright Protection
We are committed to the protection of third-party copyrights. We are required to monitor our website for content prohibited by the PRC laws and regulations. See “—Government Regulation—Regulations on Internet Content Services.”
We have invested significantly in content monitoring and copyright protection technologies. We have a content screening team dedicated to screening and monitoring the content uploaded on our website to ensure that no content that may be deemed to be prohibited by government rules and regulations is posted and the prompt removal of any allegedly infringing content once we receive proper notification from the legitimate copyright owner. We provide training to these employees and supervise and monitor their work. We implemented monitoring procedures to remove infringing content, including: (i) a text filtering system screens content based on pre-set key words; (ii) manual review, where the content that passes the technology screening is reviewed by the content screening team on a 24-hour, 7-day basis, and the flagged content identified by our technology is reviewed and confirmed that it can be released; and (iii) back-office professional supervision, where certain professional content providers who we grant access to our back-office database can directly flag the infringing content for removal. Other content on our website
When infringing content is discovered, we may take action under the agreement with our users. After a user registers and before each upload, we require the user to click a check box to confirm that the content to be uploaded is in compliance with the terms and conditions set forth in the user agreement, and to guarantee that he or she is the copyright owner or has obtained all necessary consents and authorizations for such content and that he or she is responsible for such content. Pursuant to the user agreement, each user agrees to indemnify us for all damages arising from third-party claims against us caused by violating or infringing content uploaded or linked by the user. In addition, if we find a user has violated applicable laws or regulations or infringed other parties’ legal rights, we may terminate the user account and block the user’s future uploads without prior notice under the user agreement.
Despite our efforts, due to the large amount of content uploaded by our users, we may not be able to identify all infringing content. See Item 3.D. “Risks Related to Our Business—We have been and expect to continue to be exposed to intellectual property infringement and other claims, including claims based on content posted on our website” and “—Regulation and censorship of information disseminated over the Internet in China may adversely affect our business and subject us to liability for information displayed on or linked to our websites.”
Privacy Protection and Information Security
We have established information security systems to ensure our network and information security, including website security procedures, a security and confidential information management system, and user security system. These information security systems have been filed with the MIIT or its local branch. However, we may not be able to adequately protect the privacy rights of third parties from infringing content uploaded by our users. See Item 3.D. “Risk Factors—Risks Related to Our Business—We have been and expect to continue to be exposed to intellectual property infringement and other claims, including claims based on content posted on our website.”
Intellectual Property
We rely primarily on intellectual property laws and our contractual arrangements with our employees, clients, business partners and others to protect our intellectual property rights. We require our employees to enter into agreements requiring them to keep confidential all information relating to our customers, methods, business and trade secrets during and after their employment with us. Our employees are required to acknowledge and recognize that all inventions, trade secrets, works of authorship, developments and other processes generated by them on our behalf, whether or not patentable or copyrightable, made by them during their employment are our property. They also sign agreements to transfer any ownership that they may claim in those works to us. We have registered our domain names, including ku6.com
Competition
The online video industry in China is rapidly evolving and highly competitive. We believe the key competitive factors in the online video industry in China include brand recognition, demographic composition of users, robust technology platform, ability to acquire popular premium licensed content at a reasonable cost and create differentiated content in-house, ability to source creative UGC, ability to provide innovative advertising services to customers, relationships with advertising customers, advertising prices, as well as the range of services provided to advertising customers.
We face competition from other major online video companies. Among the independent or “pure-play” online video sites, our major competitors in China include Youku Tudou and iQiyi.com. Several large Chinese Internet companies, such as SINA Corporation, Baidu, Inc., Sohu.com Inc., Tencent Holdings Limited, NetEase.com, Inc. and/or their affiliates, have launched online video websites. In addition, some of China’s TV networks, such as CCTV, Phoenix Satellite TV and Hunan Satellite TV, have launched their own video broadcasting websites. We also face competition from Internet video streaming platforms based on the P2P technology, such as PPS and PPTV.
Certain international online video sites, such as YouTube and Hulu, have large content portfolios and high brand recognition, particularly among users outside China. Currently, YouTube is not accessible by viewers in China. If China lifts the restrictions, YouTube may become our major competitor in China.
We also compete with traditional advertising media, such as television, radio, newspapers and magazines, and major out-of-home media, such as billboards, for advertisers’ advertising budgets. Large enterprises currently spend a relatively small percentage of their advertising budgets on online advertising as compared to the percentage they spend on traditional advertising media, but we expect the percentage spent on online advertising to increase in the future.
Seasonality
We experience seasonality in our online advertising business. Historically, in the China market, the fourth calendar quarter represents the best season for the general advertising market. This is followed by the third and second calendar quarters. The first calendar quarter is usually the worst season in China due to the Chinese New Year
Government Regulation
The following is a summary of the principal governmental laws and regulations that are or may be applicable to companies such as ours in China. The scope and enforcement of many of the laws and regulations described below are uncertain. We cannot predict the effect of further developments in the PRC legal system, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement of laws. For a description of the regulatory risks related to our business, see Item 3.D. “Risk Factors—Risks Related to Our Business—Complexity, uncertainties and changes in government policies or regulations of Internet industry may have a material and adverse effect on our business, financial condition, results of operations and prospects,” “—Risks Related to Our Corporate Structure” and “—Risks Related to Doing Business in China.”
Regulation on catalogue relating to foreign investment Investment activities in the PRC by foreign investors are subject to the Catalogue for the Guidance of Foreign Investment Industry, or the Catalogue, which was promulgated and is amended from time to time by the Ministry of Commerce and the National Development and Reform Commission, or the NDRC. The Catalogue divides industries into three categories: encouraged, restricted and prohibited. Industries not listed in the Catalogue are generally open to foreign investment unless specifically restricted by other PRC regulations. Pursuant to the latest Catalogue amended in 2015, the provision of value-added telecommunications services falls in the restricted category, and the percentage of foreign ownership cannot exceed 50%. The provision of internet cultural operating services (including online game operation services), internet news, and production and online transmission of audio-visual programs fall in the prohibited category, and foreign investors are prohibited from engaging in such services. We conduct our operations in China principally through contractual arrangements among our PRC subsidiaries, our consolidated affiliated entities, and their respective shareholders. These contractual arrangements enable us to exercise effective control over these entities and hence treat them as our consolidated affiliated entities and consolidate their results. For a detailed discussion of these contractual arrangements, see Item 3.D.”Risk Factors—Risks Related to Our Corporate Structure” and Item 4.C. “Organizational Structure.” Regulations on Value-Added Telecommunications Services
In September 2000, the State Council promulgated the Telecommunications Regulations, or the Telecom Regulations. The Telecom Regulations draw a distinction between “basic telecommunication services” and “value-added telecommunication services.” Internet content provision services, or ICP services, is a subcategory of value-added telecommunications businesses. Under the Telecom Regulations, commercial operators of value-added telecommunications services must first obtain an operating license from the MIIT or its provincial level counterparts.
In September 2000, the State Council issued the Administrative Measures on Internet Information Services, or the Internet Measures, which was amended in January 2011. According to the Internet Measures, commercial ICP service operators must obtain an ICP license from the relevant government authorities before engaging in any commercial ICP operations in China. In November 2000, the MIIT promulgated the Administrative Measures on Internet Electronic Messaging Services, or the BBS Measures. BBS services include electronic bulletin boards, electronic forums, message boards and chat rooms.
In March 2009, the MIIT issued the amended Telecom License Measures, which became effective in April 2009. These measures set forth the types of licenses required to operate value-added telecommunications services and the qualifications and procedures for obtaining such licenses. For example, an ICP service operator providing value-added services in multiple provinces is required to obtain an inter-regional license, whereas an ICP service operator providing the same services in one province is required to obtain a local license.
Ku6 Information Technology, as our ICP service operator, holds an ICP license issued by Beijing Telecommunications Administration Bureau, which will expire in November 2016.
Regulations on Internet Content Services
National security considerations are an important factor in the regulation of Internet content in China. The National People’s Congress, the national legislature of the PRC, has enacted laws with respect to maintaining the security of Internet operation and Internet content. According to these laws, as well as the Internet Measures, violators may be subject to penalties, including criminal sanctions, for Internet content that:
· opposes the fundamental principles stated in the PRC constitution;
· compromises national security, divulges state secrets, subverts state power or damages national unity;
· harms the dignity or interests of the state;
· incites ethnic hatred or racial discrimination or damages inter-ethnic unity;
· undermines China’s religious policy or propagates heretical teachings or feudal superstitions;
· disseminates rumors, disturbs social order or disrupts social stability;
· disseminates obscenity or pornography, encourages gambling, violence, murder or fear or incites the commission of a crime;
· insults or slanders a third party or infringes upon the lawful rights and interests of a third party; or
· is otherwise prohibited by law or administrative regulations.
ICP service operators are required to monitor their websites. They may not post or disseminate any content that falls within these prohibited categories and must remove any such content from their websites. The PRC government may shut down the websites of ICP license holders that violate any of the above-mentioned content restrictions, order them to suspend their operations, or revoke their ICP licenses.
Restrictions on Foreign Ownership in Value-Added Telecommunications Services
According to the Provisions on Administration of Foreign Invested Telecommunications Enterprises, or the FITE Provisions, promulgated by the State Council in December 2001 and amended in September 2008, the ultimate foreign equity ownership in a value-added telecommunications services provider must not exceed 50%. Moreover, for a foreign investor to acquire any equity interest in a value-added telecommunication business in China, it must demonstrate a good track record and experience in operating value-added telecommunications services. Foreign investors that meet these requirements must obtain approvals from the MIIT and MOFCOM or its authorized local branches, and the relevant approval application process usually takes six to nine months.
In July 2006, the MIIT issued the Notice of the MIIT on Intensifying the Administration of Foreign Investment in Value-added Telecommunications Services. This notice prohibits domestic telecommunication services providers from leasing, transferring or selling telecommunications business operating licenses to any foreign investor in any form, or providing any resources, sites or facilities to any foreign investor for their illegal operation of a telecommunications business in China. According to this notice, either the holder of a value-added telecommunication business operating license or its shareholders must legally own the domain names and trademarks used by such license holders in their provision of value-added telecommunication services. The notice further requires each license holder to have the necessary facilities, including servers, for its approved business operations and to maintain such facilities in the regions covered by its license. In addition, all value-added telecommunication service providers are required to maintain network and Internet security in accordance with the standards set forth in relevant PRC regulations. If a license holder fails to comply with the requirements in the notice and cure such non-compliance, the MIIT or its local counterparts have the discretion to take measures against such license holders, including revoking their valued-added telecommunication business operating licenses.
In January 2015, MIIT issued the Announcement on Lifting Restrictions on Foreign Equity Ratio in Online Data Processing and Transaction Processing Business (For-profit E-commerce) in China (Shanghai) Pilot Free Trade Zone, or the MIIT 2015 Circular. The MIIT 2015 Circular provides that in Shanghai FTZ, foreign investors in those companies engaging in the business of providing online data processing and transactions processing services (E-commerce) would be permitted to hold up to 100% of equity interests in such companies. However, restrictions on foreign investments in companies engaging in value-added telecommunications services other than online data processing and transaction processing business are not affected. In January 2015, MOFCOM published on its website for public comment on a draft Foreign Investment Law of the PRC, or the draft FIL. The draft FIL is believed to strengthen the regulation of PRC companies, such as our VIEs, which have contractual arrangements with foreign investors or foreign invested companies. Under the draft FIL, a company controlled by foreign investors through contractual arrangements is considered to be a foreign invested enterprise and as a result is explicitly subject to restrictions on foreign investment. If the current version of the draft FIL becomes effective, our VIEs could fall within the scope of foreign invested companies and be subject to restrictions on foreign investment in the telecommunication service industry including online games, and the related contractual arrangements between our VIEs and us could be challenged. Under the draft FIL, it is unclear how “control” would be determined for such purpose, and the draft FIL is silent as to the enforcement actions that might be taken against existing companies, such as our VIEs, that operate in restricted industries. Ku6 Information Technology, one of our consolidated affiliated entities, holds the licenses and permits necessary to conduct our online video, online advertising and related businesses in China. We currently operate our website through Ku6 Information Technology through a series of contractual arrangements. We believe that it would be impracticable for us to acquire any equity interest in Ku6 Information Technology without diverting management attention and resources. We believe that our contractual arrangements with Ku6 Information Technology and its respective individual shareholders provide us with sufficient and effective control over it. Accordingly, we currently do not plan to acquire any equity interest in Ku6 Beijing Information Technology. In addition, the related trademarks are owned by Beijing WFOE, one of our wholly owned PRC subsidiaries, and we may be required to transfer the related trademarks from Beijing WFOE to Ku6 Information Technology. These contractual arrangements may be subject to challenges by the PRC government authorities. See Item 3.D. “Risk Factors—Risks Related to Our Corporate Structure—If the PRC government finds that the agreements that establish the structure for operating our businesses in China do not comply with PRC governmental restrictions on foreign investment in Internet business, we could be subject to severe penalties or be forced to relinquish our interests in those operations” and Item 3.D. “Risk Factors—Risks Related to Our Corporate Structure—Substantial uncertainties exist with respect to the enactment timetable, interpretation and implementation of the draft Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations.”
Regulations on Broadcasting Audio/Video Programs through the Internet
In July 2004, 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 launch, broadcasting, aggregation, 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.
In April 2005, the State Council announced Several Decisions on Investment by Non-state-owned Companies in Culture-related Business in China. These decisions encourage and support non-state-owned companies to enter certain culture-related business in China, subject to restrictions and prohibitions for investment in audio/video broadcasting, website news and certain other businesses by non-state-owned companies. These decisions authorize the SARFT, the Ministry of Culture and the GAPP to adopt detailed implementing rules according to these decisions.
In December 2007, the SARFT and the MIIT jointly issued the Rules for the Administration of Internet Audio and Video Program Services, commonly known as Circular 56, which came into effect as of January 31, 2008. Circular 56 reiterates the requirement set forth in the Audio/Video Broadcasting Rules that online audio/video service providers must obtain a license from the SARFT. Furthermore, Circular 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 in February 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 Circular 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 Circular 56 was issued. Such policies have been reflected in the Application Procedure for Audio/Video Program Transmission License. We have obtained an audio/video program transmission license in 2008, which was renewed in 2011 and
In June 2008, the SARFT issued the Notice on the Application Procedures for Audio/Video Program Transmission Licenses. Under this notice, all online audio/video service providers are required to maintain a registered capital of not less than RMB10.0 million, and audio/video service providers that offer news, movies, television, entertainment and other designated content must have a registered capital of not
In March 2009, the SARFT released the Notice on Strengthening the Administration of Online Audio/Video Content. This notice reiterated, among other things, that all movies and television shows released or published online must be in compliance with relevant regulations on the administration of radio, film and television. In other words, these movies and television shows, whether produced in China or overseas, must be pre-approved by the SARFT and distributors of these movies and television shows must obtain a permit before releasing any movie or television show.
In April 2010, the SARFT issued the Internet Audio/Video Program Services Categories (Provisional), which classified Internet audio/video programs into four categories. Category I is only open to state-owned broadcast/television media companies operating in the broadcasting/television section, and the other three categories are open to
We obtained an Internet audio/video program transmission license for our website www.ku6.com, the scope of which was subsequently expanded in August 2013 to cover multiple categories of audio/video services. The amended license is valid for three years from February 2012 to February
Regulations on Internet News Publication
Publishing and disseminating news through the Internet are highly regulated in China. In November 2000, the SCIO and the MIIT jointly promulgated the Provisional Measures for Administrating Internet Websites Carrying on the News Publication Business, or Internet News Measures. These measures require an ICP service operator (other than a government authorized news unit) to obtain an approval from the SCIO in order to publish news on its website or disseminate news through the Internet. Furthermore, any news disseminated through the Internet must be obtained from government-approved sources based on contracts between the ICP service operator and these sources. Copies of such contracts must be filed with relevant government authorities.
In September 2005, the SCIO and the MIIT jointly issued the Provisions on the Administration of Internet News Information Services. Under this regulation, Internet news information service providers must obtain an approval from the SCIO for the services, and such approval is subject to annual inspection. This regulation also provides that Internet news information service providers may not receive any foreign investment or establish any cooperative relationship with a foreign invested enterprise before the SCIO completes the security evaluation. We currently operate, in cooperation with some media companies and news agencies, a current events channel on our website, which includes audio/video contents relating to current topics and social events. The SCIO requires entities that offer Internet news services, such as us, to apply for and obtain an “Internet News Information Service Permit” from it. To our knowledge, in practice SCIO has not accepted any application for such permit. We will continue to closely monitor any development regarding this permit and will submit an application for it once SCIO starts to accept such applications. See Item 3.D. “Risk Factors—Risks Related to Our Business—Complexity, uncertainties and changes in government policies or regulations of Internet industry may have a material and adverse effect on our business, financial condition, results of operations and prospects.”
Regulations on Internet Publication
The GAPP is responsible for nationwide supervision and administration of publishing activities in China. In June 2002, the GAPP and the MIIT jointly promulgated the Internet Publication Tentative Administrative Measures, or the Internet Publication Measures, which took effect on August 1, 2002. Pursuant to the Internet Publication Measures, any entity engaged in Internet publishing activities must obtain the Internet Publication License from the GAPP before conducting any Internet publication activities.
The Internet Publication Measures were promulgated in June 2002, which is approximately three years prior to the establishment of China’s first group of online audio/video websites. At the time of promulgation, these measures were intended to regulate the traditional audio/video products and online gaming and did not consider the issues directly relevant to online audio/video business. Furthermore, the definition of “Internet publication” under these measures is very broad and the GAPP has not provided any implementing rule or official interpretation as to the applicability of the Internet Publication Measures to a website such as Ku6.com that exclusively distributes audio/video content.
In December 2012, the GAPP published a proposed rule relating to Internet publication. The proposal is intended to, among other things, clarify the meaning of the “Internet publication service” and “Internet publication” as well as modify the application procedures for the license. We plan to apply for the license with respect to certain services provided by Ku6 Information Technology once the final rule is issued. However, we cannot assure you that such application would be approved by the relevant governmental agencies in a timely manner or at all. See Item 3.D. “Risk Factors—Risks Related to Our Business—Complexity, uncertainties and changes in government policies or regulations of Internet industry may have a material and adverse effect on our business, financial condition, results of operations and prospects.”
Regulations on Internet Medical and Health Information Services
In July 2004, the State Drug Administration, or the SDA, issued the Measures for the Administration of Internet Drug Information Services. Under these measures, websites publishing drug-related information must obtain a license from the SDA or its provincial departments. Ku6 Information Technology, our consolidated affiliated entity that is an ICP service operator, obtained the Qualification Certificate of Internet Drug Information Service from the Beijing Drug Administration in May 2013, with a validity term up to May 2018. We will apply for renewal of this certificate within the stipulated period in accordance with these measures.
Regulations on Advertisements
The SAIC, including its local branches, is the government agency responsible for regulating advertising activities in China.
In November 2004, the SAIC issued the Administrative Regulations for Advertising Operation Licenses, taking effect as of January 1, 2005, granting a general exemption to enterprises (other than radio stations, television stations, newspapers and magazines, non-corporate entities and other entities specified in laws or administrative regulations) from the previous requirement to obtain an advertising operation license in addition to a business license. We conduct our online advertising business on our website “www.ku6.com” through Ku6 Information Technology and Tianjin Ku6 Network, each of which holds a business license that permits placing advertisements as part of its business scope.
Advertisers, advertising operators and advertising distributors are required by PRC advertising laws and regulations to ensure that the contents of the advertisements they prepare or distribute are true and in full compliance with applicable laws and regulations. In addition, where a special government review is required for certain categories of advertisements before publishing, the advertisers, advertising operators and advertising distributors are obligated to confirm that such review has been performed and that relevant approval has been obtained. Violation of these regulations may result in penalties, including fines, confiscation of advertising income, orders to cease dissemination of the advertisements and orders to publish an advertisement correcting the misleading information. In circumstances involving serious violations, the SAIC or its local branches may force the violator to terminate its advertising operation or even revoke its business license. Furthermore, advertisers, advertising operators or advertising distributors may be subject to civil liability if they infringe on the legal rights and interests of third parties.
Regulations on Foreign Ownership in Advertising Business
The principal regulations governing foreign ownership in advertising businesses in China include:
· The Administrative Regulations on Foreign-invested Advertising Enterprises; and
· The Circular Regarding Investment in the Advertising Industry by Foreign Investors through Equity Acquisition.
These regulations require foreign entities that directly invest in the PRC advertising industry to have at least a two-year track record with a principal business in the advertising industry outside China. Since December 2005, foreign investors have been permitted to directly own a 100% interest in advertising companies in China, but such foreign investors are also required to have at least a three-year track record with a principal business in the advertising industry outside China. PRC laws, rules and regulations do not permit the transfer of any approvals or licenses, including business licenses containing a scope of business that permits engagement in the advertising business.
Regulations on Internet Culture Activities
The Ministry of Culture promulgated the Amended Internet Culture Administration Tentative Measures, or the Internet Culture Measures, which became effective as of April 1, 2011. The Internet Culture Measures require ICP service operators engaging in “Internet culture activities” to obtain a permit from the Ministry of Culture. The term “Internet culture activities” includes, among other things, online dissemination of Internet cultural products, such as audio-video products, gaming products, performances of plays or programs, works of art and cartoons, and the production, reproduction, importation publication and broadcasting of Internet cultural products. We obtained the permit in June 2009, which was renewed in May 2012 and is valid through June 2015.
In November 2006, the Ministry of Culture issued Several Suggestions of the Ministry of Culture on the Development and Administration of the Internet Music, or the Suggestions, which became effective on November 20, 2006. The Suggestions, among other things, reiterate the requirement for the Internet service provider to obtain an Internet culture business permit to carry on any business relating to Internet music products. In addition, foreign investors are prohibited from operating Internet culture businesses. However, the laws and regulations on Internet music products are still evolving, and there have not been any provisions stipulating whether or how music video will be regulated by the Suggestions.
In August 2009, the Ministry of Culture promulgated the Notice on Strengthening and Improving the Content Review of Online Music. According to this notice, only “Internet culture operating entities” approved by the Ministry of Culture may engage in the production, release, dissemination (including providing direct links to music products) and importation of online music products. The content of online music shall be reviewed by or filed with the Ministry of Culture. Internet culture operating entities should establish a strict self-monitoring system of online music content and set up a special department in charge of such monitoring.
In August 2013, the Ministry of Culture issued the Notice of the Ministry of Culture on Implementing the Administrative Measures for the Content Self-examination of Internet Culture Business
To comply with these laws and regulations, our content examination team reviews the music videos on our website as well as certain other content and we have two employees who have obtained the applicable content review certificates.
Regulations on Producing Audio/Video Programs
In July 2004, the SARFT promulgated the Administrative Measures on the Production and Operation of Radio and Television Programs, effective as of August 20, 2004. These Measures provide that anyone who wishes to produce or operate radio or television programs must first obtain an operating permit. Applicants for this permit must meet several criteria, including having a minimum registered capital of RMB3 million. We hold a permit for radio and television program production and operation with its scope to cover the production of animated programs, variety program and special features. This permit is valid through December 2015.
Regulations on Software Products
In October 2000, the MIIT issued the Administrative Measures on Software Products, or the Software Measures, to strengthen the regulation of software products and to encourage the development of the PRC software industry. In March 2009, the MIIT issued amended Software Measures, which became effective in April 2009. The Software Measures provide a registration and filing system with respect to software products made in or imported into China. These software products may be registered with the competent local authorities in charge of software industry administration. Registered software products may enjoy preferential treatment status granted by relevant software industry regulations. Software products can be registered for five years, and the registration is renewable upon expiration.
The State Council promulgated the Computer Software Protection Regulations in December 2001, which was amended in January 2011 and January 2013. In connection with this regulation, the NCAC issued the Computer Software Copyright Registration Procedures in February 2002, which apply to software copyright registration, license contract registration and transfer contract registration. We have obtained and maintain seven software copyright registrations.
Regulations on Intellectual Property Rights
China has adopted legislation governing intellectual property rights, including trademarks, patents and copyrights. China is a signatory to the main international conventions on intellectual property rights and became a member of the Agreement on Trade Related Aspects of Intellectual Property Rights upon its accession to the World Trade Organization in December 2001.
Patent. The National People’s Congress adopted the Patent Law in 1984, and amended it in 1992, 2000 and 2008. The purpose of the Patent Law is to protect lawful interests of patent holders, encourage invention, foster applications of invention, enhance innovative capabilities and promote the development of science and technology. To be patentable, invention or utility models must meet three conditions: novelty, inventiveness and practical applicability. Patents cannot be granted for scientific discoveries, rules and methods for intellectual activities, methods used to diagnose or treat diseases, animal and plant breeds, substances obtained by means of nuclear transformation or a design which has major marking effect on the patterns or colors of graphic print products or a combination of both patterns and colors. The Patent Office under the State Intellectual Property Office, or SIPO, is responsible for receiving, examining and approving patent applications. A patent is valid for a term of twenty years in the case of an invention and a term of ten years in the case of utility models and designs. A third-party user must obtain consent or a proper license from the patent owner to use the patent. Otherwise, the use constitutes an infringement of patent rights.
Copyright. The National People’s Congress adopted the Copyright Law in 1990 and amended it in 2001 and 2010, respectively. The Copyright Law extends copyright protection to Internet activities, products disseminated over the Internet and software products. In addition, there is a voluntary registration system administered by the China Copyright Protection Center. Creators of protected works enjoy personal and property rights, including, among others, the right of disseminating the works through informational network.
In December 2012, the PRC Supreme People’s Court adopted the Provisions on Some Issues Concerning Applicable Laws for Trial of Disputes of Infringement of Rights to Communication through Information Networks, which became effective on January 1, 2013 and replaced the previous interpretations on the same topic. Under the provisions, Internet users or service providers are subject to civil liabilities if they provide
In April 2005, the NCAC on and the MIIT jointly promulgated the Measures for Administrative Protection of Copyright Related to Internet, which became effective on May 30, 2005. This measure applies to situations where an ICP service operator (i) allows another person to post or store any works, recordings, audio or video programs on the websites operated by such ICP service operator or (ii) provides links to, or search results for, the works, recordings, audio or video programs posted or transmitted by such person, without editing, revising or selecting the content of such material. Upon receipt of an infringement notice from a legitimate copyright holder, an ICP service operator must take remedial actions immediately by removing or disabling access to the infringing content. If an ICP service operator knowingly transmits infringing content or fails to take remedial actions after receipt of a notice of infringement harming public interest, the ICP service operator could be subject to administrative penalties, including cessation of infringement activities, confiscation by the authorities of all income derived from the infringement activities and payment of a fine of up to three times the unlawful income or, in cases where the amount of unlawful income cannot be determined, a fine of up to RMB100,000. An ICP service operator is also required to retain all infringement notices for a minimum of six months and to record the content, display time and IP addresses or the domain names related to the infringement for a minimum of 60 days. Failure to comply with this requirement could result in an administrative warning and a fine of up to RMB30,000.
In September 2003, the NCAC promulgated the Measure for the Implementation of the Copyright Administrative Punishment. In August 2002, the State Council promulgated the Implementing Regulations of The Copy right Law of the PRC, which was amended in January 2013. Under these regulations, an ICP service operator that infringes upon a third party’s copyright may be subject to a fine of one to five times the unlawful income if such income exceeds RMB50,000, or up to RMB 250,000 if such income is less than RMB50,000.
In May 2006, the State Council promulgated the Regulation for the Protection of the Right of Communication through Information Networks, which was amended in January 2013. This regulation provides a safe harbor principle for ICP service operator that provides information storage space to users through which users may provide works, performance or sound or video recordings to the public. An ICP service operator will not be liable to the right owners if the following conditions are met: (i) the ICP service operator has clearly indicated that the information storage space is provided to the users, and published the name, contact person and IP address of the network service provider; (ii) it has not altered the works or recordings provided by the users; (iii) it did not know, or could not reasonably have been expected to know, that the content provided by the users infringed upon other’s rights; (iv) it has not received any direct financial gain from the users’ provision of the content; and (v) it deletes the allegedly infringing content upon receiving written notice from the right owners. An ICP service operator that provides users with search or link services will not be liable to the right owner if the ICP service operator promptly disconnects the link to the infringing content after receiving the right owner’s notice. This exemption is not valid however if the ICP service operator knew or should know that the linked content infringed upon another’s rights. In that scenario, it will be jointly liable with the user who provided the content. Under this regulation, an ICP service operator may be subject to civil liabilities, including ceasing the infringing activities, eliminating the adverse effects, and paying damages. If public interest is harmed, the ICP service operator that infringes upon a third party’s copyright may be subject to a fine of one to five times the unlawful income if such income exceeds RMB50,000, or up to
In each of the years since 2005, the NCAC, together with certain other PRC governmental authorities, have jointly launched annual campaigns specifically aimed to crack down on Internet copyright infringement and piracy in China, which normally last for three to four months. One of the main targets, among others, of these annual campaigns is Internet audio and video programs. Since the 2010 campaign commenced in late July, the local branches of the NCAC have been focusing on popular movies and television series, newly published books, online games and animation, music and software and illegal uploading or transmission of a third party’s works without proper license or permission, sales of pirated audio/video and software through e-commerce platforms, providing search links, information storage, web hosting or Internet access services for third parties engaging in copyright infringement or piracy and the infringement by use of mobile media. In serious cases, the operating permits of the websites engaging in illegal activities may be revoked, and such websites may be ordered to shut down. To comply with the Campaign’s requirements, we have adopted related measures to mitigate copyright infringement risks and submitted the supervision report to the NCAC regularly. For example, our policy is to remove links to web pages if we know these web pages contain materials that infringe upon third-party rights or if we are notified by the legitimate copyright holder of the infringement with proper evidence.
In December 2009, the Standing Committee of the National People’s Congress adopted the Torts Liability Law, which became effective on July 1, 2010. Under this new law, both Internet users and Internet service providers may be liable for the wrongful acts of users who infringe the lawful rights of other parties. If an Internet user utilizes Internet services to commit a tortious act, the party whose rights are infringed may request the Internet service provider to take measures, such as removing or blocking the content, or disabling the links thereto, to prevent or stop the infringement. If the Internet service provider does not take necessary measures after receiving such notice, it shall be jointly liable for any further damages suffered by the rights holder. Furthermore, if an Internet service provider fails to take necessary measures when it knows that an Internet user utilizes its Internet services to infringe the lawful rights and interests of other parties, it shall be jointly liable with the Internet user for damages resulting from the infringement.
In January 2011, the Supreme People’s Court, the Supreme People’s Procuratorate and the Ministry of Public Security jointly issued the Opinions on Issues Concerning Applicable Laws for Criminal Cases Involving Intellectual Property Right Infringement, which provide clear guidance on circumstances in which online piracy results in criminal liabilities.
In June 2012, The Beijing Treaty on Audiovisual Performances, a multilateral treaty that regulates copyright of audiovisual performances and expands the performers’ rights, was adopted by the Diplomatic Conference on the Protection of Audiovisual Performances of the World Intellectual Property Organization. Forty-eight countries, including the United States and the PRC, signed the treaty. The treaty will become effective after ratification by at least 30 eligible parties.
Trademark. The PRC Trademark Law, adopted in 1982 and revised respectively in 1993, 2001 and 2013, with its implementation rules adopted in August 2002 and amended in April 2014,protects registered trademarks. The Trademark Office under the SAIC handles trademark registrations and grants a term of ten years to registered trademarks. Trademark license agreements must be filed with the Trademark Office for the record.
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Domain Name. In May 2012, the China Internet Network Information Center, or the CNNIC, issued the amended Implementing Rules for Domain Name Registration setting forth detailed rules for registration of domain names. In November 2004, the MIIT promulgated the Measures for Administration of Domain Names for the Internet in China, or Domain Name Measures. The Domain Name Measures regulate the registration of domain names, such as the first-tier domain name “.cn.” In May 2012, the CNNIC issued the amended Measures on Domain Name Disputes Resolution and its implementing rules, pursuant to which the CNNIC can authorize a domain name dispute resolution institution to decide disputes. We have registered ku6.com
Regulations on Information Security
The National People’s Congress has enacted legislation that prohibits use of the Internet that breaches the public security, disseminates socially destabilizing content or leaks state secrets. Breach of public security includes breach of national security and infringement on legal rights and interests of the state, society or citizens. Socially destabilizing content includes any content that incites defiance or violations of PRC laws or regulations or subversion of the PRC government or its political system, spreads socially disruptive rumors or involves cult activities, superstition, obscenities, pornography, gambling or violence. State secrets are defined broadly to include information concerning PRC national defense, state affairs and other matters as determined by the PRC authorities.
According to the Protection and Management Regulations for Computer Information Network and Internet Security promulgated by the Ministry of Public Security in December 1997, which was amended in 2011, and other relevant regulations, ICP service operators must complete mandatory security filing procedures and regularly update information security and censorship systems for their websites with local public security authorities, and must also report any public dissemination of prohibited content.
According to the PRC Law on Protection of State Secrets, which became effective on October 1, 2010, an ICP service operator must not disseminate any information that may be deemed to be state secrets and must promptly report any relevant events to the state and public security authorities. Failure to do so may subject the ICP service operator to liability and certain penalties by the State Secrecy Bureau, the Ministry of Public Security and the MIIT or their respective local branches.
In addition, the State Secrecy Bureau has issued provisions authorizing the blocking of access to any website it deems to be leaking state secrets or failing to comply with the relevant legislation regarding the protection of state secrets during online information distribution.
In December 2005, the Ministry of Public Security promulgated Provisions on Technological Measures for Internet Security Protection, or Internet Protection Measures, which became effective in March 2006. The Internet Protection Measures require all ICP service operators to keep records of certain information about its users (including user registration information, log-in and log-out time, IP address, content and time of posts by users) for at least 60 days and submit the above information as required by laws and regulations. In August 2014, the Supreme People’s Court of the PRC promulgated the Provisions of the Supreme People’s Court on Several Issues Concerning the Application of Law to Trial of Civil Dispute Cases over Infringement upon Personal Rights and Interests by Using Information Networks, which provides that if an ICP operator uses the network to disclose the genetic information, medical records, health examination data, criminal records, home address, private events and other personal privacy and information of a natural person causing damages, the aggrieved party will be entitled to hold the ICP operator liable unless: (i) the natural person has given written consent and the disclosure is within the agreed scope; (ii) the information is disclosed in order to promote the public interest and it is within the necessary extent; (iii) the information is disclosed for the purposes of public interest of academic research or statistics by schools and research institutions that is consented by the natural person in a written form, and the way of disclosure is not sufficient to identify the specific individuals; (iv) the information is self-disclosed by the natural person or has been lawfully disclosed on the Internet; or (v) the personal information is obtained in a lawful manner.
As an ICP service operator, we are subject to the regulations relating to information security. We have taken measures to comply with such regulations. We are registered with the relevant government authority in accordance with the mandatory registration requirement. Our policy is to remove links to web pages and any content which to its knowledge contain information that would be in violation of PRC laws or regulations. In addition, we monitor our websites to ensure our compliance with such laws and regulations.
Regulations on Internet Privacy
The PRC Constitution states that PRC law protects the freedom and privacy of communications of citizens and prohibits infringement of such rights. In recent years, PRC government authorities have enacted legislation on Internet use to protect personal information from any unauthorized disclosure.
The Internet Measures prohibit an ICP service operator from producing, reproducing, disseminating or broadcasting illegal information, including information that insults or slanders a third party or infringes the lawful rights and interests of a third party. Pursuant to the BBS Measures, ICP service operators that provide electronic messaging services must keep users’ personal information confidential and must not disclose such personal information to any third party without the users’ consent or unless required by law. The regulations further authorize the relevant telecommunications authorities to order ICP service operators to rectify unauthorized disclosure. ICP service operators are subject to legal liability if the unauthorized disclosure results in damages or losses to users. The PRC government, however, has the power and authority to order ICP service operators to turn over personal information if an Internet user posts any prohibited content or engages in illegal activities on the Internet.
In December 2011, the MIIT promulgated the Several Provisions on Regulating the Market Order of Internet Information Services, which became effective on March 15, 2012. This regulation provides that ICP service operators must not, without a user’s consent, collect “user’s personal information,” that is, information that can be used, alone or in combination with other information, to identify the user. In addition, ICP service providers may not provide any such information to third parties without prior consent of the user. ICP service operators can only collect user’s personal information that is necessary to provide their services, and must expressly inform the users of the method and purpose of collecting and processing such information. An ICP service operator may only use user’s personal information for the stated purposes under its scope of service. ICP service operators must also ensure the data security of user personal information and take immediate remedial measures if any such information is suspected to have been leaked. If the consequences of any such leaks are expected to be serious, the ICP service operator must immediately report the incident to the relevant telecommunication regulatory authority and cooperate in the investigations.
In December 2011, the Beijing Municipal Government promulgated the Several Provisions on Management of Beijing Micro Blog Development, which requires micro bloggers to register their real names. In December 2012, the Beijing High People’s Court issued the Guidelines for Trial of Disputes Concerning Copyright Issues Related to Video Sharing, which provides that an ICP service operator that merely provides video sharing services, such as us, may have a valid defense to liability if it can submit the registered identification information, such as name, registered IP address and date of registration, of the person who uploaded the infringing content.
In December 2012, the Standing Committee of the National People’s Congress passed the Decision to Enhance Online Personal Data Protection and Safeguard Public Interest. According to the decision, Internet users must use real names to identify themselves to ICP service operators when signing web access agreements or acknowledging acceptance of the service provider’s service. In addition, the ICP service operators are required to instantly stop the transmission of illegal information once it is discovered, and to remove the information, retain records and report to supervisory authorities. Violation of this decision may lead to various penalties, including confiscation of illegal gains, revocations of licenses and website closures, and the ICP service operator may also be prohibited from conducting Internet-related business in the future. In addition, any person whose identity is leaked or whose rights is infringed upon has the right to require the ICP service operator to remove the relevant information and take other necessary remedial measures.
In July 2013, the MIIT issued the Order for the Protection of Telecommunication and Internet User’s Personal Information. Any collection or use of a user’s personal information must be subject to the consent of such user. An ICP service operator must keep such information strictly confidential, and it is prohibited from divulging, tampering or destroying any such information, and from selling or providing such information to other parties. Any violation may subject the ICP service operator to warnings, fines, confiscation of illegal gains, revocation of licenses, cancellation of registrations , shutdown of websites or even criminal liabilities. We have required our users to consent to our collection and use of their personal information, and have taken information security measures to protect our users’ privacy. In February 2014, the National Internet Information Office promulgated the Provisions on Administration of Internet User Account Names, which became effective on March 1, 2015. According to the Provisions, the Internet information service providers shall, pursuant to the principle of “mandatory real name registration at the back-office end, and voluntary real name display at the front-office end,” require the Internet information service users to sign up accounts after passing real identity information authentication. When signing up accounts, the Internet information service users shall enter into agreements with the Internet information service providers to undertake to abide by the seven bottom lines in terms of laws and regulations, which are the socialist system, national interests, citizens’ legitimate rights and interests, public order, social morality and the truthfulness of information. Where any Internet information service user falsifies information to get the account name registered or includes any illegal or unfavorable information in the head portrait, profile or any other registration information of the account, the Internet information service provider shall take measures such as issuing an notice to require such user to rectify within specified time limit, suspending the use of the account name by such user or deregistering the account of such user.
We currently do not require real name registration by our users, which may be deemed to violate relevant PRC laws and regulations, and the PRC regulatory authorities may impose administrative penalty on us, such as warning, fines, confiscation of illegal gains, revocation of website registration, or shutdown of our website. In addition, we may be liable for damages caused to our users.
Regulations on Foreign Exchange Controls
For information regarding relevant foreign exchange controls, please refer to Item 10.D. “Exchange Controls.”
Regulations on Dividend Distribution
The principal regulations governing dividend distributions by wholly foreign owned enterprises and Chinese-foreign equity joint ventures include the:
· Wholly Foreign-Owned Enterprise Law (1986), as amended;
· Wholly Foreign-Owned Enterprise Law Implementing Rules (1990), as amended;
· Chinese-foreign Equity Joint Venture Enterprise Law (1979), as amended;
· Chinese-foreign Equity Joint Venture Enterprise Law Implementing Rules (1983), as amended;
· The Companies Law (2013);
· The Notice on Implementation of Enterprise Income Tax Transition Preferential Policy under the PRC Enterprise Income Tax Law (2007);
· PRC Enterprise Income Tax Law (2007); and
· Implementation Rules of the PRC Enterprise Income Tax Law (2007).
Under these regulations, wholly foreign owned enterprises and Chinese-foreign equity joint ventures in China may pay dividends only out of their accumulated after-tax profits, if any, as determined in accordance with PRC accounting standards and regulations. Additionally, all enterprises are required to set aside at least 10% of their after-tax net income each year, if any, to fund their statutory capital reserves, until the aggregate amount of such reserves reaches 50% of their registered capital. These reserves are not distributable as cash dividends.
Labor Laws and Social Insurance
Pursuant to the PRC Labor Law, which became effective on January 1, 1995, the PRC Labor Contract Law, which became effective on January 1, 2008, and their implementation rules, employers must execute written labor contracts with their employees. All employers must compensate their employees with wages equal to at least the local minimum wage standards. All employers are required to establish a system for labor safety and sanitation, strictly abide by state national labor rules and standards and provide employees with workplace safety training. Employers are also obliged to provide employees with welfare schemes covering pension insurance, unemployment insurance, maternity insurance, work-related injury insurance, medical insurance and housing funds. Violations of the PRC Labor Law and the PRC Labor Contract Law may result in the imposition of fines and other administrative liabilities. Criminal liability may arise for serious violations.
The PRC Labor Contract Law and its implemental rules also allow third-party human resource companies to enter into employment contracts with employers on behalf of dispatched employees. The dispatched positions are typically temporary and complementary in nature, and the employment contracts should state the position, term and compensation of the employee, including social insurance fees. The employers must protect the rights and interests of the dispatched employees. In December 2012, the Standing Committee of the National People’s Congress enacted an amendment to the PRC Labor Contract Law, which will become effective on July 1, 2013. The amended PRC Labor Contract Law protects the right to equal pay for equal work for dispatched employees, limits the number of dispatched workers and imposes more stringent penalties on unlawful labor dispatch practices. In addition, if the employer causes losses to the dispatched employees, the human resource companies and the employer are jointly liable.
We have entered into labor contracts with most of our employees. We provide our employees with the proper welfare and employment benefits. We employ the remaining employees through third-party human resources companies that are qualified to dispatch such employees to our PRC entities. These third-party human resources companies are responsible for managing, among others, payrolls, social insurance contributions of these employees.
Pursuant to the PRC Labor Contract Law and its latest amendments effective on July 1, 2013, dispatched employees are intended to be a supplementary form of employment and shall only apply to provisional, auxiliary or substitutive positions, and the fundamental form should be direct employment by enterprises and organizations that require employees. It is expressly stated that the number of dispatched employees an employer uses may not exceed a “certain percentage” of its total labor force. The Interim Provisions on Labor Dispatch which came into force on March 1, 2014, further set such percentage at 10% and provide a two-year transitional period for compliance with such requirement. Failure to comply with these requirements may result in orders of rectification and imposition of fines. See Item 3.D. “Risk Factors—Risks Related to Doing Business in China—The enforcement of the PRC labor contract law may materially increase our costs and decrease our net income.” In addition, the State Administration for Taxation has issued circulars concerning employee share options or restricted shares. Under these circulars, employees working in the PRC who exercise share options (i.e. our existing equity compensation plans), or whose restricted shares vest, will be subject to PRC individual income tax. The PRC subsidiaries of an overseas listed company have obligations to file documents related to employee share options or restricted shares with relevant tax authorities and to withhold individual income taxes of those employees related to their share options or restricted shares. Although we currently withhold income tax from our PRC employees in connection with their exercise of options and the vesting of their restricted shares, if the employees fail to pay, or the PRC subsidiaries fail to withhold, their income taxes according to relevant laws, rules and regulations, the PRC subsidiaries may face sanctions imposed by the tax authorities or other PRC government authorities. See Item 3.D. “Risk Factors—Risks Related to Doing Business in China—Any failure to comply with PRC regulations regarding our employee equity incentive plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.” Regulations on Concentration in Merger and Acquisition Transactions
In August 2006, six PRC regulatory authorities, including MOFCOM and the China Securities Regulatory Commission, jointly adopted the M&A Rule, which were amended in June 2009. The M&A Rules established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex. These rules require, among other things, that MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor will take control of a PRC domestic enterprise or a foreign company with substantial PRC operations, if certain thresholds under the Provisions on Thresholds for Prior Notification of Concentrations of Undertakings issued by the State Council in August 2008 are triggered.
According to the Implementing Rules Concerning Security Review on the Mergers and Acquisitions by Foreign Investors of Domestic Enterprises issued by the MOFCOM in August 2011, mergers and acquisitions by foreign investors involved in “an industry related to national security” are subject to strict review by MOFCOM. These rules also prohibit any transactions attempting to bypass such security review, including by controlling entities through contractual arrangements. We believe that our business is not in an industry related to national security, but we cannot preclude the possibility that the MOFCOM or other government agencies may publish explanations contrary to our understanding or broaden the scope of such security reviews in the future.
C.Organizational Structure
We conduct our operations in China principally through contractual arrangements among our PRC subsidiaries, our consolidated affiliated entities in the PRC, and their respective shareholders. We hold no ownership interest in any of our consolidated affiliated entities in China. In August 2012, in connection with the repurchase of our ordinary shares from Mr. Shanyou Li, Mr. Shanyou Li and other shareholders of our consolidated affiliated entities Ku6 Information Technology and Ku6 Cultural transferred their equity interests in Ku6 Information Technology and Ku6 Cultural to new shareholders designated by us. Subsequently, we amended the relevant contractual agreements with respect to these controlled affiliated entities. As a result, our consolidated affiliated entities are owned, directly or indirectly, by certain individuals as follows:
· Ku6 Information Technology is 98% owned by Mr. Yingfeng Zhang and 2% owned by Mr. Mingfeng Chen;
· Tianjin Ku6 Zheng Yuan, which is wholly owned by Ku6 Information Technology, is 98% owned by Mr. Yingfeng Zhang and 2% owned by Mr. Mingfeng Chen;
· Ku6 Cultural is 98% owned by Mr. Yingfeng Zhang and 2% owned by Mr. Mingfeng Chen; and
· Tianjin Ku6 Network is 90% owned by Ms. Dongxu Wang and 10% owned by Mr. Qing Zhang.
Through our contractual arrangements with these consolidated affiliated entities, we have the power to vote all the shares held by the shareholders of these entities, through our PRC subsidiaries, as well as the right to enjoy the economic benefits derived from these entities and the exclusive right to purchase equity interests from the shareholders of these entities to the extent permitted by PRC law. For a detailed description of the regulatory environment that necessitates the adoption of our corporate structure, see Item 4.B. “Business Overview—Government Regulation.” For a detailed description of the risks associated with our corporate structure and the contractual arrangements that support our corporate structure, see Item 3.D. “Risk Factors—Risks Related to Our Corporate Structure.”
Under the guidance relating to the consolidation of consolidated affiliated entities, we are the primary beneficiary of the economic benefits of our consolidated affiliated entities, namely, Ku6 Information Technology, Tianjin Ku6 Zheng Yuan, Ku6 Cultural and Tianjin Ku6 Network. Transactions among our consolidated affiliated entities, our company and our subsidiaries are eliminated in consolidation.
The following diagram illustrates the corporate structure of our company, our subsidiaries, and our consolidated affiliated entities, as well as our shareholding in Yisheng, as of
D.Property, Plant and Equipment
Our principal executive offices are located on premises with a gross floor area of approximately 5,640 square meters in Beijing. We also have branch and representative offices in Tianjin
Item4A. Unresolved Staff Comments
Not Applicable.
Item 5. Operating and Financial Review and Prospects
The following discussion of our financial condition and results of operations is based upon and should be read in conjunction with our consolidated financial statements and their related notes included elsewhere in this annual report on Form 20-F. This discussion contains
A.Operating Results
Overview
We entered into the online video business through the acquisition of Ku6 Holding in January 2010.
In July 2012, we repurchased an aggregate of 269,409,276 ordinary shares from certain former officers, Mr. Shanyou Li, Mr. Zhizhong Hao and Ms. Xingye Zeng, and Kumella Holdings Limited, a company controlled by Mr. Shanyou Li, at a price of $0.0291 per share, and repurchased 79,717 ADSs from Mr. Shanyou Li at a price of $2.91 per ADS. The repurchase was approved by shareholders at our annual general meeting of shareholders on July 12, 2012 and consummated on July 13, 2012. All the repurchased ordinary shares and ADSs were cancelled upon repurchase.
On March 31, 2014, Mr. Xu entered into a share purchase agreement with our then controlling shareholder, Shanda Media,
Historically, we derived substantially all of our revenues from online advertising services, for which we collect service fees from advertisers through our advertising agencies. In April 2014, as a result of our management’s review and adjustment of our business strategies after the Share Purchase Transaction, we
For the years ended December 31,
Factors Affecting Our Results of Operations
Our business, financial condition and results of operations have been and will continue to be subject to general conditions affecting the online video and online marketing industries in China. These conditions, among others, include the stability and growth of China’s economy, the growth of the Internet and mobile Internet penetration rate in China, and the increasing acceptance of online video marketing by the advertisers.
In addition, our business, financial condition and results of operations are affected by a number of company-specific factors including our ability to:
· maintain and expand our user base;
· obtain and produce popular video content cost-effectively;
· procure Internet bandwidth cost-effectively;
· provide effective online marketing services;
· control sales and marketing expenses; and
· maintain our brand and market position.
Furthermore, substantial doubt exists as to our ability to continue as a going concern. See Item 5.B. “Liquidity and Capital Resources—Liquidity and Going Concern,” Item 3.D. “Risk Factors—Risks Related to
Description of Certain Statement of Operations Items
Net Revenues
In
In April 2014, we entered into a new advertising agency agreement with New Shengyue, which is no longer owned by Shanda Interactive and is an independent third party. In August 2014, we terminated this agreement with New Shengyue and entered into another new advertising agency agreement with Huzhong, an independent third party. Pursuant to our agreement with Huzhong, Huzhong will act as our exclusive advertising agency for standard media resources and non-exclusive advertising agency for highly-interactive advertising resources. Under this agreement, we guarantee a certain amount of web traffic per day for webpages on which Huzhong posts advertisements, and in return, Huzhong guarantees to us a minimum amount of advertising revenues per day. If we fail to meet the web traffic target, the minimum amount guaranteed by Huzhong will be proportionally adjusted for the shortfall. Huzhong agreed to prepay 50% of the minimum guaranteed amounts within five business days prior to the beginning of each month and settle the balance within five business days after the end of each month. For the years ended December 31, 2011, 2012, 2013 and 2014, we generated advertising revenues of $8.1 million, $12.5 million, $12.4 million and $6.0 million from advertising agencies in total. In addition, in April 2014, as a result of our management’s review and adjustment of our business strategies after the Share Purchase Transaction, we Our cooperation with Qinhe is relatively new and subject to As
Cost of Revenues
Our cost of revenues consists of Internet bandwidth costs,
(1)Include primarily advertisement production costs, platform operation costs and outside service fees.
Internet bandwidth costs. Internet bandwidth costs are the fees we pay to telecommunications carriers and other service providers for telecommunications services and for hosting our servers at their Internet data centers. Bandwidth is a significant component of our cost of revenues and therefore an important factor affecting our profitability. The bandwidth costs as a percentage of our net revenues increased from
User Generated Content costs,
Payroll costs. Payroll costs consist of salaries and benefits for our platform operation and content personnel. The payroll costs
Depreciation of servers and other equipment. We include depreciation expense for servers and other equipment that are directly related to our business operations and technical support in our cost of revenues. Our depreciation expense
In-house developed content costs. In-house developed content costs represent costs related to the production of our news, reports and interactive entertainment programs, but do not include any salaries and benefits paid to our employees.
Operating Expenses
The following table sets forth certain historical consolidated operating expenses data,
Product Development Expenses. Product development expenses consist primarily of salaries and benefits for product development personnel, including share-based compensation costs.
Selling and Marketing Expenses. Selling and marketing expenses consist primarily of sales and marketing personnel payroll compensation and related employee costs, advertising and market promotion expenses, and other overhead expenses incurred by our sales and marketing personnel.
General and Administrative Expenses. General and administrative expenses consist primarily of salary and benefits, including share-based compensation, for general management, finance and administrative personnel, bad debt
Impairment of
Furthermore, in order to reduce operating cash outflows, we
Critical Accounting Policies
The methods, estimates and judgments we use in applying our accounting policies have a significant impact on the results we report in our financial statements. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. We have summarized our accounting policies below that we believe are both important to an understanding of our financial results and involve the need to make estimates about the effect of matters that are inherently uncertain. We also have other policies that we consider to be key accounting policies. However, these policies do not meet the definition of critical accounting policies because they do not generally require us to make estimates or judgments that are difficult or subjective.
Business Combinations and Non-controlling Interests
We account for our business combinations using the purchase method of accounting. This method requires that the acquisition cost to be allocated to the assets, including separately identifiable intangible assets, and liabilities we acquired based on their estimated fair values. Any non-controlling interest was reflected at historical cost. Where the consideration in an acquisition includes contingent consideration the payment of which depends on the achievement of certain specified conditions post-acquisition, contingent consideration was not recorded until the contingency was resolved.
From January 1, 2009, we adopted ASC 805 (formerly referred to as SFAS No. 141 (revised 2007), “Business combinations”). Following this adoption, the cost of an acquisition is measured as the aggregate of the fair values at the date of exchange of the assets given, liabilities incurred, and equity instruments issued as well as the contingent considerations and all contractual contingencies as of the acquisition date. The costs directly attributable to the acquisition are expensed as incurred. Identifiable assets, liabilities and contingent liabilities acquired or assumed are measured separately at their fair value as of the acquisition date, irrespective of the extent of any non-controlling interests. The excess of (i) the total of cost of acquisition, fair value of the non-controlling interests and acquisition date fair value of any previously held equity interest in the acquiree over and (ii) the fair value of the identifiable net assets of the acquiree is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognized directly in the income statement.
We follow the guidance in ASC Topic 810 regarding non-controlling interests. Non-controlling interests are classified as a separate component within equity. Consolidated net income on a total enterprise basis is adjusted within the statement of operations and comprehensive loss for net income attributed to non-controlling interests and consolidated comprehensive income is adjusted for comprehensive income attributed to non-controlling interests.
Revenue Recognition
In accordance with
Online advertising services We derive part of our revenue from online advertising
Advertising contracts are signed to establish the price and advertising services to be provided. Advertisements are charged either based on the agreed
Under our previous agreement with Old Shengyue, which expired in March 2014, guaranteed minimum advertising revenues were not subject to downward adjustments. Under our previous agreement with New Shengyue, which was terminated in August 2014, guaranteed minimum advertising revenues must be proportionally adjusted downward if there was a shortfall relative to web traffic or video view targets. Under these two agreements, excess advertising revenues were calculated after deducting commission fees earned by Old Shengyue and New Shengyue based upon increasing percentages for additional tiers or layers of
We report the Promotional advertising services
We
We also provided online game marketing services to Qinhe from April 2014 to March 2015. In return, we share a portion of its profits that are generated from our video viewers who play Qinhe’s games through advertisements on our website. Profits are calculated as revenues from the games operated by Qinhe, net of licensing fees payable to game developers. Promotional advertising service revenues are recognized as services delivered for interactive entertainment marketing and online game. Shortly after the end of each month, with We report the revenue earned from Qinhe based on
Allowances for Doubtful Accounts
We determine the allowance for doubtful accounts when facts and circumstances indicate that receivables are unlikely to be collected by taking into account an aging analysis of receivable balances, historical bad debt records, repayment patterns in the prior year and other factors such as the policies of operators and financial condition of the customers. Our allowance for doubtful accounts
Goodwill and Intangible Assets Impairment
We test goodwill for impairment by performing a two-step goodwill impairment test, which can be preceded by an optional qualitative assessment to determine if the two-step goodwill impairment test needs to be followed. The optional qualitative assessment relies upon qualitative factors to determine if it is
We measure impairment of intangible assets whenever events or changes in circumstances indicate that the carrying amount of an asset may no longer be recoverable. When these events occur, we assess impairment by comparing the carrying value of the intangible assets to the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flow is less than the carrying amount of the assets, we would recognize an impairment loss based on the fair value of the intangible assets. We measure the fair value of intangible assets
During the annual impairment test on December 31, 2012, we performed an impairment test
During the annual impairment test on December 31,
Turnover Tax and Related Surcharges
Our subsidiaries and consolidated affiliated entities are subject to business tax and related surcharges or value-added tax, as the case may be, on the revenues earned for services provided in China. These business tax and related surcharges or value-added tax are deducted from gross
In 2012, the relevant PRC authorities introduced a turnover tax reform pilot program (the “Pilot Program”) in selected pilot cities in China for selected industries to gradually expand the scope of VAT. The Pilot Program was implemented in Beijing and Tianjin, in which our advertising revenues are sourced, effective September 1 and December 1, 2012, respectively. Prior to the implementation of the Pilot Program, the business tax rate on our advertising sales was 5% based on the gross advertising revenue before deducting advertising
Share-based Compensation
We apply Accounting Standards Codification Topic 718, “Stock Compensation,” or ASC 718, which requires all share-based payments to employees and directors, including grants of employee stock options and restricted shares, to be recognized as compensation expense in the financial statements over the vesting period of the award based on the fair value of the award determined at the grant date. The valuation provisions of ASC 718 apply to new awards, to awards granted to employees and directors before the adoption of ASC 718 whose related requisite services had not been provided, and to awards which were subsequently modified or cancelled. Under ASC 718, the number of share-based awards for which the service is not expected to be rendered for the requisite period should be estimated, and the related compensation cost not recorded for that number of awards.
In accordance with ASC 718, we have recognized share-based compensation expenses, net of a forfeiture rate, using the straight-line method for awards with graded vesting features and service conditions only and using the graded-vesting attribution method for awards with graded vesting features and performance conditions.
We grant equity incentive awards to our employees. We recorded share-based compensation expense of
Income Taxes and Valuation allowances
Current income taxes are provided for on the taxable income of each subsidiary on the separate tax return basis in accordance with the relevant tax laws. Our PRC subsidiaries and consolidated affiliated entities are generally subject to a corporate income tax rate of 25% under the EIT Law. We are not subject to income tax under the Cayman Islands law.
Deferred income taxes are provided using the liability method in accordance with Accounting Standards Codification Topic 740, “Income Taxes,” or ASC 740. Under this method, deferred income taxes are recognized for temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements, net operating loss carry forwards and credits, by applying enacted statutory tax rates applicable to future years. The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. The effect on deferred taxes of a change in tax rates is recognized in income in the period of change. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Accounting Standards Codification Topic 740-10-25 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The adoption of ASC 740-10-25 did not result in a cumulative adjustment to the opening balance of retained earnings as of January 1, 2007. We do not have any liabilities for unrecognized tax benefits as of December 31, Contingencies
We are subject to contingencies, such as legal proceedings and claims arising out of our business, that cover a wide range of matters in the normal course of our business. Liabilities for such contingencies are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated by us. As of December 31,
Results of Operations
The following discussion of our results of operations for the years ended December 31,
In April 2014, as a result of our management’s review and adjustment of our business strategies after the Share Purchase Transaction, we Year Ended December 31, 2014 Compared to Year Ended December 31, 2013 Net Revenues. Net revenues decreased by 34.4% to $8.6 million in 2014 from $13.1 million in 2013. This decrease was primarily due to the transition of our business models after the Share Purchase Transaction. We had unsatisfactory cooperation with our former advertising agency New Shengyue from April 2014 to August 2014. As a result, we terminated our agreement with New Shengyue and engaged Huzhong in August 2014. Revenues from our advertising services decreased to $6.0 million in 2014 from $12.4 million in 2013. Our cooperation with Qinhe was also new, and we generated revenues of $1.6 million from Qinhe in 2014. Cost of Revenues. Cost of revenues decreased by 24.4% to $12.1 million in 2014 from $16.0 million in 2013. This decrease was mainly attributable to the UGC Entertainment Awards production costs incurred in 2013, which did not recur in 2014. In addition, we optimized our bandwidth usage to improve its efficiency which resulted in a decrease of Internet band width costs by $1.5 million in 2014. Depreciation expenses also decreased by $0.6 million from 2013 to 2014. Such decreases were partially offset by an increase of our payroll costs in the amount of $0.7 million due to the one-time compensation paid by us in connection with the execution of our headcount reduction plan. Gross Loss. As a result of the foregoing, our gross loss increased from $2.8 million in 2013 to $3.6 million in 2014. Operating Expenses. Operating expenses decreased significantly to $9.4 million in 2014 from $40.6 million in 2013, primarily due to an impairment charge for goodwill and intangible assets of $27.2 million in 2013, which did not recur in 2014, as well as decreases in our product development expenses, selling and marketing expenses and general and administrative expenses. ·Product Development Expenses. Product development expenses decreased by 60.4% to $1.4 million in 2014 from $3.5 million in 2013. This decrease was primarily due to the decrease in labor costs as a result of our headcount reduction in 2014. ·Selling and Marketing Expenses. Selling and marketing expenses decreased by 47.6% to $0.9 million in 2014 from $1.8 million in 2013. This decrease was primarily attributable to a decrease in expenses for promotional campaigns and marketing events, as we held fewer such events in 2014 compared to 2013 to control our expenses. ·General and Administrative Expenses. General and administrative expenses decreased from $8.1 million in 2013 to $7.1 million in 2014. This decrease was primarily attributable to significant headcount reductions in 2014 and a $0.3 million reversal of accrued litigation expenses, as partially offset by provisions for bad debts recorded in 2014 of $1.0 million. ·Impairment of Goodwill and Intangible Assets. We recorded significant impairment charges of $6.2 million and $21.0 million for goodwill and for definite-lived intangible assets (mainly trademark), respectively, for the year ended December 31, 2013. This did not recur in 2014. Operating Loss. As a result of the foregoing, operating loss decreased significantly from $43.5 million in 2013 to $13.0 million in 2014. Interest Income. Interest income decreased to nil in 2014 from $0.1 million in 2013 primarily due to the repayment of interest-bearing loans by Shanda Games Limited in early 2013 and fluctuations in cash balances. Interest Expense. Interest expense decreased to $0.05 million in 2014 from $0.02 million in 2013 primarily due to the repayment of interest-bearing loans from related parties in early 2013. Other Income, Net. Other income decreased to $0.7 million in 2014 from $4.1 million in 2013, primarily due to $2.9 million in write-offs of various third-party liabilities related to our previous advertising sales model in 2013, for which settlement was judged to be remote based upon our policies and past settlement experience and for which legal obligations had expired. Also impacting changes in other income, net was a $1.0 million provision for a long-aged receivable due from Seed Music in 2013 which did not recur in 2014, as well as a decrease of $1.3 million in government subsidy income recognized. Gain from disposal of equity interest in affiliate. In June 2014, we disposed of 10% of the equity interests in Bale to a third party for a consideration of RMB9.0 million ($1.5 million). A net $1.5 million (RMB9.0 million) gain from the disposal of our equity interest in Bale was realized. We did not have such gains in 2013. Income Tax Benefit. Income tax benefit was nil in 2014 and $4.8 million in 2013. The income tax benefit in 2013 was associated with the reversal of deferred tax liabilities relating to the impairment of goodwill and intangible assets. Net Loss. Net loss decreased significantly from $34.4 million in 2013 to $10.7 million in 2014.
Year Ended December 31, 2013 Compared to Year Ended December 31, 2012
Net Revenues. Net revenues decreased by 6.9% to $13.1 million in 2013 from $14.1 million in 2012. This decrease was primarily due to a decrease in revenues from third-party advertisers. Revenues from our previous advertising agency agreement with Old Shengyue contributed approximately 88.4% and 94.4% of our total net revenues in 2012 and 2013, respectively. This agreement, as previously renewed, expired on March 31, 2014 and was not further renewed. See Item 7.B. “Related Party Transactions—Previous Advertising Agency Agreement with Old Shengyue.”
Cost of
Gross Loss. As a result of the foregoing, our gross loss increased from $0.5 million in 2012 to $2.8 million in 2013.
Operating Expenses. Operating expenses increased significantly to $40.6 million in 2013 from $10.5 million in 2012, as a result of a significant impairment charge and increases in our product development expenses, selling and marketing expenses and general and administrative expenses.
· Product Development Expenses. Product development expenses increased by 77.3% to $3.5 million in 2013 from $2.0 million in 2012. This increase was primarily due to the increase in labor costs as we recruited more talents to strengthen our research and development team.
· Selling and Marketing Expenses. Selling and marketing expenses increased by
· General and Administrative Expenses. General and administrative expenses increased from $6.8 million in 2012 to $8.1 million in 2013. This increase was primarily attributable to (i) an increase of $1.9 million in bad debt provision, because we reversed a large amount of provision in 2012 for collection of accounts receivable previously written down, which did not occur in 2013, and (ii) an increase of $0.5 million in share-based compensation expenses due to stock options awards granted to newly joined management and talents and expenses associated with the conversion of certain performance-based stock option awards to service-based option awards.
· Impairment of Goodwill and Intangible
Operating Loss. As a result of the foregoing, operating loss increased significantly from $11.0 million in 2012 to $43.5 million in 2013.
Interest Income. Interest income decreased to $0.1 million in 2013 from $0.6 million 2012 primarily due to the repayment of interest-bearing loans by Shanda Games Limited in early 2013 and the continuous decrease in balance of bank deposits throughout 2013.
Interest
Other Income, Net. Other income, net increased to $4.1 million in 2013 from $1.7 million in 2012, primarily due to (i) $2.9 million in gains from
Income Tax Benefit. Income tax benefit was $4.8 million for in 2013 and nil in 2012.
Equity in Loss of Affiliated Company, Net of Tax. Equity in loss of affiliated company, net of tax, was nil in 2013 compared to $0.2 million as a result of our share of losses in Yisheng in 2012. This loss was attributable to our disposal of an 80% interest in Yisheng in August 2011. We accounted for the retained 20% interest under the equity method as we determined that we do not have a controlling financial interest in, but rather possess significant influence on, Yisheng. As of December 31, 2012, the investment in Yisheng was reduced to nil as a result of our equity share of losses since August 2011.
Net
B.Liquidity and Capital Resources
Liquidity and Going Concern
The audited consolidated financial statements included in this annual report on Form 20-F were prepared on the basis of a going concern which contemplates that we will be able to realize assets and discharge liabilities in the normal course of business. However, we have incurred significant net losses and negative cash flows from operations in recent years. For the years ended December 31,
In April
In order to reduce operating cash outflows, we
Based on our current cash flow projections, we expect that cash inflows from operating activities, together with our current cash balances, may not be sufficient to satisfy our cash requirements in the near term. See Item 3.D. “Risk Factors—Risks Related to Our Business—We require a significant amount of cash to fund our operations. We cannot assure you that we can meet our working capital requirements or other capital needs through improved operating results.” As a result, we may need to seek additional revenue sources and additional financing in the near future to fund our daily operations. In connection with the Share Purchase Transaction, Shanda Interactive, through its affiliate, provided additional capital of RMB20.0 million ($3.2 million) to us
For the foregoing reasons, substantial doubt exists as to our ability to continue as a going concern. The audited consolidated financial statements included in this annual report on Form 20-F do not include any adjustments that might result from the outcome of these uncertainties. See
Cash Flows
The following table sets forth our cash flows with respect to operating activities, investing activities and financing activities for the periods indicated:
Operating Activities
Our net cash used in operating activities in Our net cash used in operating activities in 2013 was $11.5 million. This was primarily attributable to (i) our net loss of $34.4 million, (ii) a decrease in deferred taxes of $4.8 million, (iii)
Our net cash used in operating activities in 2012 was $8.1 million. This was primarily attributable to (i) our net loss of $9.5 million, (ii) a reversal of $2.3 million in bad debt provision due to collection of accounts receivable previously written down, (iii) an increase of $1.7 million in amounts due from related parties resulting from the delayed receipt of receivables (subsequently collected after December 31, 2012) related to advertising revenues from Old Shengyue, (iv) a decrease of $1.5 million in accounts payable due to more settlement of cash incentives to advertising agencies in 2012, which were adjusted by (i) non-cash expenses of $3.5 million in depreciation and amortization and $0.5 million in share-based compensation, and (ii) a decrease of $3.0 million in accounts receivable as a result of increased collection of advertising revenues from third parties in 2012.
Investing Activities
Our net cash provided by investing activities was $ Our net cash provided by investing activities was $3.4 million in 2013. This was primarily attributable to (i) the repayment by Shanda Games Limited of an interest-bearing loan of $3.3 million in 2013, and (ii) the proceeds of $0.2 million from disposal of property and equipment.
Our net cash provided by investing activities was $15.6 million in 2012. This was primarily attributable to
Financing Activities
Our net cash provided by financing activities was $6.2 million in 2014. This mainly consisted of $5.8 million of capital contributions received from Shanda Interactive. Our net cash used in financing activities was
Our net cash used in financing activities was $21.2 million in 2012. This consisted mainly of (i) the repayments to Shanda Games Limited of interest-bearing loans with an aggregate amount of $9.9 million, (ii) repurchase of ordinary shares with an aggregate amount of $8.2 million,
Restrictions on Cash Transfers to our Company
We are a holding company and our operations are principally conducted through our PRC subsidiaries and our consolidated affiliated entities. As a result, the ability of our company to pay dividends and to finance debts depends upon service fees paid by our consolidated affiliated entities to our PRC subsidiaries and dividends and other distributions paid by our PRC subsidiaries to our company. If any of our subsidiaries or consolidated affiliated entities incurs debt on its own behalf, the instruments governing the debt may restrict its ability to pay service fees or dividends directly or indirectly to our company.
In addition, under PRC laws and regulations, our PRC subsidiaries and our consolidated affiliated entities may pay dividends only out of their retained earnings as determined in accordance with PRC accounting standards and regulations. There is no significant difference between retained earnings as determined in accordance with PRC accounting standards and in accordance with U.S. GAAP. In addition, our PRC subsidiaries and our consolidated affiliated entities are required to set aside at least 10% of their after-tax net income each year, if any, to fund certain statutory reserves, which are not distributable as cash dividends, until the aggregate amount of such funds reaches 50% of their respective registered capital. As a result of these and other restrictions under PRC laws and regulations, our PRC subsidiaries and consolidated affiliated entities are restricted in their ability to transfer a portion of their net assets to our company either in the form of dividends, loans or advances, which restricted portion amounted to approximately $
Cash transfers from our PRC subsidiaries to our offshore subsidiary and our company are also subject to restrictions imposed by the PRC government’s currency conversion policy. See Item 3.D. “Risk Factors—Risks Related to Our Corporate Structure—Restrictions on currency exchange may limit our ability to utilize our revenues effectively.”
C.Research and Development, Patents and Licenses
See Item 4.B. “Business Overview—Technology and Infrastructure” and “—Intellectual Property.”
Our research and development expenditures were
D.Trend Information
Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events
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 that are indexed to our own shares and classified as shareholders’ equity, or that are not reflected in our 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 an 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 certain information with respect to our contractual obligations as of December 31,
We did not have any long-term debt obligations as of December 31,
Item 6.Directors, Senior Management and Employees
A.Directors and Senior Management
The names of our current directors and executive officers, their ages as of
(1) Member of the compensation and leadership development
(2) Member of the corporate development and finance
(3) Member of the audit
Biographical Information
Xudong Xu. Mr. Xu has served as chairman of our board of directors and chief executive officer since April
Robert Chiu. Mr. Chiu has served on our board of directors since June 2013. Mr. Chiu is the president of Shanda Interactive.
Haifa Zhu. Mr. Zhu has served on our board of directors since July 2009. Mr. Zhu also served as our Acting Chief Executive Officer from March 2011 to August 2011. Mr. Zhu has served at Shanda Interactive since 2004 in various positions, including as chief investment officer and senior vice president since April 2008. Prior to joining Shanda Interactive, Mr. Zhu was responsible for investments at Nuovo Assets Investment Ltd. from 2001 to 2004. Prior to joining Nuovo Assets Investment Ltd., Mr. Zhu worked in technology management for the Shanghai Academy of Science from 1996 to 2001. Mr. Zhu received a master’s degree in business administration and a bachelor’s degree from Fudan University.
Yong Gui. Mr. Gui has served on our board of directors since December 2014. He is a deputy dean, professor and Ph.D. supervisor at Fudan University’s Department of Sociology. He also serves in various managerial and academic roles including council member, deputy director of the “Economic Sociology Special Committee,” council member of “Social Network and Social Capital Special Committee” of China Sociological Association, vice general secretary of Shanghai Sociology Association, and deputy director of the Shanghai Association of Young Talent for Societal Construction. Mr. Gui has served as a director of Shanda Games since June 2013. Mr. Gui received his bachelor’s and master’s degree in sociology and a doctoral degree in economics from Fudan University. Songhua Zhang. Mr. Zhang has served on our board of directors since December 2014. He has served as a member of Investment Decision Committee in Shanghai Black Ji Horse Equity Investment Partnership since 2014, the chairman of the board of directors in Shanghai Midu Information Technology Co., Ltd since 2009 and the general manager in Shanghai Puxun Investment Management Co., Ltd since 2012. Mr. Zhang was chief executive officer of Index Asia Pacific Company from 2005 to 2012. From 1992 to 2005, Mr. Zhang was a private entrepreneur. He founded Shanghai Xindong Information Technology Co., Ltd in 2002 and has served as the chairman of the board of directors since 2002. Mr. Zhang co-founded Beijing Dongfang Wangjing Information Technology Co., Ltd in 1999. Prior to that, Mr. Zhang served in China Education Enterprise General Corporation from 1988 to 1992 and worked as a teacher in South China University of Technology from 1984 to 1988. Mr. Zhang graduated with a bachelor degree in ship design from South China University of Technology in 1984. Jiangtao Li. Mr. Li has served on our board of directors since April 2014. Mr.
Terms of Directors and Executive Officers
Each of our directors shall be re-elected annually by our shareholders at a general meeting and shall serve until his
Employment Agreements
We have entered into employment agreements with each of our executive officers. The initial term of these employment agreements is generally two to three years. Under these agreements, we may terminate the employment of an executive officer for cause at any time in case of certain acts by the executive officer. An executive officer may terminate the employment at any time upon thirty days prior written notice.
Each executive officer has agreed to hold, both during and subsequent to the term of the employment agreement, our confidential information in strict confidence and not to disclose such information to anyone except to our other employees who have a need to know such information in connection with our business or except as required in the performance of his or her duties in connection with the employment. In addition, each executive officer has agreed to be bound by non-competition restrictions during the term of the employment agreement.
B.Compensation
Compensation of Directors and Executive Officers
For the year ended December 31,
Summary of Stock Plans
2010 Equity Compensation Plan
Our board of directors adopted the 2010 Equity Compensation Plan, or the 2010 Plan, which became effective in December 2010. A total of 698,381,300 ordinary shares of our company are reserved for issuance under the 2010 Plan. A general description of the terms of the 2010 Plan is set forth below:
Plan Administration. Our board of directors or one or more committees appointed by our board acts as
Types of Awards. The principal features of the various awards that may be granted under the 2010 Plan are as follows:
· Options. Options provide for the right to purchase a specified number of our ordinary shares at a specified exercise price subject to vesting.
· Share Appreciation Rights. Share appreciation rights provide for the right to receive a payment, in cash or ordinary shares, equal to the excess of the fair market value of a specified number of our ordinary shares on the date the share appreciation right is exercised over the base price as set forth in the award document.
· Restricted Shares. Restricted shares are ordinary shares that are generally subject to restrictions on transfer and to vesting terms.
· Restricted Share Units. Restricted share units represent the right to receive a specified number of our ordinary shares, subject to vesting. Restricted share units will be settled upon vesting, subject to the terms of the award agreement, either by our delivery to the holder of the number of ordinary shares represented by the vested restricted share units or by a cash payment to the holder that equals the then fair market value of the underlying ordinary shares.
Award Document. Awards granted under the 2010 Plan are evidenced by an award document that sets forth the terms and conditions applicable to each of these awards, as determined by the administrator in its sole discretion.
Termination of the 2010 Plan. Without further action by our board of directors, the 2010 Plan will terminate in December 2020. Our board of directors may amend, suspend or terminate the 2010 Plan at any time, provided, however, that our board of directors must first seek the approval of the participants of the 2010 Plan if such amendment, suspension or termination would materially adversely affect the rights of participants with respect to any of their existing awards.
In December 2013, our board of directors approved certain modifications of the vesting conditions of certain outstanding options granted to senior management under the 2010 Plan to waive the performance condition under the relevant options with respect to a certain period from 2011 to
The table below sets forth the options that had been granted to our directors and executive officers pursuant to the 2010 Plan as of
* Upon exercise of all vested options, this person would beneficially own less than 1% of our outstanding ordinary shares as of
(1)
(2)
(3)
(4)
C.Board Practices
Our board of directors currently consists of seven members. Our board of directors includes three independent directors who satisfy the “independence” requirements of the NASDAQ Stock Market Rules and meet the criteria for “independence” under Rule 10A-3 under the Exchange Act. This home country practice of ours was established by our board of directors by reference to similarly situated issuers and differs from the NASDAQ Stock Market Rules that require the board to be comprised of a majority of independent directors.
There are, however, no specific requirements under Cayman Islands law that the board must be comprised of a majority of independent directors.
We do not have regularly scheduled meetings at which only independent directors are present, or executive sessions. This home country practice of ours was established by our board of directors by reference to similarly situated issuers and differs from the NASDAQ Stock Market Rules that require the company to have regularly scheduled executive sessions at which only independent directors are present. There are, however, no specific requirements under Cayman Islands law on executive sessions.
We have established three committees under our board of directors: an audit committee, a compensation and leadership development committee and a corporate development and finance committee. We have adopted a charter for each of the three committees. Each committee’s composition and functions are described below.
The members of the audit committees are
The members of the compensation and leadership development committee are Xudong Xu,
The members of the corporate development and finance committee are Xudong Xu, Robert Chiu and Haifa Zhu. The corporate development and finance committee is responsible for, among other things, reviewing and approving any proposed issues of debt including public and private debt, credit facilities with banks and others, and other credit arrangements such as capital and operating leases, and reviewing and approving any contract between us and our affiliates.
None of our directors have service contracts that provide for benefits upon termination of employment.
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 skills 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 amended from time to time. A shareholder has the right to seek damages if a duty owed by our directors is breached.
The functions and powers of our board of directors include, among others:
· convening shareholders’ annual general meetings and reporting its work to shareholders at such meetings;
· declaring dividends and distributions;
· appointing officers and determining the term of office of officers; and
· exercising the borrowing powers of our company and mortgaging the property of our company.
Interested Transactions
A director may vote in respect of any contract or transaction in which he or she is interested, provided that the nature of the interest of any directors in such contract or transaction is disclosed by him or her at or prior to its consideration and any vote in that matter.
D.Employees
As of December 31, In order to reduce operating cash outflows, we
E.Share Ownership
The following table sets forth certain information known to us with respect to the beneficial ownership of our ordinary shares as of
· all persons who are beneficial owners of five percent or more of our ordinary shares; and
· our executive officers and directors.
Percentage of beneficial ownership is based on
* Upon exercise of all vested options, this person would beneficially own less than 1% of our outstanding ordinary shares as of
(1) According to the Schedule 13D filed with the SEC on April 9, 2014, Mr. Xu, beneficially owned 1,938,360,784 of our ordinary shares as of April 3, 2014, including shares represented by our ADSs. We do not have further information with respect to any changes in Mr. Xu’s beneficial ownership of our shares subsequent to April 3, 2014. Mr. Xu’s business address is Building 5, No. 628 Hongqiao Road, Shanghai, P.R. China.
(2) According to the amendment to the Schedule 13D filed with the SEC on April 3, 2014, Shanda Media, a wholly owned subsidiary of Shanda Interactive, which is in turn wholly owned by Premium Lead Company Limited, beneficially owned 1,396,333,818 of our ordinary shares as of April 3, 2014, including shares represented by our ADSs. According to the Schedule 13D and its amendments filed with the SEC on or prior to April 3, 2014, Shanda Media, which was then wholly owned by Shanda Interactive, beneficially owned 70.5%, 70.5%, 66.4%, 55.9% and 66.4% of our ordinary shares as of April 1, 2014, December 31, 2012, July 7, 2011, April 20, 2011 and April 1, 2011, respectively. We do not have further information with respect to any changes in Shanda Interactive’s beneficial ownership of our shares subsequent to April 3, 2014.
As of March 31,
Our company’s major shareholders do not have different voting rights from each other or other shareholders of our company. To our knowledge, there are no arrangements the operation of which may at a subsequent date result in our undergoing a change in control.
Item 7. Major Shareholders and Related Party Transactions
A.Major Shareholders
Please refer to Item 6.E. “Directors, Senior Management and Employees—Share Ownership.”
B.Related Party Transactions
Contractual Arrangements with Respect to Our Consolidated Affiliated Entities
We conduct our operations in China principally through contractual arrangements among our PRC subsidiaries, our consolidated affiliated entities in China, and their respective shareholders. See Item 4.C. “Organizational Structure.” The principal terms of the agreements with respect to our consolidated affiliated entities are described as follows.
Loan Agreements: Each of our PRC subsidiaries entered into loan agreements with the shareholders of the relevant PRC consolidated affiliated entities (Ku6 Information Technology, Ku6 Cultural and Tianjin Ku6 Network), pursuant to which our PRC subsidiaries granted interest-free loans to these shareholders to fund their capital contributions to the consolidated affiliated entities. The total amount of these loans as of December 31,
Exclusive Business Cooperation Agreements: Tianjin WFOE, one of our PRC subsidiaries, entered into an exclusive business cooperation agreement with Tianjin Ku6 Zheng Yuan, one of our consolidated affiliated entities, pursuant to which Tianjin Ku6 Zheng Yuan agreed to appoint Tianjin WFOE as its exclusive providers of technical, consulting and other services for service fees equal to 100% of the net income of Tianjin Ku6 Zheng Yuan. Tianjin WFOE is entitled to exclusive and proprietary rights and interests in any intellectual properties arising out of or created during the performance of this agreement. This agreement has an initial term of 10 years expiring in March 2019, and will be renewable upon the request of Tianjin WFOE. Tianjin WFOE has the right to terminate the agreement at any time upon giving prior written notice, but neither Tianjin Ku6 Zheng Yuan or its shareholders may terminate the agreement prior to expiration.
Exclusive Consulting and Service Agreements or Exclusive Technology Consulting and Service Framework Agreement: Certain of our PRC subsidiaries (Beijing WFOE, Tianjin WFOE and Tianjin Ku6 Network WFOE) entered into exclusive consulting and service agreements with the relevant consolidated affiliated entities (Ku6 Information Technology, Ku6 Cultural and Tianjin Ku6 Network), pursuant to which these consolidated affiliated entities agreed to respectively engage our PRC subsidiaries as their exclusive provider of consulting and other services. The amount of service fees payable by these consolidated affiliated entities to our PRC subsidiaries shall be agreed upon by the parties based on the scope and complexity of the technologies involved, the content and duration of the services provided, and the prevailing market price for similar services. Our PRC subsidiaries will exclusively own any intellectual property arising from the performance of these agreements. Unless terminated earlier by our PRC subsidiaries, these agreements have an initial term of 20 years expiring in December 2031, and will be renewable upon the request of our PRC subsidiaries. Our consolidated affiliated entities may not terminate these agreements without cause unless they compensate our PRC subsidiaries for all losses caused by such early termination.
Business Operation Agreements: Certain of our PRC subsidiaries (Beijing WFOE, Tianjin WFOE and Tianjin Ku6 Network WFOE) entered into business operation agreements with the relevant consolidated affiliated entities (Ku6 Information Technology, Ku6 Cultural and Tianjin Ku6 Network) and their respective shareholders, which set forth the rights of these PRC subsidiaries to control the actions of these consolidated affiliated entities and their shareholders, including the rights to manage the daily operations of these consolidated affiliated entities and to appoint and remove the directors of these consolidated affiliated entities. In addition, the consolidated affiliated entities may not engage in any transactions that could materially affect their assets, liabilities, rights or operations without the prior consent of our PRC subsidiaries. These agreements have an initial term of 20 years expiring in December 2031, and will be renewable upon the request of our PRC subsidiaries. Our PRC subsidiaries have the right to terminate the agreements at any time upon giving prior written notice, but none of the consolidated affiliated entities or their shareholders may terminate the agreements prior to expiration.
Equity Pledge Agreements: Each of our PRC subsidiaries entered into equity pledge agreements with the shareholders of our consolidated affiliated entities (and, in some cases, together with our consolidated affiliated entities), pursuant to which these shareholders pledged their respective equity interests in our consolidated affiliated entities to our PRC subsidiaries as collateral to secure the obligations of these consolidated affiliated entities under the loan agreements, exclusive business cooperation agreements, exclusive consulting and service agreements, business operation agreements and equity disposition agreements, as applicable. The pledges shall remain effective until all obligations under the applicable agreements have been fully performed. During the term of the pledges, our consolidated affiliated entities are entitled to any dividends in respect of the equity interests pledged. The shareholders may not transfer their equity interests without the prior consent of our PRC subsidiaries. In case of any event of default, our PRC subsidiaries will be entitled to dispose of the equity interests pledged and use the proceeds to make any payments due under the applicable agreements.
Powers of Attorney: Each of the shareholders of our consolidated affiliated entities entered into a power of attorney to irrevocably authorize the relevant PRC subsidiary as his, her or its agent and attorney on all matters pertaining to the relevant consolidated affiliated entity and to exercise all of his, her or its rights as a shareholder of such consolidated affiliated entity, including the right to attend shareholders’ meetings, to exercise voting rights and to appoint directors and other senior management of such consolidated affiliated entity. The power of attorney is irrevocable and will continue to be effective, (i) in the case of the shareholder of Ku6 Information Technology or Ku6 Cultural, as long as such shareholder continues to be its shareholder; (ii) in the case of the shareholder of Tianjin Ku6 Zheng Yuan, until the equity interest purchase option as set forth in the exclusive option agreement has been fully exercised; and (iii) in the case of the shareholder of Tianjin Ku6 Network, for a term of 20 years, renewable upon the request of the relevant PRC subsidiary.
Exclusive Option Agreements or Equity Disposition Agreements: Each of our PRC subsidiaries entered into exclusive option agreements or equity disposition agreements with the relevant consolidated affiliated entities and their respective shareholders, pursuant to which our PRC subsidiaries or their designees are entitled to an exclusive right, exercisable at any time during the term of the agreements, to the extent permitted under PRC laws and regulations, to purchase from the shareholders of these consolidated affiliated entities all or any part of their equity interests in the consolidated affiliated entities. The purchase price shall equal to the amount of the registered capital of the consolidated affiliated entities (in respect of Tianjin Ku6 Zheng Yuan) or the lowest price permissible by the then-applicable PRC laws and regulations (in respect of Ku6 Information Technology, Ku6 Cultural and Tianjin Ku6 Network). Without the prior written consent of our PRC subsidiaries, none of the consolidated affiliated entities or their shareholders may take actions that could materially affect the assets, liabilities, operations or equity of the consolidated affiliated entities, including distribution of dividends, transfer or mortgage of assets, incurrence or guarantee of any indebtedness, or merger or consolidation, and none of the shareholders may dispose of or allow any security interest to be encumbered on their equity interests in the consolidated affiliated entities except as otherwise agreed upon with our PRC subsidiaries. The initial term of these agreements is 10 years (in respect of Tianjin Ku6 Zheng Yuan) or 20 years (in respect of Ku6 Information Technology, Ku6 Cultural and Tianjin Ku6 Network), with the earliest expiration date being March 21, 2019. These agreements will be renewable upon the request of our PRC subsidiaries.
Exclusive Intellectual Property Option Agreement: Beijing WFOE entered into an exclusive intellectual property option agreement with Ku6 Information Technology, pursuant to which Ku6 Information Technology irrevocably granted to Beijing WFOE or its designee an exclusive right, exercisable at any time during the term of this agreement, to purchase from Ku6 Information Technology, in accordance with the price agreed upon by the parties and to the extent permitted under PRC laws and regulations, certain intellectual property rights. Without Beijing WFOE’s prior consent, Ku6 Information Technology may not transfer any of these intellectual property rights to any third party. This agreement has an initial term of 10 years expiring in June 2018 and will be automatically renewed for another 10 years unless terminated by Beijing WFOE.
Cooperation Agreements with Qinhe
In
In We have generated revenues of $1.6 million from Qinhe for the year ended December 31, 2014.
Previous Advertising Agency Agreement with Old
In April 2011, we entered into an advertising agency agreement with Old Shengyue, an affiliate then wholly owned by Shanda Interactive, pursuant to which Old Shengyue agreed to act as our exclusive advertising agency. The initial term of our advertising agency agreement with Old Shengyue expired on December 31, 2012. In January 2013, we amended and restated this agreement and extended its term to December 31, 2013. In January 2014, we further extended its term to March 31, 2014. For the years ended December 31,
In March 2012, our company provided a $0.5 million unsecured loan to Shanda Capital Limited, a company controlled by Shanda Interactive, which carries an interest rate of 3% per year and was due on March 25, 2013. The term of this loan was subsequently extended to March 25, 2014. This loan was fully repaid in March 2014.
Funding from Shanda Interactive In connection with the Share Purchase Transaction, Shanda Interactive, through its affiliate, extended a loan of RMB20.0 million to us In May 2014, Shanda Interactive, through its affiliates, extended a loan of RMB21.4 million to us. This loan did not bear any interest and was due within twelve months. However, Shanda Interactive has waived our obligation to repay this loan. In connection with this loan, certain existing related party payables to companies controlled by Shanda Interactive, amounting to RMB5.3 million, were waived by us, and we received a net amount of RMB16.1 million in cash from Shanda Interactive in May 2014. We have treated this transaction as a capital contribution. Funding from In February 2015, we entered into a loan agreement with Mr. Xu, pursuant to which Mr. Xu agreed to provide a loan of RMB30.0 million to us within 20 business days from the date thereof. The term of the loan is one year, and the loan bears interest at a rate of 6.5% per annum. We received RMB30.0 million from Mr. Xu in March 2015.
A.Consolidated Financial Statements and Other Financial Information
See Item 18. “Financial Statements” for our audited consolidated financial statements filed as part of this annual report on Form 20-F.
Legal Proceedings
From time to time, we have been involved in litigation relating to copyright infringement and other matters in the ordinary course of our business. We had an accrued litigation provision balance of $
Our video content library may contain content in which others may claim to own copyrights or image rights or which others may claim to be defamatory or objectionable. Adverse results in legal proceedings against us may include awards of damages and may also result in, or even compel, a change in our business practices, which could impact our future financial results. Regardless of the outcome, however, any litigation can result in substantial costs and diversion of management resources and attention.
Although we have implemented and strengthened standard procedures to delete video content, especially our UGC, that allegedly infringes on intellectual property rights of third parties, we have limited control over the nature or types of the content posted by our users. The infringement of intellectual property rights by our users may result in litigation against us and harm our business and reputation. See Item 3.D. “Risk Factors—Risks Related to Our Business—We have been and expect to continue to be exposed to intellectual property infringement and other claims, including claims based on content posted on our website.”
Dividend Policy
We have never declared or paid any dividends on our ordinary shares. We do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain future earnings, if any, to finance operations and for the expansion of our business. Payments of dividends by our PRC subsidiaries to our company are subject to restrictions including primarily the restriction that foreign invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents. There are no such similar foreign exchange restrictions in the Cayman Islands.
B.Significant Changes
from Mr. Xu. See Item 7.B. “Related Party Transactions—
Not applicable except for Item 9.A.4. and Item 9.C.
American Depositary Shares, or ADSs, each representing 100 of our ordinary shares, have been listed on the NASDAQ Global Market since February 4, 2005. Our ADSs were traded under the symbol “HRAY” until August 16, 2010. On August 17, 2010, we changed our name to “Ku6 Media Co., Ltd.” and changed our trading symbol on the NASDAQ Global Market from “HRAY” to “KUTV.”
The following table provides the high and low prices for our ADSs on the NASDAQ Global Market for (1) the five most recent full financial years, (2) each full financial quarter in the two most recent full financial years and the subsequent period, and (3) each of the most recent six months.
Item 10. Additional Information
A.Share Capital
Not applicable.
B.Memorandum and Articles of Association
The following are summaries of material terms and provisions of our current memorandum and articles of association, as well as certain provisions of the Cayman Companies Law insofar as they relate to the material terms of our ordinary shares. This summary is not complete and some of the terms in our memorandum and articles of association are subject to other rights, restrictions and obligations set out therein, and you should read in full our memorandum and articles of association, which was included as Exhibit 3.1 to our registration statement on Form F-1 (File No. 333-121987) filed with the SEC on January 12, 2005, as amended by (i) the amendment passed by our shareholders by way of a special resolution on October 16, 2009, which was included as Exhibit 1.2 to our annual report on Form 20-F for the year ended December 31, 2009 (File No.
General
We are a Cayman Islands company and our affairs are governed by our memorandum and articles of association, the Cayman Companies Law and 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 that 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, the Cayman Islands has a less developed body of securities law as compared to the United States, and provides significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in the federal courts of the United States.
The holders of ADSs will not be treated as our shareholders and will be required to surrender their ADSs for cancellation and withdrawal from the depositary facility in which the ordinary shares are held in order to exercise shareholders’ rights in respect of the ordinary shares. The depositary will agree, so far as it is practical, to vote or cause to be voted the amount of ordinary shares represented by ADSs in accordance with the non-discretionary written instructions of the holder of such ADSs.
Directors
Interested Transactions. A director may vote in respect of any contract or transaction in which he or she is interested, provided, however, that the nature of the interest of any director in any such contract or transaction shall be disclosed by him or her at or prior to its consideration and any vote on that matter. A general notice or disclosure to the directors or otherwise contained in the minutes of a meeting, or a written resolution of the directors or any committee thereof, that a director is a shareholder of any specified firm or company and is to be regarded as interested in any transaction with such firm or company shall be sufficient disclosure, and after such general notice, it shall not be necessary to give special notice relating to any particular transaction.
Remuneration and
Qualifications. There are no membership qualifications for directors. Further, there are no share ownership qualifications for directors unless so fixed by us in a general meeting.
Rights, Preferences and Restrictions of our Ordinary Shares
General. All of our issued and outstanding ordinary shares are fully paid and non-assessable. Certificates representing our ordinary shares are issued in registered form. Our shareholders who are non-residents of the Cayman Islands may freely hold and vote their shares.
Dividends. The holders of our ordinary shares are entitled to such dividends as may be declared by our board of directors.
Voting Rights. On a poll (if demanded), each ordinary share is entitled to one vote on all matters upon which our ordinary shares are entitled to vote, including the election of directors. Voting at any meeting of shareholders is by show of hands unless a poll is demanded. A poll may be demanded by our Chairman or any other shareholder present in person or by proxy. A quorum required for a meeting of shareholders consists of shareholders who hold at least one-third of our issued and outstanding shares entitled to vote at the meeting, present in person or by proxy, except treasury shares which shall not be voted, directly or indirectly, at any meeting of the company.
Any ordinary resolution to be made by the shareholders requires the affirmative vote of a simple majority of the votes attaching to our ordinary shares cast in a general meeting, while a special resolution requires the affirmative vote of not less than two-thirds of the votes cast attaching to our ordinary shares. A special resolution is required for matters such as a change of name. Holders of our ordinary shares may, by ordinary resolution, among other things, elect directors, appoint auditors, and increase our authorized share capital.
Liquidation. Without prejudice to the rights of holders of our shares issued upon special terms and conditions, if in a winding up, the assets available for distribution among our shareholders are insufficient to repay all of the paid-up capital, such assets will be distributed so that, as nearly as may be, the losses are borne by our shareholders in proportion to the capital paid up, or which ought to have been paid up, at the commencement of the winding up on the shares held by them respectively. If in a winding up, the assets available for distribution among our shareholders
Calls on our Ordinary Shares and Forfeiture of our Ordinary Shares. Our board of directors may from time to time make calls upon shareholders in respect of any moneys unpaid on their ordinary shares in a notice served to such shareholders at least 14 days prior to the specified time and place of payment. Our ordinary shares that have been called upon and remain unpaid may be subject to forfeiture.
Redemption and Repurchase of our Ordinary Shares. The Cayman Companies Law provides that a company limited by shares may, if so authorized by its articles of association, issue shares which are to be redeemed or are liable to be redeemed at the option of the company or a shareholder. In addition, such a company may, if authorized to do so by its articles of association, purchase its own shares, including any redeemable shares. At no time may a company redeem or purchase its shares unless they are fully paid. A company may not redeem or purchase any of its shares if, as a result of the redemption or purchase, there would no longer be any member of the company holding shares other than shares held as treasury shares. Under our memorandum of association, we may issue shares that are, or at our option or at the option of the holders are, subject to redemption on such terms and in such manner as we may, before the issue of the shares, determine by special resolution. We may also purchase our own shares, including any redeemable shares, provided that the manner of purchase has been authorized in a general meeting.
A Cayman Islands company may redeem or purchase its own shares out of profits, out of its share premium account, out of the proceeds of a fresh issue of shares made for the purposes of the redemption or purchase or, provided the company will remain solvent, out of capital. A payment out of capital by a company for the redemption or purchase of its own shares is not lawful unless, immediately following the date on which the payment is proposed to be made, the company shall be able to pay its debts as they fall due in the ordinary course of business. If and to the extent that a premium is to be paid on the redemption or purchase of a company’s shares, the premium must have been provided for out of either or both of the profits of the company or out of the company’s share premium account before or at the time the shares are redeemed or purchased, or, subject to the same solvency test, out of capital.
Shares that have been purchased or redeemed by a Cayman Islands company or surrendered to the company pursuant to the Cayman Companies Law shall not be treated as cancelled but shall be classified as treasury shares if (i) the memorandum and articles of association of the company do not prohibit it from holding treasury shares, (ii) the relevant provisions of the memorandum and articles of association (if any) are complied with, and (iii) the company is authorized in accordance with the its articles of association or by a resolution of the directors to hold such shares in the name of the company as treasury shares prior to the purchase, redemption or surrender of such shares. Shares held by a company as treasury shares shall continue to be classified as such until such shares are either cancelled or transferred pursuant to the Cayman Companies Law. The company shall not be treated as a member for any purpose and shall not exercise any right in respect of the treasury shares, and any purported exercise of such a right shall be void. A treasury share shall not be voted, directly or indirectly, at any meeting of the company and shall not be counted as issued shares at any given time, whether for the purposes of the company’s articles of association or the Cayman Companies Law. No dividend may be declared or paid, and no other distribution (whether in cash or otherwise) of the company’s assets (including any distribution of assets to members on a winding up) may be made to the company, in respect of a treasury share.
Shares with Preferred Rights
Our memorandum and articles of association provide for the authorization of issuance of shares with preferred rights. Subject to any direction that may be given by us in general meetings, and without prejudice to any special rights previously conferred on the holders of existing shares, our directors may allot, issue, grant options over or otherwise dispose of shares of our company, with or without preferred rights or restrictions, whether in regard to dividend, voting, return of capital or otherwise and to such persons, at such times and on such other terms as they think proper. We have no immediate plans to issue any shares with preferred rights. The issuance of any of our shares with preferred rights could provide needed flexibility in connection with possible acquisitions and other corporate purposes. However, the issuance could also make it more difficult for a third party to acquire a majority of our outstanding voting shares or discourage an attempt to gain control of us. In addition, the board of directors, without shareholder approval, can issue shares with preferred rights with voting and conversion rights which could adversely affect the voting power and other rights of the holders of ordinary shares. These shares with preferred rights may be used for a variety of corporate purposes including future public offerings, to raise additional capital or to facilitate acquisitions. The listing maintenance requirements of the NASDAQ Global Market, which apply so long as our ADSs are quoted on that market, require shareholder approval of certain issuances of our securities equal to or exceeding 20% of the then outstanding voting power of all our securities or the then outstanding number of our ordinary shares.
Variations of Rights of Shares
All or any of the special rights attached to any class of shares
General Meetings of Shareholders
The directors may, whenever they think fit, and shall, on the requisition of our shareholders holding at the date of the deposit of the requisition not less than one-tenth of our paid-up capital, which as at the date of the deposit carries the right of voting at our general meetings, proceed to convene a general meeting of our company. If the directors do not, within 21 days from the date of the deposit of the requisition, duly proceed to convene a general meeting, the requisitionists, or any of them representing more than one-half of the total voting rights of all of them, may themselves convene a general meeting, but any meeting so convened shall not be held after the expiration of three months after the expiration of such 21 days.
At least five days’ notice shall be given of an annual general meeting or other general meeting. Every notice shall be exclusive of the day on which it is given, or deemed to be given, and of the day for which it is given.
Limitations on the Right to Own Shares
There are no limitations on the right to own our shares, provided that we are prohibited from making any invitation to the public in the Cayman Islands to subscribe for any of our securities.
Limitations on Transfer of Shares
There are no provisions in our memorandum or articles of association that would have an effect of delaying, deferring or preventing a change in control and that would operate only with respect to a merger, acquisition or corporate restructuring.
Disclosure of Shareholder Ownership
There are no provisions in our memorandum or articles of association governing the ownership threshold above which shareholder ownership must be disclosed.
Changes in Capital
We may, from time to time and by ordinary resolution, increase the share capital by such sum, to be divided into shares of such amount, as the resolution shall prescribe. The new shares shall be subject to the same provisions with reference to the payment of calls, lien, transfer, transmission, forfeiture and otherwise as the shares in the original share capital. We may by ordinary resolution:
(a) consolidate and divide all or any of our share capital into shares of larger amount than our existing shares;
(b) subdivide our existing shares, or any of them, into shares of smaller amount than is fixed by our memorandum of association, subject nevertheless to the provisions of Section 13 of the Cayman Companies Law; or
(c) cancel any shares which, at the date of the passing of the resolution, have not been taken or agreed to be taken by any person.
We may, by special resolution, reduce our share capital and any capital redemption reserve fund, in any manner authorized by the Cayman Companies Law.
Differences in Corporate Law
The company law of the Cayman Islands is historically derived, for the most part, from the laws of England, and comprises the provisions of the Cayman Companies Law, many of which are drawn from pre-1948 Companies Acts of the United Kingdom. Other provisions are original Cayman Islands provisions, some of which relate to a certain class of companies, which are commonly used for the conduct of international business from the Cayman Islands. These provisions create the concept of the “exempted” company, which is a special corporate vehicle, the business and operation of which are required to be conducted mainly outside the Cayman Islands. Decisions of the superior courts of England constitute persuasive authority in the Cayman Islands courts. The Cayman Companies Law differs from laws applicable to United States corporations and their shareholders. Set forth below is a summary of the significant differences between the provisions of the Companies Law applicable to us and the laws applicable to companies incorporated in the United States and their shareholders.
Scheme of Arrangements, Compulsory Acquisition and Merger and Consolidation.
Schemes of arrangement are governed by specific statutory provisions under the Cayman Companies Law, whereby such arrangements may be approved by a majority in number representing 75% in value of members or
Where an offer is made by a company for the shares of another company incorporated under the laws of the Cayman Islands and, within four months of the offer, the holders of not less than 90% of the shares which are the subject of the offer accept, the
Two or more companies limited by shares and incorporated under the Cayman Companies Law, may, subject to any express provisions to the contrary in the memorandum and articles of association of any of such companies as well as certain requirements under the Cayman Companies Law, merge or consolidate. One or more companies incorporated under the Cayman Companies Law may also merge or consolidate with one or more overseas companies, subject to certain requirements. The directors of each constituent company that proposes to participate in a merger or consolidation are required, on behalf of the constituent company of which they are directors, to approve a written plan of merger or consolidation. A plan of merger or consolidation shall give particulars of matters as set forth in the Cayman Companies Law, and be authorized by each constituent company by way of: (a) a special resolution of the members of each such constituent company; and (b) such other authorization, if any, as may be specified in such constituent company’s articles of association. The consent of each holder of a fixed or floating security interest of a constituent company in a proposed merger or consolidation will be required, or as determined by the Grand Court of the Cayman Islands. A dissenting member is required to give to the constituent company written objection before the vote on the merger or consolidation, and is entitled to payment of the fair value of his or her shares as determined in accordance with the procedures set forth under the Cayman Companies Law. Such objection shall include a statement that the member proposes to demand payment for his or her shares if the merger or consolidation is authorized by the vote.
Indemnification. Cayman Islands law does not (other than as set forth hereafter) limit the extent to which a company’s organizational documents may provide for indemnification of officers and directors, except to the extent any such provision may be held by the Cayman Islands courts to be contrary to public policy, such as to provide indemnification against civil fraud or the consequences of committing a crime. Our articles of association provide for indemnification of officers and directors for losses, damages, costs and expenses incurred in their capacities as such, except through their own willful neglect or default.
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,” and Item 7.B., “Related Party Transactions,” or elsewhere in this annual report on Form 20-F.
D.Exchange Controls
Foreign currency exchange regulation in China is primarily governed by the following rules:
· Notice on Issues Relating to the Administration of Foreign Exchange in Fundraising and Return Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies;
· Foreign Currency Administration Rules (2008), as amended, or the Exchange Rules;
· Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), or the Administration Rules; and
· the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of the Payment and Settlement of Foreign Currency Capital of Foreign Invested Enterprises, or Circular 142.
Under the Exchange Rules, the Renminbi is convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions. Conversion of Renminbi for capital account items, such as direct investment, loan, security investment and repatriation of investment, however, is subject to the approval of or registration with SAFE.
Under the Administration Rules, foreign-invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents and, in the case of capital account item transactions, obtaining approval from SAFE. Capital investments by foreign-invested enterprises outside of China are also subject to limitations, which include approvals by MOFCOM, SAFE and the National Development and Reform Commission of the PRC.
On August 29, 2008, SAFE promulgated Circular 142, regulating the conversion by a foreign-invested enterprise of foreign
In November 2012, SAFE promulgated the Circular of Further Improving and Adjusting Foreign Exchange Administration Policies on Foreign Direct Investment which substantially amends and simplifies the current foreign exchange procedure. Pursuant to this circular, the opening of various special purpose foreign exchange accounts (e.g. pre-establishment expenses account, foreign exchange capital account, guarantee account), the reinvestment of lawful incomes derived by foreign investors in the PRC (e.g. profit, proceeds of equity transfer, capital reduction, liquidation and early repatriation of investment), and purchase and remittance of foreign exchange as a result of capital reduction, liquidation, early repatriation or share transfer in a foreign-invested enterprise no longer require SAFE approval and multiple capital accounts for the same entity may be opened in different provinces, which was not allowed before November 2012.
In May 2013, SAFE promulgated the Circular on Printing and Distributing the Provisions on Foreign Exchange Administration over Domestic Direct Investment by Foreign Investors and the Supporting Documents, which specifies that the administration by SAFE or its local branches over direct investment by foreign investors in the PRC shall be conducted by way of registration and banks shall process foreign exchange business relating to the direct investment in the PRC based on the registration information provided by SAFE and its branches.
On July 4, 2014, SAFE promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Offshore Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, which replaced the former circular commonly known as “SAFE Circular 75” promulgated by SAFE on October 21, 2005. SAFE Circular 37 requires PRC residents to register with local branches of SAFE in connection with their direct establishment or indirect control of an offshore entity, for the purpose of overseas investment and financing, with such PRC residents’ legally owned assets or equity interests in domestic enterprises or offshore assets or interests, referred to in SAFE Circular 37 as a “special purpose vehicle.” SAFE Circular 37 further requires amendment to the registration in the event of any significant changes with respect to the special purpose vehicle, such as increases or decreases of capital contributed by PRC individuals, share transfer or exchange, merger, division or other material event. In the event that a PRC shareholder holding interests in a special purpose vehicle fails to fulfill the required SAFE registration, the PRC subsidiaries of that special purpose vehicle may be prohibited from making profit distributions to the offshore parent and from carrying out subsequent cross-border foreign exchange activities, and the special purpose vehicle may be restricted in its ability to contribute additional capital into its PRC subsidiary. Furthermore, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for evasion of foreign exchange controls. Under the Administration Measures on Individual Foreign Exchange Control issued by the PBOC on December 25, 2006, all foreign exchange matters involved in employee share ownership plans and share option plans in which PRC citizens participate require approval from SAFE or its authorized branch. Pursuant to SAFE Circular 37, PRC residents who participate in share incentive plans in overseas non-publicly-listed companies may submit applications to SAFE or its local branches for the foreign exchange registration with respect to offshore special purpose companies. In addition, under the Notices on Issues concerning the Foreign Exchange Administration for Domestic Individuals Participating in Share Incentive Plans of Overseas Publicly-Listed Companies, or the Share Option Rules, issued by SAFE on February 15, 2012, PRC residents who are granted shares or share options by companies listed on overseas stock exchanges under share incentive plans are required to (i) register with SAFE or its local branches, (ii) retain a qualified PRC agent, which may be a PRC subsidiary of the overseas listed company or another qualified institution selected by the PRC subsidiary, to conduct the SAFE registration and other procedures with respect to the share incentive plans on behalf of the participants, and (iii) retain an overseas institution to handle matters in connection with their exercise of share options, purchase and sale of shares or interests and funds transfers. We will make efforts to comply with these requirements upon completion of our initial public offering. E.Taxation
The following summary of the material Cayman Islands, PRC and U.S. federal income tax consequences relevant to the purchase, ownership or sale of our ordinary shares or ADSs is based upon laws and relevant interpretations thereof as of the date of this annual report on Form 20-F, which are subject to change. The summary does not purport to be a comprehensive description of all of the tax considerations that may be relevant to any particular investor depending on its individual circumstances. Accordingly, holders of ordinary shares or ADSs should consult their own tax advisors regarding the application of the considerations discussed below to their particular situations and the consequences of the purchase, ownership or sale of our ordinary shares or ADSs, including those arising under U.S. federal estate or gift tax laws, foreign, state, or local laws, and tax treaties.
Cayman Islands Taxation and Exchange Control
Pursuant to Section 6 of the Tax Concessions Law (1999 Revision) of the Cayman Islands (as amended by the Tax Concessions Law (2011 Revision) of the Cayman Islands), our company has obtained an undertaking from the Governor-in-Council:
(i) that no law which is enacted in the Cayman Islands imposing any tax to be levied on profits, income, gains or appreciations shall apply to our company or its operations; and
(ii) in addition, that no tax to be levied on profits, income, gains or appreciations or which is in the nature of an estate duty or inheritance tax shall be payable by our company:
(a) on or in respect of the shares, debentures or other obligations of our company; or
(b) by way of withholding, in whole or in part, of any relevant payment as defined in Section 6(3) of the Tax Concessions Law (1999 Revision).
The undertaking for our company is for a period of twenty years starting from May 7, 2002.
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 an estate duty or inheritance tax. There are no other taxes likely to be material to us levied by the Government of the Cayman Islands except for stamp duties, which may be applicable on instruments. There are no exchange control regulations or currency restrictions in the Cayman Islands.
PRC Taxation
In January 2008, the prevailing EIT Law became effective. In December 2007, the State Council promulgated the Implementation Rules of the EIT Law and the Notice on Implementation of Enterprise Income Tax Transition Preferential Policy under the EIT Law, both of which also became effective in January 2008. The EIT Law provides that legal entities organized outside China will be considered PRC residents for Chinese income tax purposes if their place of effective management or control is within China. The implementation rules to the EIT Law provide that non-resident legal entities will be considered PRC residents if substantial and overall management and control over the manufacturing and business operations, personnel, accounting, properties, etc., reside within China and will be subject to the enterprise income tax on its global income at the rate of 25%. Under current PRC laws and regulations, it is uncertain whether our company and our offshore intermediate holding company would be deemed as PRC resident enterprises under the EIT Law. If our company was treated as a PRC resident enterprise, dividends paid by our company to holders of our ordinary shares or ADSs that are non-resident enterprises and gains realized by these holders on the disposition of our ordinary shares or ADSs would generally be subject to a 10% PRC withholding tax, unless a reduced tax rate is provided by any applicable tax treaty and the holders have completed the relevant procedures prescribed by the PRC tax authorities to prove their beneficial owner status.
Under the PRC Individual Income Tax Law, or the IITL, if we are treated as a PRC resident enterprise, non-resident individual investors would be subject to PRC individual income tax on dividends paid to such investors and any capital gains realized from the transfer of our ordinary shares and ADSs, provided that such dividends and gains are deemed as China-sourced income. A non-resident individual is an individual who has no domicile in China and does not stay within China or has stayed within China for less than one year. Pursuant to the IITL and its implementation rules, for purposes of the PRC capital gains tax, the taxable income will be based on the total income obtained from the transfer of our ordinary shares or ADSs after deducting all the costs and expenses that are permitted under PRC tax laws to be deducted from the income. If we were considered a PRC resident enterprise and dividends paid with respect to our ordinary shares and ADSs and the gains realized from the transfer of our ordinary shares and ADSs were considered China-sourced income by relevant PRC tax authorities, such dividends and gains earned by
U.S. Federal Income Taxation
The following is a summary of the material U.S. federal income tax consequences of the ownership and disposition of ordinary shares or ADSs by a U.S. Holder. The following summary is not exhaustive of all possible tax considerations. This summary is based upon the Internal Revenue Code of 1986, as amended (the “Code”), regulations promulgated under the Code by the U.S. Treasury Department (including proposed and temporary regulations), rulings, current administrative interpretations and official pronouncements of the Internal Revenue Service (the “IRS”), judicial decisions and the double taxation treaty between the PRC and the United States (the “Treaty”), all as of the date hereof and all of which are subject to differing interpretations or to change, possibly with retroactive effect. Such change could materially and adversely affect the tax consequences described below. No assurance can be given that the IRS will not assert, or that a court will not sustain, a position contrary to any of the tax consequences described below.
This summary does not address state, local, or foreign tax consequences of the ownership and disposition of ordinary shares or ADSs. The United States does not have an income tax treaty with the Cayman Islands.
This summary is for general information only and does not address all aspects of U.S. federal income taxation that may be important to a particular holder in light of its investment or tax circumstances, including the potential application of the provisions of the Code known as the Medicare contribution tax, or to holders subject to special tax rules, such as: certain financial institutions; insurance companies; dealers in stocks, securities, or currencies; traders in securities that elect to use a mark-to-market method of accounting for their securities holdings; entities classified as partnerships for U.S. federal income tax purposes; tax-exempt organizations; real estate investment trusts; regulated investment companies; qualified retirement plans, individual retirement accounts, Roth IRAs and other tax-deferred accounts; expatriates of the United States; persons subject to the alternative minimum tax; persons holding ordinary shares or ADSs as part of a straddle, hedge, conversion transaction or other integrated transaction; persons who enter into a constructive sale with respect to ordinary shares or ADSs; persons who acquired ordinary shares or ADSs pursuant to the exercise of any employee stock option or otherwise as compensation for services; persons actually or constructively holding 10% or more of our voting stock; U.S. persons whose functional currency for U.S. federal income tax purposes is not the U.S. dollar; and persons holding ordinary shares or ADSs in connection with a trade or business conducted outside of the United States.
This summary is not a comprehensive description of all of the U.S. federal tax consequences that may be relevant with respect to the ownership and disposition of ordinary shares or ADSs. We urge you to consult your own tax advisor regarding your particular circumstances and the U.S. federal income and estate tax consequences to you of owning and disposing of ordinary shares or ADSs, as well as any tax consequences arising under the laws of any state, local, foreign or other tax jurisdiction and the possible effects of changes in U.S. federal or other tax laws.
This summary is directed solely to U.S. Holders who hold their ordinary shares or ADSs as capital assets for U.S. federal income tax purposes, which generally means as property held for investment. For purposes of this summary, the term “U.S. Holder” means a beneficial owner of ordinary shares or ADSs that is, for U.S. federal income tax purposes:
· a citizen or individual resident of the United States;
· a corporation, or other entity taxable as a corporation, created or organized in or under the laws of the United States, any state therein or the District of Columbia; or
· an estate or trust, the income of which is subject to U.S. federal income taxation regardless of its source.
If a partnership (including for this purpose any entity treated as a partnership for U.S. federal income tax purposes) is a beneficial owner of ordinary shares or ADSs, the U.S. federal income tax consequences to a partner in the partnership will generally depend on the status of the partner and the activities of the partnership. A holder of ordinary shares or ADSs that is a partnership, and the partners in such partnership, should consult their own tax advisors regarding the U.S. federal income tax consequences of the ownership and disposition of ordinary shares or ADSs.
This summary is based in part upon the representations of the depositary and the assumption that each obligation in the deposit agreement and any related agreement will be performed in accordance with its terms.
Generally, a U.S. Holder who owns ADSs will be treated as the owner of the underlying ordinary shares represented by those ADSs for U.S. federal income tax purposes. Accordingly, no gain or loss will be recognized if the U.S. Holder exchanges ADSs for the underlying ordinary shares represented by those ADSs. The U.S. Holder’s adjusted tax basis in the ordinary shares will be the same as the adjusted tax basis of the ADSs surrendered in exchange
The U.S. Treasury has expressed concern that parties to whom American depositary shares are released before shares are delivered to the depositary (“pre-release”), or intermediaries in the chain of ownership between holders and the issuer of the security underlying the American depositary shares, may be taking actions that are inconsistent with the claiming of foreign tax credits by holders of the American depositary shares. Accordingly, the creditability of any PRC taxes described below could be affected by actions taken by such parties or intermediaries.
Taxation of U.S. Holders
Passive Foreign Investment Company
Although we believe that we were not a PFIC for taxable
We generally will be a PFIC if, for a taxable year, either (a) 75% or more of our gross income for such taxable year is passive income under the income test or (b) 50% or more of the average quarterly value, generally determined by fair market value, of our assets during such taxable year consists of assets that either produce passive income or are held for the production of passive income under the asset test. “Passive income” includes, for example, dividends, interest, certain rents and royalties, certain gains from the sale of stock and securities and certain gains from commodities transactions.
Certain “look through” rules apply for purposes of the income and asset tests described above. If we own, directly or indirectly, 25% or more of the total value of the outstanding shares of another corporation, we generally will be treated as if we (a) held directly a proportionate share of the other corporation’s assets, and (b) received directly a proportionate share of the other corporation’s income.
In addition, we may, directly or indirectly, hold equity interests in subsidiaries or other entities which are PFICs (“Lower-tier PFICs”). Under attribution rules, if we are a PFIC, U.S. Holders will be deemed to own their proportionate shares of Lower-tier PFICs and will be subject to U.S. federal income tax according to the rules described below on (i) certain distributions by a Lower-tier PFIC and (ii) a disposition of shares of a Lower-tier PFIC, in each case, as if the U.S. Holder held such shares directly, even though holders have not received the proceeds of those distributions or dispositions directly.
If we are a PFIC for any taxable year during which a U.S. Holder holds ordinary shares or ADSs, we will generally continue to be treated as a PFIC with respect to those ordinary shares or ADSs for all succeeding years during which such U.S. Holder holds them, regardless of whether we actually continue to be a PFIC. Because we believe that we were a PFIC for taxable years 2006, 2007, 2008 and 2009, if you held ordinary shares or ADSs during any of those taxable years (or during the 2011 taxable year if we were a PFIC for that year), we would continue to be treated as a PFIC with respect to those ordinary shares or ADSs for all succeeding years during which you hold them. Similarly, if you first acquired ordinary shares or ADSs in
If we are treated as a PFIC with respect to the ordinary shares or ADSs that you hold, the U.S. federal income tax consequences to you of the ownership and disposition of ordinary shares or ADSs will depend on whether you make a mark-to-market election. If you owned or own ordinary shares or ADSs while we were or are a PFIC and have not made a mark-to-market election, you will be referred to in this summary as a “Non-Electing U.S. Holder.”
If you are a Non-Electing U.S. Holder, you will be subject to the default PFIC rules with respect to:
· any “excess distribution” paid on ordinary shares or ADSs (or by a Lower-tier PFIC to its shareholders that is deemed to be received by a U.S. Holder), which means the excess (if any) of the total distributions received (or deemed received) by you during the current taxable year over 125% of the average distributions received (or deemed received) by you during the three preceding taxable years (or during the portion of your holding period for the ordinary shares or ADSs prior to the current taxable year, if shorter); and
· any gain realized on the sale or other disposition (including a pledge) of ordinary shares or ADSs (or on an indirect disposition of shares of a Lower-tier PFIC).
Under these default tax rules:
· any excess distribution or gain will be allocated ratably over your holding period for the ordinary shares or ADSs;
· the amount allocated to the taxable year of receipt of proceeds from the excess distribution or disposition and any period prior to the first day of the first taxable year in which we were a PFIC will be treated as ordinary income in the taxable year to which it is allocated;
· the amount allocated to each other taxable year will be treated as ordinary income and taxed at the highest tax rate for individuals or corporations, as applicable, in effect for that year; and
· the resulting tax liability from any such other taxable years will be subject to the interest charge applicable to underpayments of tax.
If the ordinary shares or ADSs are “regularly traded” on a “qualified exchange,” a U.S. Holder of ordinary shares or ADSs may make a mark-to-market election that would result in tax treatment different from the default PFIC rules described above. The ordinary shares or ADSs will be treated as “regularly traded” in any calendar year in which more than a de minimis quantity of the ordinary shares or ADSs are traded on a qualified exchange on at least 15 days during each calendar quarter. NASDAQ, on which the ADSs are listed, is a qualified exchange for this purpose. U.S. Holders should consult their tax advisors regarding the availability and advisability of making a mark-to-market election in their particular circumstances. In particular, U.S. Holders should consider carefully the impact of a mark-to-market election with respect to their ordinary shares or ADSs, given that the election may not be available with respect to any Lower-tier PFICs.
If a U.S. Holder makes the mark-to-market election, the holder generally will recognize as ordinary income any excess of the fair market value of the ordinary shares or ADSs at the end of each taxable year over their adjusted tax basis, and will recognize an ordinary loss in respect of any excess of the adjusted tax basis of the ordinary shares or ADSs over their fair market value at the end of the taxable year (but only to the extent of the net amount of income previously included as a result of the mark-to-market election). If a U.S. Holder makes the election, the holder’s tax basis in the ordinary shares or ADSs will be adjusted to reflect the income or loss amounts recognized. Any gain recognized on the sale or other disposition of ordinary shares or ADSs in a year when we are a PFIC will be treated as ordinary income and any loss will be treated as an ordinary loss (but only to the extent of the net amount of income previously included as a result of the mark-to-market election). Distributions paid on ordinary shares or ADSs will be treated as discussed below under “Distributions on Ordinary Shares or ADSs.”
We do not intend to provide information necessary for U.S. Holders to make a qualified electing fund election, which, if available, could result in a materially different tax treatment of the ownership and disposition of ordinary shares or ADSs to an electing U.S. Holder.
Furthermore, if we were a PFIC or, with respect to a particular U.S. Holder, were treated as a PFIC for the taxable year in which we paid a dividend or the prior year, the reduced tax rates applicable to dividends paid to certain non-corporate U.S. Holders, as discussed below, would not apply.
If we were a PFIC for any taxable year during which a U.S. Holder held ordinary shares or ADSs, such U.S. Holder
Because the PFIC rules are complex, you should consult your own tax advisor regarding them and how they may affect the U.S. federal income tax consequences of the ownership and disposition of ordinary shares or ADSs.
Distributions on Ordinary Shares or ADSs
Subject to the discussion in “Passive Foreign Investment Company” above, if you actually or constructively receive a distribution on ordinary shares or ADSs (other than certain pro rata distributions of ordinary shares), you must include the distribution in gross income as a taxable dividend on the date of your (or in the case of ADSs, the depositary’s) receipt of the distribution, but only to the extent of our current or accumulated earnings and profits, as calculated under U.S. federal income tax principles. Such amount must be included without reduction for any foreign tax withheld. Dividends paid by us will not be eligible for the dividends received deduction allowed to corporations with respect to dividends received from certain domestic
To the extent a distribution exceeds our current and accumulated earnings and profits, it will be treated first as a non-taxable return of capital to the extent of your adjusted tax basis in the ordinary shares or ADSs, and thereafter as capital gain.
The amount of any dividend paid in Renminbi or any other foreign currency will be the U.S. dollar amount calculated by reference to the exchange rate in effect on the date of your (or in the case of ADSs, the depositary’s) receipt, regardless of whether the payment is in fact converted into U.S. dollars. If the dividend is converted into U.S. dollars on the date of receipt, a U.S. Holder should not be required to recognize foreign currency gain or loss in respect of the dividend income. A U.S. Holder may have foreign currency gain or loss if the dividend is converted into U.S. dollars after the date of receipt.
As discussed above in “PRC Taxation,” dividends paid with respect to our ordinary shares or ADSs may be subject to PRC withholding tax, and the amount of a dividend will include any amounts withheld in respect of PRC taxes. The amount of the dividend will be treated as foreign-source dividend income to U.S. Holders. Subject to applicable limitations, some of which vary depending upon a U.S. Holder’s circumstances and subject to the discussion above regarding concerns expressed by the U.S. Treasury, PRC income taxes withheld from dividends on ordinary shares or ADSs at a rate not exceeding the rate provided by the Treaty will be creditable against the U.S. Holder’s U.S. federal income tax liability. PRC taxes withheld in excess of the rate applicable under the Treaty will not be eligible for credit against a U.S. Holder’s federal income tax liability. The rules governing foreign tax credits are complex, and U.S. Holders should consult their tax advisors regarding the creditability of foreign taxes in their particular circumstances.
Dispositions of Ordinary Shares or ADSs
Subject to the discussion in “Passive Foreign Investment Company” above, you generally will realize taxable gain or loss on the sale or other disposition of ordinary shares or ADSs equal to the difference between the U.S. dollar value of (i) the amount realized on the disposition (i.e., the amount of cash plus the fair market value of any property received), and (ii) your adjusted tax basis in the ordinary shares or ADSs disposed of. Such gain or loss will be capital gain or loss.
If you have held the ordinary shares or ADSs for more than one year at the time of disposition, such capital gain or loss will be long-term capital gain or loss. Preferential tax rates for long-term capital gain will apply to non-corporate U.S. Holders. If you have held the ordinary shares or ADSs for one year or less, such capital gain or loss will be short-term capital gain or loss, taxable as ordinary income at your marginal income tax rate. The deductibility of capital losses is subject to limitations.
As discussed above in “PRC Taxation,” gains realized on the disposition of our ordinary shares or ADSs could be subject to PRC tax. Any gain or loss recognized by a U.S. Holder on a disposition of our ordinary shares or ADSs will generally be treated as U.S.-source income or loss for foreign tax credit limitation purposes. A U.S. Holder that is eligible for the benefits of the Treaty may be able to elect to treat disposition gain that is subject to PRC taxation as foreign-source gain and claim a credit in respect of the tax. The rules governing foreign tax credits are complex, and U.S. Holders should consult their tax advisors regarding the creditability of foreign taxes in their particular circumstances.
You should consult your own tax advisor regarding the U.S. federal income tax consequences if you receive currency other than U.S. dollars upon the disposition of ordinary shares or ADSs.
Information Reporting and Backup Withholding
Generally, information reporting requirements will apply to distributions on ordinary shares or ADSs or proceeds from the disposition of ordinary shares or ADSs paid within the United States (and, in certain cases, outside the United States) to a U.S. Holder unless such U.S. Holder is an exempt recipient. Furthermore, backup withholding may apply to such amounts unless such U.S. Holder (i) is an exempt recipient that, if required, establishes its right to an exemption, or (ii) provides its taxpayer identification number, certifies that it is not currently subject to backup withholding, and complies with other applicable requirements. A U.S. Holder may generally avoid backup withholding by furnishing a properly completed IRS Form W-9.
Backup withholding is not an additional tax. Amounts withheld under the backup withholding rules may be credited against your U.S. federal income tax liability. Furthermore, you may obtain a refund of any excess amounts withheld by filing an appropriate claim for refund with the IRS and furnishing any required information in a timely manner.
Certain U.S. Holders who are individuals may be required to report information relating to their ownership of an interest in certain foreign financial assets, including stock of a non-U.S. person, subject to certain exceptions (including an exception for stock held in custodial accounts maintained by a U.S. financial institution). Certain U.S. Holders who are entities may be subject to similar rules in the future. U.S. Holders should consult their tax advisors regarding their reporting obligations with respect to the ordinary shares or ADSs.
F.Dividends and Paying Agents
Not applicable.
G.Statement by Experts
Not applicable.
H.Documents on Display
We have filed this annual report, including exhibits, with the SEC. As allowed by the SEC, in Item 19 of this annual report, we incorporate by reference certain information we filed with the SEC. This means that we can disclose important information to you by referring you to another document filed separately with the SEC. The information incorporated by reference is considered to be part of this annual report.
We are subject to periodic reporting and other informational requirements of the Exchange Act as applicable to foreign private issuers. Accordingly, we will be required to file reports, including annual reports on Form 20-F, and other information with the SEC. As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of quarterly reports and proxy statements, and officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act. Our annual reports and other information so filed can be inspected and copied at the public reference facility 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 facility. Our SEC filings will also be available to the public on the SEC’s Internet Web site at http://www.sec.gov.
Our financial statements have been prepared in accordance with US GAAP.
We will make available to our shareholders annual reports, which will include a review of operations and annual audited consolidated financial statements prepared in conformity with US GAAP.
I.Subsidiary Information
Not applicable.
Item 11. Quantitative and Qualitative Disclosures
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to the interest income generated by our cash deposits in banks. We have not used derivative financial instruments in our investment portfolio. Interest-earning instruments and floating rate debt carry a degree of interest rate risk. We have not been exposed, nor do we anticipate being exposed, to material risks due to changes in interest rates. Our future interest income may fluctuate in line with changes in interest rates. However, the risk associated with fluctuating interest rates is principally confined to our cash deposits in banks, and, therefore, our exposure to interest rate risk is minimal and immaterial.
Foreign Exchange Risk
While our reporting currency is the U.S. dollar, to date, virtually all of our revenues and costs are denominated in Renminbi and substantially all of our assets
If the Renminbi had been 1% and 5% less valuable against the U.S. dollar than the actual rate as of December 31,
Inflation
Since our inception, inflation in China has not materially impacted our results of operations. According to the National Bureau of Statistics of China, the consumer price index in China increased by
Item 12. Description of Securities
D.American Depositary Shares
Citibank, N.A. is the depositary of our ADSs. The depositary’s office is located at 111 Wall Street, New York, NY 10043, U.S.A. Each of our ADSs, evidenced by American depositary receipts, or ADRs, represents 100 ordinary shares, par value $0.00005 per share.
ADR Fees Payable by Investors
The Depositary collects its fees for delivery and surrender of ADSs directly from investors depositing ordinary 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 deductions from cash distributions or by directly billing of investors or by charging the book-entry system accounts of participants acting for them. The depositary may generally refuse to provide fee-attracting services until its fees for those services are paid.
Payments Received
The depositary has agreed to reimburse us for certain expenses we incur that are related to establishment and maintenance of the ADS program, including custody costs, investor relations expenses and related expenses. There are limits on the amount of expenses for which the depositary will reimburse us, but the amount of reimbursement available to us is not necessarily tied to the amounts of fees the depositary collects from investors. In
Item 13. Defaults, Dividend Arrearages and Delinquencies
Not Applicable.
Item 14.Material Modifications to the Rights of Security Holders and Use of Proceeds
Not Applicable.
Item 15.Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this annual report on Form 20-F, our Chief Executive Officer and Acting Chief Financial Officer have performed an evaluation of the effectiveness of our disclosure controls and procedures as defined and required under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended. Based upon this evaluation, our Chief Executive Officer and Acting Chief Financial Officer concluded our company’s disclosure controls and procedures were effective.
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with U.S. GAAP. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that receipts and expenditures are made only in accordance with authorizations of management; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an assessment of the effectiveness of our internal control over financial reporting based upon criteria established by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO, in Internal Control—Integrated Framework (
Changes in Internal Control over Financial Reporting
During the year ended December 31,
Item 16A. Audit Committee Financial Expert
Our board of directors has determined that Mr.
We have adopted a Code of Business Conduct which applies to our employees, officers and non-employee directors, including our Chief Executive Officer and Chief Financial Officer, and persons performing similar functions. This code is intended to qualify as a “code of ethics” within the meaning of the applicable rules of the SEC.
The Code of Business Conduct is available on our investor relations website at http://www.mzcan.com/us/KUTV/irwebsite. To the extent required by law, any amendments to, or waivers from, any provision of the Code of Business Conduct will be promptly disclosed to the public. Copies of the Code of Business Conduct will be provided to any shareholder upon written request to: Legal Counsel, Building 6, Zhengtongchuangyi Centre, No. 18, Xibahe Xili, Chaoyang District, Beijing 100028, People’s Republic of China.
Item 16C. Principal Accountant Fees and Services
Disclosure of Fees Charged by Independent Accountants
The following table summarizes the fees charged by PricewaterhouseCoopers Zhong Tian LLP , our independent accountants, for certain services rendered to our company during
(1) “Audit fees” means the aggregate fees incurred in each of the fiscal years listed for our calendar year audits and reviews of financial statements.
Audit Committee Pre-approval Policies and Procedures
Our audit committee has adopted procedures which set forth the manner in which the committee will review and approve all audit and non-audit services to be provided by PricewaterhouseCoopers Zhong Tian LLP before it is retained for such services. The pre-approval procedures are as follows:
· Any audit or non-audit service to be provided to us by the independent accountant must be submitted to the audit committee for review and approval, with a description of the services to be performed and the fees to be charged.
· The audit committee in its sole discretion then approves or disapproves the proposed services and documents such approval, if given, through written resolutions or in the minutes of meetings, as the case may be.
Item 16D.Exemptions from the Listing Standards for Audit Committees
We have not been granted an exemption from the applicable listing standards for the audit committee of our board of directors.
Item 16E.Purchases of Equity Securities by the Issuer and Affiliated Purchasers
In December 2011, we approved a share repurchase program to purchase up to an aggregate of $3.2 million of our outstanding ADSs from time to time based on market conditions. The repurchases may be effected through open market transactions or block trades, including the use of derivative instruments, and will be financed with our cash balance. Item 16F.Changes in Registrant’s Certifying Accountant Not applicable.
Pursuant to the NASDAQ Stock Market Rules, foreign private issuers such as our company may follow home-country practice in lieu of certain NASDAQ corporate governance requirements. We have notified NASDAQ that a majority of our directors do not qualify as independent directors, we do not have a nominations committee, nor is independent director involvement required in the selection of director nominees or in the determination of executive compensation. Issuances of securities in connection with equity-based compensation of officers, directors, employees or consultants will be permitted without obtaining prior shareholder approval and we will post our annual reports to shareholders in lieu of mailing physical copies to record holders and beneficial owners of our ADSs and ordinary shares. This home-country practice of ours differs from Rules 5605(b), (d) and (e), 5635(c) and 5615(a)(3) of the NASDAQ Stock Market Rules, because there are no specific requirements under Cayman Islands law on director independence or on the establishment of a nominations committee, and neither are there any requirements on independent directors’ involvement in the selection of director nominees nor in the determination of executive compensation.
Item 16H.Mine Safety Disclosure
Not applicable.
Not applicable.
The consolidated financial statements for Ku6 Media Co., Ltd. and its subsidiaries are included at the end of this annual report on Form 20-F.
* Filed or furnished herewith
†
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
Date: April
KU6 MEDIA CO., LTD.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations and comprehensive loss, of changes in equity (deficit) and of cash flows present fairly, in all material respects, the financial position of Ku6 Media Co., Ltd. (the “Company”) and its subsidiaries at December 31,
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Notes 1 and 2 to the financial statements, facts and circumstances including recurring losses, negative working capital, net cash outflows, and uncertainties associated with significant changes made, or planned to be made, in respect of the Company’s business model raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Notes 1 and 2. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ PricewaterhouseCoopers Zhong Tian LLP
PricewaterhouseCoopers Zhong Tian LLP Shanghai, the People’s Republic of China
KU6 MEDIA CO., LTD.
The accompanying notes are an integral part of these consolidated financial statements.
KU6 MEDIA CO., LTD. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
The accompanying notes are an integral part of these financial statements.
KU6 MEDIA CO., LTD. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
The accompanying notes are an integral part of these financial statements.
KU6 MEDIA CO., LTD. CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (DEFICIT) (in U.S. dollars, except share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
KU6 MEDIA CO., LTD. CONSOLIDATED STATEMENTS OF CASH FLOWS (in U.S. dollars)
KU6 MEDIA CO., LTD. CONSOLIDATED STATEMENTS OF CASH FLOWS (in U.S. dollars)
The accompanying notes are an integral part of these consolidated financial *Refer to Note 2(31).
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, (all amounts in U.S. dollars (US$) unless otherwise stated)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES
Ku6 Media Co., Ltd. (the “Company”),
Organization
As of December 31,
On March 31, 2014, Shanda Media, the affiliate of Shanda directly owning Shanda’s share of the Company’s equity, entered into an agreement with Mr. Xudong Xu (“Mr. Xu”) to transfer approximately 41% of the Company’s total outstanding ordinary shares, or 1,938,360,784 shares, to Mr. Xu in exchange for a contemporaneously dated promissory note with a maturity of three years pursuant to which Mr. Xu committed to repay, in cash, the purchase value of the shares approximating $47 million (based upon an average of share prices immediately preceding the share transfer) to Shanda Media (the “Share Purchase Transaction”). The promissory note which was used by Mr. Xu to finance the purchase of the shares was accompanied by a share pledge in favor of Shanda Media. Additionally, Mr. Xu has granted powers of attorney and voting proxy to Shanda Media, which may
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, (all amounts in U.S. dollars (US$) unless otherwise stated)
In connection with the Share Purchase Transaction, Shanda, through its affiliate, extended a loan of $3.2 million (RMB20.0 million) to the Group on April 3, 2014. This loan was interest-free and originally due on April 2, 2015. Shanda waived the Group’s obligation to repay this loan in order to satisfy one of the closing conditions under the share purchase agreement On May 19, 2014, Shanda, through its affiliate, entered into an agreement to provide a loan of $3.4 million (RMB21.4 million) to the In connection with the Share Purchase Transaction, Mr. Xu committed to procure additional equity or debt financing of no less than $10.0 million by October 30, 2014. In light of improvements in operating cash flows in the fourth quarter of 2014, the Group opted to borrow RMB30.0 million ($4.8 million) instead from Mr. Xu. Therefore, on February 2, 2015, the Group entered into a loan agreement with Mr. Xu, pursuant to which Mr. Xu agreed to provide a loan of RMB30.0 million to the Group. The term of the loan is one year, with principal repayable at the maturity date of February 2, 2016. The loan bears interest at a rate of 6.5% per annum, which is payable at maturity. The Group received RMB30.0 million on March 4, 2015.
The Share Purchase Transaction was undertaken in the context of adopting fundamental changes to the Group’s business (a) Advertising Agency Agreement with Shengyue
· On April 30, 2014, the Group entered into a new advertising agency agreement with Shengyue, which ·On August 14, 2014, the Group sent a written notice to New Shengyue terminating the new advertising agency agreement. According to the notice of termination, the advertising agency agreement was KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) (b) Advertising Agency Agreement with Third Party Huzhong ·On August 29, 2014, the Group entered into an advertising agency agreement with Huzhong Advertising (Shanghai) Ltd. (“Huzhong”), an unrelated third party, pursuant to which Huzhong has agreed to act as the Group’s exclusive advertising agent for standard media resources and as a non-exclusive advertising agent for highly interactive advertising resources. According to the agreement, the Group has agreed to guarantee a certain amount of web traffic per day. In return, Huzhong guarantees to the Group a minimum amount of advertising revenues per day. The minimum guarantee amount under this agreement is higher than that under the agency agreement with New Shengyue terminated on August 28, 2014. If the Group fails to meet the web traffic (c) Revenue Sharing Cooperation with Related Party Qinhe
· On April 30, 2014, the Group entered into an agreement with related party Shanghai Qinhe Internet Technology Software Development Co., Ltd., (“Qinhe”), a company controlled by Mr. Xu, which operates iSpeak, a social platform that allows users to engage in real-time online group activities through voice, text and video. This agreement stipulates that the
· On May 4, 2014, the Group entered into a separate agreement with Qinhe to provide interactive entertainment marketing services under a similar arrangement to that described above. Pursuant to this agreement, the Group will share a certain percentage of Qinhe’s revenues generated from its video viewers who visit the iSpeak platform by linking thereto from advertisements on the Group’s website and spend monies with iSpeak. On May 4, 2014, the Group started to provide these marketing services to Qinhe. ·On September 15, 2014, the Group signed a supplemental agreement
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(1)Basis of presentation; liquidity and going concern
The accompanying consolidated financial statements of the Group have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). The preparation of consolidated financial statements in conformity with US GAAP requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities at the dates of the financial statements. Significant accounting estimates reflected in the Company’s financial statements include
share-based compensation expense,
The
The Group expects to derive its
Note 1 contains further descriptions of recent equity contributions from Shanda Interactive and a 2015 borrowing arranged with Mr. Xudong Xu. While these additional financing measures have assisted in alleviating pressure on the Group’s working capital and liquid
(2)Consolidation
The consolidated financial statements include the financial statements of the Company, its subsidiaries, and VIEs. All inter-company transactions and balances have been eliminated upon consolidation. Affiliated companies in which the Company has partial ownership and controls more than 20% but less than 50% of the investment are accounted for using the equity method of accounting. The Company’s share of earnings (losses) of such equity investments KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated)
The Company follows the guidance relating to the consolidation of VIEs in ASC 810-10, which requires certain VIEs to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.
To comply with PRC laws and regulations that prohibit or restrict foreign ownership of companies that provide advertising services and hold Internet Content Provider (“ICP”) licenses and/or Licenses for Transmission of Audio-Visual Programs through the Internet (“the Licenses”), the Group conducts substantially all of its advertising business through its VIEs. The paid-in capital balances of VIEs Ku6 Beijing Information and Ku6 Network were funded by the Company through loans extended to the authorized individuals (“nominee shareholders”); Tianjin Information was incorporated by Ku6 Beijing Information.
The Company has various agreements with its VIEs, through which the Company holds all the variable interests of the VIEs and has the power to direct the activities of the VIEs. Consequently the Company is the primary beneficiary of these VIEs. Details of certain key agreements with the VIEs are as follows:
Loan Agreements: Beijing Technology, Kusheng and Tianjin Technology (the “Subsidiaries”) have granted interest-free loans to the nominee shareholders with the sole purpose of providing funds necessary for the equity
capital of Ku6 Beijing Information, Ku6 Network and Ku6
Proxy Agreements: The nominee shareholders of the VIEs irrevocably appointed the Subsidiaries’ officers to vote on their behalf on all matters they are entitled to vote on, including matters relating to the transfer of any or all of their respective equity interests in the VIEs, making all the operational, financial decisions and the appointment of the directors, general managers and other senior management of the VIEs.
Equity Interest Pledge Agreements: The nominee shareholders of the VIEs have pledged their respective equity interests in the VIEs as collateral to secure the nominee shareholders’ obligations under other agreements and for the payment by the VIEs under the exclusive technical consulting and services agreements and the loan agreements. The Pledge Agreements have been registered with the applicable local branches of the State Administration for Industry and Commerce. The nominee shareholders of the VIEs cannot sell or pledge their equity interests to others without the approval from the Subsidiaries, and the nominee shareholders of the VIEs cannot receive any dividends without the approval of the Subsidiaries.
Exclusive Call Option Agreements: The nominee shareholders of the VIEs granted the Subsidiaries the exclusive and irrevocable right to purchase from the nominee shareholders, to the extent permitted under PRC laws and regulations or at the request of the Company, all of the equity interests in these entities for a purchase price equal to the amount of the registered capital or at the lowest price permitted by PRC laws and regulations. The Subsidiaries may exercise such options at any time. In addition, the VIEs and their nominee shareholders agreed that without the Subsidiaries’ prior written consent, they will not transfer or otherwise dispose of the equity interests or declare any dividends.
Exclusive Business Cooperation Agreements: The Subsidiaries are the exclusive provider of technical, consulting and related services and information to the VIEs. Under these arrangements, the Subsidiaries have the unilateral right to charge service fees to the VIEs to recover substantially all of the VIEs’ profits.
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) As a result of the above contractual agreements, the Company determined that it has the power to control the economic activities most significant to the VIEs and is the primary recipient of the economic rewards or risks, as the case may be. As such, the Company consolidates the VIEs as required by ASC 810-10.
As of December 31,
These balances are reflected in the Group’s consolidated financial statements with intercompany transactions eliminated. Under the contractual arrangements with the VIEs, the Company has the power to direct activities of the VIEs, and can have assets freely transferred out of the VIEs. Therefore, the Company considers that there is no asset in any of its consolidated VIEs that can be used only to settle obligations of the VIEs, except for registered capital
and PRC additional paid-in capital of the VIEs in the amount of
As all the VIE subsidiaries are incorporated as limited liability companies under PRC Company Law, creditors thereof do not have recourse to the general credit of the Group for any of the liabilities of the VIE subsidiaries. As of December 31, 2013
As of December 31,
For the years ended December 31,
Currently there is no contractual arrangement that requires the Company to provide additional financial support to the VIEs. However, as the Company is conducting the online advertising business substantially through the VIEs, the Company has, in the past, provided and will continue to provide financial support to the VIEs considering the business requirements of the VIEs and the Company’s own business objectives in the future, which could expose the Company to a loss. For the year ended December 31,
Please refer to “Contingencies” under Note 19 for the risks relating to the VIE arrangements.
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) (3)Significant risks and uncertainties
The Group participates in a dynamic high technology industry and believes that, in addition to the factors resulting our conclusions with respect to going concern, changes in any of the following areas could have a material adverse effect on the Group’s future financial position, results of operations or cash flows: i) changes in the overall demand for services and products; ii) changes in business offerings; iii) competitive pressures due to new entrants; iv) advances and new trends in new technologies and industry standards; v) changes in bandwidth suppliers; vi)
(4)Fair value
The Group follows ASC Topic 820, “Fair Value Measurements and Disclosures”. This guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The guidance outlines a valuation framework and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. Under US GAAP, certain assets and liabilities must be measured at fair value, and the guidance details the disclosures that are required for items measured at fair value.
Financial assets and liabilities are to be measured and disclosed using inputs from the following three levels of the fair value hierarchy. The three levels are as follows:
Level 1 inputs are unadjusted quoted prices in active markets for identical assets that the management has the ability to access at the measurement date.
Level 2 inputs include quoted prices for similar assets in active markets, quoted prices for identical or similar assets in markets that are not active, inputs other than quoted prices that are observable for the asset (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).
Level 3 includes unobservable inputs that reflect management’s judgments about the assumptions that market participants would use in pricing the assets or liabilities. Management develops these inputs based on the best information available, including their own data.
(5) Business combinations and non-controlling interests
The Group accounts for its business combinations using the purchase method of accounting. This method requires that the acquisition cost be allocated to the assets, including separately identifiable intangible assets, and liabilities the Company acquired based on their estimated fair values.
The Group follows ASC 805, “Business Combinations,” with respect to business combinations. Pursuant thereto, the cost of an acquisition is measured as the aggregate of the fair values at the date of exchange of the assets given, liabilities incurred, and equity instruments issued as well as the contingent
The Group follows guidance in ASC Topic 810 regarding non-controlling interests. Non-controlling interests are classified as a separate component within KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated)
(6) Foreign currency translation
The functional currency and reporting currency of the parent company is the United States dollar (“U.S. dollar”). The Group’s Subsidiaries and VIEs use Renminbi (“RMB”) as their functional currency.
Assets and liabilities of the Subsidiaries and VIEs are translated at the current exchange rates quoted by the Federal Reserve Bank of New York in effect at the balance sheet dates, equity accounts are translated at historical exchange rates, and revenues and expenses are translated at the average exchange rates in effect during the reporting period to the U.S. dollar. Translation adjustments resulting from foreign currency translation to reporting currency are reported as cumulative translation adjustments and recorded in accumulated other comprehensive income (loss) in the consolidated statements of changes in equity for the years presented.
Transactions denominated in currencies other than the Company’s or its Subsidiaries’ or VIEs’ functional currencies are remeasured into the functional currencies at the exchange rates quoted by the People’s Bank of China prevailing at the dates of the transactions. Gains and losses resulting from foreign currency transactions are included in the consolidated statements of operations and comprehensive loss. Monetary assets and liabilities denominated in foreign currencies are remeasured into the applicable functional currencies using the applicable exchange rates quoted by the People’s Bank of China at the balance sheet dates. All such exchange gains and losses are included in the statements of operations and comprehensive loss.
Pursuant to the People’s Republic of China State Administration of Foreign Exchange (“SAFE”), the conversion of U.S. dollars to RMB is governed as to amount and a uniform exchange rate is set by the People’s Bank of China on a daily basis pegged to a basket of major currencies. Correspondingly, RMB to U.S. dollar conversion does not carry the same ease as conversion may with other major currencies. The rates of exchange for the U.S. dollar quoted by the Federal Reserve Bank of New York were RMB
(7) Cash and cash equivalents
Cash and cash equivalents consist of cash on hand, demand deposits and highly liquid investments placed with bank or other financial institutions with no restriction to withdrawal or use, which have original maturities of three months or less.
Included in cash and cash equivalents are cash balances denominated in RMB of approximately
(8) Allowances for doubtful accounts
The Group determines allowances for doubtful accounts when facts and circumstances indicate that receivables are unlikely to be collected by taking into account an aging analysis of receivable balances, historical bad debt records, repayment patterns in the prior year, and other factors such as the policies of operators and financial conditions of customers. The Group’s accounts receivable are almost fully provided for by an allowance, and cash inflows related to accounts receivable principally consist of collections on fully reserved receivables. In KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in
(9) Investments in affiliates
Affiliated companies
The Group continually reviews its investments in affiliated companies to determine whether a decline in fair value below the carrying value is other than temporary. The primary factors the Group considers in its determination are the length of time that the fair value of the investment is below the Group’s carrying value and the financial condition, operating performance and near term prospects of the investee. In addition, the Group considers the reason for the decline in fair value, including general market conditions, industry specific or investee specific reasons, changes in valuation subsequent to the balance sheet date, and the Group’s intent and ability to hold the investment for a period of time sufficient to allow for a recovery in fair value. If the decline in fair value is deemed to be other than temporary, the carrying value of the investment is written down to fair value. There were no impairments of such investments for the years ended December 31,
(10) Property and equipment, net
Property and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated on a straight-line basis over the following estimated useful lives:
Expenditures for maintenance and repairs are expensed as incurred. Gain or loss on the disposal of property and equipment is the difference between the net sales proceeds and the carrying amount of the relevant assets and is recognized in the consolidated statements of operations.
(11) Acquired intangible assets, net
An intangible asset is required to be recognized separately from goodwill based on its estimated fair value if such asset arises from contractual or legal right or if it is separable as defined by ASC 805. Acquired intangible assets
The estimated useful economic lives by major intangible asset category used by the Company
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) (12) Video production and acquisition costs
The Company contracts third parties for the production of and self produces and self-generates video copyrights for content to exhibit on its
Following the guidance under ASC 926-20-25, video production (which mainly includes direct production costs and production overhead) and acquisition costs are capitalized, if the capitalization criteria are met, and are stated at the lower of unamortized cost or estimated fair value.
With respect to production and acquisition costs, until the Group can establish estimates of secondary market revenues, capitalized costs for each video produced are limited to the amount of revenues contracted for that video. The costs in excess of revenues contracted for that video are expensed as incurred on an actual basis, and are not restored as assets in subsequent periods. Once the Group can establish estimates of secondary market revenues in accordance with ASC 926-20-35-5(b), it capitalizes subsequent film costs.
Capitalized video production costs are amortized in accordance with the guidance in ASC 926-20-35-1 using the individual-film-forecast-computation method, based on the proportion of the revenues earned in a period to the estimated remaining unrecognized ultimate revenues as of the beginning of that period. The Group estimates total revenues to be earned (“ultimate revenues”) throughout the life of a video. Ultimate revenue estimates for the produced or acquired videos are periodically reviewed and adjustments, if any, will result in changes to amortization rates. Estimates used in calculating the fair value of the self produced content are based upon assumptions about future demand and market conditions. The capitalized costs are subject to assessment for impairment in accordance with ASC 926-20-35-12 to 35-18, if an event or change in circumstances indicates that the fair value is less than unamortized cost.
During each of the three years ended December 31,
(13) Goodwill
Goodwill represents the excess of the purchase price over the fair value of the identifiable assets acquired and liabilities assumed as a result of the Group’s acquisitions. The Group’s goodwill
The Group tests goodwill for impairment by performing a two-step goodwill impairment test, which can be preceded by an optional qualitative assessment to determine if the two-step goodwill impairment test needs to be followed. The optional qualitative assessment relies upon qualitative factors to determine if it is “more likely than not” (more than 50% probable) that the fair value of a reporting unit is less than the carrying value of the reporting unit. The Group did not apply the qualitative assessment and proceeded directly to the two-step test. The first step compares the calculated fair value of a reporting unit to its carrying amount, including goodwill. If, and only if, the carrying amount of a reporting unit exceeds its fair value as per step one, the second step is executed to compare the implied fair value of the affected reporting unit’s goodwill to the carrying value of that goodwill. The implied fair value of goodwill is determined in a manner similar to accounting for a business combination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. This allocation process is only performed for purposes of evaluating goodwill impairment and does not result in an entry to adjust the value of any assets or liabilities. An impairment loss is recognized for any excess in the carrying value of goodwill over the implied fair value of goodwill.
Based upon application of the two step impairment evaluation approach at the Group’s annual evaluation dates, no impairment losses were recorded in the KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated)
(14) Impairment of long-lived assets
The Group reviews its long-lived assets including property, plant and equipment and finite-lived intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may no longer be recoverable. When these events occur, the Group measures impairment by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flows is less than the carrying amount of the assets, the Group would recognize an impairment loss based on the fair value of the assets. The Group uses estimates and judgments in its impairment tests and if different estimates or judgments are utilized, the timing or the amount of the impairment charges could be different. No impairment was recognized in the year ended December 31, 2012. In
Group’s future projected results of operations, the Group recognized a full impairment loss of $21.0 million for its acquired intangible assets. No impairment was provided on fixed assets as the carrying value of fixed assets was less than fair value.There was no impairment loss recorded in the year ended December 31, 2014.
(15)Financial instruments
Financial instruments include cash and cash equivalents, accounts receivable, prepayments and other current assets, amounts due from/to related parties, accounts payable, and accrued expenses and other current liabilities. As of December 31, 20
(16)Revenue recognition and cost of revenues
In accordance with ASC Topic 605, “Revenue Recognition,” the The Group makes credit assessments of customers to assess the collectability of contract amounts prior to entering into contracts. For those contracts for which the collectability is assessed as not reasonably assured, the Group recognizes revenue only when cash is received and all revenue recognition criteria are met.
Online advertising services
The
Advertising contracts are signed to establish the price and advertising services to be provided. Advertisements are charged either based on the agreed measurement numbers, including but not limited to impressions and clicks, or fixed during a determined period of time. In the former case, the delivery of service occurs when those measurement numbers are achieved. In the latter case, the delivery is not linked to advertisement displays but occurs over the lapse of time.
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) In the case of Shengyue, guaranteed minimum advertising revenues were not subject to downward adjustment under the old agreement which expired in early 2014 (Note 1). Under a new agreement with Shengyue consummated in April 2014 but terminated in August 2014 (Note 1), guaranteed minimum advertising revenues were proportionally adjusted downward if there was a shortfall relative to web traffic or video view targets. For the Shengyue arrangements, excess advertising revenues were calculated after deducting commission fees earned by Shengyue based upon increasing percentages for additional tiers (layers) of
The Group reports the revenue earned from both related and third party ad agencies based on the net amount after considering the indicators to record revenue gross versus set forth in ASC 605-45, “Principal Agent Considerations.”
For revenue arrangements contracted with third-party advertising agencies (excluding the fixed arrangement with Huzhong), the Group provides cash incentives in the form of rebates based on volume and performance, and accounts for such incentives as a reduction of revenue in accordance with ASC 605-50-25. The cash incentives to third-party advertising agencies in the years ended December 31,
Promotional advertising services The Group derives a portion of its revenue from related party Qinhe in exchange for interactive media and entertainment promotional advertising services provided by the Group to Qinhe. The Group provides online game marketing services to Qinhe; in exchange, Qinhe shares a portion of its profits that are generated from the Group’s video viewers who play Qinhe’s games after linking to them through advertisements on the Group’s websites. Profits are calculated as revenues from the games operated by Qinhe, net of licensing fees payable to game developers. The Group also provides interactive entertainment marketing services to Qinhe; in exchange, Qinhe shares a certain percentage of Qinhe’s revenues generated from its video viewers who visit its proprietary social media platform by linking thereto from advertisements on the Group’s website and spend monies with Qinhe. Further to the interactive entertainment marketing services arrangement (but not the online game marketing arrangement), in September 2014 (Note 1) the Group signed a supplemental agreement providing Qinhe greater operational capabilities to manage and operate the ishow.ku6.com subdomain of domain ku6.com on its own in order to drive further user referrals. Pursuant to this supplemental agreement, Qinhe agreed to pay additional guaranteed revenue amounts, stated on a monthly basis and incremental to the revenue sharing determined on a percentage basis referenced in the foregoing paragraph. Promotional advertising services revenues are recognized as services are delivered for online game and interactive entertainment marketing. Shortly after the end of each month, with frequency sufficient to enable timely preparation of financial statements, the Group timely receives a statement from Qinhe detailing the amount of shared revenue for each type of services. Once amounts are reconciled to the Group’s records and agreed to, shared revenues are to be paid within 30 days. With respect to the additional guaranteed revenue amounts mentioned in the foregoing paragraph, such amounts are recognized on a monthly basis as they are not dependent on underlying video viewer referrals. The Group reports the revenue earned from Qinhe based on the net amount after considering the indicators to record revenue gross versus set forth in ASC 605-45, “Principal Agent Considerations.” A principal factor considered is the fact that Qinhe establishes all pricing to end customers and the Group is not responsible for providing the content or services, only for driving video viewer referrals to Qinhe. KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) Costs of revenues (applicable to both online advertising revenues and promotional revenues) consist primarily of employee
Turnover taxes and related surcharges
The China subsidiaries and VIEs are subject to business tax or value added tax (“VAT”) and related surcharges on the revenues earned for services provided.
Relevant PRC authorities introduced a turnover tax reform pilot program (the “Pilot Program”) in selected pilot cities in China for selected industries in 2012, to gradually expand the scope of VAT. The turnover tax reform pilot program was first implemented in Shanghai effective 1 January 2012. According to Circular Caishui [2012] No.71 (“Circular 71”), the Pilot Program was expanded to Beijing (effective September 1, 2012) and Tianjin (effective December 1, 2012) where the
(17)Product development expenses
Product development expenses consist primarily of salaries and benefits for product development personnel, including share-based compensation
(18)General and administrative expenses
General and administrative expenses consist primarily of salaries and benefits for general management, finance and administrative personnel, bad debt provision, litigation accruals, depreciation, amortization of intangible assets, professional service fees, share-based compensation, office rental fees, and other expenses.
(19)
(20)Advertising costs
The Group expenses advertising costs as incurred. Total advertising expenses were
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, (all amounts in U.S. dollars (US$) unless otherwise stated)
(21)Share-based compensation
The Group applies ASC 718, which requires all share-based payments to employees and directors, including grants of employee stock options and restricted shares, to be recognized as compensation expense in the financial statements over the vesting periods of the awards based on the fair values of the awards determined at the grant date. The valuation provisions of ASC 718 apply to awards granted after the adoption of ASC 718, to awards granted to employees and directors before the adoption of ASC 718 whose related requisite services had not been provided, and to awards which were subsequently modified or cancelled. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent period(s) if actual forfeitures differ from initial estimates.
In accordance with ASC 718, the Group has recognized share-based compensation expenses, net of a forfeiture rate, using the straight-line method for awards with graded vesting features and service conditions only and using the graded-vesting attribution method for awards with graded vesting features and performance conditions. See Note 14 for further information on stock-based compensation.
(22)Leases
Leases where substantially all the rewards and risks of ownership of assets remain with the leasing company are accounted for as operating leases. Other leases, meaning those meeting the capitalization criteria in ASC 840, “Leases”,
(23)Taxation
Current income taxes are provided for on the taxable income of each subsidiary on the separate tax return basis in accordance with the relevant tax laws. Deferred income taxes are provided using the liability method in accordance with ASC 740, “Income Taxes”. Under this method, deferred income taxes are recognized for temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements, net operating loss carry forwards and credits by applying enacted statutory tax rates applicable to future years. The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. The effect on deferred taxes of a change in tax rates is recognized in income in the period of change. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
ASC 740-10-25 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. The Group does not have any liabilities for unrecognized tax benefits as of December 31,
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, (all amounts in U.S. dollars (US$) unless otherwise stated)
(24) Statutory reserves
The Group’s subsidiaries incorporated in the PRC and the VIEs are required on an annual basis to make appropriations of retained earnings set at certain percentage of after-tax profit determined in accordance with PRC accounting standards and regulations (“PRC GAAP”).
The Group’s subsidiaries must make appropriations to (i) the general reserve and (ii) the enterprise expansion fund in accordance with the Law of the PRC on Enterprises Operated Exclusively with Foreign Capital. The general reserve fund requires annual appropriations of 10% of after-tax profit (as determined under PRC GAAP at each year-end) until such fund has reached 50% of the company’s registered capital; enterprise expansion fund appropriation is at the PRC subsidiaries’ directors’ discretion. The Company’s VIEs, in accordance with the China Company Laws, must make appropriations to a (i) statutory reserve fund and (ii) discretionary surplus fund. The statutory reserve fund requires annual appropriations of 10% of after-tax profit (as determined under PRC GAAP at each year-end) until such fund has reached 50% of the company’s registered capital; other fund appropriation is at the VIEs’ directors’ discretion.
The general reserve fund and statutory reserve fund can only be used for specific purposes, such as setting off the accumulated losses, enterprise expansion or increasing the registered capital. The enterprise expansion fund can be used to expand production and operations; it also may be used for increasing registered capital.
Appropriations to these funds, if they occur, are classified in the consolidated balance sheets as statutory reserves; however, such reserves are zero. No appropriations were made during the years ended December 31, 20
(25) Contingencies
In the normal course of business, the Group is subject to contingencies, such as legal proceedings and claims arising out of its business, that cover a wide range of matters. Liabilities for such contingencies are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated. See Note 19.
(26) Earnings (loss) per share
Basic earnings (loss)
For each of the three years in the period ended December 31,
(27) Comprehensive loss
Comprehensive loss is defined as the change in equity of a company during the period from transactions and other events and circumstances excluding transactions resulting from investments from owners and distributions to owners. Accumulated other comprehensive loss, as presented on the accompanying consolidated balance sheets, consists of cumulative foreign currency translation adjustments included in other comprehensive income (loss), which are presented net of tax (zero tax effect).
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, (all amounts in U.S. dollars (US$) unless otherwise stated)
(28) Recent accounting pronouncements
In
In In February 2015, the FASB issued ASU No. 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis,” or ASU 2015-02. ASU 2015-02 focuses on the consolidation evaluation for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. The ASU simplifies consolidation accounting by reducing the number of consolidation models from four to two. In addition, the new standard simplifies the FASB Accounting Standards Codification and
(29) Government Subsidies
Government subsidies represent discretionary cash subsidies granted by local governments to encourage the development of certain enterprises that are established in local special economic regions. The cash subsidies may be received in the form of (i) a fixed cash amount determined and provided by a municipal government to an operating subsidiary for product and service innovation, or (ii) an amount determined as a percentage of the income tax and business tax actually paid by an operating subsidiary.
Cash subsidies have no defined rules and regulations to govern the criteria necessary for companies to enjoy the benefits and are recognized as other income when received.
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) For the years ended December 31,
(30) Segment reporting
Based on the criteria established by ASC 280, the authoritative accounting guidance for segment reporting, the Group currently operates and manages its business as a single operating segment,
3. PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consist of:
4. PROPERTY AND EQUIPMENT, NET
Property and equipment, net, consists of:
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, (all amounts in U.S. dollars (US$) unless otherwise stated)
Depreciation expense for the years ended December 31, 2012, 2013 and 2014 was $1,941,761, $1,829,963 and $1,048,398, respectively. 5. ACQUIRED INTANGIBLE ASSETS, NET
At December 31, 2013 and 2014, net book value of intangible assets was zero. Amortization expenses for the years ended December 31, As of December 31, 2013, based upon the
Projections of future cash flows related to the asset group (the entire company, or the Group’s sole reporting unit, where the trademark intangible is the primary asset) were prepared; these projections took into account the uncertainties associated with future revenues and cash flows from advertising revenue and the
6. INVESTMENTS IN
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, (all amounts in U.S. dollars (US$) unless otherwise stated)
The Group owns a 20% equity interest in Yisheng, an online audio business originally acquired from Shanda in a transaction which at the time was a common control transaction accounted for at carryover basis, and possesses significant influence thereover. Accordingly, the Group has accounted for this investment under the equity method. As of December 31, 2012, the investment in Yisheng had been reduced to zero as a result of the Group’s equity share of losses, therefore, the preceding table depicts only 2012 activity as there has been no equity share of income since then. The Group is not obligated to continue funding Yisheng or to provide for incurred losses.
7. GOODWILL
The changes in the carrying amount of goodwill are as follows.
ASC Topic 350 requires that the goodwill impairment assessment be performed at the reporting unit level. The Group performed an impairment test at the reporting unit level and concluded that there was no impairment as to the carrying value of goodwill as of December 31,
As of December 31, 2013, based upon the KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated)
In estimating the fair value of the reporting unit in the first step of the impairment test, significant management judgement was required. The underlying assumptions used in the first step of the impairment test considered the forecasted cash flows of the Group, which were subject to further significant reduction through a discount rate in excess of 20% which considered the Group’s cost of capital and a risk premium calibrated to the significant uncertainty associated with the Group’s future revenue generating plans and business model. The most significant computational factors were the future projected revenues and the discount rate. The Group determined that the fair value of the reporting unit was less than the carrying value, which required
8. FAIR VALUE MEASUREMENTS
As of December 31,
On a non-recurring basis, the Group
The Group has not presented tabular disclosures or further qualitative information regarding fair value for these long-lived Level 3-classified assets because the related assets
9. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consist of:
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, (all amounts in U.S. dollars (US$) unless otherwise stated)
10. OTHER INCOME, NET
For the year ended December 31, 2014, gains arising from derecognition of long-aged operating liabilities of $206,533 were recognized related to write-offs of sales rebate payables included in accounts payable in 2014. For the year ended December 31, 2013, a gain arising from derecognition of long-aged operating liabilities of $2,938,250 was recognized. These amounts included $1,077,242, $818,914 and $1,042,094 in write-offs of sales rebate payables (included in accounts payable), third-party commissions (included in accounts payable), and other accrued expenses In 2013, based upon changed facts and a revised assessment indicating unlikely collection of a $980,000 loan receivable originated to Seed Music (a former subsidiary of the Group sold to Shanda Interactive in 2010) for which collection was being sought from a shareholder of Seed Music unrelated to the Group, the Group fully provided for the impaired loan and reduced its net value to zero. In light of the character of the original loan (which represented a cash outflow
11. RELATED PARTY TRANSACTIONS AND BALANCES
Current Related Parties
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) Former Related Parties Due to certain sale transactions conducted by Shanda in 2014 resulting in Shanda’s disposal of certain of its affiliates to third parties, the following entities were no longer related parties of the Group as of the dates hereby noted.
Annual Related Party Activities
During the years ended December 31, ��
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31,
(all amounts in U.S. dollars (US$) unless otherwise stated)
Note A. The Group entered into an original advertising agency agreement During the second quarter of 2014, the Company entered into two agreements with related party Qinhe, a company controlled by Mr. Xu, stipulating the provision of promotional advertising services (Notes 1 and 2(16)). As the supplemental agreement (Note 1) related to marketing services expired on December 31, 2014, the Group will share the revenue with Qinhe under the original agreement (Note 1), without the benefit of the supplemental agreement, since the beginning of 2015. The actual revenue from Qinhe may decrease in 2015 given the cessation of the supplemental agreement. Note B. In April 2013, the Group entered into a technical services agreement with Shanda Network,
Note C. During April and May 2014, Shanda provided loans totaling $5.8 million (RMB 36.1 million) to the Group. The loan were interest-free and were immediately unconditionally forgiven as to repayment. Related thereto, certain existing related party payables, amounting to $0.8 million, and receivables, amounting to $1.2 million, involving certain companies controlled by Shanda were forgiven as to repayment. The net effect of the foregoing was a $5.4 million equity contribution reflected as an increase in the Group’s additional paid-in capital (Note 1). Note D. In
Year-End Related Party Balances
At December 31,
Accounts payable balances due to related parties are as
Other balances with related parties are as
All amounts due from related parties are non-interest bearing, unsecured and receivable on demand except for the
2014, the Group forgave as to repayment its receivable due from Hurray! Media Co., Ltd. in partial exchange for an RMB 20.0 million equity contribution
12. INCOME TAXES
The Company is a tax exempted company incorporated in the Cayman Islands. The Subsidiaries or VIEs in the PRC are subject to PRC Enterprise Income Tax at a corporate income tax rate of 25%. There are no reduced tax rates afforded to the Group’s PRC entities.
Provision (benefit) for income taxes is
During the year ended December 31, 2013, the deferred tax benefit recognized related to the derecognition of remaining deferred tax liabilities associated with the Group’s full impairment of remaining intangible assets (Note 5). The principal components of deferred tax assets and liabilities are as follows:
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated)
A reconciliation between the PRC statutory income tax rate of 25% and the Company’s effective tax rate is as follows. The primary driver of the Company’s effective tax rate is the adjustments to the valuation allowance for deferred tax assets that are, as assessed under ASC 740, likely to not be realized in the foreseeable future. The primary drivers of the Company’s effective tax rate for 2013 are non-deductible impairment charges for intangible assets and goodwill (Notes 5 and 7), as well as the derecognition of deferred tax liabilities in relation
The movement of valuation allowances were as follows:
At December 31, KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated)
As noted in Note 2(23), the Company accounts for the financial statement effects of uncertain tax positions under the provisions of ASC 740-10. At December 31,
In accordance with the PRC EIT Law, dividends which arise from profits of foreign invested enterprises (“FIEs”)
13. REPURCHASE OF SHARES
Pursuant to a share repurchase program announced December 30, 2011, the Company’s Board of Directors authorized the Company to repurchase up to
In a separate transaction distinct from the
14. EQUITY COMPENSATION PLANS
2004 Share Incentive Plan
Ku6 Media’s 2004 Share Incentive Plan (“2004 Plan”) allows the Company to offer incentive awards to employees, directors, consultants or external service advisors of the Company. Under the terms of the Plan, options were generally granted at prices equal to or greater than the fair market value on the grant date, expire 10 years from the date of grant, and generally vest over 3-4 years. Stock options under these plans were all granted prior to 2006 and as of January 1, 2006 all granted stock options were vested. There were
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, (all amounts in U.S. dollars (US$) unless otherwise stated)
The aggregate intrinsic values are calculated as the differences between the market values of
2010 Equity Compensation Plan
In December 2010, the Company authorized an equity compensation plan (“2010 Equity Compensation Plan”) that provides for issuance of options to purchase up to 698,381,300 ordinary shares of the Company. Under the 2010 Equity Compensation Plan, the directors may, at their discretion, grant any officers (including directors) and employees of the Company and/or its subsidiaries, and individual consultant or advisor (i) options to subscribe for ordinary shares, (ii) share appreciation rights to receive payment, in cash and/or the Company’ ordinary shares,
On August 28, 2012, the Company granted stock options to purchase up to 28,500,000 ordinary shares under the 2010 Equity Compensation Plan at an exercise price of $0.0116 per share to its employees. The contract term of the options is six years.
On May 7, 2013, the Company granted stock options to purchase up to 254,100,000 ordinary shares under the 2010 Equity Compensation Plan at an exercise price of $0.0103 per share to its employees and senior management. Of all the stock options granted, 140,000,000 were granted to senior management of the Company, 50,600,000 were granted to employees of the Company, and 63,500,000 were granted to senior management and employees of Shanda. The contract term of the options is six years.
On June 3, 2013, the Company granted stock options to purchase up to 69,800,000 ordinary shares under the 2010 Equity Compensation Plan at an exercise price of $0.0113 per share to its senior management. The contract term of the options is six years.
There were no options granted in 2014. As of December 31,
The options granted to directors and employees vest over a four year period, with 25% of the options to vest on each of the first, second, third and fourth anniversaries of the grant date as stipulated in the stock option agreements.
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) Options which were granted to senior management prior to 2013 vest in 16 instalments. The first 2 of 16 instalments - options earned in the first two quarters after the grant date - shall vest and become exercisable at the first anniversary of the grant date. There are no performance conditions attached to the first 2 instalments. For each quarter during the four-year period after the grant date (the “Performance Period Start Date”), one 1/16th instalment of the total options have the opportunity to be earned for each quarter contingent on the achievement of positive quarterly operating income for the quarter, provided the aggregate number of options earned in the Performance Period shall not exceed 14 of the 16 instalments comprising the total options granted. On each of the first, fourth, eighth and twelfth quarter earnings release dates from the first quarter of the Performance Period, all of the earned options during the four quarters preceding such earnings release date shall vest and become exercisable, in each case, provided that the employment with the Company remains on such vesting date.
The options granted to senior management in 2013 vest over a four year period, with 25% of the options to vest on each of the first, second, third and fourth anniversaries of the grant date as stipulated in the stock option agreements.
Option Modification
On December 11, 2013, the Board of Directors approved option modifications to modify the vesting conditions of certain outstanding options (granted to senior management) that were granted by the Company under the 2010 Equity Compensation Plan. The modifications waived the performance
In accordance with ASC Topic 718, the Company recognizes share-based compensation expense for the options granted to directors and employees as well as the options to senior management vested only based on passage of time and continued employment with the Company, net of a forfeiture rate, using the straight-line method. For the options granted to senior management earned contingent on the achievement of quarterly performance targets, the
Company
Share-based compensation expense related to the stock options granted by the Company to its employees, senior management and directors under the 2010 Equity Compensation Plan amounted to $463,753, $1,023,871 and
The movements in stock options under the 2010 Equity Compensation Plan as of and for the years ended December 31,
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated)
The intrinsic values as of December 31,
The weighted average grant-date fair value of options granted during the
As of December 31,
The Black-Scholes option pricing model is used to determine the fair value of the stock options granted under the 2010 Equity Compensation Plan. The Black-Scholes model requires the input of highly subjective assumptions, including the expected stock price volatility and the sub-optimal early exercise factor. The risk-free rate for periods
within the contractual lives of the options is based on the U.S. Treasury yield curve in effect at the time of grant. The fair values of stock options were estimated using the following weighted-average assumptions:
(1) The risk-free interest rate for periods within the contractual life of the share option is based on the U.S. Treasury yield curve in effect at the time of grant for a term consistent with the expected term of the awards. (2) The expected term of stock options granted is developed giving consideration to vesting period, contractual term and historical exercise pattern of options granted by the Company. (3) The Company has no history or expectation of paying dividends on its common stock. KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) (4) Expected volatility is estimated based on the historical volatility of comparable companies’ stocks and of the Company’s common stock for a period equal to the expected term preceding the grant date.
15. SEGMENT INFORMATION
The Company follows the provisions of ASC 280, which establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Group has only one operating segment made up of Ku6’s
Geographic Information
The Company primarily operates in the PRC and derives all of its revenues (see Note 17 for revenue information) from the PRC; all of the Company’s long-lived assets are located in the PRC.
16. NET LOSS PER SHARE
The following table sets forth the computation of basic and diluted net loss per share (1 ADS = 100 Shares):
Incremental ordinary shares with dilutive effect are calculated using the treasury stock method for stock options. Under the treasury stock method, the proceeds from the assumed conversion of options are used to repurchase outstanding ordinary shares using the average fair value for the period. Table of KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated)
For all periods presented, all potentially dilutive securities associated with the Company’s
17. CONCENTRATIONS
(1)
Under agreements with Shengyue Under a new advertising agency agreement with In early 2014, the
(2) Credit risk
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, (all amounts in U.S. dollars (US$) unless otherwise stated)
18. MAINLAND CHINA CONTRIBUTION PLAN
Full time employees of the Company in the PRC participate in a government-mandated multi-employer defined contribution plan pursuant to which certain pension benefits, medical care, unemployment insurance, employee housing fund and other welfare benefits are provided to employees. Chinese labor regulations require the Company to accrue for these benefits based on certain percentages of the employees’ salaries. The total amounts charged to the statements of operations and comprehensive loss for such employee benefits were
19. COMMITMENTS AND CONTINGENCIES
Operating lease commitments
The Company entered into leasing arrangements relating to office area and internet bandwidth in
Future minimum lease payments under non-cancellable operating lease agreements are as follows:
Litigation
The Group is subject to claims and litigation, which may arise in the normal course of business. The Group is involved in a number of cases pending in various courts and arbitration as of December 31,
The Group has recorded an accrual balance of KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated)
A rollforward of the Group’s accrued litigation provision related to alleged copyright infringement is as follows.
There are no accruals for any additional losses related to unasserted claims or any other amounts.
Contingencies
The Group accounts for loss contingencies in accordance with ASC 450, “Contingencies”, and other related guidance. Set forth below is a description of certain loss contingencies as well as the opinion of management as to the likelihood of loss.
Current PRC laws and regulations place certain restrictions on foreign ownership of companies that engage in Internet business, including the provision of online video and online advertising services. Specifically, foreign ownership in an Internet content provider or other value-added telecommunication service providers may not exceed 50%. Since the Company is incorporated in the Cayman Islands, neither the Company nor its PRC subsidiary is eligible to engage in Internet business. To comply with PRC laws and regulations, the Company conducts its operations in China through a series of contractual arrangements entered into among its wholly owned PRC subsidiaries, Beijing Technology, Tianjin Technology and
Under the equity pledge agreements among the PRC subsidiaries, the VIEs and the shareholders of the VIEs, the shareholders have pledged all of their equity interests to the PRC subsidiaries by recording the pledges on the
Ku6 Beijing Information, Tianjin Information, Ku6 Cultural and Ku6 Network hold the licenses and permits necessary to conduct
Accordingly, the Company cannot be assured that PRC regulatory authorities will not ultimately take a contrary view to its opinion. If the current ownership structure of the Company and its contractual arrangements with the consolidated affiliated entities in the PRC were found to be in violation of any existing or future PRC laws and regulations, the Company may be required to restructure its ownership structure and operations in the PRC to comply with the changing and new PRC laws and regulations.
Under PRC Ministry of Commerce (“MOFCOM”) security review rules promulgated in September 2011, a national security review is required for certain mergers and acquisitions by foreign investors raising concerns regarding national defense and security. Foreign investors are prohibited from circumventing the national security review requirements by structuring transactions through proxies, trusts, indirect investment, leases, loans, control through contractual arrangements, or offshore transactions. Management has concluded there is no need to submit the existing contractual arrangements with the consolidated affiliated entities in the PRC and their shareholders to the MOFCOM for national security review based upon analysis of the rules. However, there are substantial uncertainties regarding the interpretation and application of the MOFCOM security review rules, and any new laws, rules, regulations or detailed implementation measures in any form relating to such rules. Therefore, the Company cannot be assured that the relevant PRC regulatory authorities, such as the MOFCOM, would not ultimately take a contrary view to the opinion of management and the Company’s PRC legal counsel. If the MOFCOM or other PRC regulatory authority determines that the Company needs to submit the existing contractual arrangements with the consolidated affiliated entities in the PRC and their shareholders for national security review, the Company may face sanctions by the MOFCOM or other PRC regulatory authority, which may include, among others, requiring the Company to restructure its ownership structure, discontinuation or restriction of operations in the PRC, or invalidation of the agreements that the wholly owned PRC subsidiaries have entered into with the consolidated affiliated entities in the PRC and their shareholders.
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) MOFCOM published a discussion draft of a proposed Foreign Investment Law in January 2015 aiming to, upon its enactment, replace the trio of existing laws regulating foreign investment in China, namely, the Sino-foreign Equity Joint Venture Enterprise Law, the Sino-foreign Cooperative Joint Venture Enterprise Law and the Wholly Foreign-invested Enterprise Law. The draft Foreign Investment Law embodies an expected PRC regulatory trend to rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic investments. MOFCOM is currently soliciting comments on this draft and substantial uncertainties exist with respect to its enactment timetable, interpretation and implementation. The draft Foreign Investment Law, if enacted as proposed, may materially impact the viability of the Group’s current corporate structure, corporate governance and business operations in many aspects. Among other things, the draft Foreign Investment Law expands the definition of foreign investment and introduces the principle of “actual control” in determining whether a company is considered a foreign-invested enterprise, or an FIE. The draft Foreign Investment Law specifically provides that entities established in China but “controlled” by foreign investors will be treated as FIEs, whereas an entity set up in a foreign jurisdiction would nonetheless be, upon market entry clearance by the Ministry of Commerce, treated as a PRC domestic investor provided that the entity is “controlled” by PRC entities and/or citizens. In this connection, “foreign investors” refers to the following subjects making investments within the PRC: (i) natural persons without PRC nationality; (ii) enterprises incorporated under the laws of countries or regions other than China; (iii) the governments of countries or regions other than the PRC and the departments or agencies thereunder; and (iv) international organizations. Domestic enterprises under the control of the subjects as mentioned in the preceding sentence are deemed foreign investors, and “control” is broadly defined in the draft law to cover the following summarized categories: (i) holding, directly or indirectly, not less than 50% of shares, equities, share of voting rights or other similar rights of the subject entity; (ii) holding, directly or indirectly, less than 50% of the voting rights of the subject entity but having the power to secure at least 50% of the seats on the board or other equivalent decision making bodies, or having the voting power to materially influence the board, the shareholders’ meetings, or other equivalent decision making bodies; or (iii) having the power to exert decisive influence, via contractual or trust arrangements, over the subject entity’s operations, financial matters or other key aspects of business operations. Once an entity is determined to be an FIE, it will be subject to the foreign investment restrictions or prohibitions set forth in a catalogue of “special administrative measures,” which is classified into the “catalogue of prohibitions” and “the catalogue of restrictions”, to be separately issued by the State Council later. Foreign investors are not allowed to invest in any sector set forth in the catalogue of prohibitions. However, unless the underlying business of the FIE falls within the catalogue of restrictions, which calls for market entry clearance by MOFCOM, prior approval from the government authorities as mandated by the existing foreign investment legal regime would no longer be required for establishment of the FIE. The “variable interest entity” structure, or VIE structure, has been adopted by many PRC-based companies, including the Group, to obtain necessary licenses and permits in the industries that are currently subject to foreign investment restrictions in China. Under the draft Foreign Investment Law, variable interest entities that are controlled via contractual arrangements would also be deemed FIEs if they are ultimately “controlled” by foreign investors. Therefore, for any companies with a VIE structure in an industry category that is on the “catalogue of restrictions,” the VIE structure may be deemed a domestic investment only if the ultimate controlling person(s) is/are of PRC nationality (either PRC companies or PRC citizens). Conversely, if the actual controlling person(s) is/are of foreign nationalities, then the variable interest entities will be treated as FIEs and any operation in the industry category on the “catalogue of restrictions” without market entry clearance may be considered illegal. KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) The draft Foreign Investment Law has not taken a position on what actions shall be taken with respect to the existing companies with a VIE structure, whether or not these companies are controlled by Chinese parties, and MOFCOM is soliciting comments from the public on this point. Moreover, it is uncertain whether the industry in which our variable interest entities operate will be subject to the foreign investment restrictions or prohibitions set forth in the “catalogue of special administrative measures” to be issued. If the enacted version of the Foreign Investment Law and the final “catalogue of special administrative measures” mandate further actions, such The draft Foreign Investment Law, if enacted as proposed, may also materially impact the Group’s corporate governance practices and increase compliance costs. For instance, the draft Foreign Investment Law imposes stringent ad hoc and periodic information reporting requirements on foreign investors and the applicable FIEs. Aside from an investment information report required at each investment, and investment amendment reports, which shall be submitted upon changes to investments, it is mandatory for entities established by foreign investors to submit an annual report, and large foreign investors meeting certain criteria are required to report on a quarterly basis. Any company found to be non-compliant with these reporting obligations may potentially be subject to fines and/or administrative or criminal liabilities, and the persons directly responsible may be subject to criminal liabilities. With respect to the aforementioned security review rules and draft Foreign Investment Law, and any other matters creating uncertainty regarding VIEs, the Group may not be able to operate or control its business in the same manner as it currently does, and therefore, may not be able to consolidate the affiliated entities in the PRC. In addition, the relevant regulatory authorities would have broad discretion in dealing with such violations which may adversely impact the financial statements, operations and cash flows of the
If the
In the opinion of management, the likelihood of loss in respect of the Group’s current ownership structure or the contractual arrangements with the
20. SUBSEQUENT EVENTS
On
21. RESTRICTED NET ASSETS
Relevant PRC laws and regulations permit PRC companies to pay dividends only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Additionally, the Company’s VIE subsidiaries can only distribute dividends upon approval of the shareholders after they have met the PRC requirements for appropriation to statutory reserves. The statutory general reserve fund requires annual appropriations of 10% of net after-tax income to be set aside prior to payment of any dividends. As a result of these and other restrictions under PRC laws and regulations, the PRC subsidiaries and affiliates are restricted in their ability to transfer a portion of their net assets to the Company either in the form of dividends, loans or advances, which restricted portion amounted to approximately
or KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated)
22. ADDITIONAL INFORMATION - CONDENSED FINANCIAL STATEMENTS
The following condensed financial statements have been prepared in accordance with SEC Regulation S-X
These statements should be read in conjunction with the preceding notes to the consolidated financial statements of the Group. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted.
As of December 31,
FINANCIAL INFORMATION OF KU6 MEDIA CO., LTD.
FINANCIAL INFORMATION OF KU6 MEDIA CO., LTD.
FINANCIAL INFORMATION OF KU6 MEDIA CO., LTD.
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