“$” and “U.S. dollars” refer to the legal currency of the United States;
“ADSs” refers to our American depositary shares, each of which represents 100 ordinary shares;
“$,” “US$” and “U.S. dollars” referCayman Companies Law” refers to the legal currencyCompanies Law (2011 Revision) of the United States;Cayman Islands (as amended);
“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;
“Hurray! Holding Co., Ltd.”Ku6 Holding” refers to HURRAY! HOLDING CO., LTD.Ku6 Holding Limited and its subsidiaries, affiliates and predecessor entities;
“ordinary shares” refers to our ordinary shares, par value US$0.00005$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;
“RMB” and “Renminbi” refer to the legal currency of China;
“telecom operators” referShanda Interactive” refers to China Mobile, China UnicomShanda Interactive Entertainment Limited, a Cayman Islands company;
“Shanda Group” refers to Shanda Interactive and China Telecom,its subsidiaries and consolidated affiliated entities, including, unless the three principal telecommunication network operators in China;context requires otherwise, Ku6 Media Co., Ltd. and its subsidiaries and consolidated affiliated entities;
“we,” “us,” “our company” and “our” refer to Hurray! HoldingKu6 Media Co., Ltd. and its subsidiaries, affiliatesconsolidated affiliated entities and predecessor entities.
FORWARD-LOOKING INFORMATION
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”,“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 new revenue model;
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 regional focus;
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 wireless value-added, music and online video industries;industry;
the outcome of ongoing, or any future, litigation or arbitration;
3
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 forward- lookingforward-looking statements are reasonable, we cannot assure you that our expectations will turn out to be correct. Our actual results could be materially different from and worse than our expectations. Important risks and factors that could cause our actual results to be materially different from our expectations are generally set forth in theItem 3.D. “Risk Factors” section of Item 3 and elsewhere in this annual report. The forward-looking statements made in this annual report relate only to events or information as of the date on which the statements are made in this annual report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date on which the statements are made or to reflect the occurrence of unanticipated events.
Not Applicable.
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 55. “Operating and Financial Review and Prospects” included elsewhere in this annual report on Form 20-F. The following data as of December 31, 20092010 and 20082011 and for the years ended December 31, 2009, 20082010 and 20072011 has been derived from our audited consolidated financial statements for those years and should be read in conjunction with those statements, which are included in this annual report beginning on page F-1. The following data as of December 31, 2007, 2006 and 2005 and for the years ended December 31, 2006 and 2005 have also2009 has been derived from our audited consolidated financial statements for those years, which are not included in this annual report on Form 20-F. Our auditedreport. The data as of December 31, 2007 and 2008 and for the years ended December 31, 2007 and 2008 has been derived from unaudited consolidated financial statements for the foregoing periods werenot included in this annual report. Our consolidated financial statements are prepared and presented in accordance with United States generally accepted accounting principles, or USU.S. GAAP.
Our historical results do not necessarily indicate our results expected for any future periods.
4
| For the Year Ended December 31, | ||||||||||||||||||||
| 2009 | 2008 | 2007 | 2006(1) | 2005(1),(3) | ||||||||||||||||
| (in thousands of U.S. dollars, except percentages) | ||||||||||||||||||||
Historical Condensed Consolidated Statement of Operations Data | ||||||||||||||||||||
| Net revenues: | ||||||||||||||||||||
| Wireless value-added services | 20,169 | 42,672 | 50,038 | 62,512 | 56,063 | |||||||||||||||
| Recorded music | 14,473 | 11,287 | 10,489 | 6,203 | — | |||||||||||||||
| Total net revenues | 34,642 | 53,959 | 60,527 | 68,715 | 56,063 | |||||||||||||||
| Cost of revenues: | ||||||||||||||||||||
| Wireless value-added services | (15,332 | ) | (32,840 | ) | (36,394 | ) | (40,672 | ) | (28,635 | ) | ||||||||||
| Recorded music | (12,625 | ) | (6,730 | ) | (6,233 | ) | (3,553 | ) | — | |||||||||||
| Total cost of revenues | (27,957 | ) | (39,570 | ) | (42,627 | ) | (44,225 | ) | (28,635 | ) | ||||||||||
| Gross profit | 6,685 | 14,389 | 17,900 | 24,490 | 27,428 | |||||||||||||||
| Operating expenses | (33,382 | ) | (22,669 | ) | (61,462 | ) | (19,882 | ) | (14,277 | ) | ||||||||||
| Operating income (loss) from continuing operations | (26,697 | ) | (8,280 | ) | (43,562 | ) | 4,608 | 13,151 | ||||||||||||
| Interest income | 454 | 1,613 | 2,313 | 2,529 | 1,390 | |||||||||||||||
| Interest expense | (14 | ) | — | (179 | ) | (45 | ) | (27 | ) | |||||||||||
| Gain on reduction of acquisition payable | — | 5,000 | — | — | — | |||||||||||||||
| Foreign exchange loss | — | (8,990 | ) | — | — | — | ||||||||||||||
| Other income, net | 342 | 247 | 466 | 315 | 330 | |||||||||||||||
| Income (loss) before income tax credit (expense), equity in (loss) earning of affiliated company, impairment for investment in affiliated company and discontinued operations | (25,915 | ) | (10,410 | ) | (40,962 | ) | 7,407 | 14,844 | ||||||||||||
| Income tax credit (expenses) | (234 | ) | (486 | ) | 182 | (205 | ) | (323 | ) | |||||||||||
| Equity in (loss) earning of affiliated company | (914 | ) | 64 | (63 | ) | — | — | |||||||||||||
| Impairment for Investment in affiliated company | — | (1,871 | ) | — | — | — | ||||||||||||||
| Net (loss) income from continuing operations | (27,063 | ) | (12,703 | ) | (40,843 | ) | 7,202 | 14,521 | ||||||||||||
| Discontinued operations: | ||||||||||||||||||||
| Net (loss) income from discontinued operations, net of tax | — | — | (612 | ) | (836 | ) | 4,098 | |||||||||||||
| Gain from disposal of discontinued operations | 222 | 413 | 193 | — | — | |||||||||||||||
| Net income (loss) from discontinued operations, net of tax | 222 | 413 | (419 | ) | (836 | ) | 4,098 | |||||||||||||
| Net income (loss) | (26,841 | ) | (12,290 | ) | (41,262 | ) | 6,366 | 18,619 | ||||||||||||
Less: Net income (loss) attributable to the non-controlling interests and redeemable non-controlling interest(2) | 4,183 | 337 | (688 | ) | (562 | ) | — | |||||||||||||
| Net (loss) income attributable to Hurray! Holding Co., Ltd. | (22,658 | ) | (11,953 | ) | (41,950 | ) | 5,804 | 18,619 | ||||||||||||
| Loss attributable to Hurray! Holding Co., Ltd. ordinary shareholders per share, basic and diluted | (0.01 | ) | (0.01 | ) | (0.02 | ) | — | 0.01 | ||||||||||||
| Shares used in calculating basic (loss) income per share | 2,196,291,947 | 2,185,615,129 | 2,172,208,190 | 2,189,748,563 | 2,092,089,848 | |||||||||||||||
| Shares used in calculating diluted (loss) income per share | 2,196,291,947 | 2,185,615,129 | 2,172,208,190 | 2,208,758,636 | 2,129,228,961 | |||||||||||||||
5
| For the Year Ended December 31, | ||||||||||||||||||||
| 2007 | 2008 | 2009 | 2010 | 2011 | ||||||||||||||||
| (in thousands of U.S. dollars, except for share and per share data) | ||||||||||||||||||||
Historical Condensed Consolidated Statement of Operations Data | ||||||||||||||||||||
Net revenues: | ||||||||||||||||||||
Advertising | ||||||||||||||||||||
Third parties | — | — | 758 | 15,854 | 11,146 | |||||||||||||||
Related parties | — | — | 279 | 702 | 8,076 | |||||||||||||||
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Total net revenues | — | — | 1,037 | 16,556 | 19,222 | |||||||||||||||
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Cost of revenues: | ||||||||||||||||||||
Advertising | ||||||||||||||||||||
Third parties | — | — | (557 | ) | (40,083 | ) | (30,501 | ) | ||||||||||||
Related parties | — | — | — | (376 | ) | (379 | ) | |||||||||||||
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| |||||||||||
Total cost of revenues | — | — | (557 | ) | (40,459 | ) | (30,880 | ) | ||||||||||||
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| |||||||||||
Gross profit (loss) | — | — | 480 | (23,903 | ) | (11,658 | ) | |||||||||||||
Operating expenses | (2,738 | ) | (2,401 | ) | (7,130 | ) | (29,703 | ) | (37,912 | ) | ||||||||||
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|
|
|
|
|
|
| |||||||||||
Operating loss from continuing operations | (2,738 | ) | (2,401 | ) | (6,650 | ) | (53,606 | ) | (49,570 | ) | ||||||||||
Interest income | 2,084 | 1,432 | 356 | 57 | 170 | |||||||||||||||
Interest expense | (179 | ) | — | — | (31 | ) | (1,119 | ) | ||||||||||||
Gain on reduction of acquisition payable | — | 5,000 | — | — | — | |||||||||||||||
Foreign exchange loss | — | (8,990 | ) | — | — | — | ||||||||||||||
Other income, net | 105 | — | 2 | 0 | 1,294 | |||||||||||||||
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| |||||||||||
Loss before income tax benefit from continuing operations | (728 | ) | (4,959 | ) | (6,292 | ) | (53,580 | ) | (49,226 | ) | ||||||||||
Income tax benefit | — | — | 14 | 41 | 99 | |||||||||||||||
Equity in loss of affiliated company, net of tax | — | — | — | — | (263 | ) | ||||||||||||||
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| |||||||||||
Loss from continuing operations, net of tax | (728 | ) | (4,959 | ) | (6,278 | ) | (53,539 | ) | (49,390 | ) | ||||||||||
| For the Year Ended December 31, | ||||||||||||||||||||
| 2007 | 2008 | 2009 | 2010 | 2011 | ||||||||||||||||
| (in thousands of U.S. dollars, except for share and per share data) | ||||||||||||||||||||
Discontinued operations: | ||||||||||||||||||||
Loss from operations of discontinued operations, net of tax | (40,727 | ) | (7,744 | ) | (21,778 | ) | (3,383 | ) | — | |||||||||||
Gain from disposal of discontinued operations, net of tax | 193 | 413 | 222 | 4,487 | — | |||||||||||||||
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(Loss) income from discontinued operations, net of tax | (40,534 | ) | (7,331 | ) | (21,556 | ) | 1,104 | — | ||||||||||||
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| |||||||||||
Net loss | (41,262 | ) | (12,290 | ) | (27,834 | ) | (52,435 | ) | (49,390 | ) | ||||||||||
Less: Net loss attributable to the non-controlling interests from continuing operations | — | — | 257 | 681 | 46 | |||||||||||||||
Less: Net (income) loss attributable to the non-controlling interests and redeemable non-controlling interests from discontinued operations | (688 | ) | 337 | 4,183 | 244 | — | ||||||||||||||
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Net loss attributable to Ku6 Media Co., Ltd. | (41,950 | ) | (11,953 | ) | (23,395 | ) | (51,510 | ) | (49,344 | ) | ||||||||||
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| |||||||||||
Loss from continuing operations, net of tax, attributable to Ku6 Media Co., Ltd. | (728 | ) | (4,959 | ) | (6,021 | ) | (52,858 | ) | (49,344 | ) | ||||||||||
(Loss) income from discontinued operations, net of tax, attributable to Ku6 Media Co., Ltd. | (41,222 | ) | (6,994 | ) | (17,374 | ) | 1,348 | — | ||||||||||||
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| |||||||||||
Net loss attributable to Ku6 Media Co., Ltd. | (41,950 | ) | (11,953 | ) | (23,395 | ) | (51,510 | ) | (49,344 | ) | ||||||||||
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Loss per share, basic and diluted | ||||||||||||||||||||
Loss from continuing operations attributable to Ku6 Media Co., Ltd. ordinary shareholders | — | — | (0.00 | ) | (0.02 | ) | (0.01 | ) | ||||||||||||
(Loss) income from discontinued operations attributable to Ku6 Media Co., Ltd. ordinary shareholders | (0.02 | ) | (0.01 | ) | (0.01 | ) | 0.00 | — | ||||||||||||
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| |||||||||||
Net loss attributable to Ku6 Media Co., Ltd. ordinary shareholders | (0.02 | ) | (0.01 | ) | (0.01 | ) | (0.02 | ) | (0.01 | ) | ||||||||||
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Weighted average shares used in per share calculation—basic and diluted | 2,172,208,190 | 2,185,615,129 | 2,196,291,947 | 3,096,421,097 | 4,265,277,638 | |||||||||||||||
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Historical Condensed Consolidated Balance Sheet Data Cash and cash equivalents Restricted cash Short term investments Accounts receivable, net Other current assets Property and equipment, net Goodwill Other assets Total assets Current liabilities Non-current liabilities Total liabilities Redeemable non-controlling interests Ordinary shares ($0.00005 par value; 12,000,000,000 shares authorized; 2,174,784,440, 2,193,343,740, 2,200,194,040, 3,481,174,498 and 5,019,786,036 shares issued and outstanding as of December 31, 2007, 2008, 2009, 2010 and 2011, respectively) Other Ku6 Media Co., Ltd. shareholders’ equity Non-controlling interests Total liabilities, redeemable non-controlling interests and shareholders’ equity As of December 31, 2007 2008 2009 2010 2011 (in thousands of U.S. dollars, except for share data) 65,979 59,473 49,744 27,295 26,750 — — — — 3,600 — — 10,000 — — 14,691 12,658 4,062 8,461 3,517 8,777 5,580 2,155 9,051 20,424 1,636 980 1,472 8,003 3,593 5,621 3,157 2,099 6,896 6,233 8,890 6,476 1,976 27,264 24,673 105,594 88,324 71,508 86,970 88,790 14,467 6,316 13,783 36,406 33,111 877 316 421 4,926 4,826 15,344 6,632 14,204 41,332 37,937 — — 371 — — 109 110 110 174 251 85,474 76,799 54,966 45,572 50,602 4,667 4,783 1,857 (108 ) — 105,594 88,324 71,508 86,970 88,790
| As of and for the Years Ended December 31, 2009 | ||||||||||||||||||||
| 2009 | 2008 | 2007 | 2006 | 2005 | ||||||||||||||||
| (in thousands of U.S. dollars, except percentages) | ||||||||||||||||||||
Historical Condensed Consolidated Balance Sheet Data | ||||||||||||||||||||
| Cash and cash equivalents | 48,489 | 59,473 | 65,979 | 74,597 | 75,959 | |||||||||||||||
| Short term investments | 10,000 | — | — | — | — | |||||||||||||||
| Accounts receivable, net | 3,192 | 12,658 | 14,691 | 13,449 | 18,089 | |||||||||||||||
| Other current assets | 2,094 | 5,580 | 8,777 | 3,342 | 2,297 | |||||||||||||||
| Property and equipment, net | 880 | 980 | 1,636 | 1,954 | 2,536 | |||||||||||||||
| Goodwill | 2,099 | 3,157 | 5,621 | 39,621 | 23,869 | |||||||||||||||
| Other assets | 1,414 | 6,476 | 8,890 | 7,027 | 4,953 | |||||||||||||||
| Total assets | 68,168 | 88,324 | 105,594 | 139,990 | 127,703 | |||||||||||||||
| Current liabilities | 11,327 | 6,316 | 14,467 | 12,960 | 7,636 | |||||||||||||||
| Non-current liabilities | 280 | 316 | 877 | 851 | 843 | |||||||||||||||
| Total liabilities | 11,607 | 6,632 | 15,344 | 13,811 | 8,479 | |||||||||||||||
| Redeemable non-controlling interests | 371 | — | — | — | — | |||||||||||||||
| Ordinary shares (2,200,194,040, 2,193,343,740, 2,174,784,440, 2,163,031,740 and 2,229,754,340 shares issued and outstanding as of December 31, 2009, 2008, 2007, 2006 and 2005, respectively) | 110 | 110 | 109 | 108 | 111 | |||||||||||||||
| Other Hurray! Holding Co., Ltd. shareholders’ equity | 54,286 | 76,799 | 85,474 | 122,712 | 118,508 | |||||||||||||||
| Non-controlling interests | 1,794 | 4,783 | 4,667 | 3,359 | 605 | |||||||||||||||
| Total liabilities, redeemable non-controlling interests and shareholders’ equity | 68,168 | 88,324 | 105,594 | 139,990 | 127,703 | |||||||||||||||
Other Historical Condensed Consolidated Financial Data | ||||||||||||||||||||
| Gross profit margin | ||||||||||||||||||||
| Wireless value-added services | 24.0 | % | 23.0 | % | 27.3 | % | 34.9 | % | 48.9 | % | ||||||||||
| Recorded music | 12.8 | % | 40.4 | % | 40.6 | % | 42.7 | % | — | |||||||||||
| Total gross profit margin | 19.3 | % | 26.7 | % | 29.6 | % | 35.6 | % | 48.9 | % | ||||||||||
Operating income (loss) from continuing operations margin(1) | (77.1 | %) | (15.3 | %) | (72.0 | %) | 6.7 | % | 23.5 | % | ||||||||||
Net (loss) income from continuing operations margin(1) | (78.1 | %) | (23.5 | %) | (67.5 | %) | 10.5 | % | 25.9 | % | ||||||||||
Net (loss) income attributable to Hurray! Holding Co., Ltd. margin(1) | (65.4 | %) | (22.2 | %) | (69.3 | %) | 8.4 | % | 33.2 | % | ||||||||||
| Depreciation | 837 | 990 | 1,269 | 1,580 | 1,461 | |||||||||||||||
| Amortization | 862 | 2,338 | 2,375 | 1,901 | 478 | |||||||||||||||
| Capital expenditure | 678 | 349 | 864 | 957 | 1,289 | |||||||||||||||
6
We present our historical consolidated financial statements in U.S. dollars. In addition, certain pricing information is presented in U.S. dollars and certainCertain contractual amounts that are in Renminbi include adescribed in this annual report are translated into U.S. dollar equivalentamounts solely for the convenience of the reader. Except as otherwise specified, this pricing information and these contractual amounts are translated at RMB6.8259 = US$1.00,a rate of RMB6.2939 to $1.00, the prevailing rate on December 31, 2009. The translations are not a representation that the Renminbi amounts could actually be converted to U.S. dollars at this rate. For a discussion of the exchange rates used for the presentation of our financial statements, see note 2(17) to our audited consolidated financial statements.
The following table sets forth the high and low noon buyinginformation regarding exchange rates for cable transfers between Renminbi and U.S. dollar as certifieddollars for customs purposes by the periods indicated:
| Exchange Rate | ||||||||||||||||
Period | Period End | Average(1) | High | Low | ||||||||||||
| (RMB per US$1.00) | ||||||||||||||||
2007 | 7.2946 | 7.5806 | 7.8127 | 7.2946 | ||||||||||||
2008 | 6.8225 | 6.9193 | 7.2946 | 6.7800 | ||||||||||||
2009 | 6.8259 | 6.8295 | 6.8470 | 6.8176 | ||||||||||||
2010 | 6.6000 | 6.7603 | 6.8330 | 6.6000 | ||||||||||||
2011 | 6.2939 | 6.4475 | 6.6364 | 6.2939 | ||||||||||||
September | 6.3780 | 6.3885 | 6.3975 | 6.3780 | ||||||||||||
October | 6.3547 | 6.3710 | 6.3825 | 6.3534 | ||||||||||||
November | 6.3765 | 6.3564 | 6.3839 | 6.3400 | ||||||||||||
December | 6.2939 | 6.3482 | 6.3733 | 6.2939 | ||||||||||||
2012 | ||||||||||||||||
January | 6.3080 | 6.3172 | 6.3330 | 6.2940 | ||||||||||||
February | 6.2935 | 6.2997 | 6.3120 | 6.2935 | ||||||||||||
March (through March 23, 2012) | 6.3021 | 6.3145 | 6.3315 | 6.2982 | ||||||||||||
Source: Federal Reserve Bank of New York for each of periods indicated below.
| Noon Buying Rate | ||||||||
| RMB per US$1.00 | ||||||||
| High | Low | |||||||
| November 2009 | 6.8300 | 6.8255 | ||||||
| December 2009 | 6.8299 | 6.8244 | ||||||
| January 2010 | 6.8295 | 6.8258 | ||||||
| February 2010 | 6.8330 | 6.8258 | ||||||
| March 2010 | 6.8270 | 6.8254 | ||||||
| April 2010 (through April 23) | 6.8275 | 6.8229 | ||||||
| Average Noon Buying Rate | ||||
| RMB per US$1.00 | ||||
| 2005 | 8.1826 | |||
| 2006 | 7.9579 | |||
| 2007 | 7.5806 | |||
| 2008 | 6.9193 | |||
| 2009 | 6.8307 | |||
| 2010 (through April 23) | 6.8270 | |||
| (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.
D. Risk Factors
7
We depend on China Mobile, China Unicomhave a short operating history in a new and China Telecom,unproven market, which makes it difficult to evaluate our future prospects and may increase the threerisk that we will not be successful.
We entered the online video business in January 2010 when we acquired Ku6 Holding. As we subsequently disposed of the WVAS and recorded music businesses in August 2010 and a 80% interest in the online audio business in August 2011, we are currently operating the online video business as our principal telecommunications network operators in China, for the major portionbusiness and generate substantially all of our revenue,revenues from online advertising. However, we only have a short operating history in this new and any loss or deterioration ofunproven market that may not develop as expected, if at all. This short operating history makes it difficult to effectively assess our relationship with China Mobile, China Unicom and China Telecom, due to the 2008 government imposed restructurings or otherwise, may result in severe disruptions tofuture prospects. You should consider our business operations and prospects in light of the loss of a major portion of our revenue.
We have a limited term (generally one year for China Mobilehistory of losses, and onewe may be unable to achieve or two years for China Unicom). We usually renew these agreements or enter into new ones when the prior agreements expire, but occasionally the renewal or new agreements can be delayed by periods of one month or more. In 2008, China Telecom and its provincial affiliates entered into new agreements with us in connection with the network assets that they acquired from China Unicom (as discussed below).
sustain profitability.
8
growth of the online video industry and the online advertising market;
the transition from long-form professional content to short-form user-generated content, or UGC;
the continued growth and maintenance of our user base;
our ability to control our costs and expenses; and
our ability to provide new advertising services to meet the demands of our advertising customers.
Many of these factors are beyond our control. For example, our revenues and profitability depend on the continuous development of the online advertising market in China and brand advertisers’ allocation of more budgets to online video industry. We incurredcannot assure you that online advertising, as a new marketing channel, will become more widely accepted in China or that the advertisers will increase their spending on online video websites. We may continue to incur net losses in 2007, 2008, 2009 primarily as a result of changes in the telecom operator policies and the manner in which they are enforced and intense market competition in the WVAS and music industries. Additionally, in January 2010, we acquired Ku6 Holding Limited (“Ku6 Holding”), an online video site in China to complement our WVAS, by issuing an aggregate of 723,684,204 ordinary shares. Ku6 Holding and its affiliates hereinafter are referred to collectively as our online video business, Ku6 or Ku6.com in this annual report on Form 20-F. Ku6 also incurred net losses in 2007, 2008 and 2009 primarily as a result of competition for online advertisers and costs associated with acquiring content and paying bandwidth fees. See “— Legal Risks Relatedfuture due to our Online Video Business — Maintaining copyright protection controls may prove to be costlycontinued investments in content, bandwidth and our online video business’ revenue from online marketing services may not be able to offset its cost in acquiring legally licensed content.” In light of this, we have recently been implementing certain cost control measures. However,technology. If we cannot successfully offset our increased costs with an increase in net revenues, our gross margin, financial condition and results of operations could be certain that these measures will be effectivematerially and that we will be able to return to profitability. Moreover, we couldadversely affected. We may also continue to incur net losses in the future due to changes in the market, operatingmacroeconomic and regulatory environment, and competitive dynamics and our abilityinability to respond to thosethese changes as well as any possible new strategic initiatives launched by our company. If we do not restore profitability, the market price of our ADSs may decline.
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We recognize revenue for a portion of our 2G services on an accrual basis, based on an internal estimation process which involves the use of estimates of monthly revenues to the extent we are unable to obtain actual figures from the telecom operators before we finalize our financial statements, which could in turn require us to make adjustments to our financial statements.
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We face significant competition, primarily from those companies that operate online video portal. Thus, the operational and financial results of the merger may differ from our expectations.
operations.
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relatively low cost.
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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 or additional financings in amounts or on terms acceptable to us, or at all.
The operation of an online video business requires significant upfront capital expenditures as well as continuous, substantial investment in content, technology 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 reported net losses attributable to our company of $23.4 million, $51.5 million and $49.3 million for the years ended December 31, 2009, 2010 and 2011, respectively. As of December 31, 2011, we had cash and cash equivalents of $26.8 million and net current assets of $21.2 million. Our net cash used in operating activities in 2011 was $39.2 million. We cannot assure you that we will be able to generate sufficient cash flows or otherwise maintain sufficient working capital to finance our anticipated operations and capital expenditure requirements, as well as achieve projected cash collections from customers and contain expenses and cash used in operations. Achievement of better operating performance is not assured and management expects to continue to implement its liquidity plans, which includes reducing operating expenses. In addition, various matters may impact our liquidity such as:
inability to achieve planned operating results that could increase liquidity requirements beyond those considered in our business plan;
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; and
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.
If we cannot meet our liquidity needs through improved operating results, we may need to obtain financings from financial institutions or issue debt securities. For example, on June 29, 2011, we issued $50,000,000 aggregate principal amount of senior convertible bonds to Shanda Media Group Limited (formerly known as Shanda Music Group Limited), or Shanda Media, a wholly owned subsidiary of Shanda Interactive. These senior convertible bonds were to mature in three years after issuance, but based on our working capital position, we redeemed the senior convertible bonds on September 30, 2011. 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 obtain additional funding through equity offerings. For example, pursuant to a share purchase agreement dated April 1, 2011, we issued 1,538,461,538 ordinary shares to Shanda Media for an aggregate purchase price of $50,000,000 (or $0.0325 per ordinary share). We may have to issue and sell additional securities to meet our liquidity needs, but our ability to sell our securities is not assured. Any additional issuance of 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;
general market conditions for financing activities by companies in our industry; and
macroeconomic, political and other conditions in China and elsewhere.
If we cannot obtain sufficient capital to meet our capital expenditure needs, we may not be able to execute our growth strategies and our business, financial condition and prospects may be materially and 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 industries,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 introduction of 3G mobile services by all three mobile carriers in China in 2009, 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 make it difficultresult 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.
We generate substantially all of our revenues from online advertising. If we fail to retain existing advertisers or attract new advertisers to advertise on our website or if we are unable to collect accounts receivable from the advertisers or advertising agencies in a timely manner, our financial condition, results of operations and prospects may be materially and adversely affected.
We generate substantially all of our revenues from online advertising. The online advertising market is new and rapidly evolving, particularly in China. As a result, many of our current and potential advertising clients have limited experience using the Internet for investorsadvertising purposes and historically have not devoted a significant portion of their advertising budget to evaluateInternet-based advertising. Moreover, changes in government policy could restrict or curtail our business.
We retain existing advertisers and attract new advertisers by maximizing return on their investment. If, however, our advertisers determine that their expenditures on online video websites do not generate expected returns, they may allocate a portion or all of their advertising budgets to other advertising channels such as television, newspapers and magazines and reduce or discontinue business with us. Since most of our advertisers are not bound by long-term contracts, they may amend or terminate advertising arrangements with us easily without incurring liabilities. Failure to retain existing advertisers or attract new advertisers to advertise on our website may materially and adversely affect our business, financial condition, results of operations and prospects.
Historically, we entered into a majority of our online advertising agreements with various third-party advertising agencies. Beginning in the second quarter of 2011, we have relied on Shanghai Shengyue Advertising Ltd., or Shengyue, an affiliate wholly owned by Shanda Interactive, as our advertising agency for sales to, and collection of payments from, a majority of our advertisers. The industriesfinancial soundness of our advertisers and Shengyue may affect our collection of accounts receivable. Any inability of our advertisers or Shengyue to pay us in a timely manner may adversely affect our liquidity and cash flows.
If we operate in are subjectfail to rapidcontinue to anticipate user preferences and continual changes. You should consider our prospects in light of the risksprovide products and difficulties frequently encountered by companies in an early stage of development. These risks include our ability to:
Our success depends on our WVAS;
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 offer;
The success of our online video business’ resources;
We believe that maintaining and
is of Our quarterly revenues and operating results may fluctuate, which makes our results of operations difficult to predict and may cause our quarterly results of operations to fall short of expectations.
Our quarterly revenues and operating results have fluctuated in the past and may continue to fluctuate depending upon a number of factors, many of which are out of our control. For these reasons, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our quarterly and annual revenues and costs and expenses as a percentage of our revenues may be severely disrupted if we losesignificantly different from our historical or projected rates. Our operating results in future quarters may fall below expectations. Any of these events could cause the servicesprice of our key executivesADSs to fall. Other factors that may affect our financial results include, among others:
global economic conditions;
our ability to maintain and employees or fail to add new senior and middle managers to our management.increase user traffic;
our ability to attract and retain qualified senioradvertisers;
changes in government policies or regulations, or their enforcement; and middle managers
geopolitical events or natural disasters such as war, threat of war, earthquake or epidemics.
Our operating results tend to our management team. If one or morebe seasonal. For instance, we may have slightly lower revenues during the first quarter of each year primarily due to the Chinese New Year holidays in that quarter. In addition, advertising spending in China has historically been cyclical, reflecting overall economic conditions as well as the budgeting and buying patterns of our current or future key executives or employees are unable or unwilling to continue in their present positions, wecustomers.
We may not be able to easily replace them, and our business may be severely disrupted. In addition, if any of these key executives or employees joins a competitor or forms a competing company, we could lose customers and suppliers and incur additional expenses to recruit and train personnel. Each of our executive officers has entered into an employment agreement and a confidentiality, non-competition and non-solicitation agreement with us. As we believe is customary in our industry in China, we do not maintain key-man life insurance for any of our key executives.
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Our net revenues grew significantly from $1.0 million in 2009 to $16.6 million in 2010 and financial resources, which may be inadequatefurther to sustain$19.2 million in 2011. To manage the further expansion of our business and the growth we want to achieve. If the user base of our WVAS increases or our affiliated musicoperations and online video companies expand,personnel, we will need to increase our investment in our technology infrastructure, facilitiescontinuously expand and other areas of operations, in particular our product development, customer service and sales and marketing, which are important to our future success. If we are unable to manage our growth and expansion effectively, the quality of our services and our customer support could deteriorate and our business may suffer. For example, any such performance issue could prompt China Mobile, China Unicom, or China Telecom to cease offering our services over their networks. Our future success will depend on, among other things, our ability to:
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 our periodic public disclosure undersuch 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 U.S. securitiesfines, 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.
A majority of the advertisements shown on our website are provided to us by advertising agencies 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 completefalse or fraudulent will be subject to joint and accurate.
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.
We may need to record impairment charges to earnings if our acquisition goodwill or acquired intangible assets are determined to be impaired, which would adversely affect our results of operations.
As part of our expansion and diversification strategy, we may acquire or invest in companies in the same or related industries in which we operate. We record acquisition goodwill and acquired intangible assets on our balance sheet in connection with such acquisitions and investments arrangements, respectively. We are required to review our acquisition goodwill for impairment at least annually and review our acquired intangible assets for impairment when events or changes in circumstances indicate that the carrying value may not be recoverable, including a decline in stock price and market capitalization and a slow down in our industry, which may result from the recent global economic slowdown. If the carrying value of our acquisition goodwill or acquired intangible assets were determined to be impaired, we would be required to write down the carrying value or to record charges to earnings in our financial statements during the period in which our acquisition goodwill or acquired intangible assets is determined to be impaired. During the years ended December 31, 2009, 2010 and 2011, we recorded impairment of $3.6 million, nil and nil, respectively, for acquisition goodwill relating to our discontinued operations and impairment of $3.5 million, nil and $1.4 million, respectively, for acquired intangible assets relating to our discontinued operations and continued operations. Any significant impairment charges would adversely affect our results of operations.
Disruption or failure of our systems could impair our users’ online video experience and adversely affect our reputation.
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, 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/or (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 the mobile telecommunications network, the Internet or our technology platformown 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 rely uponwill be successful in minimizing the frequency or duration of service interruptions.
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 revenues.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 WVAS are offered throughproducts and services depend on the networksability of China Mobile, China Unicom and China Telecom. In addition, we use our website to promote our services and enable users to order them. Thus, bothaccess the continual accessibilityInternet. Therefore, the successful operation of our business depends on the performance of the telecom operators’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 performanceMIIT. Moreover, we have entered into contracts with various subsidiaries of a limited number of telecommunications service providers in each province and reliabilityrely 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 are criticalor 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 abilitytechnology and infrastructure to attractkeep 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 retain users. Any server interruptions, break-downs or system failures, including failures caused by computer viruses, hacking or sustained power shutdowns, floods or fire causing loss or corruptionInternet services rise significantly, our results of data or malfunctions of software or hardware equipment,operations may be materially and adversely affected. If Internet access fees or other events outsidecharges to Internet users increase, our control that could result in a sustained shutdown of all or a material portion of the mobile networks, the Internet oruser traffic may decline and our technology platform, could adversely impact our ability to provide our services to users and decrease our revenues.
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.
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We have been and management. In addition,expect we control Hurray! Digital Media through threewill continue to be exposed to intellectual property infringement and other claims, including claims based on content posted on our website, which could be time-consuming and costly to defend and may result in substantial damage awards and/or court orders that may prevent us from continuing to provide certain of our VIEs, Hurray! Solutions, Beijing Network and Beijing Hutong. It is possible that the relevant Chinese authorities could, at any time, assert that our agreements with our VIEs or any portion or all of the existing or future ownership structure and businesses of each of our company, our wholly owned subsidiary, Beijing Hurray! Times Technology Co., Ltd. (“Beijing Hurray! Times”), or our VIEs violate existing or future Chinese laws, regulations or policies. It is also possible that the new laws or regulations governing the telecommunication or Internet sectorsservices.
Our success depends, in China that have been adopted or may be adopted in the future will prohibit or restrict foreign investment in, or other aspects of, any of our, Beijing Hurray! Times’ or our VIEs’ current or proposed businesses and operations. In addition, these new laws and regulations may be retroactively applied. If any of our company, Beijing Hurray! Times or our VIEs is found to be in violation of any existing or future Chinese laws or regulations, the relevant regulatory authorities would have broad discretion in dealing with such violation, including, without limitation, the following:
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We have no significant assets other than our equity interests in Beijing Hurray! Times, Hurray! Media (through which we hold equity interests in Seed Music Group)been and Ku6 Holding. We are a holding company, and we rely principally on dividends that may be paid from Beijing Hurray! Times, Hurray! Media and Ku6 Holding from timecontinue to time and technical consulting and service fees, license fees and other fees paid to Beijing Hurray! Times by our VIEs for our cash requirements, including any debt we may incur. We are likely to lose all of our sources of funds if Beijing Hurray! Times, Hurray! Media or Ku6 Holding is restricted from paying dividends to us.
Due to the significant number of videos uploaded by users, which currently amounts to an average of approximately 150,000 files on a daily basis, we may not be able to accessidentify all content that may infringe on third-party rights. Thus, our internal source of funds.
Additionally, although we have not previously been subject to legal actions for copyright infringement in jurisdictions other than the PRC, it is possible that we may be subject to such claims in the future. Many ofSuch other jurisdictions may impose different protections for copyrights, and the factors that cause such fluctuationclaims may result in potentially larger damages awards than have been imposed in the PRC. For example, although our operations are outsidein the PRC and our control. Steady revenuessite is targeted at audiences in Asia, our site includes some English-language content and results of operations will depend largely on our ability to:
United States.
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We believe the copyrights, service marks,that trademarks, trade secrets, patents, copyrights and other intellectual property we use are important componentsto our business. We rely on a combination of our WVAStrademark, copyright, patent and online services. In addition, our affiliated music companies are substantially dependent on their ability to protect their rights over their music content. Any unauthorized use of our intellectual property by third parties may adversely affect our currenttrade secret protection laws in China and future revenue from such services and software,other jurisdictions, as well as our reputation. For example, rampant piracy in China has negatively affected offline sales of CDs and tapes by our affiliated music companies, and their financial results may be further materially adversely affected by piracy in online distribution channels. We rely primarily on intellectual property lawsconfidentiality procedures and contractual arrangements with our employees, clients, business partners, and users and othersprovisions to protect our intellectual property rights. Third parties may nonetheless obtain and use our intellectual property without our authorization.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. Furthermore, theIn 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 wireless value-added and music industriesindustry in China isare uncertain and still evolving,evolving. Implementation and theseenforcement of PRC intellectual property-related laws may not protecthave historically been deficient and ineffective. Accordingly, protection of intellectual property rights to the same extent as the laws of some other jurisdictions. In particular, intellectual property law in China is less developed thanmay not be as effective as in the United States or other western countries. Furthermore, policing unauthorized use of proprietary technology is difficult and historically, China has often not protected private intellectual property rightsexpensive, and we may need to the same extent as the United States. Moreover,resort to litigation may be necessary in the future to enforce or protectdefend patents issued to us or our other intellectual property or to determine the enforceability, scope and validity of our proprietary rights whichor those of others. Such litigation and an adverse determination in any such litigation, if any, could result in substantial costs and diversion of our resources and management attention.
Changes in government policies or regulations may have a material and adverse effect on our business, financial condition, results of operations and cash flows.
Our online video business is subject to strict government regulations in the PRC. Under the current PRC regulatory scheme, a number of regulatory agencies, including the State Administration of Radio, Film, and Television, or SARFT, the Ministry of Culture, the Ministry of Industry and Information Technology, or MIIT, the General Administration of Press and Publication, or GAPP, and the State Council Information Office, or SCIO, jointly regulate all major aspects of the Internet industry, including the online video industry. Operators must obtain various government approvals and licenses, including an Internet content provider license, or ICP license, and an Internet audio/video program transmission license, prior to the commencement of online video operations. We have obtained the licenses and permits essential for our business operations. We have obtained the ICP license, the Internet audio/video program transmission license (currently covering the Internet user uploaded audio/video program service) and a permit from the Beijing Drug Administration to post approved non-prescription drug advertisement on our website We currently operate a current events channel on our website, which includes audio/video content relating to current topics and social events.
Any of these actions by the PRC government may have a material and adverse effect on our results of operations. In addition, the PRC government may promulgate regulations restricting the types and content of advertisements that may be transmitted online, which could have a direct adverse impact on our business.
Our ability to operate effectively could be impaired if we fail to attract and retain our executive officers.
Our success depends, in part, upon the continuing contributions of our executive officers. Although we have an employment agreement with our chief financial officer and the third-party human resources agency that we use has an employment agreement with our chief executive officer, we cannot assure you that we will be able to retain these executive officers. The loss of the services of any of our executive officers or the failure to attract other executive officers could have a material adverse effect on our business overall financial condition and results of operations.
prospects.
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Insurance companies in China currently do not offer limited businessas extensive an array of insurance products andas insurance companies do not, to our knowledge, offer business liability insurance. As a result, wein more developed economies. We do not have any business liability or disruption insurance coverage forto cover our operations. Moreover, while business disruption insurance is available, weWe have determined that the costs of insuring for these risks of disruption and costthe difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. Any uninsured occurrence of the insurance are such that we do not require it at this time. Any business disruption litigation or natural disaster mightmay result in our incurring substantial costs and the diversion of resources, particularly if it affects our technology platform which we depend on for delivery of our WVAS.
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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 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 whichthat 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.
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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. In addition, an independent registered public accounting firm must report on such company’s internal control over financial reporting.
Our management concluded that our internal control over financial reporting was effective as of December 31, 2011 and our independent registered public accounting firm has issued an attestation report concluding that our internal control over financial reporting was effective in all material aspects. However, we had identified a material weakness in our internal control over financial reporting as of December 31, 2010 relating to a lack of sufficient competent accounting personnel with appropriate levels of accounting knowledge and experience to address complex U.S. GAAP accounting issues and prepare financial statements and related disclosures under U.S. GAAP and we cannot assure you that we will be able to maintain the effectiveness of our internal control over financial reporting on a continuing basis in the future. As effective internal control over financial reporting is necessary for us to produce reliable financial reports and are important to help prevent fraud, any failure to maintain effective internal control over financial reporting could harm our business and result in a loss of investor confidence in the reliability of our financial statements, which in turn could negatively impact the trading price of our ADSs. Furthermore, we may need to incur additional costs and use additional management and other resources in an effort to comply with Section 404 of the Sarbanes-Oxley Act and other requirements going forward.
It is not clear whether we were a passive foreign investment company, or PFIC, for taxable year 2011. Although we believe we were not a PFIC for taxable year 2010, we believe that we were a PFIC for taxable years 2006, 2007, 2008 and 2009, which could result in adverse U.S. federal income tax consequences to U.S. investors.
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 is not clear whether we were a PFIC for taxable year 2011.That determination is subject to uncertainty because of the uncertain characterization of our assets and income for purposes of the PFIC rules. If we were a PFIC for 2006, 2007, 2008, 2009 or 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, even if we cease to be a PFIC in taxable years ending after 2011. Because 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), there can be no assurance 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 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 “Taxation—U. S. Federal Income Taxation” below.
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 the PRC, it is uncertain whether we would be deemed a PRC tax resident enterprise under the EIT Law and other related PRC laws and regulations. If we are deemed to be a PRC tax resident enterprise, our global income will be subject to PRC enterprise income tax at the rate of 25%, which would have a material adverse effect on 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, or FIEs, earned after January 1, 2008, are subject to a 10% withholding tax. There are no undistributed earnings of our subsidiaries located in the PRC that are available for distribution as of December 31, 2011. In addition, we (i) do not have any present plan to pay any cash dividends on our ordinary shares in the foreseeable future and (ii) intend to retain most of our available funds and any future earnings for use in the operation and expansion of our business in the PRC. Accordingly, no provision has been made for the PRC dividend withholding taxes that would be payable upon distributions of dividends by our PRC subsidiaries to us. Any future dividends that we will receive from our PRC subsidiaries will be subject to PRC withholding tax.
All participants of our existing equity compensation plans who are PRC citizens are required to register with the State Administration of Foreign Exchange of the PRC, or SAFE, and the failure to so comply could subject us and such participants to penalties.
On March 28, 2007, SAFE issued the Operating Procedures for Administration of Domestic Individuals Participating in the Employee Stock Ownership Plan or Stock Option Plan of an Overseas Listed Company, or Circular 78. On May 29, 2007, SAFE issued the Notice on Printing and Distributing the Operating Rules for the Notice of the State Administration of Foreign Exchange on the Relevant Issues about Foreign Exchange Control over the Financing and Return Investment of Domestic Residents through Overseas Special Purpose Companies, or Circular 106. According to these regulations, PRC citizens who participate in an employee stock ownership plan or a stock option plan in an overseas, publicly listed company are required to register with SAFE and complete certain other procedures. 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. In the case of an employee stock ownership plan, an overseas custodian bank should be retained by the PRC agent to hold in trusteeship all overseas assets held by such participants under the employee stock ownership plan. In the case of a stock option plan, a financial institution with stock brokerage qualification in the jurisdiction where the overseas publicly-listed company is listed or a qualified institution designated by the overseas, publicly listed company is required to be retained by the PRC agent to handle matters in connection with the exercise or sale of stock options for the stock option plan participants. The PRC agents or employers should, on behalf of the PRC citizens, apply annually to SAFE or its competent local branches for a quota for the conversion and/or payment of foreign currencies in connection with the PRC citizens’ exercise of the employee stock options. The foreign exchange proceeds received by the PRC citizens from 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 citizen employees who participate in the employee stock ownership plan or a stock option plan have not yet completed the required registration with SAFE. 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.
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, or if these regulations or the interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations.
Current PRC laws and regulations place certain restrictions on foreign ownership of companies that engage in 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%. We conduct our operations in China principally through contractual arrangements among our PRC subsidiaries (Beijing WFOE, Tianjin WFOE and Tianjin Ku6 Network WFOE), our consolidated affiliated entities in the PRC (Ku6 Information Technology, Tianjin Ku6 Zheng Yuan, Ku6 Cultural and Tianjin Ku6 Network), and their respective shareholders. Ku6 Information Technology holds the licenses and permits necessary to conduct our online video, online advertising and related businesses in China. Our contractual arrangements with Ku6 Information Technology, Tianjin Ku6 Zheng Yuan, Ku6 Cultural and Tianjin Ku6 Network and their respective shareholders 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. “Information on the Company—Organizational Structure.”
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. 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. If the PRC government determines that we do not comply with applicable laws and regulations, it could revoke our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues, block our 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.
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 the PRC. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in 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.
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 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.
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, 2011, the registered capital was $11,700,000 for Beijing WFOE, $60,000,000 for Tianjin WFOE and $30,000,000 for Tianjin Ku6 Network WFOE, respectively. As none of our PRC subsidiaries has made any profits to date, our PRC subsidiaries have not been subject to the statutory reserve fund requirements and have not set aside any money to fund the statutory reserve funds or staff welfare and bonus funds. Our PRC subsidiaries will not be able to pay dividends to us or our offshore subsidiaries until they generate accumulated profits and meet the requirements for statutory reserve funds. 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 $59.4 million, or 116.7% of our company’s total consolidated net assets as of December 31, 2011. In addition, our PRC subsidiaries and our consolidated affiliated entities may, at their discretion, allocate a portion of their after-tax profits based on PRC accounting standards to staff welfare and bonus funds. These staff welfare and bonus funds are not distributable as cash dividends.
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.
Restrictions on currency exchange may limit our ability to utilize our revenues effectively.
Most of our revenues and operating expenses are denominated in Renminbi. The Renminbi is currently freely convertible under the “current account,” which includes dividends, trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans.
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 its current account, subject to a ceiling approved by SAFE, to satisfy foreign exchange liabilities or to pay dividends. 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.
Since a significant amount of our future revenues will be denominated in Renminbi, the existing and any future restrictions on currency exchange may limit our ability to utilize revenues generated in Renminbi to fund our business activities outside China, if any, or expenditures denominated in foreign currencies.
Foreign exchange transactions under the capital account are subject to limitations and require registration with or approval by the relevant PRC governmental authorities. In particular, if we finance our PRC subsidiaries by means of foreign currency loans, those loans cannot exceed certain statutory limits and must be registered with SAFE, and if we finance our PRC subsidiaries by means of capital contributions, those capital contributions must be approved by the Ministry of Commerce of the PRC, or MOFCOM. Our ability to use the U.S. dollar proceeds of the sale of our equity or debt to finance our business activities conducted through our PRC subsidiaries will depend on our ability to obtain these governmental registrations or approvals. In addition, because of the regulatory issues related to foreign currency loans to, and foreign investment in, domestic PRC enterprises, we may not be able to finance our PRC operating companies’ operations by loans or capital contributions. We cannot assure you that we can obtain these governmental registrations or approvals on a timely basis, if at all.
We may be unable to collect long-term loans extended to the shareholders of our consolidated affiliated entities.
As of December 31, 2011, we made long-term, interest-free loans in an aggregate principal amount of RMB20.0 million ($3.2 million) to the shareholders of our consolidated affiliated entities to enable them to fund the initial capitalization and the subsequent financial requirements of our consolidated affiliated entities. The initial term for such loans is 10 years (in respect of loans to shareholders of Ku6 Information Technology and Ku6 Cultural) or 20 years (in respect of loans to shareholders of Tianjin Ku6 Network) and can be extended upon written agreement. We may in the future make additional loans to the shareholders of our consolidated affiliated entities in China in connection with any increase in the capitalization or financial requirements of these entities to the extent necessary and permissible under applicable PRC laws and regulations. Our ability to collect these long-term loans will depend on the profitability and results of operations of these consolidated affiliated entities, which are uncertain.
The new PRC Property Rights Law may affect the perfection of the pledge in our equity pledge agreements with our consolidated affiliated entities and their individual shareholders.
Under the equity pledge agreements among Beijing Hurray! Times and someour PRC subsidiaries, certain of our VIEs,consolidated affiliated entities and their respective individual shareholders, the individual shareholders of these VIEsour consolidated affiliated entities, the shareholders of our consolidated affiliated entities have pledged all of their equity interests thereinin these entities to Beijing Hurray! Timesour relevant subsidiaries by recording the pledge on the shareholder registers of the respective entities. However, according to the PRC Property Rights Law, which became effective as of October 1, 2007, a pledge is not effective without beingvalid unless it is registered with the relevant local administration for industry and commerce. The StateSAIC and many of its local branches, including Shanghai Administration for Industry and Commerce or SAIC, and the BeijingTianjin Administration for Industry and Commerce, have adopted registration procedures with respect to the registration of equity interest pledgepledges according to the Property Rights Law. These VIEsKu6 Information Technology and Tianjin Ku6 Network have completed the registration of equity pledges on November 13, 2008 and January 20, 2012, respectively. Ku6 Culture and Tianjin Ku6 Zheng Yuan are in the process of registering the relevant equity pledgepledges with the Beijing/Shanghai Administrationlocal administration for Industryindustry and Commerce.commerce for the benefit of our PRC subsidiaries. We cannot assure you that they will be able to register the equity pledges. If they are unable to do so, the pledges may be deemed ineffectiveunenforceable under the PRC Property Rights Law. IfUntil such pledge interests are registered, they are not considered perfected under the PRC law. Consequently, if any individual shareholder of our VIEsconsolidated affiliated entities breaches his or her obligations under the agreementcontractual arrangements with Beijing Hurray! Times,respect to these entities, there is a risk that Beijing Hurray! Timesour PRC subsidiaries may not be able to successfully enforce the pledgeequity pledges and would need to resort to legal proceedings to enforce itstheir contractual rights.
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As of December 31, 2011, Shanda Interactive beneficially owned approximately 66.4% of our outstanding equity interests. Conflicts of interest may arise between Shanda Interactive and us in a number of areas relating to our past and ongoing relationships. In addition to the conflicts of interests we have discussed in other risk factors, potential conflicts of interest that we have identified include the following:
| • | Our board members or executive officers may have conflicts of interest. Mr. Tianqiao Chen, Ms. Grace Wu and Mr. Danian Chen, who are our directors, currently also serve as directors or officers of Shanda Interactive. Some of our directors also own equity interests in Shanda Interactive. Our board members may receive incentive share compensation from Shanda Games, a subsidiary of Shanda Interactive, from time to time. These relationships could create perceived or actual conflicts of interest when these persons are faced with decisions with potentially different implications for Shanda Interactive and us. |
| • | Potential competition with Shanda Interactive. Shanda Interactive may engage in certain transactions or businesses that directly or indirectly compete with our online video and audio businesses. |
| • | Business opportunities. Business opportunities may arise that both we and Shanda Interactive find attractive, and which would complement our respective businesses. Due to the controlling interest of Shanda Interactive and its leading market position and brand in China, we may not be able to pursue these business opportunities effectively if Shanda Interactive decides to take advantage of such opportunities itself. |
| • | Developing business relationships with Shanda Interactive’s competitors. So long as Shanda Interactive remains our controlling shareholder, we may be limited in our ability to do business with its competitors, such as other interactive entertainment media companies in China. |
Although our company is a stand-alone entity, we expect to operate, for as long as Shanda Interactive is our controlling shareholder, as a part of the Shanda Group. Shanda Interactive may from time to time make strategic decisions that it believes are in the best interests of Shanda Group as a whole. These decisions may be different from the decisions that we would have made on our own. Shanda Interactive’s decisions with respect to us or renew certain permits or licenses, including without limitation an Internet news license, which is issued by the State Council News Office, an Internet culture business permit, which is issued by the Ministry of Culture, an audio/video program transmission license, which is issued by the State Administration of Radio, Film and Television, an Internet publication business license, which is issued by the General Administration of Press and Publication, an online game virtual currency issuance or trading license, which is issued by the Ministry of Culture, and a surveying and mapping qualification certificate for Internet map services, which is issued by the State Bureau of Surveying and Mapping. This may significantly disrupt our business or subject us to sanctions, requirements to increase capital or other conditions or enforcement, or compromise enforceability of related contractual arrangements, or have other harmful effects on us.
Risks Related to register any new Internet cafesDoing Business in 2007. In 2008 and 2009, the Ministry of Culture, the State Administration for Industry and Commerce and other relevant government authorities, individually or jointly, issued several notices that provide various ways to strengthen the regulation of Internet cafes, including investigating and punishing Internet cafes that accept minors, cracking down on Internet cafes without sufficient and valid licenses, limiting the total number of Internet cafes and approving Internet cafes within the planning made by relevant authorities, screening unlawful and adverse games and websites, and improving the coordination of regulation over Internet cafes and online games. So long as Internet cafes are one of the primary venues for our users to access our websites, any reduction in the number, or any slowdown in the growth, of Internet cafes in China could limit our ability to maintain or increase user traffic to our websites.
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The ChinesePRC 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 ChinesePRC 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 ChinesePRC government may enact new laws or amend current laws that may be detrimental to our current contractual arrangements with respect to our Chinese affiliates,consolidated affiliated entities, which may in turn have a material adverse effect on our ability to operate our business.
AnyPRC 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.
In October 2005, SAFE issued the 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, which became effective as of November 1, 2005, and which was supplemented by an implementing notice issued on November 24, 2005. We refer to them collectively as Notice 75. Under Notice 75, PRC residents and citizens must register with the relevant local SAFE branch prior to their establishment or control of an offshore entity established for the purpose of an overseas equity financing involving onshore assets or equity interests held by them, and must also make filings with SAFE thereafter upon the occurrence of pandemic avian influenzacertain material capital changes. The registration and filing procedures under Notice 75 are prerequisites for other approval and registration procedures necessary for capital inflow from the offshore entity, such as inbound investments or shareholders’ loans, or capital outflow to the offshore entity, such as the payment of profits or dividends, liquidating distributions, equity sale proceeds or the return of funds upon a capital reduction. Notice 75 also requires that if a PRC resident has established or gained control of an SPV and completed the return investment prior to the implementation of this Notice 75 but failed to complete the foreign exchange registration in relation with its overseas investment, it shall carry out such registrations with the local branch of SAFE in accordance with this Notice 75 by March 31, 2006. After the PRC resident has retroactively completed the foreign exchange registration in relation with its overseas investment, the local branch of SAFE may process the registration pertaining to foreign investment and foreign debt for the relevant PRC enterprises.
The failure or inability of our shareholders who are PRC citizens or PRC residents to comply with the registration procedures set forth in these regulations may subject us to fines or legal sanctions, restrictions on our cross-border investment activities or our PRC subsidiaries’ ability to distribute dividends to, or obtain foreign-exchange-dominated loans from, our company, or prevent us from making distributions or paying dividends. As a result, our business operations and our ability to make distributions to you could be materially and adversely affected.
The failure to comply with the regulations regarding the use of the foreign currency registered capital may subject us to severe monetary or other widespread public health problem,penalties.
On August 29, 2008, SAFE promulgated the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of the Payment and Settlement of Foreign Currency Capital of Foreign Invested Enterprises, or SAFE Circular 142, regulating the conversion by a foreign-invested enterprise of foreign currency registered capital into Renminbi by restricting how the converted Renminbi may be used. SAFE Circular 142 provides that the Renminbi capital converted from foreign currency registered capital of a foreign-invested enterprise may only be used for purposes within the business scope approved by the applicable governmental authority and may not be used for equity investments within the PRC, unless it is provided for otherwise. In addition, SAFE strengthened its oversight of the flow and use of the Renminbi capital converted from foreign currency registered capital of a foreign-invested company. The use of such Renminbi capital may not be altered without SAFE approval, and such Renminbi capital may not in any recurrencecase be used to repay Renminbi loans if the proceeds of severe acute respiratory syndrome,such loans have not been used. Failure to comply with SAFE Circular 142 could result in liabilities for such PRC subsidiaries under PRC laws for evasion of applicable foreign exchange restrictions, including (i) being required to take appropriate remedial action, confiscation of any illegal income and imposition of a fine of up to 30% of the illegal amount involved and (2) in circumstances involving serious violations, a fine of between 30% and 100% of the illegal amount involved shall be imposed on the organization or SARS, could adversely affect our business and results of operations.
We may incur substantial increases in labor cost due to the promulgation of the new labor contract law.
The PRC National People’s Congress of China enactedpromulgated the Labor Contract Law, which became effective on January 1, 2008. TheCompared to previous labor laws, the Labor Contract Law contains substantial provisionsprovides stronger protection for employees and imposes more obligations on employers. According to the Labor Contract Law, employers have the obligation to enter into written labor contracts with employees to specify the key terms of the employment relationship. The law also stipulates, among other things, (i) that all written labor contracts shall contain certain requisite terms; (ii) that the length of trial employment periods must be in proportion to the terms of the relevant labor contracts, which in any event shall be no longer than six months; (iii) that in certain circumstances, a view toward improve job securitylabor contract shall be deemed to be without a fixed term and thus an employee can only be terminated with cause; and (iv) that there shall be certain restrictions on the circumstances under which employers may terminate labor contracts as well as the economic compensations to protectemployees upon termination of the rightsemployee’s employment.
In addition, some of our employees, including our chief executive officer, are contracted through a third-party human resources agency that is responsible for managing, among others, payrolls, social insurance contributions and interestslocal residency permits of these employees. We may be held jointly liable if the third-party agency fails to pay such employees their wages and other benefits or otherwise become liable to these employees for labor law violations. In order to fully comply with the legal requirements under the Labor Contract Law and other related laws, we may incur substantial increases in labor cost.
Our failure to make adequate contributions to various employee benefit plans as required by PRC regulations may subject us to penalties.
We are required by PRC laws and regulations to participate in various government-sponsored employee benefit plans, including social insurance funds (namely a pension contribution plan, a medical insurance plan, an unemployment insurance plan, a work-related injury insurance plan and a maternity insurance plan) and a housing provident fund and contribute to the plans in amounts equal to certain percentages of salaries, including bonuses and allowances, of our employees up to a maximum amount specified by the local government from time to time at locations where we operate our businesses. Employers who fail to report and pay social insurance funds in accordance with the relevant rules may be ordered to rectify the problem and pay the social insurance funds within a stipulated deadline. According to the Interim Regulation on the Collection and Payment of Social Insurance Premiums, if payment of certain social insurance funds is not made by the stipulated deadline, the relevant authority can charge a late fee payment of 0.2% per day from the original due date and fine the responsible persons of the employer up to RMB10,000. If an employer is found to be concealing the actual number of employees or the total amount of salaries from competent social insurance authorities, the employer may be subject to penalties. According to relevant PRC laws, for the failure to register or open housing provident fund accounts for employees, the employer may be required to rectify such breach within certain period and if such breach persists after such period, the employer may be subject to a fine ranging from RMB10,000 to RMB50,000. For the failure of payment of housing provident fund and failure to rectify such breach within certain period prescribed by the relevant authorities, the relevant housing provident fund authorities may apply for a court order requiring employers to make such payment.
A severe and prolonged global economic recession andslowdown of the corresponding slowdown in the ChinesePRC economy may adversely affect our business, results of operations and financial condition.
Since we generate substantially all of our revenue from online advertising, a slowdown of the recent global financial crisis has persisted, with most of the world’s major economies remainingPRC economy could cause decreases or delays in recessionadvertising spending, a reduction in 2010. While there has been improvement in some areas, it is still unclear whether the recovery is sustainable. There is considerable uncertainty over the long-term effects of the expansionary monetaryour revenue and fiscal policies adopted by the central banks and financial authorities of the world's leading economies, including China’s. Continued concerns about the systemic impact of potential long-term and wide-spread recession, energy costs, geopolitical issues, the availability and cost of credit, the global housing and mortgage markets and the European debt crisis have contributed to increased market volatility and diminished expectations for economic growth around the world. The grim economic outlook has negatively affected business and consumer confidence and contributed to volatility of unprecedented levels. The Chinese economy also faces challenges. The stimulus plans and other measures implemented by the Chinese government may not avert an economic downturn amid a severe and prolonged global economic recession. Any prolonged slowdown in the Chinese economy may have a negative impact on our business, operatingability to grow our revenue. Further, any decreased collectability of accounts receivable or early termination of advertising agreements as a result of adverse economic conditions could negatively impact our results and financial condition in a number of ways. For example, our customers may reduce or delay spending with us, while we may have difficulty expanding our customer base fast enough, or at all, to offset the impact of decreased spending by our existing customers.
operations.
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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 ChinesePRC 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 ChinesePRC 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 ChinesePRC economy were similar to those of the OECD member countries.
Governmental control of currency conversion may affect the value of our ordinary shares and ADSs.
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. We receive substantially all of our revenue in Renminbi, which is currently not a freely convertible currency. Under our current corporate structure, the income of our company will be primarily derived from dividend payments from Beijing Hurray! Times.WFOE and Tianjin WFOE. Shortages in the availability of foreign currency may restrict the ability of Beijing Hurray! TimesWFOE and Tianjin WFOE to remit sufficient foreign currency to pay dividends to us, or otherwise satisfy its foreign currency-dominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, can be made in foreign currencies without prior approval from SAFE by complying with certain procedural requirements. However, in most cases, particularly payments of capital accounts items, approval from appropriate governmental authorities is required where (i) 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 or (ii) any foreign currency is to be converted into Renminbi for investment in China. The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from converting Renminbi into foreign currencies or vice versa, and obtaining sufficient Renminbi or foreign currency to satisfy our currency demands, our ability to transfer Renminbi to fund our business operations in China or to pay dividends in foreign currencies to our shareholders may be adversely affected.
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 products and 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 slow downslowdown in the PRC economy could also materially and adversely affect our business and prospects.
Our shareholders may face difficulties in effecting service of process, enforcing foreign judgments or bringing original actions in China based on United States or other foreign laws against us or our management.
We conduct substantially all of our operations in China and substantially all of our assets are located in China. In addition, mostall of our directors and executive officers reside within China. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon some of our directors and senior executive officers, including with respect to matters arising under U.S. federal securities laws or applicable state securities laws. Moreover, the PRC does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgment of courts.
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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 financial condition and results of operations. Conversely, as we rely entirely on dividends paid
Risks Related to us by Beijing Hurray! Times, any depreciation of the Renminbi may materially and adversely affect our cash flows, revenue and financial condition, and the value of, and any dividends payable on, our ordinary shares in foreign currency terms.
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. Since we completed our initial public offering on January 13, 2005, theThe sale pricesprice of our ADSs on the NASDAQ Global Market ranged from US$0.93$0.75 to US$11.80$8.12 per ADS in 2011 and the last reported sale price on April 23, 2010March 26, 2012 was US$3.50.
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 regarding intellectual property rights litigation;
actual or anticipated fluctuations in our quarterly operating results;
changes in financial estimates by securities research analysts;
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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 issuances, or perceived future sales or issuances, of our ADSs also could be affected by possible salessubstantial amounts of our ordinary shares or ADSs by investors who viewcould adversely affect the convertible notesprice of our ADSs.
If our existing shareholders sell, or are perceived as a more attractive meansintending to sell, substantial amounts of equity participation in our company and by hedging or arbitrage activity involving our ordinary shares or ADSs, including those issued upon the exercise of our outstanding stock options, following this offering, the market price of our ADSs could fall. Such sales, or perceived potential sales, by our existing 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. The ADSs that we believe has developedoffered in this offering will be eligible for immediate resale in the public market without restrictions, and shares held by our existing shareholders may also be sold in the public market in the future subject to the restrictions contained in Rule 144 and Rule 701 under the Securities Act of 1933, as amended, or the Securities Act, and the applicable lock-up agreements. If any existing shareholder or shareholders sell a resultsubstantial amount of ordinary shares after the expiration of the issuance oflock-up period, the convertible notes.
As a foreign private issuer with ADSs listed on the NASDAQ Global Market, we follow certain 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 certain 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 Select 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 of the Cayman Islands (2009 Revision) and the common law of the Cayman Islands. The rights of our 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 ofin the Cayman Islands is derived in part from comparatively limited judicial precedentprecedents in the Cayman Islands as well as that from English common law, which hasthe decisions of whose courts are of persuasive authority but are 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 arein 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 lawlaws as compared to the United States, and provides significantly less protectionsome 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 investors. In addition,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 a shareholder derivative action in theactions before any federal court of the United States.
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A final and conclusive judgmentin personam of a competent foreign court against our company based upon the agreements under which a definite sum of money is no statutory recognitionpayable (not being a sum payable in respect of taxes or other charges of a like nature of, in respect 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 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 of judgments obtainedand (b) the judgment is not contrary to public policy in the United States, although the courts of the Cayman Islands, will generally recognizehas not been obtained by fraud or in proceedings contrary to natural justice and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrialis not based on the merits.
As a result of all of the above, our shareholders may have more difficulties in protecting their interests in the face of actions by our management, directors or controlling shareholders than would shareholders of a public company incorporated in a jurisdiction in the United States.
In addition, Cayman Islands companies may not have standing to sue before the federal courts of the United States. As a result, our ability to protect our interests if we are harmed in a manner that would otherwise enable us to sue in a United States federal court may be limited.
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 the PRC. 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. In addition, there is uncertainty as to whether the courts of the Cayman Islands or the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the United States or any state due to the lack of reciprocal treaty in the Cayman Islands or the PRC providing statutory recognition of judgments obtained in the United States. Furthermore, it is uncertain whether such Cayman Islands or PRC courts would be competent to hear original actions brought in the Cayman Islands or the PRC against us or such persons who reside outside the United States predicated upon the securities laws of the United States or any state.
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 amended and restated memorandum and articles of association include provisions that could limit the ability of others to acquire control of us, modify our structure or cause us to engage in change of control transactions, 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 amended and restated memorandum and articles of association and Cayman Islands law, the minimum notice period required for convening a general meeting is tenfive days. When a general meeting is convened, you may not receive sufficient notice of a shareholders’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.
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Pursuant to the New EIT Law, we may be treated as a PRC resident enterprise for PRC tax purposes. See “— Additional Risks Related to Our Company — Changes inBusiness—We may be deemed a PRC tax laws could have a material adverse effectresident enterprise under the EIT Law and be subject to PRC taxation on our operating results.”worldwide income” above. If we are so treated by the PRC tax authorities, we wouldmay be obligated to withhold PRC income tax of up to 5.0% on payments of dividends on our shares and/or ADSs to investors that are non-resident enterprises of the PRC located in Hong Kong and 10.0% on payments of dividends on our ordinary shares and/orand ADSs to investors that are non-resident enterprises of the PRC located outside Hong Kong, ifbecause the dividends payable on our ordinary shares and/orand ADSs are consideredmay be regarded as being derived from sources within the PRC. A non-resident enterprise is an enterprise that does not have an establishment or place of business in the PRC or that has such establishment or place of business but its income is not effectively connected with the establishment or place of business. The withholding tax rate would generally be 10% on dividends paid to non-resident enterprises. In addition, any gain realized by investors who are non-resident investorsenterprises from the transfer of our ordinary shares and/or ADSs couldmay be regarded as being derived from sources within the PRC and be subject to a 10% PRC tax. Such
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 at a rate of 20% on dividends paid to such investors and any capital gains realized from the transfer of our ordinary shares and ADSs if such dividends and gains are deemed income derived from sources within the PRC. A non-resident individual is an individual who has no domicile in the PRC and does not stay within the PRC or has stayed within the PRC 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 we pay with respect to our ordinary shares and ADSs and the gains realized from the transfer of our ordinary shares and ADSs were considered income derived from sources within the PRC by relevant PRC tax authorities, such dividends and gains earned by non-resident individuals would also be subject to PRC tax at a rate of 20% except in the case of individuals that qualify for a lower rate under a tax treaty. Under the PRC-U.S. tax treaty, a 10% rate will apply to dividends provided certain conditions are met.
The foregoing PRC taxes may reduce your investment return on our ordinary shares and/orand ADSs and may also adversely affect the price of our ordinary shares and/orand ADSs.
You may be subject to limitations on transfer of your ADSs.
Your ADSs represented by American Depositary Receipts 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. The depositary may also close its books in emergencies, and on weekends and public holidays. The depositary may refuse to deliver, transfer, or register transfers of our ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary thinks it is advisable to do so because of any requirement of law or any government or governmental body, or under any provision of the deposit agreement, or for any other reason.
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.effective nor is it our current intention to do so. Moreover, we may not be able to establishrely on an exemption from registration under the Securities Act. Accordingly, ADS holders may be unable to participate in ourfuture 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.
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. At that time, we focused on developing billing software and providing system integration services for telecommunications network operators in their fixed-line Internet infrastructure build-outs. In June 2001, members of our current management team conducted a management buy-in by purchasing a substantial equity interest in our company, at which time the team assumed management control of us with the purpose of developing products and services for 2.5G mobile networks. Prior to the management buy-in, a majority of the new management team had previously worked together in senior management positions at AsiaInfo Holdings, Inc., a Nasdaq-listed company and a leading provider of telecommunications software and system integration services in China.
In April 2002, we established a new holding company, Hurray! Holding Co., Ltd., in the Cayman Islands. We currently conduct our business in China through our wholly owned subsidiary, Beijing Hurray! Times. To comply with ownership requirements under Chinese law which imposes certain restrictions on foreign companies from investing in certain industries such as value-added telecommunication and Internet services, we have entered into a series of agreements with our nine VIEs and their respective shareholders. We hold no ownership interest in any such VIEs. See Item 7.B. “Related Party Transactions,” and Item 4.C. “Information on the Company — Organizational Structure.”
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In June 2009, we entered into a tender offer agreement with Shanda Interactive under which Shanda Interactive commenced a tender offer to acquire 51% of our outstanding ordinary shares (including shares represented by our ADSs) at a price of US$0.04 per ordinary share (or US$4.00 per ADS).the time. The tender offer was successfully completed in July 2009. As of April 1,
In January 2010, Shanda owned approximately 42.0% of our outstanding equity interests.
On May 28, 2010, we sold all of our 51% interest in Huayi Music to Huayi Brothers Media Corporation for an aggregate consideration of RMB34,450,000.
On August 17, 2010, we sold our WVAS and recorded music businesses to Shanda Interactive for $37,243,904 in cash, pursuant to a master transaction agreement with Ku6entered into between us and Shanda Interactive on June 1, 2010. Concurrently, we acquired a 75% interest in Yisheng, an online audio business, from Shanda Interactive in exchange for 415,384,615 newly issued ordinary shares and the remaining 25% interest from a non-controlling shareholder in exchange for 138,461,539 newly issued ordinary shares.
On August 17, 2010, we changed our name from “Hurray! Holding Co., Ltd.” to complement“Ku6 Media Co., Ltd.”
On August 11, 2011, we disposed of a significant interest in Yisheng as a result of management’s review of our digital musicbusiness strategies. After the disposal, our company ceases to control Yisheng and mobile distribution platform. only retains a 20% interest in Yisheng.
We completedcurrently operate and focus on our online video business as our principal business. We derive substantially all of our revenues from online advertising services. As a result of management’s review and adjustment of our business strategies, beginning in the acquisition in January 2010. Ku6 Holding is currently asecond quarter of 2011, we have engaged Shengyue, an affiliate wholly owned subsidiary of Hurray! and has retained its brand name.
Our principal executive offices are located at c/o Hurray! Holding Co., Ltd., 11/F, China Railway Construction Tower,Building 6, Zhengtongchuangyi Centre, No. 20, Shijingshan Road, Shijingshan18, Xibahe Xili, Chaoyang District, Beijing PRC, 100131,100020, People’s Republic of China. Our telephone number is +86 10 8869 5000.5758-6813. Our agent for service of process in the United States is CT Corporation System,Puglisi & Associates, located at 111 Eighth Avenue, New York, New York 10011.
B. Business Overview
Introduction
We are a leading online distributorvideo company in China. 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 content and we seek to be a strategically focused company with focuses on users’ experience and technology development. We provide a comprehensive selection of unique and differentiated UGC, in-house developed content and some licensed content on our websites. Our broad selection of online video content includes news, comedies, Channel V music videos, games, micro movies and music-related productssub-channels such as ringtones, ring-back-tones (“RBT”),entertainment, sports, finance, fashion, technology, automobile, education and true-tonesothers. We also provide an online platform that allows users to mobileshare comments on videos, ensuring that our users enjoy a highly engaging and interactive experience on our websites. As of December 31, 2011, our content library had more than 55 million video clips. The volume of high-quality and differentiated content available on our website has allowed us to establish a valuable user base in China, throughconsisting primarily of young urban educated users between the fullages of 18 and 44, a particularly attractive demographic to advertisers.
We currently derive substantially all of our revenues from online advertising services primarily using performance advertising. Our advertising solutions present advertisers with a complete range of WVAS platformsadvertisement creation, matching, placement and presentation. Our online advertising services include in-video, display, sponsorship and other forms. We sell our advertising services primarily through Shengyue, an affiliate wholly owned by Shanda Interactive, as our advertising agency.
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 in-house produced or provided by users or our content partners. Our website still provides users access to some long-form videos, primarily in-house produced movies, variety shows and programs.
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 “Upload Speed” and install a Ku6 application on their computer desktops or 3G mobile phones, which allows users to use one-step PC/ mobile application to shoot and upload video clips. As of December 31, 2011, “Upload Speed” has been downloaded approximately 1.0 million times and used to upload approximately 10.0 million video clips. We have also cooperated with Shanda Innovations to develop a new product Micro Cool which focuses on short videos of not more than thirty seconds. Users may download this tool on mobile phones that provides a mobile community platform supporting video shooting, editing, uploading and sharing.
In January 2012, we entered into an agreement with YouTube, a renowned international video-sharing website owned by Google, which would allow 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
Users can use their 3G mobile phones to watch a large number of videos on ku6.com. We are also developing applications for a variety of major 3G mobile phones.
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 has experienced rapid growth in terms of the number of users who upload video clips, the number and varieties of video clips uploaded every day, and the number of daily video views. In 2011, we delivered an average of over mobile networks and through the Internet. Our company also provides30,000 new UGC video clips each day covering 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. We have also introduced the product New Weiguan which is designed to increase users’ attention to each other WVASand increase viewership of UGC.
In order to mobileencourage more users to upload UGC to our website, we have purchased the licensing rights to some popular UGC, and have started to share advertising revenues with individual users whose number of uploads exceed certain threshold. In August 2011, we established a revenues sharing program to target three types of users: contracted users, certified original content providers and general uploading users. We reward each type of users in China, including games, pictures and animation, community, and other media and entertainment services. We are also a leader in artist development, music production, offline distribution and event organization in China through our music subsidiaries Huayi Brothers Music, Freeland Music, Secular Bird, Seed Music Group and Fly Songs as well as our affiliated music company, New Run. In addition,accordance with different revenues sharing criteria. For example, we recently acquired Ku6, a leading online video portal in China.
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In-house Developed Content
Our Music and Artist Agency Business
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We believe our online video business’ strong brand name, its close relationships with media and copyright owners, its rich product line and its high degreedetermine the types of user loyalty will enable it to continuecontent to be oneproduced generally based on our assessment of China’s leading online video companies.
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We typically renew these contracts or enter into new ones when the prior contracts expire, but on occasion, the renewal or new contract can be delayed by periods of one month or more. The agreements can also be terminated in advance for a variety of reasons which vary among the individual contracts with the operators, including, for example, when we breach our obligations under the contract, a high number of customer complaints are made about our services or we cannot satisfy the operational or financial performance criteria established by the applicable operator.
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Licensed Content
In June 2011, we ceased purchasing copyrights of movies and original providersTV dramas from professional studios and their distributors. Previously purchased movies and TV drama will be shown on ku6.com through the end of news and information services. With the exception of music, content from international and domestic content providers has not contributed a significant portion of our WVAS revenues to date, and we do not expect it to do so for the foreseeable future. Nonetheless, we will continue to seek out content relationships with leading international and domestic content providers to further increase the variety of our services. Under our agreements with these content providers, we pay them a fixed licensing fee or a percentage of the revenuetheir license periods.
Our Users
We have an extensive user base for our services, which we receivevideo platform. Most users visit our website from direct navigation, with the telecom operators after deducting serviceremainder from organic search results or third-party website links connecting to us. Our user base has increased significantly primarily due to our ability to consistently provide appealing video content to users and network fees.
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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 Mobile’s music portalalso represent a more affluent and better-educated segment of the music search platform of Baidu.com, Inc., an online search platform in China. For example, “Write a Poem for You” (“Wei Ni Xie Shi”) by Kenji Wu, and ‘Right Hand’ (“You Shou Bian”) by Liang Guang, were among the most popular songs released by our recording artists on those services in 2009. Hurray! artists have been honored in various music award ceremonies in Asia. For example, in 2009, Guang Liang was awarded “Annual Golden Song”, Kenji Wu was awarded “Best New Single” and Landy Wen was awarded “Best Episode”.
Advertising Services and Customers
We currently derive substantially all of our affiliated music companies’ record labels.
Our offerings enable advertisers to post theirAdvertising Services
Our online advertising services include in-video, display, sponsorship and other forms of advertisements. In-video advertisements in different forms, including textual, rich media and video advertisements. Our brand advertising products include but are not limited to (i) video screen advertisements which appear on-screen before,at certain times during and/or after the user selected video, (ii) banners, links, logos, buttons and stream advertisements placed on the Ku6.com website, (iii) short product placement videos and (iv) sponsorships that typically focus on a particular event or a particular website area. We charge advertisers per impression for on-screen advertising, per diem for images and links and per project for product placements. Sponsorship contracts for a particular areaplayback of a Ku6.comvideo. These video advertisements can be pre-roll, post-roll, mid-roll or forpause advertisements. Display advertisements can be delivered alongside a particular eventvideo and may require fixed payments overtake the contract period.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.
Advertisers are increasingly seeking measurable results to maximize their return on investment. Our standard advertising charges vary depending onsolutions present brand advertisers with attractive opportunities to combine the termsvisual impact and engagement of traditional television-like multimedia formats with the interactivity and precise targeting capabilities of the contract and the advertisement’s location within our website. Discounts from standard rates are typically provided for higher-volume, longer-term advertising contracts, and may be provided for promotional purposes.
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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 have an advertising tracking system which records and maintains the traffic statistics and other data relating to the effectiveness of advertisements. 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.
Advertising Sales
We engage in advertising sales primarily through Shengyue, an affiliate wholly owned by Shanda Interactive, as our advertising agency. As a relatively young media company, we intend to leverage Shengyue’s existing long-term relationships and network resources to increase our sales and expand our customer base.
We cooperate with Shengyue to provide current and prospective advertisers with comprehensive information about our services and the advantages of using our advertising solutions. The commission fee for Shengyue is based in part on the sales revenues it achieved. We believe that having a commission fee that is linked to advertising performance helps motivate Shengyue to generate sales for us.
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:
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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. |
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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.
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We believe our proprietary technologies and infrastructure are critical to our success. We have made significant investments in developing a proprietary, scalable technology platform that differentiates our online video distribution system. In 2011, we established a new research and development department.
Architecture
CDN Technology. CDN technology utilizes additional data storage to maintain copies of popular content at the “edge” of the Internet, 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, 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 work to provide high quality customer service. This is an important factor for maintaining our relationships with the telecom operators in China as discussed above in “— Network Service Agreements with Operators.” Our dedicated customer service center in Beijing provides our users real-time support and employed 24 customer service representativeshad established approximately 2,760 servers nationwide as of December 31, 2009.2011, 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.
AA System
The AA system tracks the reach, delivery duration and frequency, targeting and quantity of advertisements delivered by our website. The system supports monitoring of our advertising efforts by enabling retrieval of real-time advertisement delivery data using certain system application interfaces. We strivehave 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 achievehelp optimize our advertisers’ strategy by forecasting the fastest response times and highest customer satisfaction levelsresults of a given campaign, factoring in the industry. Our centralized customer service centercovered audience and the frequency and reach of such campaign.
Content Monitoring and Copyright Protection
We are committed to the protection of third-party copyrights. The online video industry in China suffers from copyright infringement issues and online content providers are frequently involved in litigation based on allegations of infringement or other violations of copyrights. We have invested significantly in copyright protection technologies. We have a content screening team of over 38 contract employees dedicated to screening and monitoring the content uploaded on our website to help ensure that no content that may be deemed to be prohibited by government rules and regulations is supported by our local customer service teams locatedposted and to promptly remove 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. 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 our four regional offices. We also maintain a dedicated billing and collection center, which workscompliance with the various offices of the telecom operators to ensure that we receive the correct fees for our services provided over their networks.
We implemented monitoring procedures to remove infringing content, and such procedures include: (i) technology screening, where a video fingerprint system developed by us to optimize the efficiencycompares newly uploaded videos with fingerprint trails of copyrighted videos in our system and quickly address any problems. The platformscreens out those that have piracy issues, a text filtering system screens content based on pre-set key words, and another filtering system automatically screens out pornographic and obscene content based on colors and images; (ii) manual review, where the content that passes the technology screening is equipped with an open application interface for rapid connectivityreviewed by third partythe 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 andwho we grant access to multiple channelsour back-office database can directly flag the infringing content for SMS, IVR, RBT, WAP, MMS, Java™ and Web connectivity.
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, whether or not patentable or copyrightable, made by them during their employment are our platform, allows usproperty. They also sign agreements to store, analyze, retrievesubstantiate our sole and compare various statistical informationexclusive right to those works and to identify relevant trends. This database also supportstransfer any ownership that they may claim in those works to us. We have registered our customer service activities by providingdomain names, including ku6.com, juchang.com and juchang.cn.
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 service professionals with real-time user datamajor competitors in China include Youku.com and information regarding service delivery and billing.Tudou.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 platform can rapidly schedule, deploymajor competitor in China.
We also compete with traditional advertising media, such as television, radio, newspapers and manage WAP pushesmagazines, and SMS pushesmajor 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 promote our services.
Seasonality
We experience seasonality in our online advertising business. Traditionally,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 holidays. Seasonality in our WVAS and other businesses is less apparent.
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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 ChinesePRC 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, please see Item 3.D. “Risk Factors — Legal Risks Related to Wireless and Internet Services — The telecommunication laws and regulations in China are evolving and subject to interpretation and will likely change in the future. If we are found to be in violation of current or future Chinese laws or regulations, we could be subject to severe penalties;” “— Legal Risks Related to Wireless and Internet Services — The regulation of Internet website operators is also new and subject to interpretation in China, and our business could be adversely affected if we are deemed to have violated applicable laws and regulations;” and “— Factors—Risks Related to Our Company — Additional Business—Changes in government policies or regulations may have a material and adverse effect on our business, financial condition and results of operations,” “—Risks Related to Our Company — Our corporate structure could be deemedCorporate Structure” and “—Risks Related to beDoing Business in violation of current or future Chinese laws and regulations, which could adversely affect our ability to operate our business effectively or at all.China.”
Regulation of Telecommunication and Internet ContentRegulations on Value-Added Telecommunications Services
On September 25, 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 China,value-added telecommunications businesses. Under the Telecom Regulations, commercial operators of value-added telecommunications services must first obtain an operating license from the MIIT and otheror its provincial level counterparts.
On September 25, 2000, the State Council issued the Administrative Measures on Internet Information Services, or the Internet Measures. According to the Internet Measures, commercial ICP service operators must obtain an ICP license from the relevant government authorities cover many aspects of telecommunications network operation, including entry into the telecommunications industry, the scope of permissible business activities, interconnection and transmission line arrangements, tariff policy and foreign investment.
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On June 27, 2002,December 26, 2001, the MIIT andpromulgated the SNPA jointly promulgated theInternet Publication Tentative Administrative Measures, on Telecommunications Business Operating License, or the Internet PublicationTelecom License Measures. On March 1, 2009, the MIIT issued revised Telecom License Measures, which took effect on August 1, 2002.April 10, 2009. The Internet PublicationTelecom License Measures require Internet publishersset forth the types of licenses required to secure approval from the SNPA to conduct Internet publication activities. The term “Internet publication” is defined as an act of online dissemination where Internet information service providers select, edit and process works created by themselves or others (including content from books, newspapers, periodicals, audio and video products, electronic publications, and other sources that have already been formally published or works that have been made public in other media) which they then post on the Internet or transmit to users via the Internet for browsing, use or downloading by the public. We currently do not conduct any Internet publication business. The SNPAoperate value-added telecommunications services and the MIIT have not specified whetherqualifications and procedures for obtaining such licenses. For example, an ICP operator providing value-added services in multiple provinces is required to obtain an inter-regional license, whereas an ICP operator providing the approval required by the Internet Publishing Measures is applicable to the dissemination of works through SMS, WAP, Java™, IVR or other wireless technologies. If,same services in the future, the SNPA and the MIIT confirm that the Internet Publishing Measures apply to wireless value-added telecommunication services operators or issue new regulations or rules regulating publishing through SMS, WAP, Java™, IVR or other wireless technologies, we may need to apply for a license or permit from relevant governmental agencies in charge of publishing. We cannot assure you that such application would be approved by the relevant governmental agencies.
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Regulations on Internet Culture Business Operations from the MCC in accordance with the procedures set forthContent Services
National security considerations are an important factor in the Internet Culture Measures. Hurray! Solutions and Beijing Hutong were granted such a license in August 2004 and December 2007, which license permits them to conduct an Internet games business.
opposes the fundamental principles determinedstated in China’s Constitution;the PRC constitution;
compromises statenational 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 the PRC’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 crimes;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 lawslaw or administrative regulations.
ICP 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, andorder 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 on December 11, 2001 and amended on September 10, 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. We believe that it would be impracticable for us to acquire any equity interest in our consolidated affiliated entities without diverting management attention and resources. In addition, we believe that our contractual arrangements with these entities and their respective individual shareholders provide us with sufficient and effective control over these entities. Accordingly, we currently do not plan to acquire any equity interest in any of these entities.
On July 13, 2006, the Supreme CourtMIIT issued the Notice of Chinathe 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 Supreme People’s Procuratorate of China have issued quantitative guidancenecessary facilities, including servers, for its approved business operations and to the courts in China regarding when criminal penalties should be imposed on persons who distribute or assistmaintain such facilities in the distributionregions 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.
Regulations on Broadcasting Audio/Video Programs through the Internet
On July 6, 2004, the SARFT promulgated the Rules for the Administration of obscene contentBroadcasting of Audio/Video Programs through the Internet and Other Information Networks, or wireless services.
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.
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On December 20, 2007, the SARFT and the MIIT jointly issued the Rules for the Administration of Internet Audio and Video Program Services, commonly known as 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 dated February 3, 2008, officials from the SARFT and the MIIT clarified that online audio/video service providers that already had been operating lawfully prior to the issuance of 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, which is valid from June 2008 to June 2011.
On March 31, 2009, SARFT released a 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 the PRC or overseas, must be pre approved by SARFT and distributors of these movies and television shows must obtain an applicable permit before releasing any movie or television show.
CopyrightRegulations on Internet News Publication. See “—Copyright” below.
Publishing and disseminating news through the Internet are highly regulated in the PRC. On November 6, 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 operator (other than a government authorized news unit) to obtain the approval from SCIO to publish news on its website or disseminate news through the Internet. Furthermore, any disseminated news is required to be obtained from government-approved sources based on contracts between the ICP operator and these sources. The copies of advertisements.such contracts must be filed with relevant government authorities.
On September 25, 2005, the SCIO and the MIIT jointly issued the Provisions on the Administration of Internet News Information Services, requiring Internet news information service organizations to provide services as approved by the SCIO, subject to annual inspection under the new provisions. These Provisions also provide that no Internet news information service organizations may take the form of a foreign-invested enterprise, whether jointly or wholly owned by the foreign investment, and no cooperation between Internet news information service organizations and foreign-invested enterprise is allowed before the SCIO completes the security evaluation.
SCIO requires organizations operating Internet news services apply for and obtain the “Internet News Information Service Permit” from it. To our knowledge, in practice SCIO does not accept such application at present and we will submit an application once SCIO starts to accept. Currently in cooperation with some media companies and news agencies, we operate a current events channel on our website, which includes audio/video contents relating to current topics and social events.
Regulations for Internet Publication
The GAPP is responsible for nationwide supervision and administration of publishing activities in China. On June 27, 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 term “Internet publication” is defined as Internet transmission activity by which Internet information service providers publish on the Internet or transmit to end-users via the Internet works that they or others have created, after selection and editing, for browsing, reading, use or downloading by the general public. The works in question primarily include (i) content that has already been published formally, such as books, newspapers, periodicals, audio/video products and electronic publications, or that has been made public via other media; and (ii) edited works of literature and art or works concerning natural science, social science, engineering or other topics.
However, 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 implementation 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. To our knowledge, in practice no website exclusively providing online audio or video content has obtained an Internet publication license in China. Ku6 Information may apply for an Internet Publication License once this issue is clarified and confirmed officially.
Regulations on Internet Medical and Health Information Services
On May 1, 2009, the Ministry of Health promulgated the revised Internet Medical Information Measures, which became effective on July 1, 2009. The revised Internet Medical Information Measures require an ICP operator engaging in providing medical and health information to Internet users (which, among others, includes the provision of such information through the health channel on the operator’s website) to obtain a permit from the relevant provincial counterpart of the Ministry of Health. We obtained the Certificate of Internet Medical Information Service from the Beijing Drug Administration on June 2, 2008.
Regulations on Advertisements
The SAIC is the government agency responsible for regulating advertising activities in China. One provisional regulation issued by Shanghai municipal government prohibits service providers from sending SMS advertisements without the client’s consent.
On November 30, 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 through Ku6 Information Technology and Tianjin Ku6 Zheng Yuan, each of which holds a business license that includes advertising in its business scope.
On January 26, 2005, the SAIC and the MIIT jointly promulgated a Circular Regarding the Prohibition of Advertisements for Voice Messages, SMS and other Information Services Which Contain Unhealthy Content, or the SMS Advertising Circular. The SMS Advertising Circular prohibits advertisement of information services with pornographic, obscene, superstitious and other unhealthy content, or advertisements that are misleading in pricing and payment terms of information services. The SMS Advertising Circular further provides that information service providers and advertising companies involved in the dissemination of advertisements for information services with pornographic, obscene, superstitious and other unhealthy content, or advertisements that are misleading in pricing and payment terms of information services will be subject to penalties by relevant authorities pursuant to PRC advertising regulations, and that information service providers providing unhealthy contentscontent will be subject to administrative and other measures by telecommunications authorities, the public security authorities and national security authorities in accordance with Telecommunications Regulations (2000) and other applicable laws and regulations.
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 State Administration for Industry and Commerce 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.
RegulationRegulations on Information Security.foreign ownership in advertising business
The National People’s Congress has enacted legislationprincipal regulations governing foreign ownership in advertising businesses in China include:
The Foreign Investment Industrial Guidance Catalog (2011 Revision);
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 prohibits usedirectly 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.
As a result of current PRC laws, rules and regulations that impose substantial restrictions on foreign investment in the Internet and advertising businesses in China, we conduct this portion of our operations through a series of contractual arrangements among our PRC subsidiaries and our consolidated controlled entities. See “C. Organizational Structure.”
Regulations on Internet Culture Activities
On May 10, 2003, the Ministry of Culture promulgated the Internet Culture Administration Tentative Measures, or the Internet Culture Measures, which was revised on July 1, 2004. The Internet Culture Measures require ICP 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, sale (wholesale or retail), leasing and broadcasting of Internet cultural products. We obtained the permit on June 20, 2009.
On November 20, 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.
On August 18, 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.
To comply with these laws and regulations, our content examination team reviews the music videos on our website as well as certain other content.
Regulations on Producing Audio/Video Programs
On July 19, 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 breachesanyone 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. Our current permit has expired and we are in the public security, disseminates socially destabilizing contentprocess of applying for a new one.
Regulations on Software Products
On October 27, 2000, the MIIT issued the Administrative Measures on Software Products, or leaks state secrets. Breachthe Software Measures, to strengthen the regulation of public security includes breach of national securitysoftware products and infringement on legal rights and interests ofto encourage the state, society or citizens. Socially destabilizing content includes any content that incites defiance or violations of PRC laws or regulations or subversiondevelopment of the PRC governmentsoftware industry. On March 1, 2009, the MIIT issued amended Software Measures, which became effective on April 10, 2009. The Software Measures provide a registration and filing system with respect to software products made in or 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.
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In order 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.
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Regulations on Intellectual Property Rights
China orhas adopted legislation governing intellectual property rights, including trademarks, patents and copyrights. China is a signatory to the NCAC; the MCC, the MIIT;main international conventions on intellectual property rights and other relevant government authorities cover many aspectsbecame a member of the industry, including entry intoAgreement on Trade Related Aspects of Intellectual Property Rights upon its accession to the market, scopeWorld 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 permissible businessthe 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, tariff policymethods used to diagnose or treat diseases, animal and foreign investment.
Copyright. See “—Copyright” below.
To address copyright issues relating to the Internet, the PRC Supreme People’s Court on November 22,December 19, 2000 adopted the Interpretations on Some Issues Concerning Applicable Laws for Trial of Disputes over Internet Copyright, or the Interpretations, which were subsequently amended on December 23, 2003January 2, 2004 and November 20,22, 2006. The Interpretations establish joint liability for ICP operators if they knowingly participate in, assist in or incite infringing activities or fail to remove infringing content from their websites after knowing the infringement of copyrights conducted by Internet users through the Internet or receiving notice from the rights holder. In addition, ICP operators shall be liable for knowingly uploading, disseminating or providing any actmeasures, facilities or materials intended to bypass circumvention technologies designed to protect copyrights constitutes copyright infringement.copyrights. Upon request, the ICP operators must provide the rights holder with registration information of the alleged violator, provided that such rights holder has produced relevant identification, copyright certificate and evidence of infringement. AnA court shall not uphold the alleged infringer’s claim against an ICP operator is exempted from any liabilities as long as itfor breach of contract if the ICP operator removes the alleged infringing content after receiving the rights holder’s notice accompanied with proper evidence.
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This measure applies to situations where an ICP operator (i) allows another person to post or store any works, recordings, audio or video programs on the websites operated by such ICP 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 operator must take remedial actions immediately by removing or disabling access to the infringing content. If an ICP operator knowingly transmits infringing content or fails to take remedial actions after receipt of a notice of infringement harming public interest, the ICP 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 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.
On May 18, 2006, the State Council promulgated the Protection of the Right of Communication through Information Network,Networks, which became effective on July 1, 2006. Under this regulation, with respect to any information storage space, search or link services provided by an Internet service provider, may be exempted from liabilities for providing links to infringing or illegal content if it does not know that such content is infringing other parties’ rights or is illegal. However, if the legitimate right owner believes that the works, performance or sound or video recordings pertaining to that service infringe his or her rights of communication, the content notifiesright owner may give the Internet service provider a written notice containing the relevant information along with preliminary materials proving that an infringement has occurred, and requests removalrequesting that the Internet service provider delete, or disconnect the links to, such works or recordings. The right owner will be responsible for the truthfulness of the content of the notice.
Upon receipt of the notice, the Internet service provider must delete or disconnect the links to the infringing content immediately and forward the notice to the user that provided the infringing works or recordings. If the written notice cannot be sent to the user due to the unknown IP address, the contents of the notice shall be publicized via information networks. If the user believes that the subject works or recordings have not infringed others’ rights, the user may submit to the Internet service provider would be deemeda written explanation with preliminary materials proving non-infringement, and a request for the restoration of the deleted works or recordings. The Internet service provider should then immediately restore the deleted or disconnected content and forward the user’s written statement to have constructive knowledge upon receipt of such notification but wouldthe right owner.
An Internet service provider that provides information storage space to users through which users may provide works, performance or sound or video recordings to the public will be exempted from liabilitiesliability for compensation to right owners where the following conditions apply: (i) the Internet service provider has clearly indicated that the information storage space is provided to 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 users; (iii) it did not know, or could not reasonably have been expected to know, that the content provided by users infringed 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 rights owners. An Internet service provider that provides users with search or link services will be exempted from liability for compensation to right owner if it removes orthe Internet service provider promptly disconnects the linkslink to the infringing content atafter receiving the request of the legitimate owner. At the request of the alleged violator,right owner’s notice. This exemption is not valid however if the Internet service provider knew or should immediately restoreknow that the linked content infringed another’s rights; in that scenario, it will be jointly liable with the user who provided the content.
Since 2005, the National Copyright Administration, or the NCA, 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 every year. According to theNotice of 2010 Campaign to Crack Down on Internet Infringement and Piracy promulgated by the NCA, the Ministry of Public Security and MIIT on July 19, 2010, one of the main targets, among others, of the 2010 campaign is Internet audio and video programs. Since the 2010 campaign commenced in late July, the local branches of NCA 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 content previously disconnected upon receipt of initial non-infringing evidence.
We have adopted measures to mitigate copyright infringement risks. For example, our policy is to remove links to web pages if we know these web pages contain materials that infringe third-party rights or if we are notified by the legitimate copyright holder of the infringement with proper evidence.
On December 26, 2009, the Standing Committee of the CopyrightNational People’s Congress adopted the Torts Liability Law, cover major aspects of our business related towhich became effective on July 1, 2010. Under this new law, both onlineInternet users and offline music distribution. These provisions grant performers and record production companies personal and property rights (neighboring rights), including the right to fair compensation for the use of originals or copies of their works. In addition, authors of lyrics and music composers have separate and independent rights with respect to any particular song. The term of the copyright is 50 years after the first performance or authorized publication.
infringement.
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Domain Name. In September 2002, the China Internet Network Information Center (“CNNIC”)CNNIC issued the Implementing Rules for Domain Name Registration setting forth detailed rules for registration of domain names. On November 5, 2004, the MIIT promulgated the Measures for Administration of Domain Names for the Chinese 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 February 2006, CNNIC issued the Measures on Domain Name Disputes Resolution and its implementing rules, pursuant to which CNNIC can authorize a domain name dispute resolution institution to decide disputes.
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 other relevant regulations, ICP 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.
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.
On January 13, 2006, the Ministry of Public Security promulgated Provisions on Technological Measures for Internet Security Protection, or Internet Protection Measures. The Internet Protection Measures require all ICP 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.
As an ICP 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 operator from insulting or slandering a third party or infringing the lawful rights and interests of a third party. Pursuant to the BBS Measures, ICP 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 operators to rectify unauthorized disclosure. ICP 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 operators to turn over personal information if an Internet user posts any prohibited content or engages in illegal activities on the Internet.
Foreign exchange controls.Exchange Controls
For information regarding relevant foreign exchange controls, please refer to Item 10.D. “Exchange Controls.”
Dividend Distribution.Distribution
The principal regulations governing dividend distributions by wholly foreign ownedforeign-owned enterprises and Sino-foreign equity joint ventures include the:
Wholly Foreign Owned Enterprise Law (1986), as amended;
Wholly Foreign Owned Enterprise Law Implementing Rules (1990), as amended;
Sino-foreign Equity Joint Venture Enterprise Law (1979), as amended;
Sino-foreign Equity Joint Venture Enterprise Law Implementing Rules (1983), as amended;
The Companies Law (2005);
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 ownedforeign-owned enterprises and Sino-foreign equity joint ventures in the PRC may pay dividends only out of their accumulated profits, if any, as determined in accordance with PRC accounting standards and regulations. Additionally, these foreign-invested enterprises are required to set aside certain amounts of their accumulated profits each year, if any, to fund certain reserve funds. These reserves are not distributable as cash dividends.
Regulations on Labor.Employee Stock Options Plan
In December 2006, the People’s Bank of China promulgated the Administrative Measures of Foreign Exchange Matters for Individuals, setting forth the respective requirements for foreign exchange transactions by individuals (both PRC or non-PRC citizens) under either the current account or the capital account. In January 2007, SAFE issued implementing rules for the Administrative Measures of Foreign Exchange Matters for Individuals, which, among other things, specified approval requirements for certain capital account transactions, such as a PRC citizen’s participation in employee stock ownership plans or share option plans of an overseas, publicly listed company. On June 29,March 28, 2007, the National People’s CongressState Administration of Foreign Exchange promulgated the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Ownership Plan or Stock Option Plan of Overseas Listed Company, or the Stock Option Rules. The purpose of the Stock Option Rules is to regulate the foreign exchange administration of PRC domestic individuals who participate in employee stock holding plans and share option plans of overseas listed companies.
According to the Stock Option Rules, if a PRC domestic individual participates in any employee stock ownership plan or share option plan of an overseas listed company, a PRC domestic qualified agent or the PRC subsidiary of such overseas listed company must, among other things, file, on behalf of such individual, an application with SAFE or its local counterpart to obtain approval for an annual allowance with respect to the purchase of foreign exchange in connection with stock holding or share option exercises as PRC domestic individuals may not directly use overseas funds to purchase shares or exercise share options. Concurrent with the filing of such application with SAFE or its local counterpart, the PRC domestic qualified agent or the PRC subsidiary shall obtain approval from SAFE or its local counterpart to open a special foreign exchange account at a PRC domestic bank to hold the funds required in connection with the stock purchase or option exercise, any returned principal or profits upon sales of shares, any dividends issued on the stock and any other income or expenditures approved by SAFE or its local counterpart. The PRC domestic qualified agent or the PRC subsidiary is also required to obtain approval from SAFE or its local counterpart to open an overseas special foreign exchange account at an overseas trust bank with custody qualifications to hold overseas funds used in connection with any shares purchase.
Under the Foreign Currency Administration Rules, as amended in 2008, the foreign exchange proceeds of domestic entities and individuals can be remitted into China enactedor deposited abroad, subject to the terms and conditions to be issued by SAFE. However, the implementing rules in respect of depositing the foreign exchange proceeds abroad have not been issued by SAFE. The foreign exchange proceeds from the sales of shares can be converted into RMB or transferred to such individuals’ foreign exchange savings account after the proceeds have been remitted back to the special foreign exchange account opened at the PRC domestic bank. If share options are exercised in a cashless exercise, the PRC domestic individuals are required to remit the proceeds to special foreign exchange accounts.
Many issues with respect to the Stock Option Rules require further interpretation. We and our PRC employees who have participated in an employee stock ownership plan or share option plan are subject to the Stock Option Rules. If we or our PRC employees fail to comply with the Stock Option Rules, we and our PRC employees may face sanctions imposed by the PRC foreign exchange authority or any other PRC government authorities, including restriction on foreign currency conversions and additional capital contribution to our PRC subsidiaries.
In addition, the State Administration of Taxation has issued a few circulars concerning employee share options. Under these circulars, our employees working in China who exercise share options will be subject to PRC individual income tax. Our PRC subsidiaries have obligations to file documents related to employee share options with relevant tax authorities and withhold the individual income taxes of employees who exercise their share options. If our employees fail to pay and we fail to withhold their income taxes, we may face sanctions imposed by tax authorities or any other PRC government authorities.
Labor Laws and Social Insurance
Pursuant to the PRC Labor Law and the PRC Labor Contract Law, which became effective on January 1, 2008. Comparedemployers must execute written labor contracts with fulltime employees. All employers must compensate their employees with wages equal to at least the Labor Law,local minimum wage standards. All employers are required to establish a system for labor safety and sanitation, strictly abide by state rules and standards and provide employees with workplace safety training. Violations of the PRC Labor Contract Law establishes more restrictions and increases coststhe PRC Labor Law may result in the imposition of fines and other administrative liabilities. Criminal liability may arise for serious violations.
In addition, employers including specific provisions related to fixed-term employment contracts, temporary employment, probation, consultation with the labor union and employee assembly, employment without a contract, dismissal of employees, compensation upon termination and overtime work, and collective bargaining. According to the Labor Contract Law, an employer isin China are obliged to sign labor contractprovide employees with unlimited termwelfare schemes covering pension insurance, unemployment insurance, maternity insurance, work-related injury insurance, medical insurance and housing funds.
To comply with an employee if the employer continues to hire the employee after the expiration of two consecutive fixed-term labor contracts. The employer has to compensate the employee upon the expiration of a fixed-term labor contract, unless the employee refuses to renew such contract on terms the same as or better than those contained in the expired contract. The employer also has to indemnify an employee if the employer terminates a labor contract without a cause permitted by law. In addition, under the Regulations on Paid Annual Leave for Employees, which became effective on January 1, 2008, employees who have served more than one year for an employer are entitled to a paid vacation ranging from 5 to 15 days, depending on their length of service. Employees who waive such vacation time at the request of employers shall be compensated for three times their regular salaries for each waived vacation day.
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Regulations on Concentration in Merger and Acquisition Transactions
The M&A Rule 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 China relating to an offline method byany change-of-control transaction in which our customers can directly access our wireless value-added products. This application is currentlya foreign investor will take control of a PRC domestic enterprise or a foreign company with substantial PRC operations, if certain thresholds under examination and our rights to this patent could be affected adversely if this application is rejectedthe Provisions on Thresholds for Prior Notification of Concentrations of Undertakings issued by the State Intellectual Property Office of China.
C. Organizational Structure
We conduct our operations in China principally through contractual arrangements among our PRC subsidiaries (Beijing WFOE, Tianjin WFOE and seeking patent protection for wireless services-related technologies. We expect these parties to continue to take steps to protect these technologies, including seeking patent protection. There may be patents issued or pending that are held by others and that cover significant parts ofTianjin Ku6 Network WFOE, which was established on December 14, 2011), our technology, business methods or services. Disputes over rights to these technologies are likely to ariseconsolidated affiliated entities in the future. We cannot be certain that our productsPRC (Ku6 Information Technology, Tianjin Ku6 Zheng Yuan, Ku6 Cultural and services do not or will not infringe valid patents, copyrights or other intellectual property rights held by third parties. We may be subject to legal proceedings and claims from time to time relating to the intellectual property of others, as discussed in “Risk Factors — Additional Risks Related to Our Company — We may not be able to adequately protect our intellectual property, and we may be exposed to infringement claims by third parties.”
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Ku6 Information Technology is 98% owned by Mr. Shanyou Li and 2% owned by Mr. Hailong Han;
Tianjin Ku6 Zheng Yuan is wholly owned by Ku6 Information Technology, which in turn is 98% owned by Mr. Shanyou Li and 2% owned by Mr. Hailong Han;
Ku6 Cultural is 98% owned by Mr. Shanyou Li and 2% owned by Ms. Xingye Zeng; and
Tianjin Ku6 Network is 90% owned by Ms. Dongxu Wang and 10% owned by Mr. Qing Zhang.
Through our agreementscontractual arrangements with these Chinese affiliates,consolidated affiliated entities, we have the power to vote all the shares of allheld by the shareholders of those companies on their matters,these entities, through the general manager of Beijing Hurray! Times,our PRC subsidiaries, as well as the right to enjoy the economic benefits of those companiesderived from these entities, and the exclusive right to purchase equity interests from the shareholders of those companiesthese entities to the extent permitted by Chinese laws.
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Under the guidance relating to the consolidation of VIEs,consolidated affiliated entities, we are the primary beneficiary of the economic benefits of our VIEsconsolidated affiliated entities, namely, Ku6 Information, Tianjin Ku6 Zheng Yuan, Ku6 Cultural and their subsidiaries, Hurray! Solutions, WVAS Solutions, Beijing Palmsky, Beijing Network, Beijing Hutong, Hengji Weiye, Shanghai Magma, Hurray! Digital Media, Shanghai Saiyu, Henan Yinshan, Huayi Brothers Music, Freeland Music, Secular Bird, New Run and Fly Songs. Accordingly, these entities are consolidated into our financial statements or, in the case of New Run, accounted for as an equity method investment from and after the date we became the primary beneficiary of each such entity.Tianjin Ku6 Network. Transactions among theour consolidated affiliated entities, and our company and our subsidiaries are eliminated in consolidation.
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February 29, 2012:
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Our company, certainprincipal executive offices are located on premises with a gross floor area of our non-music affiliates and Freeland Music currently lease an approximate total of 2,710approximately 5,640 square meters of office space at China Railway Construction Tower in Beijing. We also have branchesbranch and representative offices in Beijing, Shandong, Heilongjiang, Guangdong, Zhejiang, Liaoning, Chongqing, Shanghai, Henan and Sichuan.
Not Applicable.
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 reportdiscussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, including, without limitation, statements regarding our expectations, beliefs, intentions or future strategies that are signified by the words “expect,” “anticipate,” “intend,” “believe,”“believe” or similar language. All forward-looking statements included in this annual reportprospectus are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. In evaluating our business, you should carefully consider the information provided under the caption “Risk Factors” in this annual report on Form 20-F.Factors.” We caution you that our businesses and financial performance are subject to substantial risks and uncertainties.
A. OPERATING RESULTS
Overview
We are oneentered into the online video business through the acquisition of China’s leading digital media platforms, offering a broad arrayKu6 Holding in January 2010.
In May 2010, we sold all of online and wireless entertainment contentour 51% interest in Huayi Music to a large and diverse user base. Our primary businesses are:
In August 2010, we disposed of |
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As a result of management’s review and adjustment of our business strategies, beginning in the second quarter of 2011, we have engaged Shengyue, an affiliate wholly owned by Shanda Interactive, as our advertising agency using performance advertising under which advertisers pay only for measurable results. We have also shifted our focus from purchasing licensed video copyrights to relying on UGC.
On April 1, 2011, we entered into agreements with Shanda Media, pursuant to which we agreed to issue to Shanda Media 1,538,461,538 ordinary shares for an aggregate purchase price of $50,000,000 (or $0.0325 per ordinary share) and $50,000,000 aggregate principal amount of senior convertible bonds at face value. Based on our working capital position, we redeemed the convertible bonds on September 30, 2011.
On August 11, 2011, we disposed of a significant interest in Yisheng. After the disposal, our company ceases to control Yisheng and only retains a 20% interest in Yisheng.
On December 30, 2011, we approved a share repurchase program to repurchase up to an aggregate of $3.2 million of our outstanding ADSs from time to time based on market conditions. Any repurchases may be effected through open market purchases or block trades, including the use of derivative instruments, and will be financed with our cash balance. As of February 29, 2012, we had not made any repurchases under this share repurchase program.
We currently operate our business as a single segment. We derive substantially all of our revenues from online advertising services. For the years ended December 31, 2010 and 2011, our revenues were $16.6 million and $19.2 million, respectively, and our net loss was $52.4 million and $49.4 million, respectively.
Discontinued Operations
Historically, we derived most of our revenues from the WVAS business, which included 2G services such as short message service, interactive voice response and ring back tone, and 2.5G services such as WAP, MMS, and Java™, each of which is available on the networks of principal telecom operators in China. We also had a recorded music business, which involves discovering, developing and representing recording artists and promoting, selling and licensing their works through designated third parties. In 2010, we made the strategic decision to divest our WVAS and recorded music businesses to focus on our online video business.
On May 28, 2010, we sold all of our 51% interest in Huayi Music to Huayi Brothers Media Corporation and recognized gain of $4.5 million from disposal of discontinued operations.
On August 17, 2010, we sold our WVAS and recorded music businesses to Shanda Interactive. As the transaction was treated as a transaction between entities under common control, no gain or loss was recognized. The difference of $13.6 million between the consideration received of $37.2 million and the carrying amount of the assets and liabilities of WVAS and recorded music business of $23.7 million and the corresponding cumulative translation difference of $10.3 million were accounted for as contribution by Shanda Interactive in additional paid-in capital in 2010.
According to Accounting Standards Codification, or ASC, 205, the reclassification of discontinued operations of WVAS and recorded music businesses for the year ended December 31, 2009 and the eight months ended August 31, 2010 has been accounted for retroactively. Results from these discontinued operations, net of tax, in 2009, 2010 and 2011 were a loss of $21.6 million, an income of $1.1 million (including a gain of $4.5 million from the disposal of our 51% interest in Huayi Music) and an income of nil, respectively.
Disposal of Interest in Online Audio Business
The acquisition of Yisheng’s online audio business from Shanda Interactive in 2010 was accounted for as a common control transaction as we were considered to be under the control of Shanda Interactive at the time of the acquisition. Accordingly, the accompanying consolidated financial statements have been prepared as if the acquisition of Yisheng had been in effect since August 31, 2009, the date of inception of common control, which is the date on which we were consolidated into Shanda Interactive’s consolidated financial statements. Therefore total assets and liabilities as well as the non-controlling interests of Yisheng were recorded at their carrying amount as capital contribution from Shanda Interactive in the consolidated statements of changes in equity. The effect of accounting for the acquisition under common control has increased the net loss for the year ended December 31, 2009 by $0.7 million, which represents the net loss of this business from August 31, 2009 through December 31, 2009. The $12.5 million fair value of the 415,384,615 ordinary shares that we issued to Shanda Interactive was recorded through equity as a deemed distribution to Shanda Interactive in 2010.
The issuance of 138,461,539 ordinary shares to the 25% non-controlling shareholders of Yisheng in August 2010 was accounted for as an equity transaction in 2010 and the difference between fair value of the ordinary shares issued and carrying amount of the non-controlling interest was recognized as a decrease in additional paid-in capital attributable to us in accordance with ASC 810.
On August 11, 2011, we disposed of a significant interest in Yisheng as a result of management’s review of our business strategies. After the disposal, our company ceases to control Yisheng and only retains a 20% interest in Yisheng. This disposal gain was recognized as an increase in additional paid-in capital for the year ended December 31, 2011.
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 advertising industries in China. These conditions, among others, include the stability and growth of China’s economy, the growth of the Internet penetration rate in China, and the increasing acceptance of online video advertising by the advertisers. In addition, our business, financial condition and results of operations are affected by a 3.0%number of company-specific factors including our ability to:
maintain and 5.0%expand our user base;
obtain and produce popular video content cost-effectively;
procure Internet bandwidth cost-effectively;
provide effective advertising services;
control sales and marketing expenses; and
maintain leading brand and market position.
Description of Certain Statement of Operations Items
Net Revenues
We currently derive substantially all of our net revenues from online advertising services. Historically, we derived these revenues primarily from various third-party advertising agencies. Beginning in the second quarter of 2011, we have relied on Shengyue, an affiliate wholly owned by Shanda Interactive, as our advertising agency for sales to, and collection of payments from, a majority of our advertisers. Advertisers broadcast their online advertising through the AA system supplied by Shengyue. We pay the commission fee except for the commission free period and in the form of direct-deduction of the advertising revenue to the related party advertising agency and recognize revenues net of the commission fee. We expect that revenues from online advertising services will continue to be the primary source of our revenues in the foreseeable future.
We believe the most significant factors that directly or indirectly affect our advertising service revenues include the following:
the number of advertising customers;
the number of users visiting our website and the amount of time they spend on our website;
the prices of our performance advertising;
the commission fee for Shengyue; and
the perceived effectiveness of online video advertising as compared to advertising in more traditional media, particularly television.
The number of advertising customers during any period is affected by our services, our sales and marketing efforts and influenced by our market position and advertisers’ perception of the effectiveness of our online advertising services. The size of our advertising customer base is also driven by customer-specific factors such as the timing of the introduction of new advertising campaigns, our ability to maintain favorable demographic user base, seasonality of advertising customers’ operations and growth of business tax, respectively.
Cost of Revenues
Our cost of revenues consist of Internet bandwidth costs, amortization and write-down of licensed video copyrights, payroll costs associated with the platform operation and content, depreciation expenses, in-house developed content costs, and other costs. Our total cost of revenues amounted to $30.8 million for the year ended December 31, 2011.
| Year ended December 31, | ||||||||||||
| 2009 | 2010 | 2011 | ||||||||||
| (in thousands of U.S. dollars) | ||||||||||||
Internet bandwidth costs | 534 | 10,279 | 9,025 | |||||||||
Termination of long-form videos | — | — | 5,267 | |||||||||
Payroll costs | — | 6,167 | 4,734 | |||||||||
Depreciation of servers and other equipments | — | 2,503 | 2,528 | |||||||||
Amortization of licensed video copyrights cost | — | 8,012 | 2,201 | |||||||||
Impairment write-down of licensed video copyrights cost | — | 7,740 | 1,521 | |||||||||
In-house developed content costs | — | 1,596 | 845 | |||||||||
Other costs(1) | 23 | 4,162 | 4,759 | |||||||||
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Total costs | 557 | 40,459 | 30,880 | |||||||||
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| (1) | Include primarily advertisement production costs and outside service fees and UGC costs. |
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 following table sets forth certain historical consolidated revenues, by amount andbandwidth costs as a percentage of our totalnet revenues decreased from 62.1% for the periods indicated:
| For the Year Ended December 31, | ||||||||||||||||||||||||
| 2009 | 2008 | 2007 | ||||||||||||||||||||||
| Percentage | Percentage | Percentage | ||||||||||||||||||||||
| Amount | of revenues | Amount | of revenues | Amount | of revenues | |||||||||||||||||||
| (in thousands of U.S. dollars, except percentages) | ||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||
| Wireless value-added services | $ | 20,169 | 58.2 | % | $ | 42,672 | 79.1 | % | $ | 50,038 | 82.7 | % | ||||||||||||
| Recorded music | 14,473 | 41.8 | % | 11,287 | 20.9 | % | 10,489 | 17.3 | % | |||||||||||||||
| Total revenues | $ | 34,642 | 100.0 | % | $ | 53,959 | 100.0 | % | $ | 60,527 | 100.0 | % | ||||||||||||
year ended December 31, 2010 to 47.0% for the year ended December 31, 2011. This decrease was consistent with historical trends of decreasing unit cost of data hosting and transmission services.
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Termination of long-form videos.As a result of the termination of licensing contracts with certain content providers, we charged a one-time termination penalty of $5.3 million in 2011.
Payroll costs. Payroll costs consist of salaries and benefits for our platform operation and content personnel. As the change in business strategy in 2011 improved our cost structure and our operating efficiency, the payroll costs decreased from $6.2 million for the year ended December 31, 2010 to $4.7 million for the year ended December 31, 2011.
| For the Year Ended December 31, 2009 | ||||||||||||||||||||||||
| China | China | China | China | |||||||||||||||||||||
| Mobile | Unicom | Telecom | Netcom | Others | Total | |||||||||||||||||||
| (in millions of U.S. dollars) | ||||||||||||||||||||||||
| SMS | $ | 3.0 | $ | 1.5 | $ | 0.2 | $ | — | $ | 0.6 | $ | 5.3 | ||||||||||||
| IVR | 1.4 | 1.0 | 1.4 | — | 0.1 | 3.9 | ||||||||||||||||||
| RBT | 2.3 | 1.6 | 0.6 | — | 0.1 | 4.6 | ||||||||||||||||||
| 2G Revenues | 6.7 | 4.1 | 2.2 | — | 0.8 | 13.8 | ||||||||||||||||||
| WAP | 0.4 | 0.9 | 1.8 | — | — | 3.1 | ||||||||||||||||||
| MMS | 1.5 | — | 0.2 | — | — | 1.7 | ||||||||||||||||||
| Java | 1.6 | — | — | — | — | 1.6 | ||||||||||||||||||
| 2.5G revenues | 3.5 | 0.9 | 2.0 | — | — | 6.4 | ||||||||||||||||||
| Other revenues | — | — | — | — | — | — | ||||||||||||||||||
| Total | $ | 10.2 | $ | 5.0 | $ | 4.2 | $ | — | $ | 0.8 | $ | 20.2 | ||||||||||||
| For the Year Ended December 31, 2008 | ||||||||||||||||||||||||
| China | China | China | China | |||||||||||||||||||||
| Mobile | Unicom | Telecom | Netcom | Others | Total | |||||||||||||||||||
| (in millions of U.S. dollars) | ||||||||||||||||||||||||
| SMS | $ | 9.5 | $ | 2.4 | $ | 0.4 | $ | 0.1 | $ | 0.9 | $ | 13.3 | ||||||||||||
| IVR | 7.2 | 1.3 | 3.2 | 0.2 | 0.3 | 12.2 | ||||||||||||||||||
| RBT | 2.6 | 1.9 | 0.5 | — | — | 5.0 | ||||||||||||||||||
| 2G Revenues | 19.3 | 5.6 | 4.1 | 0.3 | 1.2 | 30.5 | ||||||||||||||||||
| WAP | 2.1 | 4.7 | 0.6 | — | — | 7.4 | ||||||||||||||||||
| MMS | 0.8 | 0.5 | 0.1 | — | — | 1.4 | ||||||||||||||||||
| Java | 2.2 | — | — | — | 0.1 | 2.3 | ||||||||||||||||||
| WEB | — | — | 0.2 | — | — | 0.2 | ||||||||||||||||||
| 2.5G revenues | 5.1 | 5.2 | 0.9 | — | 0.1 | 11.3 | ||||||||||||||||||
| Other revenues | — | — | — | — | 0.9 | 0.9 | ||||||||||||||||||
| Total | $ | 24.4 | $ | 10.8 | $ | 5.0 | $ | 0.3 | $ | 2.2 | $ | 42.7 | ||||||||||||
| For the Year Ended December 31, 2007 | ||||||||||||||||||||||||
| China | China | China | China | |||||||||||||||||||||
| Mobile | Unicom | Telecom | Netcom | Others | Total | |||||||||||||||||||
| (in millions of U.S. dollars) | ||||||||||||||||||||||||
| SMS | $ | 7.0 | $ | 2.5 | $ | 0.2 | $ | 0.3 | $ | 1.0 | $ | 11.0 | ||||||||||||
| IVR | 13.3 | 1.2 | 2.4 | 0.3 | — | 17.2 | ||||||||||||||||||
| RBT | 1.6 | 1.7 | 0.4 | — | — | 3.7 | ||||||||||||||||||
| 2G Revenues | 21.9 | 5.4 | 3.0 | 0.6 | 1.0 | 31.9 | ||||||||||||||||||
| WAP | 5.9 | 6.7 | — | — | — | 12.6 | ||||||||||||||||||
| MMS | 0.7 | 0.7 | — | — | — | 1.4 | ||||||||||||||||||
| Java | 1.4 | — | — | — | — | 1.4 | ||||||||||||||||||
| WEB | — | — | 2.0 | — | — | 2.0 | ||||||||||||||||||
| 2.5G revenues | 8.0 | 7.4 | 2.0 | — | — | 17.4 | ||||||||||||||||||
| Other revenues | 0.1 | — | — | — | 0.6 | 0.7 | ||||||||||||||||||
| Total | $ | 30.0 | $ | 12.8 | $ | 5.0 | $ | 0.6 | $ | 1.6 | $ | 50.0 | ||||||||||||
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Amortization and write-down of 2.5G WAPlicensed video copyrights. The licensed video copyrights are carried at the lower of unamortized cost or net realizable value and JavaTM decreased sharplyare amortized over their respective licensing periods as compared with 2008 due in partthere is no limit of the showings of the licensed videos and we cannot reliably estimate the future number of showings for the licensed videos. We estimate the expected cash inflows that are directly attributed to the tentative suspension of allcontents licensed under the net realizable value approach. We write down the carrying value of the serviceslicensed content to net realizable value if the estimated net future direct cash inflows from the licensed video copyrights over the licensing period are lower than the carrying value. Amortization and write-down expenses were $8.0 million and $7.7 million, respectively, for the year ended December 31, 2010 and $2.2 million and $1.5 million, respectively, for the year ended December 31, 2011. As of each of December 31, 2010 and 2011, the carrying value of licensed video copyrights was written down to nil. The decrease in the amortization and write-down of licensed video copyrights was primarily a result of the telecom operators’ WAP service partnerschange in China beginning in November 2009.
In-house developed content costs. In-house developed content costs represent costs related to the production offline music distribution, and online music distribution through WVAS and the Internet, which accounted for approximately 41.8% of our total revenues in 2009.
| For the Year Ended December 31 | ||||||||||||
| 2009 | 2008 | 2007 | ||||||||||
| (in thousands of U.S. dollars) | ||||||||||||
Cost of Revenues: | ||||||||||||
| Wireless value-added services | $ | 15,332 | $ | 32,840 | $ | 36,394 | ||||||
| Recorded music | 12,625 | 6,730 | 6,233 | |||||||||
| Total cost of revenues | $ | 27,957 | $ | 39,570 | $ | 42,627 | ||||||
| For the Year Ended December 31, | ||||||||||||
| 2009 | 2008 | 2007 | ||||||||||
| (in thousands of U.S. dollars, except percentages) | ||||||||||||
Gross Profits: | ||||||||||||
| Wireless value-added services | $ | 4,837 | $ | 9,832 | $ | 13,644 | ||||||
| Recorded music | 1,848 | 4,557 | 4,256 | |||||||||
| Total gross profits | $ | 6,685 | $ | 14,389 | $ | 17,900 | ||||||
model.
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| For the Year Ended December 31, | ||||||||||||
| 2009 | 2008 | 2007 | ||||||||||
Gross Profit Margin: | ||||||||||||
| Wireless value-added services | 24.0 | % | 23.0 | % | 27.3 | % | ||||||
| Recorded music | 12.8 | % | 40.4 | % | 40.6 | % | ||||||
| Total gross profit margin | 19.3 | % | 26.7 | % | 29.6 | % | ||||||
The following table sets forth certain historical consolidated operating expenses data, in terms of amount and as a percentage of our total revenues, for the periods indicated:
| For the Year Ended December 31, | ||||||||||||||||||||||||
| 2009 | 2008 | 2007 | ||||||||||||||||||||||
| Percentage | Percentage | Percentage | ||||||||||||||||||||||
| Amount | of revenues | Amount | of revenues | Amount | of revenues | |||||||||||||||||||
| (in thousands of U.S. dollars, except percentages) | ||||||||||||||||||||||||
Operating Expenses: | ||||||||||||||||||||||||
| Product development expenses | $ | 467 | 1.3 | % | $ | 992 | 1.8 | % | $ | 2,028 | 3.4 | % | ||||||||||||
| Selling and marketing expenses | 6,330 | 18.3 | 9,132 | 16.9 | 11,514 | 19.0 | ||||||||||||||||||
| General and administrative expenses | 22,992 | 66.4 | 11,984 | 22.2 | 9,141 | 15.1 | ||||||||||||||||||
| Provision for goodwill impairment | 3,593 | 10.4 | 2,675 | 5.0 | 38,779 | 64.1 | ||||||||||||||||||
| Gain on reduction of Unicom liability | — | — | (1,557 | ) | (2.9 | ) | — | — | ||||||||||||||||
| Gain from reversed litigation expenses | — | — | (557 | ) | (1.0 | ) | — | — | ||||||||||||||||
| Total operating expenses | $ | 33,382 | 96.4 | % | $ | 22,669 | 42.0 | % | $ | 61,462 | 101.6 | % | ||||||||||||
| Year Ended December 31, | ||||||||||||
| 2009 | 2010 | 2011 | ||||||||||
| (in thousands of U.S. dollars) | ||||||||||||
Operating Expenses | ||||||||||||
Product development | — | — | 2,693 | |||||||||
Selling and marketing | 665 | 16,196 | 11,817 | |||||||||
General and administrative | 6,465 | 13,507 | 23,402 | |||||||||
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Total operating expenses | 7,130 | 29,703 | 37,912 | |||||||||
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Product Development ExpensesExpenses.. Product development expenses consist primarily consist of researchsalaries and development staff costs related to our WVAS business. Most of ourbenefits for product development expenses related to enhancing our portfolio of 2G and 2.5G services. Product development expenses also include depreciation and amortization of computers and software related to the activities of our product development teams. We depreciate our computer equipment, software and other assets on a straight-line basis over their estimated useful lives, which are three to five years.
Selling and Marketing ExpensesExpenses.. Selling and marketing expenses consist primarily consist of staff costs related to managing the development of our service offerings. These expenses also include advertising, sales and marketing personnel payroll compensation and related employee costs, advertising and market promotion expenses, such asand other overhead expenses associated with sponsoring promotional events, salariesincurred by our sales and benefits for our direct sales force, free trial services we offer through, for example, certain retailers of mobile phones in China.
General and Administrative ExpensesExpenses.. General and administrative expenses consist primarily consist of stock-based compensationsalary and benefits for our management, salaries for our finance and administrative personnel, professional service fees, lease expenses, other office expenses, expenses related to depreciation of equipment for general corporate purposes and expenses related to amortization of intangible assets from our acquisitions and any impairment write-downs of such assets.
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expenses.
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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 combinationsCombinations and non-controlling interestsNon-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.
From January 1, 2009, we adopted ASC 805 (formerly referred to as SFAS No. 141 (revised 2007), “Business combinations”“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 (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.
The determination and allocation of fair values to the identifiable assets acquired and liabilities assumed is based on various assumptions and valuation methodologies requiring considerable management judgment. The most significant variables in these valuations are discount rates, terminal values, the number of years on which to base the cash flow projections, as well as the assumptions and estimates used to determine the cash inflows and outflows. We determine discount rates to be used based on the risk inherent in the related activity’s current business model and industry comparisons. Terminal values are based on the expected life of assets and forecasted life cycle and forecasted cash flows over that period. Although we believe that the assumptions applied in the determination are reasonable based on information available at the date of acquisition, actual results may differ from the forecasted amounts and the difference could be material.
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In accordance with ASC 605, “Revenue Recognition,” we recognize revenues when the following criteria are met: persuasive evidence of an arrangement exists, the sales price is fixed or determinable, delivery has occurred and collectability is reasonably assured. Revenues are recorded net of sales taxes.
Our revenues are derived principally from providing personalized media, games, entertainmentonline brand advertising arrangements, where the advertisers (including third parties and communicationrelated parties) pay to place their advertisements on our online video platform in different formats. Such formats generally include banners, buttons, links, pre-roll or post-roll video advertisements.
Advertising contracts are signed to establish the price and advertising services to mobile phone and personal handy phone (collectively “mobile phones”) customers of the various subsidiaries of the telecom operators. Fees for these services, whichbe provided. Advertisements are negotiated in network service agreements with the telecom operators and indicated in the message receivedcharged either based on the mobile phone,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 charged on a per-use basis or on a monthly subscription basis, and vary accordingachieved. In the latter case, the delivery is not linked to advertisement displays, but occurs over time.
Under the arrangements with advertisers where the advertisement placement includes different formats to be delivered over different periods of time, our revenue is accounted for using the guidance under ASC 605-25 “Multiple Element Arrangements” as such revenue arrangements involve multiple deliverables to the type ofadvertisers. We sell the advertising services delivered.
Under the arrangements with our advertising agency Shengyue, an affiliate wholly owned by Shanda Interactive, components of the arrangement include an arrangement for guaranteed advertising revenue and an arrangement for sharing of excess advertising revenues and costafter deducting commission fees earned by Shengyue based upon increasing percentage for additional tiers of services earned during the period coveredrevenue. The guaranteed advertising revenues are recognized ratably over varying service periods as governed by the statement based on our internally generated information, historical experience and/specific agreements with Shengyue. Any excess advertising revenues realized from these arrangements, which are not subject to any refundability or other assumptions that are believedcontingency provisions from us to Shengyue, would be reasonable underrecognized ratably over the circumstances.
We make credit assessments of customers to assess the collectability of contract amounts prior to entering into contracts. For those contracts for which the telecom operators billcollectability was assessed as not reasonably assured, we recognize revenue only when cash is received and collect on our behalf. Accordingly, the service fee paid to the telecom operators is includedall revenue recognition criteria are met.
For revenue arrangements contracted with third-party advertising agencies, we provide cash incentives in the costform of revenues. In addition, in respect of 2G services, the telecom operators charge us a network feerebates based on volume and performance, and account for such incentives as a per message fee, which varies depending on the volumereduction of messages sentrevenue in accordance with ASC 605-50-25. The cash incentives to third-party advertising agencies in the relevant month, multipliedyear ended December 31, 2010 and 2011 were $5.4 million and $1.4 million, respectively.
Allowances for Doubtful Accounts
We determine the allowance for doubtful accounts when facts and circumstances indicate that the receivable is unlikely to be collected by taking into account an aging analysis of the excessaccounts receivable balances, historical bad debt records, repayment patterns in the prior year and other factors such as the policies of messages sent over messages received. These network fees are likewise retained by the telecom operators and are reflected as cost of revenues. The cost of revenues also includes fees paid to our content providers and marketing partners, maintenance costs related to equipment used to provide the services, bandwidth leasing charges and data center services, alternative channels, media and related Internet costs, operator imposed penalty charges, and certain distribution costs.
Video Production and actual revenue confirmed subsequently were not material.
Acquisition Costs
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Capitalized video production and recognize the fee as revenue when the master CD is provided. In the latter case, we ship the produced CDs to retail distributors and recognize wholesale revenues at the time of shipment less a provision for future estimated returns.
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Licensed Video Copyrights
The licensed video copyrights are amortized over their respective licensing periods. The amortization period of the investment is below its carryinglicensed video copyrights mainly ranged from one year to three years for all periods presented.
The licensed video copyrights are carried at the lower of amortized cost or net realizable value. Under the net realizable value andapproach, we determine the financial condition, operating performance and near term prospectsexpected cash inflows that are directly attributed to the premium content category, which comprises the expected revenues directly attributable to the content category less the direct costs to deliver the content to derive the net realizable value of the investee. In addition, we consider the reasons 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 our intent and ability to hold the investment for a period of time sufficient to allow for a recovery in fair value. The determination of whether a decline in value is other than temporary requires significant judgment. If the decline in fair value is deemed to be other than temporary,asset. We write down the carrying value of the investment is written down to fair value. Write-downs for equity method investmentslicensed content if the estimated net future direct cash inflows from the licensed video copyrights over the licensing period are included in equity in earning (loss) of affiliated company.
Goodwill and Intangible Assets Impairment
We test goodwill for impairment by reporting unit on an annual basis or more frequently if an event occurs or circumstances change that could more likely than not reduce the fair value of the goodwill below their carrying amount. We performperforming a two-step goodwill impairment test. The first step compares the calculated fair valuesvalue of eacha reporting unit to its carrying amount, including goodwill. If the fair value of each reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and the second step will not be required. Ifonly if the carrying amount of a reporting unit exceeds its fair value as per step one, the second step comparesis 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. WeWhen available, we use observable market data, including pricing on recent closed market transactions, to determine the fair value of the reporting units and compare with carrying amount of the reporting units to assess any goodwill impairment. The fair value of reporting units was determined based on the market capitalization of the respective entities as of the valuation date. When there is little or no observable market data, we measure the fair value of each reporting unit primarily using the income approach and using the market approach as a validation of the value derived from income approach. The market approach includedincludes using financial metrics and ratios of comparable public companies. When the goodwill was determined to be impaired, we use income approach including discounted cash flow model for each reporting unit and unobservable inputs including assumptions of projected revenue, expenses, capital spending and other costs, as well as a discount rate calculated based on the risk profile of the relating industry to determine the amount of any impairment.
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 measureassess 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 based on an in-use premise using the discounted cash flow model and unobservable inputs including assumptions of projected revenue, expenses, capital spending and other costs, as well as a discount rate calculated based on the risk profile of the relating industry. If different estimates or judgments are utilized, the timing or the amount of the impairment charges could be different.
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During the annual goodwill impairment test on December 31, 2010, we performed an impairment test at the reporting unit level relating to goodwill from acquisitions and concluded that there was no impairment as to the carrying value of goodwill as of December 31, 2010.
During the second quarter of 2011, we performed impairment testing for the online video operations due to a change in our business strategy. This resulted in an impairment charge for acquired intangible assets of $1.4 million. During the annual impairment test on December 31, 2011, we performed an impairment test at reporting unit level relating to acquired intangible assets and goodwill and concluded that there was no additional impairment required as to the carrying value of intangible assets and goodwill as of December 31, 2011.
Business Tax and Related Surcharges
Our subsidiaries and consolidated affiliated entities are subject to business tax and related surcharges and value-added tax on the revenues earned for services provided in the PRC. The applicable business tax rate for advertising business is 5% based on the gross advertising revenue before deducting the advertising agencies rebate. In the accompanying consolidated statements of operations, business tax and related surcharges for advertising revenues are deducted from gross revenues to arrive at net revenues when incurred.
Share-based Compensation
We apply ASC 718 “Stock Compensation” (formerly referred to as Statement of Financial Accounting Standard 123(R), or SFAS123(R), 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 expenses of $1.9 million and $1.8 million in 2010 and 2011, respectively. The share-based compensation expenses in 2010 included one-time compensation expenses of $1.3 million relating to incremental value of the ordinary shares issued by us to replace the options issued by Ku6 Holding before its acquisition by us. The share-based compensation expenses in 2011 included one-time compensation expenses of $0.5 million relating to the 20% interest in Yisheng that we gave to a former employee which is now the chief executive officer of Yisheng. Our share-based compensation expenses are included in our operating expenses as well as cost of revenue.
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.
Deferred income taxes are provided using the liability method in accordance with ASC 740 (formerly referred to as SFAS No. 109, “Income Taxes”“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(formerly740-10-25 (formerly referred to as Interpretation No. 48, (“or FIN 48”), “Accounting48, “Accounting for Uncertainty in Income Taxes — Taxes—an interpretation of FASB Statement No. 109”109”) 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 diddo not incurhave any interest or penalties related to potential underpaid income tax expenses, and also does not expect to have a significant increase or decrease in theliabilities for unrecognized tax benefits within 12 months from December 31, 2009.
Contingency
We are subject to contingencies, such as legal proceedings and claims arising out of our business that cover a 10% withholding tax. In addition, under the tax treaty between the PRC and Hong Kong, if a foreign investor is incorporated in Hong Kong and qualifies as a Hong Kong tax resident, the applicable withholding tax rate is reduced to 5%, if the investor holds at least a 25% interestwide range of matters in the FIE, or 10%, if the investor holds less than a 25% interest in the FIE.
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Going Concern
We operate with significant losses and negative cash flows from operations in recent years. As of December 31, 2011, our accumulated deficit was $132.4 million and our net current assets were $21.2 million. On April 1, 2011, we entered into agreements with Shanda Media, pursuant to which we agreed to issue to Shanda Media 1,538,461,538 ordinary shares for an aggregate purchase price of $50,000,000 (or $0.0325 per ordinary share) and $50,000,000 aggregate principal amount of senior convertible bonds at face value. Since mid-2011, we have any present planadjusted our business strategy by substantially reducing our sales force and ceasing to pay anypurchase long-form videos. Based on the implementation result of our adjusted strategy in the second half of 2011, we anticipated that the cash dividendsoutflow from both operations and investment would likely be substantially reduced in 2012. Based on our ordinary sharesanticipated working capital position, we redeemed the convertible bonds on September 30, 2011. We believe that we have sufficient cash to fund operations and capital expenditures for at least the next 12 months. Accordingly, our consolidated financial statements have been prepared on a going-concern basis.
Results of Operations
As mentioned above in the foreseeable futuresection of “Critical Accounting Policies,” the financial statements have been prepared as if the acquisition of Yisheng had been in effect since the inception of common control on August 31, 2009 and (ii) intend to retain mostthe operating results of our available fundsWVAS and any future earnings for userecorded music were presented as “Results of Discontinued Operations” in the operation and expansion of our business in the PRC. Accordingly, no provision has been madeincome statements for the Chinese dividend withholding taxes that would be payable upon distributions to us.
The following discussion of our results of operations for the years ended December 31, 2007, 20082009, 2010 and 20092011 is based upon our audited consolidated financial statements included elsewhere in this annual report on Form 20-F.
Year Ended December 31, 20092011 Compared withto Year Ended December 31, 20082010
Net Revenues.OurNet revenues declined 35.8%increased by 16.1% to $34.6$19.2 million in 20092011 from $54.0$16.6 million in 2008.2010. This decreaseincrease was primarily due to a growth in revenues generated from performance advertising. We began to generate revenue from performance advertising in the second quarter of 2011, which contributed approximately 38% of our ongoing resource realignment and business integration.
Cost of Revenues. Cost of revenues decreased by 23.7% to $30.9 million for 2009in 2011 from $42.7$40.5 million for 2008, primarily duein 2010. This decrease was mainly attributable to (i) a declinedecrease of $12.0 million in amortization and write-down of licensed video copyrights as we shifted our SMS, IVRfocus from long-form videos to UGC, (ii) a decrease of $1.4 million in payroll costs as the change in business strategy in 2011 improved our cost structure and WAP services. SMS revenuesour operating efficiency, and (iii) a decrease of $1.3 million in Internet bandwidth costs in 2011 compared to 2010. These were partially offset by a one-time charge of $5.3 million in 2009, a declinetermination of 60.2% from $13.3 million for 2008. IVR revenues were $3.9 millionlong-form videos in 2009, a decline of 68.0% from $12.2 million for 2008. WAP revenues were $3.1 million in 2009, a decline of 58.1% from $7.4 million for 2008.
Gross Loss.As a result of the acquisition of Seed Music.
Operating ExpensesExpenses.. Our operatingOperating expenses increased 47.3% from $22.7by 27.6% to $37.9 million in 2008 to $33.42011 from $29.7 million in 2009, primarily due2010. This increase was attributable to an increase of $11.0 millionincreases in general and administrative expenses and an increase of $1.5 million in provision for impairment of goodwill and intangible assets,product development expenses, partially offset by a decrease of $2.8 million in selling and marketing expenses and a decrease of $0.5 million in product development expenses.
| • | Product Development Expenses. Product development expenses were $2.7 million in 2011 compared to nil in 2010. This increase was primarily due to payroll costs of $2.2 million for our research and development department newly established in 2011. |
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| • | Selling and Marketing Expenses. Selling and marketing expenses decreased by 27.0% to $11.8 million in 2011 from $16.2 million in 2010. This decrease was primarily attributable to a decrease of $3.6 million in marketing commission and a decrease of $1.2 million in salaries and benefits of sales and marketing staff, partially offset by an increase due to the one-off severance payments of $0.9 million as a result of the restructuring of our sales department. |
| • | General and Administrative Expenses. General and administrative expenses increased by 73.3% to $23.4 million in 2011 from $13.5 million in 2010. This increase was primarily attributable to (i) a $2.4 million loss from disposal of network equipment due to technological upgrades, (ii) an increase of $2.1 million in provision for copyright lawsuits, (iii) increases of $1.4 million in bad debt provision and $1.4 million in impairment due to abandonment of intangible assets resulting from our changes in business strategies, and (iv) an increase of $1.2 million in annual bonus in 2011 compared to 2010. |
Interest Income and ExpenseIncome.. Interest income was $0.5 million for 2009, compared with $1.6 million for 2008. Interest expense was $0.01 million for 2009 as compared with nil for 2008, which was relatedincreased to the non-controlling interest shareholder loan from Seed Music.
Income Taxes.Interest Expense.Income taxes were anInterest expense of $0.2 and $0.5increased significantly to $1.1 million in 20092011 from $31,134 in 2010 primarily due to the interest on the senior convertible notes accrued from the issuance date in June 2011 to the redemption date in September 2011 and 2008, respectively.
Other Income, Net.Other net income increased significantly to $1.3 million in 2011 from $3 in 2010. We received government subsidies of $1.3 million in the form of cash subsidies in 2011, which were granted by the local government to encourage development of certain enterprises in the local special economic region.
Income Tax Benefit.Income tax benefit increased to $0.1 million in 2011 from $41,172 in 2010. These amounts represented the deferred income tax benefit from continuing operations.
Equity in Loss of Affiliated Company,Net of Tax. Equity in loss of affiliated company,. The equity in the loss net of New Runtax, was $0.9$0.3 million in 2009 as2011 compared with equityto nil in the income2010. This loss was attributable to our disposal of New Run of $0.06 millionan 80% interest in 2008.
Net Loss from Continuing Operations.Operations, Net of Tax, Attributable to Ku6 Media Co., Ltd.Net loss from continuing operations was $27.1attributable to our company decreased by 6.6% to $49.3 million for 2009 compared with a net loss of $12.7in 2011 from $52.9 million for 2008in 2010.
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Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
Net Revenues. Net revenues increased significantly to $16.6 million in 2010 from $1.0 million in 2009. The increase was $4.2 million for 2009, compared with $0.3 million for 2008.
Cost of Revenues. Our cost of revenues increased significantly to $40.5 million in 2010 from $0.6 million in 2009. This increase was primarily the result of our acquisition of Ku6 Holding. The cost of revenues in 2010 consisted mainly of Internet bandwidth cost of $10.3 million, amortization and write-down of licensed video copyrights of $15.6 million, and payroll cost relating to platform operation and content of $6.2 million. The cost of revenues in 2009 consisted mainly of Internet bandwidth cost.
Gross Loss.As a result of the foregoing, we have nethad a gross loss attributable to Hurray! Holding Co., Ltd. of $22.7 million for 2009, compared with $12.0 million for 2008.
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Operating Expenses. OurOperating expenses increased significantly to $29.7 million in 2010 from $7.1 million in 2009. Operating expenses for the year ended December 31, 2010 consisted of operating expenses decreased 63.1% from $61.5 million in 2007 to $22.7 million in 2008, primarily due to a decreaseassociated with our online video business since January 18, 2010 and operating expenses associated with our online audio business for the entire year. Operating expenses for the year ended December 31, 2009 consisted of $35.7 million in provision for impairment of goodwill and intangible assets, a decrease of $2.4 million in selling and marketingoperating expenses and a decrease of $1.0 million in product development expenses, offset by an increase of $2.9 million in general and administrative expenses.
| • | Selling and Marketing Expenses. Selling and marketing expenses increased significantly to $16.2 million in 2010 from $0.7 million in 2009. This increase was primarily attributable to Ku6 Holding’s higher advertising and marketing expenses, salaries and benefits of sales and marketing staff, sales commission to the sales team, and travelling and entertainment expenses. |
| • | General and Administrative Expenses. General and administrative expenses increased significantly to $13.5 million in 2010 from $6.5 million in 2009. This increase was primarily attributable to (i) an increase of $1.7 million in amortization of intangible assets arising from the acquisition of Ku6 Holding, (ii) an increase of $1.6 million in bad debt provision due to the expansion of our advertising business as a result of our acquisition of Ku6 Holding, (iii) an increase of $1.6 million in business tax for intercompany transactions, and (iv) an increase of $1.5 million in share-based compensation expenses primarily as a result of the one-time compensation expense of $1.3 million relating to the incremental value of the ordinary shares issued by us to replace the options issued by Ku6 Holding before its acquisition by us, partially offset by a decrease of $2.5 million in consulting and legal expenses which were incurred in 2009 mainly for the tender offer by Shanda Interactive. |
Selling and Marketing Expenses. Our selling and marketing expenses decreased 20.7% to $9.1 million in 2008 from $11.5 million in 2007. The decrease was mainly due to the fact that we recorded a write-down of $1.8 million for intangible assets of WVAS in 2007 compared with a write-down of $0.4 million in 2008.
2009.
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| For the Year Ended December 31, | ||||||||||||
| 2009 | 2008 | 2007 | ||||||||||
| (in thousands of U.S. dollars) | ||||||||||||
| Net cash (used in) provided by operating activities | $ | (1,455 | ) | $ | (5,553 | ) | $ | (2,055 | ) | |||
| Net cash used in investing activities | (9,376 | ) | (2,265 | ) | (8,120 | ) | ||||||
| Net cash provided by (used in) financing activities | 3 | 2 | 16 | |||||||||
| Net (decrease) in cash and cash equivalents | $ | (10,828 | ) | $ | (7,816 | ) | $ | (10,159 | ) | |||
Unaudited Consolidated Pro Forma Statements of miscellaneous receivables due from employees or artists and relating items expensed according to the beneficial period, an increase in accrued expenses and other current liabilitiesOperations
The unaudited consolidated pro forma statements of $2.3 million due to certain accrued liabilities not paid as of December 31, 2009.
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The following table shows the pro forma statements of operations for the years ended December 31, 2009 and 2010:
| For the Year Ended December 31, 2009 | ||||||||||||||||||||
| Ku6 Media Co., Ltd. | Ku6 Holding | Yisheng(1) | Pro Forma Adjustments(2) | Pro Forma Consolidation | ||||||||||||||||
| (in thousands of U.S. dollars, except for share and per share data) | ||||||||||||||||||||
Total net revenues | 1,037 | 6,225 | 985 | — | 8,247 | |||||||||||||||
Total cost of revenues | (557 | ) | (10,018 | ) | (428 | ) | — | (11,003 | ) | |||||||||||
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Gross profit (loss) | 480 | (3,793 | ) | 557 | — | (2,756 | ) | |||||||||||||
Total operating expenses | (7,130 | ) | (6,374 | ) | (1,203 | ) | (1,962 | ) | (16,669 | ) | ||||||||||
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Operating loss from continuing operations | (6,650 | ) | (10,167 | ) | (646 | ) | (1,962 | ) | (19,425 | ) | ||||||||||
Interest income | 356 | 8 | — | — | 364 | |||||||||||||||
Interest expense | — | (40 | ) | (1 | ) | — | (41 | ) | ||||||||||||
Other income, net | 2 | 2 | 39 | — | 43 | |||||||||||||||
Foreigin exchange loss | — | — | — | — | — | |||||||||||||||
Fair value changes in warrant liabilities | — | 186 | — | — | 186 | |||||||||||||||
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Loss before income tax benefit from continuing operations | (6,292 | ) | (10,011 | ) | (608 | ) | (1,962 | ) | (18,873 | ) | ||||||||||
Income tax benefit | 14 | — | — | — | 14 | |||||||||||||||
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Loss from continuing operations, net of tax | (6,278 | ) | (10,011 | ) | (608 | ) | (1,962 | ) | (18,859 | ) | ||||||||||
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Discontinued operations: | ||||||||||||||||||||
Loss from operations of discontinued operations, net of tax | (21,778 | ) | — | — | — | (21,778 | ) | |||||||||||||
Gain from disposal of discontinued operations | 222 | — | — | — | 222 | |||||||||||||||
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Loss from discontinued operations, net of tax | (21,556 | ) | — | — | — | (21,556 | ) | |||||||||||||
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Loss from continuing and discontinued operations, net of tax | (27,834 | ) | (10,011 | ) | (608 | ) | (1,962 | ) | (40,415 | ) | ||||||||||
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Less: Net loss attributable to the non-controlling interests from continuing operations | 256 | — | — | — | 256 | |||||||||||||||
Less: Net loss attributable to the non-controlling interests and redeemable non-controlling interests from discontinued operations | 4,183 | — | — | — | 4,183 | |||||||||||||||
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Net loss attributable to Ku6 Media Co., Ltd. | (23,395 | ) | (10,011 | ) | (608 | ) | (1,962 | ) | (35,976 | ) | ||||||||||
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Loss from continuing operations, net of tax, attributable to Ku6 Media Co., Ltd. | (6,022 | ) | (10,011 | ) | (608 | ) | (1,962 | ) | (18,603 | ) | ||||||||||
Loss from discontinued operations, net of tax, attributable to Ku6 Media Co., Ltd. | (17,373 | ) | — | — | — | (17,373 | ) | |||||||||||||
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Net loss attributable to Ku6 Media Co., Ltd. | (23,395 | ) | (10,011 | ) | (608 | ) | (1,962 | ) | (35,976 | ) | ||||||||||
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| (1) | The above financial information of Yisheng reflects its results of operations for the period from January 1, 2009 to August 31, 2009, as its results of operations from September 1, 2009 have already been included in the consolidated results of Ku6 Media Co., Ltd. |
| (2) | Represents the incremental amortization expense for the intangible assets resulting from the Ku6 Holding acquisition. |
Total net revenues Total cost of revenues Gross loss Total operating expenses Operating loss from continuing operations Interest income Interest expense Other income, net Foreigin exchange loss Fair value changes in warrant liabilities Loss before income tax benefit from continuing operations Income tax benefit Loss from continuing operations, net of tax Discontinued operations: Loss from operations of discontinued operations, net of tax Gain from disposal of discontinued operations Loss from discontinued operations, net of tax Loss from continuing and discontinued operations, net of tax Less: Net loss attributable to the non-controlling interests from continuing operations Less: Net loss attributable to the non-controlling interests and redeemable non-controlling interests from discontinued operations Net loss attributable to Ku6 Media Co., Ltd. Loss from continuing operations, net of tax, attributable to Ku6 Media Co., Ltd. Loss from discontinued operations, net of tax, attributable to Ku6 Media Co., Ltd. Net loss attributable to Ku6 Media Co., Ltd. For the Year Ended December 31, 2010 Ku6 Media
Co., Ltd. Ku6 Holding (1) Pro Forma
Adjustments(2) Pro Forma
Consolidation 16,556 232 — 16,788 (40,459 ) (3,956 ) — (44,415 ) (23,903 ) (3,724 ) — (27,627 ) (29,703 ) (641 ) (154 ) (30,498 ) (53,606 ) (4,365 ) (154 ) (58,125 ) 57 — — 57 (31 ) — — (31 ) — — — — — (4 ) — (4 ) — — — — (53,580 ) (4,369 ) (154 ) (58,103 ) 41 — — 41 (53,539 ) (4,369 ) (154 ) (58,062 ) (3,382 ) — — (3,382 ) 4,486 — — 4,486 1,104 — — 1,104 (52,435 ) (4,369 ) (154 ) (56,958 ) 681 — — 681 244 — — 244 (51,510 ) (4,369 ) (154 ) (56,033 ) (52,858 ) (4,369 ) (154 ) (57,381 ) 1,348 — — 1,348 (51,510 ) (4,369 ) (154 ) (56,033 )
| (1) | The above financial information of Ku6 Holding reflects its results of operations for the period from January 1, 2010 to January 17, 2010, as the Ku6 Holding acquisition was completed on January 18, 2010. |
| (2) | Represents the incremental amortization expense for the intangible assets resulting from the Ku6 Holding acquisition. |
Year Ended December 31, 2010 (pro forma) Compared to Year Ended December 31, 2009 (pro forma)
Net Revenues. Our pro forma net revenues increased 104% to $16.8 million $0.3in 2010 from $8.2 million and $0.9 million, respectively. Our capital divestitures are not material.
Cost of Revenues. Our pro forma cost of revenues increased to $44.4 million in 2010 from $11.0 million in 2009.
| Year ended December 31, 2009 (in thousands) | Year ended December 31, 2010 (in thousands) | |||||||||||||||||||||||
| Actual | Pro forma Adjustments | Pro forma | Actual | Pro forma Adjustments | Pro forma | |||||||||||||||||||
Internet bandwidth costs | 534 | 4,137 | 4,671 | 10,279 | 497 | 10,776 | ||||||||||||||||||
Amortization and write-down of purchased video copyright cost | — | 1,747 | 1,747 | 15,619 | 2,852 | 18,471 | ||||||||||||||||||
Payroll cost | — | 2,506 | 2,506 | 6,167 | 350 | 6,517 | ||||||||||||||||||
In-house developed content costs | — | — | — | 1,596 | — | 1,596 | ||||||||||||||||||
Depreciation of servers and other equipments | — | 1,278 | 1,278 | 2,503 | 109 | 2,612 | ||||||||||||||||||
Other costs(1) | 23 | 778 | 801 | 4,295 | 148 | 4,443 | ||||||||||||||||||
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Total costs | 557 | 10,446 | 11,003 | 40,459 | 3,956 | 44,415 | ||||||||||||||||||
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| (1) | Includes primarily advertisement production costs and outside service fees and UGC costs. |
The $33.4 million increase in our cashpro forma cost of revenues from 2009 to 2010 was mainly due to (i) an increase from $1.7 million in U.S. dollar or RMB denominated bank accounts or short-term time deposits for two principal purposes:2009 to finance$18.5 million in 2010 of amortization and write-down of purchased video copyright costs, as a result of our operationssignificantly increased investment in professional content in 2010 compared to 2009, including licensed video copyrights related to the 2010 FIFA World Cup, the 2010 Asian Games and to manage the interest rate and currency risks arising from our operations. We adjust the amount of cash held in U.S. dollars and RMB from time to time to maximize our interest rate returns and to ensure that we have sufficient RMB for our operational needs, including for leasemovies, TV series and other commitments. Inentertainment programs. As of December 31, 2010, the first half of 2008, we converted a significant portioncarrying value of our U.S. dollar deposits into Euros, which were subsequently converted back into U.S. dollars.licensed video copyrights was written down to zero. Also, our pro forma bandwidth costs increased 154% from $4.2 million in 2009 to $10.8 million in 2010, due to the growth in our traffic volume as a result of our large content library established in 2010.
Gross Loss. We have not historically used derivative instruments to hedge market risks. We recordedhad a foreign exchangepro forma gross loss of $4.5$27.6 million arisingin 2010, compared to a pro forma gross loss of $2.8 million in 2009. This increase in gross loss was largely due to our increases in costs related to both platform operation and content, including Internet bandwidth leasing costs, depreciation expenses, amortization and write-down of licensed video copyrights, in-house developed content costs and related employee costs.
Operating Expenses. Pro forma operating expenses were $30.5 million in 2010, representing an increase of 82.6% from the decrease$16.7 million in the value of the Euro against the U.S. dollar in the third quarter of 2008.2009.
| • | Selling and Marketing Expenses. Our pro forma selling and marketing expenses increased to $16.8 million in 2010 from $5.0 million in 2009. The increase in pro forma selling and marketing expenses was the result of higher sales commissions to our sales team tied to sales performance and more marketing promotion activities in 2010 to enhance the reputation of our Ku6.com website. |
| • | General and Administrative Expenses. Our pro forma general and administrative expenses increased to $13.7 million in 2010 from $11.6 million in 2009 mainly due to the increase of $1.4 million in share-based compensation expenses including one-time compensation expenses of $1.3 million relating to the fair value of ordinary shares issued by us to replace the options issued by Ku6 Holding over the acquisition date fair value of those options attributable to the pre-combination portion in connection with the acquisition of Ku6 Holding. Also the increase of bad debt expenses of $1.6 million due to expansion of our advertising business, business tax of $1.7 million for the intercompany transactions within the group and rental and management expenses of $0.6 million due to relocation and expansion of our office building, was partially offset by the decrease of the consulting and legal expenses for the Shanda tender offer of $2.5 million. |
Operating Loss from Continuing Operations. As a result of the foregoing, pro forma operating loss from operations was $58.1 million for the year ended December 31, 2010 compared to $19.4 million for the year ended December 31, 2009.
Loss from Continuing Operations attributable to Ku6 Media Co., Ltd. Loss from continuing operations attributable to Ku6 Media Co., Ltd. was $57.4 million for 2010 compared to a net loss of $18.6 million for 2009.
Income (Loss) from Discontinued Operations attributable to Ku6 Media Co., Ltd. Income from discontinued operations attributable to us was $1.3 million for 2010 due to a gain of $4.5 million from the disposal of Huayi Music, offset by a loss of $3.4 million from operations of our WVAS and recorded music businesses for the eight months ended August 31, 2010, after giving effect to the loss attributable to the non-controlling and redeemable non-controlling interests of $0.2 million for 2010. Loss from discontinued operations attributable to us was $17.4 million for 2009 mainly due to loss of $21.8 million from operations of our WVAS and recorded music businesses for the full year of 2009, of which $4.2 million was attributable to the non-controlling and redeemable non-controlling interests.
B. LIQUIDITY AND CAPITAL RESOURCES
Cash Flows and Working Capital
Our online video business requires significant upfront capital expenditures as well as continuous, substantial investment in content, technology 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 appreciation of the U.S. dollar, we recorded a further exchange losscapital needs in the fourth quarter of 2008 of $4.5 million. Currently we hold all non-Renminbi cash in U.S. dollars.
Based upon anticipated cash flow related to operating activities and our present cash balances and working capital position, we expect that we will have sufficient sources of cash to fund our needs for at least the next 12 months.
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Net cash used in operating activities Net cash (used in) provided by investing activities Net cash provided by financing activities Effect of exchange rate changes on cash and cash equivalents Net decrease in cash and cash equivalents Year Ended December 31, 2009 2010 2011 (in thousands of U.S. dollars) (2,092 ) (29,570 ) (39,175 ) (8,931 ) 2,168 (25,712 ) 1,448 4,616 63,328 (154 ) 337 1,014 (9,729 ) (22,449 ) (545 )
Operating Activities
Our net cash used in respectoperating activities in 2011 was $39.2 million. This was primarily attributable to (i) our net loss of capital leasing$49.4 million, (ii) a decrease of $7.9 million in accounts payable due to more settlement of internet bandwidth costs and cash incentives to advertising agencies in 2011, and (iii) an increase of $3.9 million in the amount due from related parties under common control by Shanda Interactive, which were adjusted by (i) non-cash expenses of $5.2 million in depreciation and amortization, $3.7 million in amortization and write-down of licensed video copyrights, $3.5 million in bad debt provision due to changes in business strategy, and $3.0 million in loss from disposal of property and equipment due to technological upgrades, and (ii) a decrease of $3.8 million in accounts receivable as a result of the increased collection of advertising revenue in 2011.
Our net cash used in operating activities in 2010 was $29.6 million. This was primarily attributable to (i) our Beijing office we didnet loss of $52.4 million and (ii) an increase of $8.7 million in accounts receivable mainly due to the advertising revenue generated in the last quarter of 2010 not have any indebtedness or any materialreceived, most of which was still within the normal credit terms, which were adjusted by (i) non-cash expenses of $15.8 million in amortization and write-down of licensed video copyrights, $5.3 million in depreciation and amortization, $1.9 million in share-based compensation cost, and $1.5 million in bad debt securities, mortgages or liens. In addition,provision, (ii) an increase of $8.8 million in accounts payable due to certain payables in connection with Internet bandwidth and cash incentives to advertising agencies not paid as of December 31, 2010, and (iii) an increase of $6.0 million in accrued expenses and other current liabilities mainly due to the business tax and salesman commission not paid as a result of the increase of the advertising revenue in 2010.
Our net cash used in operating activities in 2009 we didwas $2.1 million. This was primarily attributable to our net loss of $27.8 million, which was adjusted by (i) non-cash expenses of $3.8 million in bad debt provision, $3.6 million in impairment of goodwill, and $1.8 million in depreciation and amortization, (ii) a decrease of $5.9 million in accounts receivable mainly due to the proceeds received from telecom operators, (iii) a decrease of $2.7 million in prepaid expenses and other current assets primarily due to the collection of miscellaneous receivables due from employees or artists and relating items expensed according to the beneficial period, and (iv) an increase of $2.3 million in accrued expenses and other current liabilities due to certain accrued liabilities not have any material contingent liabilities. We may, however, be obligatedpaid as of December 31, 2009.
Investing Activities
Our net cash used in investing activities was $25.7 million in 2011. This consisted mainly of (i) the interest-bearing loans with an aggregate amount of $14.1 million provided to make certain earn-out paymentsShanda Games in 2011, (ii) $5.5 million used in payment for licensed video copyrights, (iii) our pledge of $3.6 million cash as collateral for the bank loan, and (iv) payment of $2.4 million for the purchases of property and equipment.
Our net cash provided by investing activities was $2.2 million in 2010. This was primarily attributable to (i) net cash of $12.3 million received from the disposal of the WVAS and recorded music businesses, (ii) a decrease of $10.0 million in short-term investments in connection with our investmentthe maturity of time deposits, and (iii) net proceeds of $4.4 million from the disposal of Huayi Music, partially offset by (i) $15.0 million used in payment for licensed video copyrights, (ii) $6.6 million used in the purchase of property and equipment, and (iii) a $3.2 million loan paid to related parties under common control by Shanda Interactive.
Our net cash used in investing activities was $8.9 million in 2009. This was primarily attributable to (i) an increase of $10.0 million in short-term investments in the form of time deposits and (ii) payment of $0.9 million for the purchase of fixed assets, partially offset by (i) net cash of $1.0 million received from the acquisition of Seed Music, (ii) net cash of $0.6 million received from the acquisition of Yisheng, and (iii) net proceeds of $0.3 million from the disposal of a subsidiary.
Financing Activities
Our net cash provided by financing activities was $63.3 million in 2011. This consisted mainly of (i) proceeds of $50.0 million from the issuance of ordinary shares to Shanda Media and $50.0 million from the issuance of senior convertible bonds to Shanda Media, (ii) net borrowings of $10.1 million from certain affiliates, and (iii) a domestic bank borrowing of RMB20.0 million ($3.2 million), partially offset by the full redemption of the $50.0 million senior convertible bonds based on our working capital position.
Our net cash provided by financing activities was $4.6 million in 2010. This consisted mainly of borrowings of $4.6 million from related parties under common control by Shanda Interactive.
Our net cash provided by financing activities was $1.4 million in 2009. This consisted mainly of capital injection of $1.4 million into Yisheng by Shanda Interactive and Yisheng’s non-controlling shareholder.
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 discusseddetermined 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 “Tabular DisclosurePRC laws and regulations, our PRC subsidiaries and consolidated affiliated entities are restricted in their ability to transfer a portion of Contractual Obligations” below.
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. “Information Onon the Company — Company—Business Overview — ProductOverview—Technology and Content Development,” “—Infrastructure and Technology,”Infrastructure” and “—Intellectual Property and Proprietary Rights.Property.”
Our research and development expenditures were $0.5 million, $1.0 millionnil, nil and $2.0$2.7 million in 2009, 20082010 and 2007,2011, respectively.
D. TREND INFORMATION
Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events since January 1, 2010 that are reasonably likely to have a material adverse effect on our net revenues, income, profitability, liquidity or capital resources, or that caused the disclosed financial information to be not necessarily indicative of future operating results or financial conditions.
E. OFF-BALANCE SHEET ARRANGEMENTS
We 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. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The following table sets forth certain information with respect to our contractual obligations as of December 31, 2009:
| Payments Due by Period | ||||||||||||||||
| Less than | 1-3 | 3-5 | ||||||||||||||
| Total | 1 year | years | years | |||||||||||||
| (in thousands of U.S. dollars) | ||||||||||||||||
| Operating lease commitments | $ | 862 | $ | 492 | $ | 370 | $ | — | ||||||||
| Other contractual commitments* | 2,024 | 852 | 1,172 | — | ||||||||||||
| Total contractual obligations | $ | 2,886 | $ | 1,344 | $ | 1,542 | $ | — | ||||||||
| Payments Due by Period | ||||||||||||||
| Total | Less than 1 year | 1-3 years | 3-5 years | |||||||||||
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Operating lease commitments | 6,562 | 6,132 | 430 | |||||||||||
We did not achieve the specified earnings target, we were not required need to make additional payment.
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On September 29, 2011, Tianjin WFOE obtained a bank loan from Shanghai Pudong Development Bank in preparing our audited financial statements asthe amount of andRMB20.0 million ($3.2 million) for theone year ended December 31, 2009, our net asset value, as presented in U.S. dollars, would have been reduced by $0.1 million and $0.6 million, respectively. Conversely, if the Renminbi had been 1% and 5% more valuable against the U.S. dollar as of that date, then our net asset value would have increased by $0.1 million and $0.6 million, respectively.
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We had other payables due to 15%. In addition, new technology enterprises previously qualified under the previous income tax laws and rules as of December 31, 2007 are eligible to enjoy certain unexpired tax holidays which have been grandfathered in under the New EIT Law, on the condition that they have been re-approved as a “high and new technology enterprise” under the New EIT Law. Two of our subsidiaries, Saiyu and Henan Yinshan, continue to benefit from the preferential tax rate of 25% of the calculated taxable income, which is based on 10% of the revenues. Our qualified new cultural enterprises, Huayi Brothers Broker, Freeland Culture and Secular Bird, were also entitled to a tax exemption in 2008. In December 2008, certain local governments announced the recognition of our subsidiaries and VIEs, including Beijing Palmsky, Beijing Hutong, Beijing Enterprise and Hurray! Solutions Ltd., as “high and new technology enterprises” entitled to a preferential tax rate of 15% effective retroactively from January 1, 2008 through January 1, 2011. In addition, Beijing Hutong is new-technology enterprises locatedrelated parties in the Beijing new technology development zone and under PRC Income Tax Laws, is entitled to a three-year tax exemption followed by three years with a 50% reduction in its tax rate, commencing 2004. In 2009, Beijing Hutong was subject to a preferential tax rateamount of 12.5%.
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A. Directors and Senior Management
The names of our current directors and executive officers, their ages as of April 1, 2010February 29, 2012, and the principal positions with us held by them are as follows:
Name | Age | Position | ||
| Independent Director and Chairman of the Board of Directors | ||||
| Director | ||||
| Director | ||||
| Director | ||||
| Haifa Zhu | 39 | Director | ||
| Haibin Qu | ||||
| 37 | Director | |||
| 43 | Independent Director | |||
Wenwen Niu | 45 | Independent Director | ||
| Chief Executive Officer and Acting Chief Editor | ||||
| Tony Shen | 44 | Chief Financial Officer | ||
| (1) | Member of the compensation and leadership development committee | |
| (2) | Member of the corporate development and finance committee |
| (3) | Member of the audit committee |
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Bruno Wu. Mr. Wu has served as an independent director on our board of directors since September 1, 2009 and has been Chairman of the board of directors since August 17, 2010. Mr. Wu also has served as a director of Shanda Interactive from October 2006 to August 2009. Mr. Wu is the co-founder and chairman of The Sun Media Investment Holding Group of Companies, one of China’s largest privately held media groups. Mr. Wu served as co-chairman of SINA Corporation from 2001 to 2002 and as the chief operating officer of ATV, one of the two free-to-air networks in Hong Kong, from June 1998 until February 1999. Mr. Wu received a doctorate degree in international politics from Fudan University in 2001, a master of arts degree in international affairs from Washington University in Missouri in 1993, a bachelor of science degree in business administration-finance from Culver-Stockton College in Missouri in December 1990, and a diploma of studies in French civilization from the University of Savoie in France in 1987.
Tianqiao Chen.Mr. Chen has served ason our board of directors since July 24, 2009 and was Chairman of the Board sinceboard of directors from July 24, 2009.2009 to August 17, 2010. Mr. Tianqiao Chen is one of the co-founders of Shanda Interactive and has served as the chairman of the board of directors and the chief executive officer of Shanda Interactive since its inception in December 1999. From 1998 to 1999, Mr. Chen served as the deputy director of the office of the president of Kinghing Trust & Investment Co., Ltd. From 1994 to 1998, Mr. Chen served in various management positions with Shanghai Lujiazui Group. Mr. Chenalso serves as a member of the board of directors of SinoMedia Holding Ltd., which is listed on the Hong Kong Stock Exchange.Exchange, and Shanda Games Limited. Mr. Chen holdsreceived a bachelor’s degree in economics from Fudan University.
DaNianDanian Chen.Mr. Danian Chen has served on our board of directors since January 19, 2010. Mr. Danian Chen is one of the co-founders of Shanda Interactive. Mr. Danian Chen has served in various capacities at Shanda Interactive, mostly recently as the chief operating officer beginning in April 2008. Mr. Chen is also a member of the board of directors of Shanda Interactive, a position which he has held since April 2008its inception in 1999, and as a director since 1999. Previously, he served as Shanda’s directormember of products, vice president, senior vice president, and executive senior vice president. Prior to joiningthe board of directors of Shanda he held various positions with Xinghui International Transport Company, Haijie Shipping Agency Company, and Jinyi Network Company from 1996 to 1999.
Grace Wu.Ms. Wu has served on our board of directors since July 24, 2009. Ms. Wu has served as Shanda’sShanda Interactive’s senior vice president since April 2008 and chief financial officer since November 2007 and a director since December 2007. Ms. Wu previously served as Shanda’sa director of Shanda Interactive from December 2007 to February 2012, vice president from November 2007 to March 2008, and vice president of strategic investments from October 2007 to November 2007. Prior to joining Shanda Interactive, Ms. Wu spent five years with AU Optronics Corp., where she was responsible for financial planning and analysis, investor relations and capital markets activities. Prior to that, Ms. Wu worked at Goldman Sachs and Lehman Brothers where she divided her responsibilities between the equity capital markets and investment banking divisions. Ms. Wu holdsreceived a bachelor’s degree from National Taiwan University and a Mastermaster of International Affairsinternational affairs degree in international banking and finance from Columbia University and a bachelor’s degree from National Taiwan University.
Haifa Zhu.Mr. Zhu has served on our board of directors since July 24, 2009. Mr. Zhu also served as our Acting Chief Executive Officer from March 14, 2011 to August 1, 2011. Mr. Zhu has served as chief investment officer and senior vice president of Shanda Interactive since April 2008. Mr. Zhu previously served as Shanda’sShanda Interactive’s assistant vice president of investments, director of platform operations, director of central user platform and deputy director of new business center. 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 holdsreceived a master’s degree in business administration and a bachelor’s degree from Fudan University.
Haibin Qu.Mr. Qu has served on our board of directors since July 24, 2009. Mr. Qu has served as Shanda’sShanda Interactive’s senior executive vice president since August 2005. Mr. Qu previously served as Shanda’sShanda Interactive’s senior vice president from July 2003 to August 2005, vice president from September 2002 to June 2003 and director of business development from February 2000 to August 2002. Prior to joining Shanda Interactive, Mr. Qu served as a vice president of Shanghai Fuwei Technology Development Co., Ltd. from September 1996 to December 1999. Mr. Qu holdsreceived a bachelor’s degree in mechanics from Fudan University.
Tongyu Zhou.Ms. Zhou has served as an independent director on our board of directors since September 1, 2009. Ms. Zhou is the Founderfounder and Chairmanchairman of Shanghai Weida Hi-Tech Group Co., Ltd., a leading and comprehensive enterprise engage in IT product distribution, real estate development, infrastructure construction, fast moving consumer goods sales and marketing in China since 1994. Ms. Zhou is a member of the national committee of CPPCC and Chinese National Youth Union, vice president of the Chinese Young Entrepreneurs’ Association and Shanghai Chamber of Commerce. Ms. Zhou received a Ph.D.doctorate degree in economics from Fudan University in 2008 and an MBAa master’s degree in business administration from China Europe International Business School in 2002.
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Li YaoYu Shi.. Mr. YaoYu Shi has served as our acting Chief TechnologyExecutive Officer since October 15, 2009.August 1, 2011 and our Acting Chief Editor since July 2011. Mr. Yao hasShi previously served as Shanda’s associate presidentShanda Interactive’s senior director of strategy and financial director since November 2007. Mr. Yao also serves as a member of the board of directors and Chief Financial Officer of Actoz Soft Co., Ltd.integration from 2009 to July 2011. Prior to joining Shanda Interactive, Mr. Yao was devotedShi worked at Juneyao Group as deputy general manager of strategy planning and capital markets from September 2006 to July 2009 and at Arthur Andersen and KPMG Consulting from September 2000 to August 2006. Mr. Shi received a bachelor’s degree in public accounting sector, including over 11-year experience with KPMG Huazhen Certified Public Accountants and holds extensive finance and M&A expertise in a wide range of industries.telecommunications from Shanghai Jiao Tong University.
Tony Shen. Mr. Yao graduated from the College of International Business and Management, Shanghai University, majoring in Finance and Accounting. In addition, he is a member of the Institute of Certified Public Accountants of People’s Republic of China.
Terms of Directors and Executive Officers
Each of our directors shall be re-elected annually by our shareholders at a general meeting and until his or her successor is duly elected and qualified, or until his or her earlier removal, or earlier vacation of office. Our executive officers are appointed by and serve at the discretion of our board of directors.
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 to six months’ 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 and for a certain period after the termination of his or her employment.
B. Compensation
Compensation of Directors and Executive Officers
For the year ended December 31, 2011, we paid aggregate compensation of $1.3 million to our outstanding shares pursuant to a tender offer in July 2009 (which amount has decreased to approximately 42.0% as of April 1, 2010) Shanda subsequently began compensating all of ourdirectors and officers, including former officers and directors except for one officer, Haoyu Yang.
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2004 Share Incentive2010 Equity Compensation Plan
Our board of directors and shareholders adopted our 2004 Share Incentivethe 2010 Equity Compensation Plan, or 2004the 2010 Plan, which became effective in July 2004.December 2010. A total of 180,740,200698,381,300 ordinary shares of our company are reserved for issuance under the 20042010 Plan. A general description of the terms of the 20042010 Plan is set forth below.
Plan Administration. Our board of directors or one or more committees appointed by our board acts as of the administrator of the 2010 Plan.
Types of Awards. Awards. The principal features of the various awards that canmay be granted under the 20042010 Plan consist of:
| • | Options. Options provide for the right to purchase a specified number of our ordinary shares at a specified exercise price subject to vesting. |
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| • | 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. |
Termination of the award prior to full vesting2010 Plan. Without further action by our board of directors, the award.
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C. Board Practices
Our board has determinedof directors currently consists of eight 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 our current boarddirectors: 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 Zhengof the audit committees are Bruno Wu, Tongyu Zhou and Wenwen Niu, are “independent” as defined in Rule 5605(a)(2)all of whom satisfy the “independence” requirements of the NASDAQ Listing Rules.
The members of the compensation and leadership development committee held one meeting in 2009. Ourare Tianqiao Chen, Danian Chen and Grace Wu. The compensation committee’s functions are to review and makeleadership development committee is responsible for, among other things, reviewing and making recommendations to our board of directors regarding our compensation policies and all forms of compensation to be provided to our executive officers and directors.
The members of the corporate development and finance committee are Tianqiao Chen, Bruno Wu and Grace Wu. 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 Shanda Interactive or any affiliate of Shanda Interactive.
None of our directors have existed betweenservice 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 or compensation committeeinclude, 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 boardterm of directors or compensation committeeoffice 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 other company.
D. Employees
As of December 31, 2009, 20082010 and 2007,2011, we had 230, 328816 and 444232 full-time employees, respectively. In addition, our affiliated music companies (Freeland Music, Huayi Brothers Music, New Run, and Secular Bird) had an aggregate of 120 employees as of December 31, 2009. Seed Music Group had 47 employees. None of our personnel are represented under collective bargaining agreements.
E. Share Ownership
The following table sets forth certain information known to us with respect to the beneficial ownership as of April 1, 2010February 29, 2012 by:
all persons who are beneficial owners of five percent or more of our ordinary shares;
our current executive officers and directors; and
all current directors and executive officers as a group.
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| Number of Shares | ||||||||
| Beneficially Owned | ||||||||
| Name | Number | Percentage | ||||||
5% and above Shareholders | ||||||||
| Shanda Interactive Entertainment Ltd | 1,233,161,592 | 41.97 | % | |||||
Romasco Place, Wickhams Cay 1, P.O. Box 3140, Road Town, Tortola, British Virgin Islands, VG1110(1) | ||||||||
| Granite Global Ventures | 256,850,015 | 8.74 | % | |||||
2494 Sand Hill Road Suite 100 Menlo Park, CA 94025 United States(2) | ||||||||
Executive Officers and Directors(3) | ||||||||
Shanyou Li(3) | 274,077,076 | 9.33 | % | |||||
| Tianqiao Chen | — | — | ||||||
| Danian Chen | — | — | ||||||
| Grace Wu | — | — | ||||||
| Haifa Zhu | — | — | ||||||
| Haibin Qu | — | — | ||||||
| Shanyou Li | — | — | ||||||
| Zheng Wu | — | — | ||||||
| Tongyu Zhou | — | — | ||||||
| Wenwen Niu | — | — | ||||||
| Li Yao | — | — | ||||||
| Haoyu Yang | — | — | ||||||
| Yanmei Zhang | — | — | ||||||
| Jianwu Liang | — | — | ||||||
| All current directors and executive officers as a group (11 persons) | 274,077,076 | 9.33 | % | |||||
| Number of Shares | ||||||||
| Beneficially Owned | ||||||||
Name | Number | Percentage | ||||||
5% and Above Shareholders | ||||||||
Shanda Interactive Entertainment Limited(1) | 3,334,694,602 | 66.4 | % | |||||
Shanyou Li(2) | 274,077,076 | 5.5 | % | |||||
Executive Officers and Directors | ||||||||
Bruno Wu | * | * | ||||||
Tianqiao Chen | — | — | ||||||
Danian Chen | * | * | ||||||
Grace Wu | * | * | ||||||
Haifa Zhu | * | * | ||||||
Haibin Qu | * | * | ||||||
Tongyu Zhou | * | * | ||||||
Wenwen Niu | * | * | ||||||
Yu Shi | * | * | ||||||
Tony Shen | * | * | ||||||
All current directors and executive officers as a group | * | * | ||||||
| * | Upon exercise of all options, |
| (1) | Shanda Interactive’s beneficial ownership of our ordinary shares consists of (i) 1,155,045,300 ordinary shares, including ordinary shares represented by our ADSs, acquired by Shanda Media, in connection with the tender offer completed in July 2009, (ii) 78,116,292 ordinary shares, including ordinary shares represented by ADSs, acquired by Shanda Media from certain selling shareholders in private transactions in September 2009, (iii) 47,389,700 ordinary shares, including ordinary shares represented by our ADSs, acquired by Shanda Media under a 10b5-1 trading plan during the period from October 2009 to October 2010, (iv) 83,076,923 ordinary shares acquired by Shanda Media from Chris Anjun Chen in August 2010, (v) 17,220,214 ordinary shares acquired by Shanda Media from ITOCHU Corporation in September 2010, (vi) 415,384,615 ordinary shares issued to Shanda Interactive |
| (2) |
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As of April 1, 2010,February 29, 2012, approximately 1,026,270,8002,430,983,200 of our ordinary shares were held in the U.S. by 102105 holders of record, excluding shares held by our ADS depositary bank, Citibank N.A., on behalf of our ADS holders. Citibank N.A. has advised us that as of that date 10,262,70814,044,121 ADSs, representing 1,026,270,8001,404,412,100 ordinary shares, were held of record by Cede & Co and 101 other registered shareholders.Co. We have no further information as to ordinary shares held, or beneficially owned, by U.S. persons.
Our company’s major shareholders do not have different voting rights from each other or other shareholders of our company. To our knowledge, except as disclosed above, we are not owned or controlled, directly or indirectly, by another corporation, by any foreign government or by any other natural or legal person or persons, severally or jointly. To our knowledge, there are no arrangements the operation of which may at a subsequent date result in usour undergoing a change in control.
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 currently conduct our WVAS businessoperations in China principally through contractual arrangements among our wholly owned subsidiary, Beijing Hurray! Times. To comply with ownership requirements under Chinese law, which impose certain restrictions on foreign companies from investingPRC subsidiaries (Beijing WFOE, Tianjin WFOE and Tianjin Ku6 Network WFOE), our consolidated affiliated entities in certain industries such as value-added telecommunicationthe PRC (Ku6 Information Technology, Tianjin Ku6 Zheng Yuan, Ku6 Cultural and Internet services, Beijing Hurray! Times entered into a series of agreements with our VIEsTianjin Ku6 Network), and their respective shareholders. In January 2010, we began conducting our online video business in China through our wholly owned subsidiaries, Ku6 (Beijing) Technology Co., Ltd. and WeiMoSanYi (Tianjin) Technology Co., Ltd. To comply with ownership requirements under Chinese law, which impose certain restrictions on foreign companies from investing in certain industries such as online video business, Ku6 (Beijing) Technology Co., Ltd. entered into agreements with our affiliated Chinese entity, Ku6 Information and its respective shareholders, WeiMoSanYi (Tianjin) Technology entered into agreements with our affiliated Chinese entity, Tianjin Ku6 and its respective shareholders. We hold no ownership interest in such VIEs. In addition, we control Hurray! Digital Media through three of our VIEs, Hurray! Solutions, Beijing Network and Beijing Hutong. See Item 4.C. “Information on the Company — Company—Organizational Structure.”
The principal terms of the agreements with respect to our VIEsconsolidated 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, 2011 was RMB20.0 million ($3.2 million). The initial term of the loans is 10 years (in respect of loans to shareholders of Ku6 Information Technology and Ku6 Cultural) or 20 years (in respect of loans to shareholders of Tianjin Ku6 Network), with the earliest expiration date being April 11, 2017. The loans are repayable on demand, but the shareholders of our consolidated affiliated entities may not repay all or any part of the loans without the prior written consent of our PRC subsidiaries.
Exclusive Business Cooperation Agreements: Certain of our PRC subsidiaries (Beijing WFOE and Tianjin WFOE) entered into exclusive business cooperation agreements with the relevant consolidated affiliated entities (Ku6 Information Technology and Tianjin Ku6 Zheng Yuan), pursuant to which these consolidated affiliated entities agreed to respectively appoint our PRC subsidiaries as their exclusive providers of technical, consulting and other services for service fees equal to 100% of the net income of the consolidated affiliated entities. Our PRC subsidiaries are entitled to exclusive and proprietary rights and interests in any intellectual properties arising out of or created during the performance of these agreements. These agreements have an initial term of 10 years, with the earliest expiration date being June 23 2018, 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.
Exclusive Consulting and Service Agreements: Certain of our PRC subsidiaries (Tianjin WFOE and Tianjin Ku6 Network WFOE) entered into exclusive consulting and service agreements with the relevant consolidated affiliated entities (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 consult 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, with the earliest expiration date being May 27, 2030, 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 (Tianjin WFOE and Tianjin Ku6 Network WFOE) entered into business operation agreements with the relevant consolidated affiliated entities (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, with the earliest expiration date being May 27, 2030, 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 described below.
Powers of Attorney.Attorney:Each of the shareholders of our VIEs has irrevocably designated Qindai Wang, as attorney-in-fact, to vote on their behalf at shareholders meetings on matters on which they are entitled to vote with respect to Hurray! Solutions, WVAS Solutions, Beijing Network, Beijing Palmsky, Beijing Hutong, Hengji Weiye, Henan Yinshan, Shanghai Saiyu and Shanghai Magma, as the case may be, including matters relating to the transfer of any or all of their respective equity interests in our VIEs and the appointment of the directors of our VIEs. The term of each of the powers of attorney is ten years. These powers of attorney do not extend to votes by the shareholders of our company or subsidiaries.
Exclusive Option Agreements or Equity Disposition Agreements: Each of our VIEs, as well as accept the guidance of Beijing Hurray! Times regarding their day-to-day operations, financial management and the hiring and dismissal of their employees. While Beijing Hurray! Times has the right to terminate all of itsPRC subsidiaries entered into exclusive option agreements or equity disposition agreements with the relevant consolidated affiliated entities and their respective shareholders, pursuant to which our VIEs ifPRC subsidiaries or their designees are entitled to an exclusive right, exercisable at any of our agreements with them expires or is terminated, our VIEs may not terminate the operating agreementstime during the term of the agreements, which is ten years.
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Software Transfer Agreements and Software License Agreements.Exclusive Intellectual Property Option Agreement: Beijing Palmsky alsoWFOE entered into agreementsan exclusive intellectual property option agreement with Ku6 Information Technology, pursuant to transferwhich Ku6 Information Technology irrevocably granted to Beijing Hurray! TimesWFOE or its ownership rights in its games software, which Beijing Hurray! Times has licensed back for Beijing Palmsky’s use in its operations on a non-exclusive basis for a nominal license fee.
Business Cooperation AgreementsOur Asset Transactions with Shanda Interactive. We have
On June 1, 2010, we entered into Business Cooperation Agreementsa master transaction agreement with Shanda Interactive, pursuant to which we agreed to acquire certain online audio assets from Shanda Interactive in exchange for 415,384,615 newly issued ordinary shares in us and, concurrently, Shanda Interactive agreed to acquire our WVAS and recorded music businesses in exchange for an aggregate of $36,944,267 in cash, subject to adjustment based on the May 31, 2010 cash balances of the businesses being transferred to Shanda Interactive. On August 17, 2010, we and Shanda collaborate on wirelessInteractive completed the asset transactions contemplated under the master transaction agreement. We issued 415,384,615 ordinary shares to Shanda Interactive in exchange for its 75% interest in an online audio business promotions, commercial artist performances and celebrity gameshowsissued 138,461,539 ordinary shares to the non-controlling shareholder in exchange for the remaining 25% interest in the online audio business. Shanda Interactive acquired our WVAS and recorded music businesses in exchange for an aggregate of $37,243,904 in cash.
Share Purchase Agreement with Shanda Media
On April 1, 2011, we entered into a share licensed content. The initial termpurchase agreement with Shanda Media, pursuant to which we agreed to issue to Shanda Media 1,538,461,538 ordinary shares for an aggregate purchase price of most$50,000,000 (or $0.0325 per ordinary share). Our shareholders approved the issuance of these agreements is oneordinary shares at our extraordinary general meeting on June 24, 2011. We issued these ordinary shares to two years.
Convertible Bond Purchase Agreement with Shanda Media
On April 1, 2011, we entered into certain agreementsa convertible bond purchase agreement with Huayi Brothers MusicShanda Media, pursuant to which we agreed to sell to Shanda Media $50,000,000 aggregate principal amount of 3% senior convertible bond at face value. The convertible bonds were to mature in three years after issuance and Freeland Music for onlinebear interest at a rate of 3% per annum, payable semi-annually in arrears on June 30 and offline distributionDecember 31 of music contenteach year, commencing December 31, 2011. Beginning six months after issuance and at any time before maturity, the convertible bonds would be convertible into our ordinary shares at a price of $0.03925 per ordinary share (or $3.925 per ADS). Our shareholders approved the issuance of these convertible bonds at our extraordinary general meeting on June 24, 2011, and we issued the convertible bonds on June 29, 2011. Based on our working capital position, we entered into a redemption agreement with Shanda Media on September 30, 2011, pursuant to which are describedwe agreed to redeem the entire $50,000,000 convertible bonds at face value plus accrued but unpaid interest. We redeemed the convertible bonds and paid the full redemption price to Shanda Media on September 30, 2011.
Proposed Acquisition of Pipi
On April 20, 2011, we entered into an equity purchase agreement with the shareholders of Hangzhou Soushi Networking Co., Ltd., or Pipi, a limited liability company established under Item 4.B. “Business Overview — Product and Content Development — Music Production.”
Disposal of Interest in Online Audio Business
In August 2011, we terminated our contractual arrangements with respect to the control of Yisheng, our online audio business operating entity, as a result of management’s review of our business strategies. After the completion of certain equity transfer and increase in registered capital by Beijing Sunshine Culture Communication Co., Ltd., or Sunshine, and Beijing Huaying Shengshi Cultural Communication Co., Ltd., both of which are subsidiaries of Shanda Interactive and limited liability companies established under the laws of the PRC, we hold a 20% economic interest, down from 100%, in Yisheng and have ceased to control Yisheng as a consolidated affiliated entity. All local government registrations relating to the above changes in the registered capital and shareholding of Yisheng were completed on August 11, 2011.
Other Related Party Transactions
In December 2010, Ku6 Information Technology borrowed RMB20.0 million on an unsecured basis from Shanghai Shulong Technology Co., Ltd., a company controlled by Shanda Interactive, pursuant to an entrusted loan agreement. This loan carried an interest rate of 5.05% per year and was originally due in June 2011. The term of the loan was subsequently extended to December 2011 and the interest rate was revised to 5.68%. This loan was fully repaid in December 2011.
In February 2011, Ku6 Information Technology borrowed RMB40.0 million ($6.4 million) on an unsecured basis from Shanghai Shulong Technology Co., Ltd., pursuant to an entrusted loan agreement. This loan carried an interest rate of 5.05% per year and was originally due in August 2011. We repaid RMB250,000 ($39,721) and the term of the loan with respect to the remaining amount of RMB39.8 million ($6.3 million) was subsequently extended to February 2012. The interest rate was revised to 6.71% per year. In February 2012, we repaid RMB19.8 million ($3.1 million). We extended the term of the loan with respect to the remaining amount of RMB20.0 million ($3.2 million) to August 2012 and the interest rate remained at 6.71% per year.
In June 2011, Ku6 Information Technology borrowed RMB43.0 million ($6.8 million) on an unsecured basis from Shanghai Shulong Computer Technology Co., Ltd., pursuant to an entrusted loan agreement. This loan carries an interest rate of 6.31% per year and is due in June 2012.
In December 2010, Ku6 Media Co., Ltd. provided a $3.2 million unsecured loan to Shanda Games Limited, a company controlled by Shanda Interactive, which carried an interest rate of 0.6% per year and was originally due in July 2011. In January 2011, Ku6 Media Co., Ltd. provided a $6.7 million unsecured loan to Shanda Games Limited, which carried an interest rate of 0.6% per year and was originally due in July 2011. The terms of these loans are in the process of being extended. In June 2011, Ku6 Media Co., Ltd. provided a $7.3 million unsecured loan to Shanda Games Limited, which carries an interest rate of 1.37% per year and is due in May 2012.
On April 1, 2011, we entered into an advertising agency agreement with Shengyue, an affiliate wholly owned by Shanda Interactive, pursuant to which Shengyue agreed to act as our advertising agency in respect of our website advertising space on www.ku6.com and generate advertising revenue for us by using the other shareholders, or their related parties, of these companies. In addition these parties may useAA system. We agreed to pay Shengyue certain commission fee accordingly. For the music or artists of these companies and make royalty and other payments to Huayi Brothers Music, Freeland Music or New Run Entertainment. These agreements are for duration of one year but may be extended by the mutual agreement of both parties. During the years ended December 31, 2007, 20082011, we received revenues of $8.1 million from Shengyue and 2009 significant related party transactions werepaid nil commission fee to Shengyue as follows:
| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2007 | December 31, 2008 | December 31, 2009 | ||||||||||
| Consulting, royalty and artist performance fee from Huayi Brothers Media Corporation | 26,087 | 281,795 | — | |||||||||
| Consulting, production and marketing service fee from Huayi Brothers Times Culture Broker Co., Ltd. | — | — | 281,580 | |||||||||
| Royalty revenue from Shanghai Haiyue Music Distribution Co., Ltd. | 185,510 | 120,129 | — | |||||||||
| Royalty revenue from Beijing Oriental Freeland Film Media Co., Ltd. | — | 128,995 | — | |||||||||
| CD distribution revenue from Beijing Century Freeland Film Media Co., Ltd. | 262,520 | 35,625 | 52,248 | |||||||||
| Royalty revenue from Guangdong Freeland Film Media Co., Ltd. | 64,450 | — | — | |||||||||
| Royalty revenue from New Run | 106,567 | — | — | |||||||||
| 645,134 | 566,544 | 333,828 | ||||||||||
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| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2007 | December 31, 2008 | December 31, 2009 | ||||||||||
| Content purchase, minimum guarantee and trade-name usage fee to Huayi Brothers Media Corporation | 80,285 | 58,501 | 208,663 | |||||||||
| Content purchase and information service fee to New Run | 16,440 | 26,771 | 15,053 | |||||||||
| Expenses paid on behalf of Beijing Secular Bird Culture Art Development Center | — | 19,009 | — | |||||||||
| 96,725 | 104,281 | 223,716 | ||||||||||
A. Consolidated 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.
A.7 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 $2.7 million as of December 31, 2011. The accrual was based on judgments handed down by the court and out-of-court settlements as of or after December 31, 2011 but related to alleged copyright infringement arising before December 31, 2011. The accrual was based upon management’s best estimation according to the historical actual compensation amount per video of Ku6 Holding for the similar legal actions and the advice from PRC counsel. We are in the process of appealing certain judgments for which the loss has been accrued.
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 subject todefamatory or objectionable. Adverse results in legal proceedings investigationsagainst 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 “Risk Factors—Risks Related to Our Business—We have been and expect we will continue to be exposed to intellectual property infringement and other claims, relatingincluding claims based on content posted on our website, which could be time-consuming and costly to the conductdefend and may result in substantial damage awards and/or court orders that may prevent us from continuing to provide certain of our business from time to time. We may also initiate legal proceedings in order to protect our contractual and property rights. We are not currently a party to, nor are we aware of, any legal proceeding, investigation or claim which, in the opinion of our management, is likely to have a material adverse effect on our business, financial condition or results of operations.
A.8 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 in China 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
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 tradewere traded under the symbol “HRAY.“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.”
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| Sales Price | ||||||||
| High | Low | |||||||
| Annual highs and lows | ||||||||
| 2005 (February 4, 2005 through December 31, 2005) | $ | 11.80 | $ | 7.67 | ||||
| 2006 | $ | 9.71 | $ | 4.70 | ||||
| 2007 | $ | 6.53 | $ | 3.05 | ||||
| 2008 | $ | 4.21 | $ | 1.08 | ||||
| 2009 | $ | 2.28 | $ | 0.93 | ||||
| Quarterly highs and lows | ||||||||
| First Quarter 2008 | $ | 4.21 | $ | 2.36 | ||||
| Second Quarter 2008 | $ | 3.30 | $ | 2.61 | ||||
| Third Quarter 2008 | $ | 3.19 | $ | 2.21 | ||||
| Fourth Quarter 2008 | $ | 2.75 | $ | 1.08 | ||||
| First Quarter 2009 | $ | 2.04 | $ | 0.93 | ||||
| Second Quarter 2009 | $ | 4.00 | $ | 0.95 | ||||
| Third Quarter 2009 | $ | 3.95 | $ | 3.25 | ||||
| Fourth Quarter 2008 | $ | 7.16 | $ | 3.85 | ||||
| First Quarter 2010 | $ | 4.50 | $ | 2.22 | ||||
| Second Quarter 2010 (April 1, 2010 through April 23, 2010) | $ | 3.57 | $ | 3.03 | ||||
| Monthly highs and lows | ||||||||
| October 2009 | $ | 7.16 | $ | 3.85 | ||||
| November 2009 | $ | 6.15 | $ | 4.63 | ||||
| December 2009 | $ | 4.90 | $ | 3.89 | ||||
| January 2010 | $ | 4.50 | $ | 3.50 | ||||
| February 2010 | $ | 3.85 | $ | 2.22 | ||||
| March 2010 | $ | 3.85 | $ | 2.84 | ||||
| April 2010 (April 1, 2010 through 23, 2010) | $ | 3.57 | $ | 3.03 | ||||
| Sales Price | ||||||||
| High | Low | |||||||
| (in U.S. dollars) | ||||||||
Annual highs and lows | ||||||||
2007 | 6.53 | 3.05 | ||||||
2008 | 4.21 | 1.08 | ||||||
2009 | 7.16 | 0.93 | ||||||
2010 | 8.40 | 2.22 | ||||||
2011 | 8.12 | 0.75 | ||||||
Quarterly highs and lows | ||||||||
First quarter 2010 | 4.50 | 2.22 | ||||||
Second quarter 2010 | 3.84 | 2.45 | ||||||
Third quarter 2010 | 5.19 | 2.36 | ||||||
Fourth quarter 2010 | 8.40 | 4.14 | ||||||
First quarter 2011 | 5.25 | 2.59 | ||||||
Second quarter 2011 | 8.12 | 2.83 | ||||||
Third quarter 2011 | 3.68 | 1.70 | ||||||
Fourth quarter 2011 | 2.10 | 0.75 | ||||||
Monthly highs and lows | ||||||||
September 2011 | 2.15 | 1.73 | ||||||
October 2011 | 2.10 | 1.69 | ||||||
November 2011 | 1.88 | 1.12 | ||||||
December 2011 | 1.39 | 0.75 | ||||||
January 2012 | 4.04 | 1.03 | ||||||
February 2012 | 2.30 | 1.75 | ||||||
March 2012 (through March 26, 2012) | 2.80 | 1.93 | ||||||
A. Share Capital
Not applicable.
B. Memorandum and Articles of Association
The following are summaries of Share Capital”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 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. 000-51116) filed with the SEC.
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 Borrowing. The directors may determine remuneration to be paid to the directors. The directors may exercise all the powers of our company to borrow money and to mortgage or charge our undertaking, property and uncalled capital or any part thereof, and to issue debentures, debenture stock and other securities whether outright or as security for any of our debts, liabilities, or obligations or those of any third party.
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 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 outstanding shares entitled to vote at the meeting present in person or by proxy.
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 no 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 is more than sufficient to repay all of the paid-up capital at the commencement of the winding up, the excess will be distributed among our shareholders in proportion to the capital paid up at the commencement of the winding up on our shares held by them respectively.
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 the memorandum and articles of association of the company do not prohibit it from holding treasury shares, the relevant provisions of the memorandum and articles of association (if any) are complied with, and 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 National 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 maybe varied, either with the consent in writing of the holders of three-fourths of the issued shares of that class or with the sanction of a special resolution passed at a general meeting of the holders of the shares of that class.
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 its 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 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 creditors, depending on the circumstances, as are present at a meeting called for such purpose and thereafter sanctioned by the courts. While a dissenting member would have the right to express to the court his view that the transaction for which approval is being sought would not provide the members with a fair value for their shares, the courts are unlikely to disapprove the transaction on that ground alone in the absence of evidence of fraud or bad faith on behalf of management; and if the transaction were approved and consummated, the dissenting member would have no rights comparable to the appraisal rights (i.e., the right to receive payment in cash for the judicially determined value of their shares) ordinarily available, for example, to dissenting members of a United States corporation.
Where an offer is made by a company for the shares of another company 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 offeror may at any time within two months after the expiration of the said four months, by notice, require the dissenting members to transfer their shares on the terms of the offer. A dissenting member may apply to the court of the Cayman Islands within one month of the notice objecting to the transfer. The burden is on the dissenting member to show that the court should exercise its discretion, which it will be unlikely to do unless there is evidence of fraud or bad faith or collusion, as between the offeror and the holders of the shares who have accepted the offer as a means of unfairly forcing out minority members.
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 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 (1996), as amended, or the Exchange Rules; and
Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), or the Administration Rules.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 SAFE 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 SAFE.
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In October 2005, SAFE issued the 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, or Notice 75, which took effect on November 1, 2005. Notice 75 supersedes prior SAFE regulations promulgated in January and April of 2005. In May 2007, SAFE issued the Notice of the State Administration of Foreign Exchange on Operating Procedures Concerning Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Return Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or Notice 106. Notices 75 and 106 require PRC residents to register with the relevant local SAFE branch in connection with their establishment or control of an offshore entity established for the purpose of overseas equity financing involving onshore assets or equity interests held by them and direct investment through such an offshore entity in the PRC. The term “PRC residents,” as used in Notice 75, includes not only PRC citizens but also other persons who habitually reside in the PRC for economic benefit. Such PRC residents are required to register with the relevant SAFE branch before establishing or taking control of such an offshore entity and complete amended registrations with the relevant SAFE branch uponupon: (i) injection of equity interests or assets of an onshore enterprise into the offshore entity,entity; (ii) subsequent overseas equity financing by such offshore entity,entity; or (iii) any material change in the shareholding or capital of the offshore entity, such as changes in share capital, share transfers and long-term equity or debt investments, and providing security. The PRC residents who have already incorporated or gained control of offshore entities that had completed onshore investments in the PRC before Notice 75 took effect must register with the relevant local SAFE branch on or before March 31, 2006. In addition, such PRC residents are required to repatriate into the PRC all of their dividend profits or capital gains from their shareholdings in the offshore entity within 180 days of their receipt of such profits or gains.
The registration and amendment procedures set forth by Notices 75 and 106 are prerequisites for other approval and registration procedures necessary for capital inflow from the offshore entity, such as inbound investment or shareholdersshareholders’ loans, or capital outflow to the offshore entity, such as the payment of profits or dividends, liquidating distributions, equity sale proceeds or the return of funds upon a capital reduction.
A number of terms and provisions in Notices 75 and 106 remain unclear. Because of uncertainty over how Notices 75 and 106 will be interpreted and implemented, we cannot predict how they will affect our business operations or future strategies. For example, our present and prospective PRC subsidiaries’ ability to conduct foreign exchange activities, such as remitting dividends and foreign currency-denominated borrowings, may be subject to compliance with requirements of Notices 75 and 106 by the PRC resident holders of our ordinary shares and ADSs. Despite our effort to fully comply with the SAFE regulations, we cannot assure you that we will obtain, or receive waivers from, any necessary approvals or not be found in violation of the SAFE regulations or any other related foreign exchange regulations. In particular, we cannot assure you that we will be able to cause all the present or prospective PRC resident holders of our ordinary shares or ADSs to comply with all SAFE regulations. A failure by the PRC resident holders of our ordinary shares or ADSs to comply with Notices 75 and 106 or our inability to secure required approvals or registrations may subject us to fines or legal sanctions, limit our subsidiaries’ ability to make distributions or pay dividends, restrict our overseas or cross-border investment activities or affect our ownership structure, any of which could affect our business and prospects.
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On August 29, 2008, SAFE promulgated SAFE Circular 142, regulating the conversion by a foreign-invested enterprise of foreign currency registered capital into Renminbi by restricting how the converted Renminbi may be used. SAFE Circular 142 provides that the Renminbi capital converted from foreign currency registered capital of a foreign-invested enterprise may only be used for purposes within the business scope approved by the applicable governmental authority, and may not be used for equity investments within the PRC, unless it is provided for otherwise. In addition, SAFE strengthened its oversight of the flow and use of the Renminbi capital converted from foreign currency registered capital of a foreign-invested company. The use of such Renminbi capital may not be altered without SAFE approval, and such Renminbi capital may not in any case be used to repay Renminbi loans if the proceeds of such loans have not been used. Failure to comply with SAFE Circular 142 could result in liabilities for such PRC subsidiaries under PRC laws for evasion of applicable foreign exchange restrictions, including: (i) being required to take appropriate remedial action, confiscation of any illegal income and being fined up to 30% of the illegal amount involved; (2) in circumstances involving serious violations, a fine of between 30% and 100% of the illegal amount involved shall be imposed on the organization or individual concerned.
The following summary of the material Cayman Islands, People’s Republic of ChinaPRC and United StatesU.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 sectionSection 6 of the Tax Concessions Law (1999 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, |
| (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 |
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 or estate duty.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. The Cayman Islands is not party to any double tax treaties. There are no exchange control regulations or currency restrictions in the Cayman Islands.
PRC Taxation
On January 1, 2008, the New EIT Law became effective. The New EIT Law includes a provision specifyingprovides 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. IfThe implementation rules to the EIT Law provide that non-resident legal entities organized outside China werewill be considered PRC residents for Chinese income tax purposes, theyif substantial and overall management and control over the manufacturing and business operations, personnel, accounting, properties, etc., reside within China. Under current PRC laws and regulations, it is uncertain whether we would be subject todeemed a PRC resident enterprise under the 25% enterprise income tax imposed by the New EIT Law on their worldwide income. Accordingly, ifLaw. If we are deemed to betreated as a PRC tax resident enterprise, our global income will be subject to PRC enterprise income tax at the rate of 25%, which would have a material adverse effect on our financial condition and results of operations. In addition, dividends paid by us with respect to holders of our ordinary shares or ADSADSs that are non-resident enterprises would be subject to a 10% PRC withholding tax, and gains realized by non-PRCthese holders on the disposition of our ordinary shares or ADSs could be subject to a 10% PRC withholding tax. The
Under the IITL, if we are treated as a PRC resident enterprise, non-resident individual investors would be subject to PRC individual income tax at a rate of 20% on dividends paid to such investors and any capital gains realized from the transfer of our ordinary shares and ADSs if such dividends and gains are deemed income derived from sources within the PRC. A non-resident individual is an individual who has no domicile in the PRC and does not stay within the PRC or has stayed within the PRC for less than one year. Pursuant to the IITL and its implementation rules, tofor purposes of the New EIT Law provide that non-resident legal entitiesPRC capital gains tax, the taxable income will be considered China residents if substantialbased on the total income obtained from the transfer of our ordinary shares or ADSs after deducting all the costs and overall management and control over the manufacturing and business operations, personnel, accounting, properties, etc. resides within China. Under current PRC laws and regulations, it is uncertain whether we would be deemedexpenses that are permitted under PRC tax laws to be deducted from the income. If we were considered a PRC resident enterprisesenterprise and dividends we pay with respect to our ordinary shares and ADSs and the gains realized from the transfer of our ordinary shares and ADSs were considered income derived from sources within the PRC by relevant PRC tax authorities, such dividends and gains earned by non-resident individuals would also be subject to PRC tax at a rate of 20% except in the case of individuals that qualify for a lower rate under a tax treaty. Under the New EIT Law.
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 thea U.S. Holder described below.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”),or 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”),or the IRS, judicial decisions and the double taxation treaty between the PRC and the United States, (the “Treaty”),or 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 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; and U.S. persons whose functional currency for U.S. federal income tax purposes is other than the U.S. dollar.
dollar; and persons holding ordinary shares or ADSs in connection with a trade or business conducted outside of the United States.
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This summary is directed solely to personsU.S. Holders who hold their ordinary shares or ADSs as capital assets for U.S. Federalfederal 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. Federalfederal income tax purposes:
a citizen or 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 holder of 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 holder exchanges ADSs for the underlying ordinary shares represented by those ADSs. The holder’s adjusted tax basis in the ordinary shares will be the same as the adjusted tax basis of the ADSs surrendered in exchange therefor, and the holding period for the ordinary shares will include the holding period for the surrendered ADSs.
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 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.
Passive Foreign Investment Company
It is not clear whether we were a PFIC for taxable year 2011. That determination is subject to uncertainty because of the uncertain characterization of our assets and income for purposes of the PFIC rules. Although we believe that we were not a PFIC for taxable year 2010, we believe that we were a PFIC for taxable years 2006, 2007, 2008 and 2009 and we may be a PFIC for the current taxable year.years ending after 2011. Because 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), there can be no assurance we will not be a PFIC for any future taxable year.
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 (the “income test”)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 (the “asset test”).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.
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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 such U.S. Holderthose ordinary shares or ADSs for all succeeding years during which such U.S. Holder holds ordinary shares or ADSs,them, regardless of whether we actually continue to be a PFIC. SinceBecause we believe that we were a PFIC for 2006, 2007, 2008 and 2009, if you held ordinary shares or ADSs in 2006, 2007, 2008 or 2009,during any of those taxable years, we would continue to be treated as a PFIC with respect to youthose ordinary shares or ADSs for all succeeding years during which you hold ordinary shares or ADSs. Eventhem. Similarly, if you only began holdingfirst acquired ordinary shares or ADSs in the current taxable year, if it turns out that2010 and we arebecame a PFIC for the currentin a subsequent year, we would continue to be treated as a PFIC with respect to youthose ordinary shares or ADSs for all succeeding years during which you hold ordinary shares or ADSs.them. You may terminate this deemed PFIC status by electing to recognize gain (which will be taxed under the default PFIC rules discussed below) as if your ordinary shares or ADSs had been sold on the last day of the last taxable year for which we were a PFIC.
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 shareholdershareholders 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 byof 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 current taxable year of receipt of 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 current taxable year;year to which it is allocated;
the amount allocated to each of the other yearstaxable year will be treated as ordinary income and taxed at the highest applicable tax rate in effect for that year; and
the resulting tax liability from any such priorother 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 general tax treatment for PFICsdefault PFIC rules described above. The ordinary shares or ADSs will be treated as “regularly traded” in any calendar year in which more than ade minimisquantity 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 ordinary shares or ADSs are listed, is a qualified exchange for this purpose. U.S. Holders should consult their tax advisersadvisors 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 forwith 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 in income 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.”
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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 dividend rates with respect to the dividends paid to certain non-corporate U.S. Holders would not apply.
If you ownwe were a PFIC for any taxable year during which a U.S. Holder held ordinary shares or ADSs, during any year in which we aresuch U.S. Holder may be required to file a PFIC, you must generally file an annual report with respect to us, generally with your federal income tax return for that year.
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(other than certain pro rata distributions of ordinary shares,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 receiveddividends-received deduction allowed to corporations with respect to dividends received from certain domestic corporations orand may not be eligible for the favorablereduced tax raterates on certain qualified dividend incomedividends received by certain non-corporate holders.
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. Preferential tax rates for long-term capital gain may be applicable to non-corporate U.S. Holders. We do not intend to calculate our earnings and profits under U.S. federal income tax principles. Therefore, you should expect that a distribution will generally be reported to U.S. Holders as a dividend, even if that distribution would otherwise be treated as a non-taxable return of capital or as capital gain under the rules described above.
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 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 “People’s Republic of China Taxation,”“—PRC Taxation” above, dividends paid with respect to our ordinary shares or ADSs may be subject to PRC withholding tax.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-sourced 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 advisersadvisors 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.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 (currently, with a maximum rate of 15% for taxable years beginning before January 1, 2011)2013) 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 “People’s Republic of China Taxation,”“—PRC Taxation” above, 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 advisersadvisors regarding the creditability of foreign taxes in their particular circumstances.
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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 (currently at 28%) 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 incorporated in the Cayman Islands because of the following benefits found there:
ordinary shares or ADSs.
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Not applicable.
G. Statement by Experts
Not applicable.
H. Documents on Display
We have previouslyfiled 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 Commission a registration statement on Form F-1 and prospectus, and a registration statement on Form F-6, underSEC. This means that we can disclose important information to you by referring you to another document filed separately with the Securities ActSEC. The information incorporated by reference is considered to be part of 1933, as amended, with respect to our ordinary shares represented by ADSs, as well as the ADSs.
We are subject to the periodic reporting and other informational requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Under the Exchange Act,applicable to foreign private issuers. Accordingly, we arewill be required to file reports, including annual reports on Form 20-F, and other information with the SEC. Specifically, we are required to file annually a Form 20-F no later than six months after the close of each fiscal year, which is December 31 of each year. Copies of reports and other information, when so filed, may be inspected without charge and may be obtained at prescribed rates at the public reference facilities maintained by the SEC at 100 F Street, N.E., Washington, D.C. 20549. You can request copies of these documents upon payment of a duplicating fee, by writing to the SEC. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference rooms. The SEC also maintains a website atwww.sec.govthat contains reports, proxy and information statements, and other information regarding registrants that make electronic filings with the SEC using its EDGAR system. As a foreign private issuer, we are exempt from the rules 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 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.
Interest Rate Risk
Our exposure to Item 5. “Operatingmarket 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 Financial Reviewfloating 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, Prospects—Quantitativetherefore, our exposure to interest rate risk is minimal and Qualitative Disclosures About Market Risk.”
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 (other than the proceeds from our initial public offering) and liabilities are denominated in Renminbi. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be impacted by fluctuations in the exchange rate between U.S. dollars and Renminbi. If the Renminbi depreciates against the U.S. dollar, the value of our Renminbi revenues and assets as expressed in U.S. dollars in our financial statements will decline. We may also be exposed to foreign exchange risk in the event we hold other currencies in an effort to hedge against potential depreciation of the U.S. dollar or otherwise.
If the Renminbi had been 1% and 5% less valuable against the U.S. dollar than the actual rate as of December 31, 2011 which was used in preparing our audited financial statements as of and for the year ended December 31, 2011, our net asset value, as presented in U.S. dollars, would have been increased by $0.2 million and $1.0 million, respectively. Conversely, if the Renminbi had been 1% and 5% more valuable against the U.S. dollar as of that date, then our net asset value would have reduced by $0.2 million and $1.1 million, respectively.
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 decreased by 0.7% in 2009 and increased by 3.3% and 5.4% in 2010 and 2011, respectively. Although we have not in the past been materially affected by inflation since our inception, we can provide no assurance that we will not be affected in the future by higher rates of inflation in China.
D. American Depositary Shares
Citibank, N.A. is the depositary of our Depositary.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, of par value US$0.00005$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 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.
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Persons depositing or withdrawing shares must pay: | For: | ||||
| A fee not in excess of $5.00 per 100 ADSs | • | Issuance of ADSs, including issuances resulting from a distribution of ordinary shares or rights or other property | |||
• | Cancellation or withdrawals of ADSs | ||||
• | Distributions of securities other than ADSs or rights to purchase additional ADSs | ||||
| A fee not in excess of $2.00 per 100 ADSs | • | Distributions of cash dividends or other cash distributions to holders of ADRs | |||
• | Annual depositary services, except to the extent of any cash dividend fee(s) charged | ||||
| A fee not in excess of $1.50 per ADR | • | Transfers of ADRs | |||
| Taxes and other governmental charges the depositary or the custodian have to pay on any ADS or ordinary shares underlying an ADS, for example, stock transfer taxes, stamp duty or withholding taxes | • | As necessary | |||
| Any charges, fees or expenses incurred by the depositary or its agents for servicing the deposited securities | • | As necessary | |||
Payments Received
For the year ended December 31, 2010,2011, the Depositary made payments on our behalf to third parties of $22,022 ($6,958approximately $39,521 (approximately $2,829 for legal expenses, $3,875$9,410 for account maintenance and $11,189$27,282 for proxy expenses), which is deducted from the amount of reimbursements made by the Depositary to us.
Not Applicable.
Use of Proceeds
The following “Use of Proceeds” information relates to theour registration statement on Form F-1 (File No. 333-121987) (the “Registration Statement”) for our initial public offering of 6,880,000 American Depositary Shares, each representing 100 of our ordinary shares,ADSs, which were sold by us and certain selling shareholders for an aggregate offering price of $70.5 million. Our Registration StatementThis registration statement was declared effective by the SEC on February 3, 2005.
We received net proceeds of approximately $59.4 million from our initial public offering (taking into account underwriting discounts of approximately $4.9 million, transaction expenses of approximately $3.8 million and payments to selling shareholders of approximately $2.4 million). None, all of the transaction expenses included payments to directors or officers of our company or their associates, persons owning 10% or more of our equity securities or our affiliates.
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Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this annual report on Form 20-F, our acting chief executive officerChief Executive Officer, Chief Financial Officer and acting chief financial officerVice President of Finance and Controller have conductedperformed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as defined inand required under Rules 13a-15(e) and 15d-15(e) underof the Securities Exchange Act of 1934, as amended. Based onupon this evaluation, our acting chief executive officerChief Executive Officer, Chief Financial Officer and acting chief financial officerVice President of Finance and Controller concluded that, as of December 31, 2009, our company’s disclosure controls and procedures were effective in ensuring that the information required to be disclosed by us in the reports that we file and furnish under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in by the Securities and Exchange Commission’s rules and regulations.
Management’s Report on Internal Control over Financial Reporting
Management of Hurray! Holding Co., Ltd. (together with its consolidated subsidiaries, the “Group”) 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. The Group’s internalInternal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of consolidated financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Group’s internalU.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 the transactions and dispositions of the assets of the Group;assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles,U.S. GAAP, and that receipts and expenditures of the Group are being 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 the Group’s 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 acting chief executive officerChief Executive Officer, Chief Financial Officer and acting chief financial officer, the GroupVice President of Finance and Controller, we conducted an assessment of the effectiveness of itsour internal control over financial reporting based upon criteria established by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO, in Internal Control — Control—Integrated Framework. Based on this assessment, management determined that the Group’sour internal control over financial reporting was effective as of December 31, 2009.
The effectiveness of our internal control over financial reporting as of December 31, 20092011 has been audited by PricewaterhouseCoopers Zhong Tian CPAs Limited Company, our independent registered public accounting firm, as stated in its report included on page F-2.
Changes in Internal Control Overover Financial Reporting
In 2011, we shifted our 2008 Form 20-F,content focus from long-form videos to short-form videos. In order to encourage more users to upload UGC to our management reported a material weaknesseswebsite, we have purchased the licensing rights to some popular UGC, and have also started to share advertising revenues with individual users whose numbers of video uploads exceed certain thresholds.
In connection with the business process changes resulting from this advertising revenue sharing program, as well as the generation of advertising revenues through an arrangement with Shengyue, an affiliate wholly owned by Shanda Interactive, we implemented further enhancements to the design and documentation of our internal control processes in itsthe form of comprehensive process documentation, coupled with testing of the operating effectiveness of controls, to help ensure the effectiveness of internal controls over financial reporting.
There were no changes in our internal control over financial reporting that whilehave materially affected, or are reasonably likely to materially affect our affiliated music companies make an allowance for doubtful debts against trade receivables basedinternal control over financial reporting, except as described above.
Remediation of Material Weaknesses Reported in Prior Year
Based on a reviewmanagement’s assessment of each individual account,internal control over financial reporting in the prior year, management of these companies dodetermined that our internal control over financial reporting was not use a set of criteria (sucheffective as payment history and account activity) to determine whether an allowance for an individual account is necessary
During the year ended December 31, 2011, our management determined thattook remediation measures which included but were not limited to the applicable controls were effectively designedfollowing: (a) we hired an Associate Director of Finance who is a member of the American Institute of Certified Public Accountants and operating so asa licensed CPA with appropriate knowledge and experience in U.S. GAAP; (b) we hired a Vice President of Finance and Controller who worked at PricewaterhouseCoopers Zhong Tian CPAs Limited Company and KPMG Huazhen CPAs Limited Company for a combined total of over 12 years with appropriate knowledge and experience in U.S. GAAP; (c) our Chief Financial Officer attended specific relevant training courses; (d) we provided in-depth training on U.S. GAAP to enable management to conclude that the above described material weaknesses have been remediated.
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Our board of directors has determined that Mr. Bruno Wu qualifies as an Audit Committee Financial Expert as defined byaudit committee financial expert in accordance with the applicable rulesterms of Item 16A of Form 20-F. Mr. Wu satisfies the “independence” requirements of the SECNASDAQ Stock Market Rules and that Mr. Powrie is “independent” as definedmeets the criteria for “independence” under applicable Nasdaq rules.
We have adopted a Code of Business Conduct which applies to our employees, officers and non-employee directors, including our principal executive officer, principal financial officer, principal accounting officer or controller,Chief Executive Officer, Chief Financial Officer, Vice President of Finance and Controller, 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 atwww.hurray.com. 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 theto: Legal Counsel, 15/F, Tower B, Gateway Plaza, No.18 Xia Guang Li, East Third Ring,Building 6, Zhengtongchuangyi Centre, No. 18, Xibahe Xili, Chaoyang District, Beijing 100027,100020, People’s Republic of China.
Disclosure of Fees Charged by Independent Accountants
The following table summarizes the fees charged by Deloitte Touche Tohmatsu CPA Ltd. (our independent accountants from 2001 to the second quarter of 2009) and PricewaterhouseCoopers Zhong Tian CPAs Limited Company, (ourour independent accountants, from the third quarter of 2009 until present time) for certain services rendered to our company during 20092010 and 2008.
| For the year ended | ||||||||
| December 31, | ||||||||
| 2009 | 2008 | |||||||
Audit fees(1) | $ | 1,247,687 | $ | 437,132 | ||||
Audit related fees(2) | — | — | ||||||
Tax fees(3) | — | 96,455 | ||||||
All other fees(4) | 41,233 | — | ||||||
| For the year ended December 31, | ||||||||
| 2010 | 2011 | |||||||
| (in thousands of U.S. dollars) | ||||||||
Audit fees(1) | 1,027 | 873 | ||||||
Audit-related fees(2) | — | — | ||||||
Tax fees(3) | 30 | — | ||||||
All other fees(4) | — | 4 | ||||||
| (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. | |
| (2) | “Audit-related fees” means the aggregate fees incurred in each of the fiscal years listed for professional services related to the audit of our financial statements that are not reported under “Audit fees” and consultation on accounting standards or transactions. | |
| (3) | “Tax fees” means the aggregate fees incurred in each of the fiscal years listed for professional services rendered for tax compliance, tax advice and tax planning. | |
| (4) | “All other fees” means the aggregate fees incurred in each of the fiscal years listed for professional services rendered other than those reported under “Audit fees,” “Audit-related fees,” and “Tax fees.” |
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 Deloitte Touche Tohmatsu CPA Ltd. and PricewaterhouseCoopers Zhong Tian CPAs Limited Company before those firms areit 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.
100
We have not been granted an exemption from the applicable listing standards for the audit committee of our board of directors.
On December 30, 2011, we approved a share repurchase program to repurchase up to an aggregate of $3.2 million of our outstanding ADSs from time to time based on market conditions. Any repurchases may be effected through open market purchases or block trades, including the use of derivative instruments, and will be financed with our cash balance. As of February 29, 2012, we had not made any repurchases under this share repurchase program.
Pursuant to the NASDAQ MarketplaceStock 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, issuancescompensation. Issuances of securities in connection with equity-based compensation of officers, directors, employees or consultants will be permitted without obtaining prior shareholder approval and that 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 countryhome-country practice of ours differs from Rules 5605(b), (d) and (e), 5635(c) and 5615(a)(3) of the NASDAQ ListingStock 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.
16H. Mine Safety Disclosure
101
The consolidated financial statements for Hurray! HoldingKu6 Media Co., Ltd. and its subsidiaries are included at the end of this annual report on Form 20-F.
Exhibit | Document | ||||
| 1.1 | Amended and Restated Memorandum and Articles of Association of | ||||
| 1.2 | Amendment to the Amended and Restated Memorandum and Articles of Association | ||||
| 1.3 | Amendment to the Amended and Restated Memorandum and Articles of Association of our company as adopted on June 24, 2011 (incorporated herein by reference to Exhibit 1.3 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | ||||
| 2.1 | Specimen Share Certificate. | ||||
| 2.2 | Specimen American Depositary Receipt of | ||||
| 2.3 | Form of Deposit Agreement | ||||
| 4.1 | 2010 Equity Compensation Plan (incorporated herein by reference to Exhibit 4.41 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | ||||
| 4.2 | Form of Indemnification Agreement (incorporated by reference to Exhibit 10.4 of our registration statement on Form F-1 (File No. 333-121987) filed with the | ||||
| 4.3 | Form of Employment Agreement. | ||||
| 4.4 | |||||
102
103
104
105
| 4.5 | ||||
| 4.6 | ||||
106
| 4.7 | ||||
| 4.8 | ||||
| 4.9 | ||||
| 4.10 | ||||
107
| 4.11 | ||||
| 4.12 | ||||
| 4.13 | ||||
| 4.14 | ||||
| 4.15 | ||||
| 4.16 | ||||
| 4.17 | ||||
| 4.18 | ||||
| 4.19 | English translation of Exclusive Consulting And Service Agreement between WeiMoSanYi (Tianjin) Technology Co., Ltd. and Ku6 (Beijing) Cultural Media Co., Ltd dated May 27, 2010 (incorporated herein by reference to Exhibit 4.23 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | |||
| 4.20 | English translation of Business Operation Agreement among WeiMoSanYi (Tianjin) Technology Co., Ltd., Ku6 (Beijing) Cultural Media Co., Ltd., Shanyou Li and Xingye Zeng dated May 27, 2010 (incorporated herein by reference to Exhibit 4.24 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | |||
| 4.21 | English translation of Share Pledge Agreement between WeiMoSanYi (Tianjin) Technology Co., Ltd. and Shanyou Li dated May 27, 2010 (incorporated herein by reference to Exhibit 4.27 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | |||
| 4.22 | English translation of Share Pledge Agreement between WeiMoSanYi (Tianjin) Technology Co., Ltd. and Xingye Zeng dated May 27, 2010 (incorporated herein by reference to Exhibit 4.28 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | |||
| 4.23 | English translation of Power of Attorney by Shanyou Li dated May 27, 2010 (incorporated herein by reference to Exhibit 4.25 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | |||
| 4.24 | English translation of Power of Attorney by Xingye Zeng dated May 27, 2010 (incorporated herein by reference to Exhibit 4.26 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | |||
| 4.25 | English translation of Equity Disposition Agreement among WeiMoSanYi (Tianjin) Technology Co., Ltd., Shanyou Li, Xingye Zeng and Ku6 (Beijing) Cultural Media Co., Ltd. dated May 27, 2010 (incorporated herein by reference to Exhibit 4.29 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | |||
| 4.26 | English translation of Exclusive Business Cooperation Agreement between WeiMoSanYi (Tianjin) Technology Co., Ltd., and Tianjin Ku6 Zheng Yuan Information Technology Co., Ltd. dated March 21, 2009 (incorporated herein by reference to Exhibit 4.38 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | |
| 4.27 | English translation of Equity Interest Pledge Agreement among WeiMoSanYi (Tianjin) Technology Co., Ltd., Ku6 (Beijing) Information Technology Co., Ltd and Tianjin Ku6 Zheng Yuan Information Technology Co., Ltd. dated March 21, 2009 (incorporated herein by reference to Exhibit 4.39 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | |
| 4.28 | English translation of Power of Attorney by Ku6 (Beijing) Information Technology Co., Ltd dated March 21, 2009 (incorporated herein by reference to Exhibit 4.40 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | |
| 4.29 | English translation of Exclusive Option Agreement among WeiMoSanYi (Tianjin) Technology Co., Ltd., Ku6 (Beijing) Information Technology Co., Ltd and Tianjin Ku6 Zheng Yuan Information Technology Co., Ltd. dated March 21, 2009 (incorporated herein by reference to Exhibit 4.37 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | |
| 4.30 | English translation of Loan Agreement between Kusheng (Tianjin) Technology Co., Ltd. and Dongxu Wang dated December 14, 2011. | |
Exhibit | Document | |
| 4.31 | English translation of Loan Agreement between Kusheng (Tianjin) Technology Co., Ltd. and Qing Zhang dated December 14, 2011. | |
| 4.32 | English translation of Exclusive Consulting and Services Agreement between Kusheng (Tianjin) Technology Co., Ltd. and Tianjin Ku6 Network Communication Technology Co., Ltd. dated December 14, 2011. | |
| 4.33 | English translation of Business Operation Agreement among Kusheng (Tianjin) Technology Co., Ltd., Tianjin Ku6 Network Communication Technology Co., Ltd., Dongxu Wang and Qing Zhang dated December 14, 2011. | |
| 4.34 | English translation of Share Pledge Agreement between Kusheng (Tianjin) Technology Co., Ltd. and Dongxu Wang dated December 14, 2011. | |
| 4.35 | English translation of Share Pledge Agreement between Kusheng (Tianjin) Technology Co., Ltd. and Qing Zhang dated December 14, 2011. | |
| 4.36 | English translation of Power of Attorney by Dongxu Wang dated December 14, 2011. | |
| 4.37 | English translation of Power of Attorney by Qing Zhang dated December 14, 2011. | |
| 4.38 | English translation of Equity Disposition Agreement among Kusheng (Tianjin) Technology Co., Ltd., Dongxu Wang, Qing Zhang and Tianjin Ku6 Network Communication Technology Co., Ltd. dated December 14, 2011. | |
| 4.39 | English translation of Equity Transfer Agreement dated May 17, 2010, between Hurray! Digital Media Technology Co., Ltd. and Huayi Brothers Media Corporation relating to the equity interest in Beijing Huayi Brothers Music Co., Ltd. (incorporated herein by reference to Exhibit 4.1 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | |
| 4.40 | Master Transaction Agreement between Shanda Interactive Entertainment Limited and Hurray! Holding Co., Ltd., dated June 1, 2010 (incorporated by reference to Exhibit 99.2 to our press release on Form 6-K (File No. 000-51116) furnished with the SEC on June 2, 2010). | |
| 4.41 | Share Purchase Agreement between Ku6 Media Co., Ltd. and Shanda Media Group Limited dated April 1, 2011 (incorporated herein by reference to Exhibit 4.43 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | |
| 4.42 | Senior Convertible Bond Purchase Agreement between Ku6 Media Co., Ltd. and Shanda Media Group Limited dated April 1, 2011 (incorporated herein by reference to Exhibit 4.44 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | |
| 4.43 | Redemption Agreement between Ku6 Media Co., Ltd. and Shanda Media Group Limited dated September 30, 2011. | |
Exhibit | Document | ||
| English Translation of Ku6 Advertising Agency Agreement dated April 1, 2011 between Shanghai Shengyue Advertising Co., Ltd. and Ku6 (Beijing) Information Technology Co., Ltd. | |||
| 4.45 | English Translation of Loan Agreement between Ku6 Media Co., Ltd. and Shanda Games Limited dated December 27, 2010 (incorporated herein by reference to Exhibit 4.6 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | ||
| 4.46 | English Translation of Loan Agreement between Ku6 Media Co., Ltd. and Shanda Games Limited dated January 25, 2011 (incorporated herein by reference to Exhibit 4.7 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | ||
| 4.47 | English Translation of Loan Agreement between Ku6 Media Co., Ltd. and Shanda Games Limited dated June 8, 2011 (incorporated herein by reference to Exhibit 4.49 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | ||
| 4.48 | English Translation of Loan Agreement between Ku6 (Beijing) Information Technology Co., Ltd. and Shanghai Dongfang Branch of China Merchants Bank Co., Ltd. dated February 10, 2011 (incorporated herein by reference to Exhibit 4.5 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | ||
| 4.49 | English Translation of Loan Renewal Agreement between Ku6 (Beijing) Information Technology Co., Ltd. and Shanghai Dongfang Branch of China Merchants Bank Co., Ltd. dated August 14, 2011. | ||
| 4.50 | English Translation of Loan Renewal Agreement between Ku6 (Beijing) Information Technology Co., Ltd. and Shanghai Dongfang Branch of China Merchants Bank Co., Ltd. dated March 6, 2012. | ||
| 4.51 | English Translation of Loan Agreement between Ku6 (Beijing) Information Technology Co., Ltd. and Shanghai Dongfang Branch of China Merchants Co., Ltd. dated June 16, 2011 (incorporated herein by reference to Exhibit 4.48 to our annual report on Form 20-F (File No. 000-51116) filed with the SEC on June 28, 2011). | ||
| 8.1 | List of Significant Subsidiaries and Affiliates. | ||
108
| 11.1 | Code of Business Conduct (incorporated by reference to Exhibit 11.1 of our annual report on Form 20-F (File No. 000-51116) filed with the | ||||
| 12.1 | Certification of Chief Executive Officer Required by Rule 13a-14(a). | ||||
| 12.2 | Certification of Chief Financial Officer Required by Rule 13a-14(a). | ||||
| 12.3 | Certification of Vice President of Finance and Controller Required by Rule 13a-14(a). | ||||
| 13.1 | Certification of Chief Executive Officer Required by Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code. | ||||
| 13.2 | Certification of Chief Financial Officer Required by Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code. | ||||
| 15.1 | |||||
| Consent of PricewaterhouseCoopers Zhong Tian CPAs Limited | |||||
109
| * | Confidential treatment has been requested for portions of this exhibit. |
SIGNATURES
| KU6 MEDIA CO., LTD. | ||||
| By: | /s/ Yu Shi | |||
| Name: | Yu Shi | |||
| Title: | ||||
Date: March 29, 2012
KU6 MEDIA CO., LTD.
110
| F-2 | |||||||
| F-3 | |||||||
| F-4 | |||||||
| F-9 | |||||||
F-1
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OFHURRAY! HOLDING
KU6 MEDIA CO., LTD.:
In our opinion, the accompanying consolidated balance sheetsheets and the related consolidated statements of operations and comprehensive income,loss, of changes in equity and of cash flows present fairly, in all material respects, the financial position of Hurray! HoldingKu6 Media Co., Ltd. (the “Company”) and its subsidiaries as ofat December 31, 20092011 and 2010, and the results of their operations and their cash flows for each of the yearthree years in the period ended December 31, 20092011 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the accompanying financial statement schedule as of and for the year ended December 31, 2009 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009,2011, based on criteria established in Internal Control — Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, and the Financial Statement Schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting included in Item 15 of the accompanying Form 20-F (“Management’s Report on Internal Control over Financial Reporting”).Reporting. Our responsibility is to express opinions on these financial statements on the Financial Statement Schedule, and on the Company’s internal control over financial reporting based on our integrated audit.audits. We conducted our auditaudits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the auditaudits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our auditaudits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our auditaudits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s 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 the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s 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.
/s/ PricewaterhouseCoopers Zhong Tian CPAs Limited Company
PricewaterhouseCoopers Zhong Tian CPAs Limited Company
Shanghai, the People’s Republic of ChinaApril
March 29, 2010
2012
F-2
F-3
| December 31, 2008 | December 31, 2009 | |||||||
| (in U.S. dollars, except number of shares) | ||||||||
Assets | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | 59,472,703 | 48,489,095 | ||||||
| Short term investments | — | 10,000,000 | ||||||
| Accounts receivable, net of allowance | 12,658,287 | 3,192,366 | ||||||
| Prepaid expenses and other current assets | 4,170,323 | 1,834,361 | ||||||
| Amount due from related parties | 745,351 | 62,725 | ||||||
| Inventories | 254,589 | 196,745 | ||||||
| Current deferred tax assets | 363,330 | — | ||||||
| Receivable on disposal of a subsidiary | 46,860 | — | ||||||
Total current assets | 77,711,443 | 63,775,292 | ||||||
| Property and equipment, net | 980,060 | 879,775 | ||||||
| Acquired intangible assets, net | 1,945,322 | 1,081,962 | ||||||
| Investment in an affiliated company | 824,579 | — | ||||||
| Goodwill | 3,156,664 | 2,099,290 | ||||||
| Deposits and other non-current assets | 719,977 | 331,958 | ||||||
| Prepaid acquisition costs | 1,907,400 | — | ||||||
| Investment at cost | 600,038 | — | ||||||
| Non-current deferred tax assets | 478,919 | — | ||||||
Total assets | 88,324,402 | 68,168,277 | ||||||
Liabilities and shareholders’ equity | ||||||||
| Current liabilities: | ||||||||
| Accounts payable | 2,454,064 | 3,731,562 | ||||||
| Notes payable | — | 227,720 | ||||||
| Acquisitions payable | 14,657 | — | ||||||
| Accrued expenses and other current liabilities | 3,018,203 | 6,260,849 | ||||||
| Amount due to related parties | 207,879 | 439,445 | ||||||
| Income tax payable | 123,626 | 654,835 | ||||||
| Current deferred tax liabilities | 497,283 | 12,316 | ||||||
Total current liabilities | 6,315,712 | 11,326,727 | ||||||
| Long-term payable | 24,002 | 17,554 | ||||||
| Non-current deferred tax liabilities | 292,194 | 262,665 | ||||||
Total liabilities | 6,631,908 | 11,606,946 | ||||||
| Commitments and contingencies | — | — | ||||||
| Redeemable non-controlling interest | — | 370,870 | ||||||
Equity: | ||||||||
| Ordinary shares ($0.00005 par value; 4,560,000,000 shares authorized; 2,193,343,740 and 2,200,194,040 shares issued and outstanding as of December 31, 2008 and December 31, 2009, respectively) | 109,617 | 109,959 | ||||||
| Additional paid-in capital | 75,012,693 | 75,190,411 | ||||||
| Statutory reserves | 1,791,324 | 1,791,324 | ||||||
| Accumulated deficits | (9,991,663 | ) | (32,649,555 | ) | ||||
| Accumulated other comprehensive income | 9,987,314 | 9,953,826 | ||||||
Total Hurray! Holding Co., Ltd. shareholders’ equity | 76,909,285 | 54,395,965 | ||||||
| Non-controlling interests | 4,783,209 | 1,794,496 | ||||||
Total equity | 81,692,494 | 56,190,461 | ||||||
Total liabilities and equity | 88,324,402 | 68,168,277 | ||||||
| Note | December 31, 2010 | December 31, 2011 | ||||||||
| (in U.S. dollars, except number of shares) | ||||||||||
Assets | ||||||||||
Current assets: | ||||||||||
Cash and cash equivalents | 2(8) | 27,294,819 | 26,750,427 | |||||||
Restricted cash | 2(9), 11 | — | 3,600,000 | |||||||
Accounts receivable, net of allowance for doubtful accounts | 18(2) | 8,135,195 | 777,393 | |||||||
Accounts receivable due from related parties | 13 | 325,757 | 2,740,179 | |||||||
Prepaid expenses and other current assets | 5 | 3,487,327 | 884,344 | |||||||
Other receivables due from related parties | 13 | 5,532,248 | 19,539,269 | |||||||
Inventories | 31,038 | — | ||||||||
|
|
|
| |||||||
Total current assets | 44,806,384 | 54,291,612 | ||||||||
|
|
|
| |||||||
Property and equipment, net | 6 | 8,003,474 | 3,592,745 | |||||||
Acquired intangible assets, net | 7 | 27,264,283 | 24,111,111 | |||||||
Investment in equity affiliate | 8 | — | 255,281 | |||||||
Goodwill | 9 | 6,896,340 | 6,232,770 | |||||||
Deposits and other non-current assets | — | 306,741 | ||||||||
|
|
|
| |||||||
Total assets | 86,970,481 | 88,790,260 | ||||||||
|
|
|
| |||||||
Liabilities and shareholders’ equity | ||||||||||
Current liabilities: | ||||||||||
Short-term borrowings | 11 | — | 3,177,680 | |||||||
Accounts payable | 15,502,901 | 6,364,753 | ||||||||
Accounts payable due to related parties | 1,664,570 | 10 | ||||||||
Accrued expenses and other current liabilities | 12 | 11,462,241 | 10,016,650 | |||||||
Other payables due to related parties | 13 | 7,776,698 | 13,552,080 | |||||||
|
|
|
| |||||||
Total current liabilities | 36,406,410 | 33,111,173 | ||||||||
|
|
|
| |||||||
Non-current deferred tax liabilities | 2(26), 14 | 4,925,538 | 4,826,059 | |||||||
|
|
|
| |||||||
Total liabilities | 41,331,948 | 37,937,232 | ||||||||
|
|
|
| |||||||
Commitments and contingencies | 20 | |||||||||
Equity: | ||||||||||
Ordinary shares ($0.00005 par value; 12,000,000,000 shares authorized; 3,481,174,498 and 5,019,786,036 shares issued and outstanding as of December 31, 2010 and 2011, respectively) | 174,008 | 250,939 | ||||||||
Additional paid-in capital | 130,100,153 | 184,874,259 | ||||||||
Accumulated deficits | (83,105,464 | ) | (132,449,371 | ) | ||||||
Accumulated other comprehensive loss | (1,422,414 | ) | (1,822,799 | ) | ||||||
|
|
|
| |||||||
Total Ku6 Media Co., Ltd. shareholders’ equity | 45,746,283 | 50,853,028 | ||||||||
Non-controlling interests | (107,750 | ) | — | |||||||
|
|
|
| |||||||
Total equity | 45,638,533 | 50,853,028 | ||||||||
|
|
|
| |||||||
Total liabilities and shareholders’ equity | 86,970,481 | 88,790,260 | ||||||||
|
|
|
| |||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-4
| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2007 | December 31, 2008 | December 31, 2009 | ||||||||||
| (in U.S. dollars, except number of shares) | ||||||||||||
| Net revenues: | ||||||||||||
| Wireless value-added services | 50,038,014 | 42,671,588 | 20,169,110 | |||||||||
| Recorded music | 10,488,613 | 11,286,812 | 14,473,185 | |||||||||
| Total net revenues | 60,526,627 | 53,958,400 | 34,642,295 | |||||||||
| Cost of revenues: | ||||||||||||
| Wireless value-added services | (36,394,300 | ) | (32,839,642 | ) | (15,331,675 | ) | ||||||
| Recorded music | (6,232,728 | ) | (6,729,725 | ) | (12,625,139 | ) | ||||||
| Total cost of revenues | (42,627,028 | ) | (39,569,367 | ) | (27,956,814 | ) | ||||||
| Gross profit | 17,899,599 | 14,389,033 | 6,685,481 | |||||||||
| Operating expenses: | ||||||||||||
| Product development | (2,028,265 | ) | (991,689 | ) | (466,543 | ) | ||||||
| Selling and marketing | (11,513,850 | ) | (9,132,374 | ) | (6,329,856 | ) | ||||||
| General and administrative | (9,141,381 | ) | (11,983,973 | ) | (22,992,865 | ) | ||||||
| Goodwill impairment | (38,778,584 | ) | (2,675,211 | ) | (3,592,933 | ) | ||||||
| Gain on reduction of Unicom liability | — | 1,557,153 | — | |||||||||
| Gain from reversed litigation expenses | — | 557,167 | — | |||||||||
| Total operating expenses | (61,462,080 | ) | (22,668,927 | ) | (33,382,197 | ) | ||||||
| Loss from continuing operations | (43,562,481 | ) | (8,279,894 | ) | (26,696,716 | ) | ||||||
| Interest income | 2,313,576 | 1,613,078 | 454,438 | |||||||||
| Interest expense | (179,062 | ) | — | (13,681 | ) | |||||||
| Other income, net | 465,825 | 247,156 | 341,651 | |||||||||
| Gain on reduction of acquisition payable | — | 5,000,000 | — | |||||||||
| Foreign exchange loss | — | (8,990,067 | ) | — | ||||||||
| Loss before income tax credit (expense), equity in (loss) earning of affiliated company, impairment for investment in affiliated company and discontinued operations | (40,962,142 | ) | (10,409,727 | ) | (25,914,308 | ) | ||||||
| Income tax benefit (expense) | 182,370 | (486,250 | ) | (234,286 | ) | |||||||
| Equity in (loss) earning of affiliated company | (62,756 | ) | 64,293 | (914,072 | ) | |||||||
| Impairment for investment in affiliated company | — | (1,870,897 | ) | — | ||||||||
| Net loss from continuing operations | (40,842,528 | ) | (12,702,581 | ) | (27,062,666 | ) | ||||||
| Discontinued operations: | ||||||||||||
| Net loss from discontinued operations, net of tax | (612,170 | ) | — | — | ||||||||
| Gain from disposal of discontinued operations | 192,943 | 412,530 | 221,899 | |||||||||
| Net (loss) income from discontinued operations, net of tax | (419,227 | ) | 412,530 | 221,899 | ||||||||
| Net loss | (41,261,755 | ) | (12,290,051 | ) | (26,840,767 | ) | ||||||
| Less: Net (income) loss attributable to the non-controlling interests and redeemable non-controlling interest | (688,440 | ) | 337,455 | 4,182,875 | ||||||||
| Net loss attributable to Hurray! Holding Co., Ltd. | (41,950,195 | ) | (11,952,596 | ) | (22,657,892 | ) | ||||||
| Net loss | (41,261,755 | ) | (12,290,051 | ) | (26,840,767 | ) | ||||||
| Other comprehensive income: | ||||||||||||
| Currency translation adjustments of subsidiaries | 4,642,922 | 2,658,344 | (37,917 | ) | ||||||||
| Comprehensive loss | (36,618,833 | ) | (9,631,707 | ) | (26,878,684 | ) | ||||||
| Comprehensive (income)/loss attributable to non-controlling interest and redeemable non-controlling interest | (1,077,837 | ) | 11,551 | 4,187,304 | ||||||||
| Comprehensive loss attributable to Hurray! Holding Co., Ltd. | (37,696,670 | ) | (9,620,156 | ) | (22,691,380 | ) | ||||||
| Note | Year ended December 31, 2009 | Year ended December 31, 2010 | Year ended December 31, 2011 | |||||||||||
(Adjusted) (Note 2(1)) | ||||||||||||||
| (in U.S. dollars, except number of shares) | ||||||||||||||
Net revenues: | 2(19) | |||||||||||||
Advertising | ||||||||||||||
Third parties | 757,723 | 15,853,948 | 11,145,833 | |||||||||||
Related parties | 279,341 | 701,732 | 8,076,155 | |||||||||||
|
|
|
|
|
| |||||||||
Total net revenues | 1,037,064 | 16,555,680 | 19,221,988 | |||||||||||
|
|
|
|
|
| |||||||||
Cost of revenues: | 2(15) | |||||||||||||
Advertising | ||||||||||||||
Third parties | (556,639 | ) | (40,082,758 | ) | (30,500,596 | ) | ||||||||
Related parties | — | (376,302 | ) | (379,465 | ) | |||||||||
|
|
|
|
|
| |||||||||
Total cost of revenues | (556,639 | ) | (40,459,060 | ) | (30,880,061 | ) | ||||||||
|
|
|
|
|
| |||||||||
Gross profit/(loss) | 480,425 | (23,903,380 | ) | (11,658,073 | ) | |||||||||
|
|
|
|
|
| |||||||||
Operating expenses: | ||||||||||||||
Product development | 2(20) | — | — | (2,692,884 | ) | |||||||||
Selling and marketing | 2(22) | (665,131 | ) | (16,195,539 | ) | (11,817,758 | ) | |||||||
General and administrative | 2(21) | (6,465,080 | ) | (13,507,701 | ) | (23,401,769 | ) | |||||||
|
|
|
|
|
| |||||||||
Total operating expenses | (7,130,211 | ) | (29,703,240 | ) | (37,912,411 | ) | ||||||||
|
|
|
|
|
| |||||||||
Operating loss from continuing operations | (6,649,786 | ) | (53,606,620 | ) | (49,570,484 | ) | ||||||||
|
|
|
|
|
| |||||||||
Interest income | 356,167 | 57,464 | 169,854 | |||||||||||
Interest expense | 13 | — | (31,134 | ) | (1,119,429 | ) | ||||||||
Other income, net | 2(32) | 1,783 | 3 | 1,294,135 | ||||||||||
|
|
|
|
|
| |||||||||
Loss before income tax benefit from continuing operations | (6,291,836 | ) | (53,580,287 | ) | (49,225,924 | ) | ||||||||
Income tax benefit | 2(26), 14 | 13,721 | 41,172 | 99,479 | ||||||||||
Equity in loss of affiliated company, net of tax | 8 | — | — | (263,313 | ) | |||||||||
|
|
|
|
|
| |||||||||
Loss from continuing operations, net of tax | (6,278,115 | ) | (53,539,115 | ) | (49,389,758 | ) | ||||||||
|
|
|
|
|
| |||||||||
Discontinued operations: | ||||||||||||||
Loss from operations of discontinued operations, net of tax | 4 | (21,778,174 | ) | (3,382,438 | ) | — | ||||||||
Gain from disposal of discontinued operations, net of tax | 221,899 | 4,486,786 | — | |||||||||||
|
|
|
|
|
| |||||||||
(Loss) income from discontinued operations, net of tax | (21,556,275 | ) | 1,104,348 | — | ||||||||||
|
|
|
|
|
| |||||||||
Net loss | (27,834,390 | ) | (52,434,767 | ) | (49,389,758 | ) | ||||||||
Less: Net loss attributable to non-controlling interests from continuing operations | 256,654 | 680,837 | 45,851 | |||||||||||
Less: Net loss attributable to non-controlling interests and redeemable non-controlling interests from discontinued operations | 4,182,875 | 243,666 | — | |||||||||||
|
|
|
|
|
| |||||||||
Net loss attributable to Ku6 Media Co., Ltd. | (23,394,861 | ) | (51,510,264 | ) | (49,343,907 | ) | ||||||||
|
|
|
|
|
| |||||||||
Loss from continuing operations, net of tax, attributable to Ku6 Media Co., Ltd. | (6,021,461 | ) | (52,858,278 | ) | (49,343,907 | ) | ||||||||
(Loss) income from discontinued operations, net of tax, attributable to Ku6 Media Co., Ltd. | (17,373,400 | ) | 1,348,014 | — | ||||||||||
|
|
|
|
|
| |||||||||
Net loss attributable to Ku6 Media Co., Ltd. | (23,394,861 | ) | (51,510,264 | ) | (49,343,907 | ) | ||||||||
|
|
|
|
|
| |||||||||
F-5
| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2007 | December 31, 2008 | December 31, 2009 | ||||||||||
| (in U.S. dollars, except number of shares) | ||||||||||||
| Loss per ADS-basic and diluted (1ADS = 100 shares): | ||||||||||||
| Loss from continuing operations attributable to Hurray! Holding Co., Ltd. common shareholders | (1.91 | ) | (0.57 | ) | (1.04 | ) | ||||||
| Discontinued operations attributable to Hurray! Holding Co., Ltd. common shareholders | (0.02 | ) | 0.02 | 0.01 | ||||||||
| Net loss attributable to Hurray! Holding Co., Ltd. common shareholders | (1.93 | ) | (0.55 | ) | (1.03 | ) | ||||||
| Weighted average ADS used in per ADS calculation | ||||||||||||
| Basic | 21,722,082 | 21,856,151 | 21,962,919 | |||||||||
| Diluted | 21,722,082 | 21,856,151 | 21,962,919 | |||||||||
| Amounts attributable to Hurray! Holding common shareholders: | ||||||||||||
| Loss from continuing operations, net of tax | (41,530,968 | ) | (12,365,126 | ) | (22,879,791 | ) | ||||||
| Discontinued operations, net of tax | (419,227 | ) | 412,530 | 221,899 | ||||||||
| Net loss | (41,950,195 | ) | (11,952,596 | ) | (22,657,892 | ) | ||||||
| Share-based compensation included in: | ||||||||||||
| Product development | 921 | 40,102 | — | |||||||||
| Selling and marketing | 286,885 | 621,094 | 118,521 | |||||||||
| General and administrative | 155,169 | 284,086 | 50,789 | |||||||||
F-6
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
Note (cont’d) | Year ended December 31, 2009 | Year ended December 31, 2010 | Year ended December 31, 2011 | |||||||||||
(Adjusted) (Note 2(1)) | ||||||||||||||
| (in U.S. dollars, except number of shares) | ||||||||||||||
Net loss | (27,834,390 | ) | (52,434,767 | ) | (49,389,758 | ) | ||||||||
Other comprehensive loss: | ||||||||||||||
Currency translation adjustments of subsidiaries | (36,057 | ) | (809,654 | ) | (624,595 | ) | ||||||||
|
|
|
|
|
| |||||||||
Comprehensive loss | (27,870,447 | ) | (53,244,421 | ) | (50,014,353 | ) | ||||||||
Comprehensive loss attributable to non-controlling interests and redeemable non-controlling interests | 4,443,959 | 921,701 | 49,390 | |||||||||||
|
|
|
|
|
| |||||||||
Comprehensive loss attributable to Ku6 Media Co., Ltd. | (23,426,488 | ) | (52,322,720 | ) | (49,964,963 | ) | ||||||||
|
|
|
|
|
| |||||||||
Loss per share-basic and diluted | 17 | |||||||||||||
Loss from continuing operations attributable to Ku6 Media Co., Ltd. common shareholders | (0.00 | ) | (0.02 | ) | (0.01 | ) | ||||||||
Income (loss) from discontinued operations attributable to Ku6 Media Co., Ltd. common shareholders | (0.01 | ) | 0.00 | — | ||||||||||
|
|
|
|
|
| |||||||||
Net loss attributable to Ku6 Media Co., Ltd. common shareholders | (0.01 | ) | (0.02 | ) | (0.01 | ) | ||||||||
|
|
|
|
|
| |||||||||
Weighted average shares used in per share calculation-basic and diluted | 2,196,291,947 | 3,096,421,097 | 4,265,277,638 | |||||||||||
|
|
|
|
|
| |||||||||
Loss per ADS-basic and diluted (1ADS = 100 shares): | 17 | |||||||||||||
Loss from continuing operations attributable to Ku6 Media Co., Ltd. common shareholders | (0.27 | ) | (1.71 | ) | (1.16 | ) | ||||||||
(Loss) income from discontinued operations attributable to Ku6 Media Co., Ltd. common shareholders | (0.79 | ) | 0.04 | — | ||||||||||
|
|
|
|
|
| |||||||||
Net loss attributable to Ku6 Media Co., Ltd. common shareholders | (1.06 | ) | (1.67 | ) | (1.16 | ) | ||||||||
|
|
|
|
|
| |||||||||
Weighted average ADS used in per ADS calculation-basic and diluted | 21,962,919 | 30,964,211 | 42,652,776 | |||||||||||
|
|
|
|
|
| |||||||||
The accompanying notes are an integral part of these financial statements.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
| Retained | Accumulated | Total Hurray! | |||||||||||||||||||||||||||||||||||
| Ordinary shares | Additional | earnings | other | Holding Co., Ltd. | |||||||||||||||||||||||||||||||||
| (US$0.00005 par value) | paid-in | Statutory | (Accumulated | comprehensive | shareholders’ | Non-controlling | Total | ||||||||||||||||||||||||||||||
| Shares | Amount | capital | reserves | deficits) | income | equity | interests | equity | |||||||||||||||||||||||||||||
| (in U.S. dollars, except shares data) | |||||||||||||||||||||||||||||||||||||
| Balance as of January 1, 2007 | 2,163,031,740 | 108,102 | 73,608,117 | 5,661,061 | 40,041,391 | 3,401,349 | 122,820,020 | 3,359,193 | 126,179,213 | ||||||||||||||||||||||||||||
| Non-controlling interest arising from acquisition of Secular Bird and Beijing Hurray! Fly Songs | — | — | — | — | — | — | — | 230,372 | 230,372 | ||||||||||||||||||||||||||||
| Stock-based compensation expense | 11,099,300 | 554 | 442,421 | — | — | — | 442,975 | — | 442,975 | ||||||||||||||||||||||||||||
| Exercise of stock options | 653,400 | 33 | 16,301 | — | — | — | 16,334 | — | 16,334 | ||||||||||||||||||||||||||||
| Appropriations to statutory reserves | — | — | — | 841,788 | (841,788 | ) | — | — | — | — | |||||||||||||||||||||||||||
| Cumulative currency translation adjustments of subsidiaries | — | — | — | — | — | 4,253,525 | 4,253,525 | 389,397 | 4,642,922 | ||||||||||||||||||||||||||||
| Net (loss) income | — | — | — | — | (41,950,195 | ) | — | (41,950,195 | ) | 688,440 | (41,261,755 | ) | |||||||||||||||||||||||||
| Balance as of December 31, 2007 | 2,174,784,440 | 108,689 | 74,066,839 | 6,502,849 | (2,750,592 | ) | 7,654,874 | 85,582,659 | 4,667,402 | 90,250,061 | |||||||||||||||||||||||||||
| Stock-based compensation expense | 18,499,300 | 925 | 944,357 | — | — | — | 945,282 | — | 945,282 | ||||||||||||||||||||||||||||
| Exercise of stock options | 60,000 | 3 | 1,497 | — | — | — | 1,500 | — | 1,500 | ||||||||||||||||||||||||||||
| Appropriations to statutory reserves | — | — | — | (4,711,525 | ) | 4,711,525 | — | — | — | — | |||||||||||||||||||||||||||
| Capital injection to Secular Bird attributable to non-controlling interest | — | — | — | — | — | — | — | 127,358 | 127,358 | ||||||||||||||||||||||||||||
| Cumulative currency translation adjustments of subsidiaries | — | — | — | — | — | 2,332,440 | 2,332,440 | 325,904 | 2,658,344 | ||||||||||||||||||||||||||||
| Net loss | — | — | — | — | (11,952,596 | ) | — | (11,952,596 | ) | (337,455 | ) | (12,290,051 | ) | ||||||||||||||||||||||||
| Balance as of December 31, 2008 | 2,193,343,740 | 109,617 | 75,012,693 | 1,791,324 | (9,991,663 | ) | 9,987,314 | 76,909,285 | 4,783,209 | 81,692,494 | |||||||||||||||||||||||||||
| Stock-based compensation expense | 6,500,300 | 324 | 168,986 | — | — | — | 169,310 | — | 169,310 | ||||||||||||||||||||||||||||
| Exercise of stock options | 350,000 | 18 | 8,732 | — | — | — | 8,750 | — | 8,750 | ||||||||||||||||||||||||||||
| Cumulative currency translation adjustments of subsidiaries | — | — | — | — | — | (33,488 | ) | (33,488 | ) | (4,429 | ) | (37,917 | ) | ||||||||||||||||||||||||
| Net loss | — | — | — | — | (22,657,892 | ) | — | (22,657,892 | ) | (2,984,284 | ) | (25,642,176 | ) | ||||||||||||||||||||||||
| Balance as of December 31, 2009 | 2,200,194,040 | $ | 109,959 | 75,190,411 | 1,791,324 | (32,649,555 | ) | 9,953,826 | 54,395,965 | 1,794,496 | 56,190,461 | ||||||||||||||||||||||||||
| xx | xx | xx | xx | xx | xx | xx | xx | xx | ||||||||||||||||||||||||||||
| Ordinary shares ($0.00005 par value) | Additional paid-in capital | Statutory reserves | Accumulated deficits | Accumulated other comprehensive income / (loss) | Total Ku6 Media Co., Ltd. shareholders’ equity | Non-controlling interests | Total equity | |||||||||||||||||||||||||||||
| Shares | Amount | |||||||||||||||||||||||||||||||||||
| (in U.S. dollars, except shares data) | ||||||||||||||||||||||||||||||||||||
Balance as of December 31, 2008 | 2,193,343,740 | 109,617 | 75,012,693 | 1,791,324 | (9,991,663 | ) | 9,987,314 | 76,909,285 | 4,783,209 | 81,692,494 | ||||||||||||||||||||||||||
Stock-based compensation expense | 6,500,300 | 324 | 168,986 | — | — | — | 169,310 | — | 169,310 | |||||||||||||||||||||||||||
Exercise of stock options | 350,000 | 18 | 8,732 | — | — | — | 8,750 | — | 8,750 | |||||||||||||||||||||||||||
Online audio business (“Yisheng”) contributed by Shanda Interactive Entertainment Limited (“Shanda”) | — | — | 1,415,547 | — | — | — | 1,415,547 | (43,533 | ) | 1,372,014 | ||||||||||||||||||||||||||
Capital contribution to Yisheng by non-controlling shareholders | — | — | — | — | — | — | — | 362,773 | 362,773 | |||||||||||||||||||||||||||
Cumulative currency translation adjustments of subsidiaries | — | — | — | — | — | (31,627 | ) | (31,627 | ) | (4,430 | ) | (36,057 | ) | |||||||||||||||||||||||
Net loss | — | — | — | — | (23,394,861 | ) | — | (23,394,861 | ) | (3,240,927 | ) | (26,635,788 | ) | |||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||
Balance as of December 31, 2009 (Adjusted (Note 2(1))) | 2,200,194,040 | 109,959 | 76,605,958 | 1,791,324 | (33,386,524 | ) | 9,955,687 | 55,076,404 | 1,857,092 | 56,933,496 | ||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||
Stock-based compensation expense | 3,000,100 | 150 | 607,014 | — | — | — | 607,164 | — | 607,164 | |||||||||||||||||||||||||||
Exercise of stock options | 450,000 | 22 | 20,328 | — | — | — | 20,350 | — | 20,350 | |||||||||||||||||||||||||||
Issuance of ordinary shares related to acquisitions of Ku6 Holding Limited | 723,684,204 | 36,185 | 28,838,816 | — | — | — | 28,875,001 | — | 28,875,001 | |||||||||||||||||||||||||||
Disposal of Huayi Brothers Music Co., Ltd. | — | — | — | (74,246 | ) | 74,246 | (221,315 | ) | (221,315 | ) | (209,736 | ) | (431,051 | ) | ||||||||||||||||||||||
Contribution by Shanda related to Yisheng | — | — | 663,570 | — | — | — | 663,570 | — | 663,570 | |||||||||||||||||||||||||||
Issuance of ordinary shares for Yisheng to Shanda | 415,384,615 | 20,769 | 12,440,769 | — | — | — | 12,461,538 | — | 12,461,538 | |||||||||||||||||||||||||||
Deemed distribution to Shanda related to Yisheng | — | — | (12,461,538 | ) | — | — | — | (12,461,538 | ) | — | (12,461,538 | ) | ||||||||||||||||||||||||
Purchase of additional equity interests of Yisheng from non-controlling shareholders | 138,461,539 | 6,923 | (520,181 | ) | — | — | — | (513,258 | ) | 513,258 | — | |||||||||||||||||||||||||
Disposal of WVAS and recorded music businesses to Shanda | — | — | 23,905,417 | (1,717,078 | ) | 1,717,078 | (10,344,330 | ) | 13,561,087 | (1,464,169 | ) | 12,096,918 | ||||||||||||||||||||||||
Cumulative currency translation adjustments of subsidiaries | — | — | — | — | — | (812,456 | ) | (812,456 | ) | 2,802 | (809,654 | ) | ||||||||||||||||||||||||
Net loss | — | — | — | — | (51,510,264 | ) | — | (51,510,264 | ) | (806,997 | ) | (52,317,261 | ) | |||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||
Balance as of December 31, 2010 | 3,481,174,498 | 174,008 | 130,100,153 | — | (83,105,464 | ) | (1,422,414 | ) | 45,746,283 | (107,750 | ) | 45,638,533 | ||||||||||||||||||||||||
|
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|
|
|
|
|
|
|
|
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Issuance of ordinary shares to Shanda | 1,538,461,538 | 76,924 | 49,923,076 | — | — | — | 50,000,000 | — | 50,000,000 | |||||||||||||||||||||||||||
Exercise of stock options | 150,000 | 7 | 3,743 | — | — | — | 3,750 | — | 3,750 | |||||||||||||||||||||||||||
Stock-based compensation expense (Note 2(1)(a), 15) | — | — | 1,754,170 | — | — | — | 1,754,170 | — | 1,754,170 | |||||||||||||||||||||||||||
Disposition of equity interests in Yisheng (Note 2(1)(a)) | — | — | 1,373,190 | — | — | 220,671 | 1,593,861 | 157,140 | 1,751,001 | |||||||||||||||||||||||||||
Liabilities waived by Shanda (Note 13) | — | — | 1,719,927 | — | — | — | 1,719,927 | — | 1,719,927 | |||||||||||||||||||||||||||
Currency translation adjustments of subsidiaries | — | — | — | — | — | (621,056 | ) | (621,056 | ) | (3,539 | ) | (624,595 | ) | |||||||||||||||||||||||
Net loss | — | — | — | — | (49,343,907 | ) | — | (49,343,907 | ) | (45,851 | ) | (49,389,758 | ) | |||||||||||||||||||||||
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Balance as of December 31, 2011 | 5,019,786,036 | 250,939 | 184,874,259 | — | (132,449,371 | ) | (1,822,799 | ) | 50,853,028 | — | 50,853,028 | |||||||||||||||||||||||||
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The accompanying notes are an integral part of these consolidated financial statements.
F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS
| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2007 | December 31, 2008 | December 31, 2009 | ||||||||||
| (in U.S. dollars) | ||||||||||||
Operating activities: | ||||||||||||
| Net loss | (41,261,755 | ) | (12,290,051 | ) | (26,840,767 | ) | ||||||
| Adjustments for: | ||||||||||||
| Share-based compensation | 442,975 | 945,282 | 169,310 | |||||||||
| Depreciation and amortization | 3,644,095 | 3,327,798 | 1,699,171 | |||||||||
| Impairment of goodwill | 38,778,584 | 2,675,211 | 3,592,933 | |||||||||
| Impairment for investment in affiliated company | — | 1,870,897 | — | |||||||||
| Impairment of intangible assets | 2,480,253 | 2,850,714 | 3,542,071 | |||||||||
| Bad debt provision | 453,674 | 1,012,738 | 3,422,876 | |||||||||
| Inventory provision | — | — | 238,370 | |||||||||
| Exchange loss | — | — | 17,198 | |||||||||
| Equity in (earning) loss of affiliated company | 62,756 | (64,293 | ) | 914,072 | ||||||||
| Gain from disposal of subsidiary | (192,943 | ) | (412,530 | ) | (221,899 | ) | ||||||
| Receivable from disposal of subsidiary (net of cash disposed of $771,570) | (3,186,887 | ) | — | — | ||||||||
| Loss (gain) on disposal of property and equipment | 74,300 | 112,745 | (5,843 | ) | ||||||||
| Change in fair value of contingent consideration | — | — | (352,217 | ) | ||||||||
| Gain on reduction of acquisition payable | — | (5,000,000 | ) | — | ||||||||
| Gain on reduction of Unicom liability | — | (1,557,153 | ) | — | ||||||||
| Gain from reversed litigation expenses | — | (557,167 | ) | — | ||||||||
| Changes in assets and liabilities net of effect of businesses acquired and sold: | ||||||||||||
| Accounts receivable | (2,069,378 | ) | 3,492,068 | 6,439,522 | ||||||||
| Prepaid expenses and other current assets | (138,548 | ) | (1,142,954 | ) | 2,727,610 | |||||||
| Amount due from related parties | (273,618 | ) | (245,724 | ) | 733,151 | |||||||
| Deposits and other non-current assets | (147,543 | ) | 183,003 | 439,859 | ||||||||
| Inventories | (81,422 | ) | 56,833 | (128,122 | ) | |||||||
| Deferred taxes | (749,936 | ) | 187,671 | (516,469 | ) | |||||||
| Accounts payable | (140,809 | ) | (761,068 | ) | 187,315 | |||||||
| Notes payable | — | — | 22,901 | |||||||||
| Accrued expenses and other current liabilities | 305,097 | (71,705 | ) | 2,253,594 | ||||||||
| Amount due to related parties | 245,379 | (63,140 | ) | (80,199 | ) | |||||||
| Income tax payable | (299,897 | ) | (102,057 | ) | 290,670 | |||||||
Net cash used in operating activities | (2,055,623 | ) | (5,552,882 | ) | (1,454,893 | ) | ||||||
Investing activities: | ||||||||||||
| Increase of short-term investments | — | — | (10,000,000 | ) | ||||||||
| Purchases of property and equipment | (863,603 | ) | (349,233 | ) | (678,282 | ) | ||||||
| Proceeds from disposal of property and equipment | — | — | 80,498 | |||||||||
| Purchase of intangible assets | (1,535,436 | ) | (1,718,340 | ) | (66,259 | ) | ||||||
| Proceeds from disposal of a subsidiary | — | 4,517,070 | 254,102 | |||||||||
| Acquisition of subsidiaries, net of cash acquired ($1,398,709, nil, and $1,034,308 for the years ended December 31, 2007, 2008 and 2009, respectively) | (3,237,834 | ) | (2,207,132 | ) | 1,034,308 | |||||||
| Payments related to acquisition not yet consummated | — | (1,907,400 | ) | — | ||||||||
| Investment at cost in Seed Music Group Limited | — | (600,038 | ) | — | ||||||||
| Investment in an affiliated company | (2,483,277 | ) | — | — | ||||||||
Net cash used in investing activities | (8,120,150 | ) | (2,265,073 | ) | (9,375,633 | ) | ||||||
Financing activities: | ||||||||||||
| Proceeds from exercise of options | 16,334 | 1,500 | 2,500 | |||||||||
Net cash provided by financing activities | 16,334 | 1,500 | 2,500 | |||||||||
Effect of exchange rate changes on cash and cash equivalents | 1,541,345 | 1,310,274 | (155,582 | ) | ||||||||
| Net decrease in cash and cash equivalents | (10,159,439 | ) | (7,816,455 | ) | (10,828,026 | ) | ||||||
| Cash and cash equivalents, beginning of year | 74,596,978 | 65,978,884 | 59,472,703 | |||||||||
| Cash and cash equivalents, end of the year | 65,978,884 | 59,472,703 | 48,489,095 | |||||||||
Supplemental disclosure of cash flow information: | ||||||||||||
| Income taxes paid | 854,864 | 385,501 | 465,696 | |||||||||
| Year ended December 31, 2009 | Year ended December 31, 2010 | Year ended December 31, 2011 | ||||||||||
(Adjusted) (Note 2(1)) | ||||||||||||
| (in U.S. dollars) | ||||||||||||
Net loss | (27,834,390 | ) | (52,434,767 | ) | (49,389,758 | ) | ||||||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||||||
Share-based compensation | 169,310 | 607,164 | 1,231,919 | |||||||||
Share-based compensation cost in relation to disposition of Yisheng | — | — | 522,251 | |||||||||
Share based compensation cost in relation to acquisition of Ku6 | — | 1,284,766 | — | |||||||||
Depreciation and amortization | 1,798,396 | 5,266,212 | 5,197,444 | |||||||||
Amortization and write-down of licensed video copyrights | — | 15,751,814 | 3,721,696 | |||||||||
Impairment for goodwill | 3,592,933 | — | — | |||||||||
Impairment for investment in affiliated company | 209,848 | — | — | |||||||||
Impairment for intangible assets | 3,542,071 | — | 1,365,376 | |||||||||
Bad debt provision | 3,819,894 | 1,474,568 | 3,459,826 | |||||||||
Inventory provision | 238,370 | 84,481 | — | |||||||||
Exchange loss (gains) | 17,198 | (898,682 | ) | 292,296 | ||||||||
Equity in losses of affiliated companies | 704,224 | — | 263,313 | |||||||||
Gain from disposal of subsidiary | (221,899 | ) | (4,486,786 | ) | — | |||||||
Losses (gain) on disposal of property and equipment | (5,843 | ) | 196,969 | 2,977,098 | ||||||||
Change in fair value of contingent consideration | (352,217 | ) | — | — | ||||||||
Changes in assets and liabilities, net of acquisitions and dispositions: | ||||||||||||
Accounts receivable | 5,883,070 | (8,678,575 | ) | 3,815,524 | ||||||||
Prepaid expenses and other current assets | 2,737,066 | (796,237 | ) | (1,519,380 | ) | |||||||
Amount due from related parties | 732,563 | (2,836,461 | ) | (3,913,409 | ) | |||||||
Deposits and other non-current assets | 439,859 | (414 | ) | (306,741 | ) | |||||||
Inventories | (130,333 | ) | (94,101 | ) | 31,038 | |||||||
Deferred taxes | (530,190 | ) | (72,985 | ) | (99,479 | ) | ||||||
Accounts payable | 579,864 | 8,753,566 | (7,906,294 | ) | ||||||||
Notes payable | 22,901 | (54,218 | ) | — | ||||||||
Accrued expenses and other current liabilities | 2,283,336 | 5,976,116 | 621,237 | |||||||||
Amount due to related parties | (78,307 | ) | 1,408,305 | 461,247 | ||||||||
Income tax payable | 290,670 | (20,633 | ) | — | ||||||||
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| |||||||
Net cash used in operating activities | (2,091,606 | ) | (29,569,898 | ) | (39,174,796 | ) | ||||||
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Investing activities: | ||||||||||||
(Increase)/decrease of short-term investments | (10,000,000 | ) | 10,000,000 | — | ||||||||
Purchases of property and equipment | (867,061 | ) | (6,586,819 | ) | (2,362,785 | ) | ||||||
Proceeds from disposal of property and equipment | 80,498 | — | — | |||||||||
Purchase of intangible assets | (66,258 | ) | — | — | ||||||||
Payment for licensed video copyright | — | (15,046,257 | ) | (5,529,949 | ) | |||||||
Proceeds (cash-out) from disposal of subsidiaries, net of cash disposed (nil, $669,705 and $111,597 for the years ended December 31, 2009, 2010 and 2011, respectively) | 254,102 | 4,376,048 | (111,597 | ) | ||||||||
Acquisition of subsidiaries, net of cash acquired ($1,034,308, $329,743 and nil for the years ended December 31, 2009, 2010 and 2011, respectively) | 1,034,308 | 329,743 | — | |||||||||
Cash received upon consolidation of a subsidiary contributed by Shanda | 633,424 | — | — | |||||||||
Proceeds from disposal of wireless value-added service and recorded music businesses to Shanda, net of cash disposed ($24,948,577 for the year ended December 31, 2010) | — | 12,295,323 | — | |||||||||
Restricted cash for pledge of bank loans | — | — | (3,600,000 | ) | ||||||||
Loan to related parties under common control by Shanda | — | (3,200,000 | ) | (14,108,019 | ) | |||||||
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Net cash provided by (used in) investing activities | (8,930,987 | ) | 2,168,038 | (25,712,350 | ) | |||||||
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(Adjusted) (Note 2(1)) Financing activities: Proceeds from exercise of stock options Proceeds from issuance of ordinary shares to Shanda Proceeds from issuance of convertible bond to Shanda Cash paid for redemption of convertible bond to Shanda Cash injection into VIE subsidiary by Shanda Borrowings from bank Borrowings from related parties under common control by Shanda Repayment for loans from related parties under common control of Shanda Cash injection in VIE subsidiary by non-controlling shareholders Net cash provided by financing activities Effect of exchange rate changes on cash and cash equivalents Net decrease in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of the year Supplemental disclosure of cash flow information: Loan interest paid Income taxes paid Supplemental disclosure of non-cash investing and financing activities: Accounts payable related to purchase of property and equipment Accounts payable related to licensed video copyright Issuance of ordinary shares to Shanda for Yisheng Purchase of additional equity interests of Yisheng from non-controlling shareholders Issuance of ordinary shares related to acquisition of Ku6 Holding Limited Year ended
December 31, 2009 Year ended
December 31, 2010 Year ended
December 31, 2011 (in U.S. dollars) 2,500 20,350 3,750 — — 50,000,000 — — 50,000,000 — — (50,000,000 ) 1,083,057 — — — — 3,177,680 — 4,596,001 13,335,896 — — (3,189,527 ) 362,773 — — 1,448,330 4,616,351 63,327,799 (154,506 ) 336,394 1,014,955 (9,728,769 ) (22,449,115 ) (544,392 ) 59,472,703 49,743,934 27,294,819 49,743,934 27,294,819 26,750,427 — 30,903 703,108 465,696 23,047 — — 2,045,032 — — 2,946,304 1,108,057 — 12,461,538 — — 4,153,846 — — 28,875,000 —
The accompanying notes are an integral part of these consolidated financial statements.
statements
F-8
Ku6 Media Co., Ltd. (formerly known as Hurray! Holding Co., Ltd. (“Hurray!, “Hurray!” or the “Company”), a Cayman Islands corporation, and its consolidated subsidiaries, its variable interest entities and equity associate (collectively referred to as the “Group”) provideoriginally provided wireless value-added services (“WVAS”) to mobile phone users delivered over the wireless networks of the three telecommunication operators in the People’s Republic of China (“PRC”) and also engageengaged in music production and distribution in the PRC and Taiwan. The Company specializes in the development, marketing and distribution of music and entertainment oriented consumer wireless value-added services.
As of December 31, 2011, the Group’s ownership structure is entitled to the whole benefit of these entities’ economic interest ):
| Names of Major Subsidiaries, Variable Interest Entities and Affiliate | Date of incorporation | Percentage of ownership | ||||||
Subsidiaries | ||||||||
Ku6 (Beijing) Technology Co., Ltd. (“Beijing | ||||||||
| 100 | % | |||||||
Wei Mo San Yi (Tianjin) Science and Technology Co., Ltd. (“Tianjin Technology”) | 100 | % | ||||||
Kusheng (Tianjin) Technology Co., Ltd. (“Kusheng”) | 100 | % | ||||||
Variable Interest Entities (“VIEs”) | ||||||||
Ku6 (Beijing) Information Technology Co., Ltd. (“Beijing Information”) | April 20, 2006 | N/A | ||||||
Tianjin Ku6 Zheng Yuan Information Technology Co., Ltd. (“Tianjin Information”) | March 20, 2009 | N/A | ||||||
Tianjin Ku6 Network Communication Technology Co., Ltd. (“Ku6 Network”) | December14, 2011 | N/A | ||||||
Affiliate | ||||||||
Shanghai Yisheng Network Technology Co., Ltd. (“ | ||||||||
| % | ||||||||
In July, 2009, Shanda Interactive Entertainment Limited (“Shanda”), a leading interactive entertainment media company in China, and Shanda Music Group Limited (“Shanda Music”), a wholly owned subsidiary of Shanda, announced its completion of a tender offer of totaling $46.2 million for 1,155,045,300 ordinary shares, par value $0.00005 per ordinary share (“Shares”), of the Company, including Shares represented by American Depositary Shares (“ADSs,” each representing 100 Shares) at a purchase price of $0.04 per Share (equivalent to $4.00 per ADS) in cash, without interest and subject to any applicable withholding taxes. Immediately after giving effect to the acquisition of Shares (including Shares represented by ADSs) in the tender offer, Shanda held approximately 51% of the Company’s total outstanding Shares calculated on a fully-diluted basis as of December 31, 2009.
In January, 2010, the Company completed the acquisition of 100% of the equity interests of Ku6 Holding Limited (“Ku6 Holding”), a leading online video portal in China, pursuant to the share purchase agreement entered into by and among Hurray!, Ku6 Holding and the shareholders of Ku6 Holding dated as of November 26, 2009 by issuing an aggregate of 723,684,204 ordinary shares. After the closing of the acquisition of Ku6 Holding, Shanda’s equity interest in the Company was diluted to 41.97%.
In May, 2010, the Company sold all of its 51% equity interest in Beijing Huayi Brothers Music Co., Ltd. including its wholly owned subsidiary of Beijing Huayi Brothers Music Broker Co., Ltd. (collectively referred to as “Huayi Music”) to Huayi Brothers Media Corporation (“Huayi Media”) for aggregate consideration of RMB 34,450,000 (equivalent to $5,045,754).
In August 2010, the Company completed (1) the disposal of all of its subsidiaries and VIEs related to WVAS and recorded music businesses as well as the equity investment in an affiliated company to Shanda for $37,243,904 in cash and (2) acquisition of 75% of the equity interest of Yisheng, an online audio business, from Shanda in exchange for 415,384,615 newly issued ordinary shares (collectively the “2010 Reorganization”). In connection with the acquisition of 75% of the equity interests in Yisheng from Shanda, the Company issued 138,461,539 ordinary shares to acquire the remaining 25% of equity interests in Yisheng from the non-controlling shareholders in August 2010. The 2010 Reorganization was approved by a committee comprised of three independent directors after receiving a fairness opinion on the proposed transaction from its independent financial advisor. Following the 2010 Reorganization, the Company changed its name to Ku6 Media Co., Ltd. and changed its trading symbol on the Nasdaq Global Market from HRAY to KUTV. At December 31, 2010, Shanda’s equity interest in the Company was 51.65%.
In April 2011, the Company entered into agreements with Shanda Media Group Ltd., a wholly owned subsidiary of Shanda, pursuant to which the Company issued 1,538,461,538 ordinary shares for an aggregate purchase price of $50 million and $50 million aggregate principal amount of senior convertible bond at face value (“Convertible Bond”). The Convertible Bond would mature in three years after issuance and would bear an interest of 3% per annum. The closing date of the ordinary shares and Convertible Bond issuance was June 29, 2011. Based on the Company’s working capital position, the Company redeemed the Convertible Bond in September 2011 at its issue price.
In August 2011, the Company disposed of a significant interest in Yisheng to the related entities and a then employee of Ku6. After the disposal, the Company retains a 20% interest in Yisheng. This transaction is further described in Note 2(1)(a).
At December 31, 2011, Shanda’s equity interest in the Company was 66.43%.
The Group has adjusted its business strategy in 2011. The adjustments primarily refer to 1) the appointment of Shanghai Shengyue Advertising Ltd (“Shengyue”), a wholly owned subsidiary of Shanda, as its primary agency of the online advertising services, and 2) the change in business focus from purchasing the long-form licensed video contents to relying more on the user generated contents and short-form video contents. Shengyue operates the advertising system of Application Advertisement (“AA”) and charges the advertisement fees from its customers based on the advertising effects, including but not limited to views, clicks, responses and etc., (“performance advertisement”). After the appointment of Shengyue as its primary agency, the Group primarily relies on Shengyue to sell the online advertising service, therefore, the Group significantly reduced its sales forces and recorded the severance payments of $0.9 million through the general and administrative expenses ($0.15 million) and selling expenses ($0.75 million) in 2011. The intangible asset of the customer list of $1.46 million, representing the customer relationships under the original business model, has also been abandoned and recorded through the general and administrative expenses in 2011 (Note 7). In relation to the cease of purchasing the long-form licensed video copyrights, the Group has exited two long-term licensed contents purchase agreements with the content providers by paying a one-time termination fee of $5.3 million, which was recorded into the cost of revenues.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(1) Basis of presentation
The accompanying consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”).
As a result of the disposal of Huayi Music in May 2010 and the 2010 Reorganization, the Company adjusted its consolidated financial statements for the years ended December 31, 2009 and 2010 for the above mentioned transactions to present the WVAS and recorded music businesses as discontinued operations and to reflect the Yisheng merger as a common control transaction.
(a)Acquisition under common control
The acquisition of Yisheng’s online audio business from Shanda was accounted for as a common control transaction as Hurray! was under the control of Shanda since the Company was acquired by Shanda in July 2009. Accordingly, the accompanying consolidated financial statements have been prepared as if the acquisition of Yisheng had been in effect since the inception of common control, which is the date that Hurray! was consolidated into Shanda’s consolidated financial statements on August 31, 2009. Therefore, total assets and liabilities, as well as the non-controlling interests of Yisheng, were recorded at the carrying amount as capital contribution from Shanda in the consolidated statements of changes in equity at the inception of common control. The effect of accounting for the acquisition under common control increased the net loss for the year ended December 31, 2009 by $736,969, which represented the net loss of this business from August 31, 2009 through December 31, 2009. The fair value of the 415,384,615 ordinary shares issued by the Company amounting to $12,461,538 was recorded through equity as a deemed distribution to Shanda in 2010.
In connection with the acquisition of 75% of the equity interests in Yisheng from Shanda, the Company issued 138,461,539 ordinary shares to acquire the remaining 25% of the equity interests in Yisheng from non-controlling shareholders in August 2010. This transaction was accounted for as an equity transaction in 2010 and the difference between the fair value of the ordinary shares issued amounting to $4,153,846 and carrying amount of the non-controlling interest was recognized as a decrease in additional paid-in capital attributable to the Company in accordance with ASC 810.
In August 2011, the Company disposed of 80% of its (previously 100%) equity interest in Yisheng by contributing a 60% stake in Yisheng to affiliates of Shanda. A remaining 20% stake, to arrive at the 80% disposed, was granted to a then-employee of Ku6 (20%). The Company’s remaining interest in Yisheng was 20% as at December 31, 2011. As a result of the previous capital transaction related to Yisheng and the loss of a controlling financial interest, the Company deconsolidated Yisheng and recorded its remaining interest in Yisheng as an investment subject to the equity method of accounting (Note 8).
Given the presence of common control from parent Shanda, the disposition of the 60% to the related Shanda entities was accounted for as a common control transaction. Therefore, the gain on deconsolidation of Yisheng amounting to $1,373,190 (a gain due to the de-recognition of the net liabilities of the Yisheng business) was recorded in stockholders’ equity as a contribution from Shanda in 2011. At the time of deconsolidation, a Shanda affiliate receiving a portion of the contributed stake also made a capital investment of cash in Yisheng resulting in a higher equity fair value ascribed to Yisheng immediately prior to the deconsolidation. The 20% equity interest in Yisheng transferred to the then-employee of Ku6 was recorded as a compensation charge of $522,251 based on Yisheng’s equity fair value subsequent to the injection of capital from a Shanda affiliate, and was included in general and administrative expenses.
(b) Disposal of WVAS and recorded music businesses
As mentioned above, the Company completed the disposal of Huayi Music to Huayi Media for RMB 34,450,000 (equivalent to $5,045,754) in cash in May, 2010 and the corresponding disposal gain of Huayi Music recognized in 2010 was $4,486,786. The disposal of WVAS and recorded music businesses under common control was consummated in August, 2010. The difference of $13,561,087 between the cash consideration received from Shanda of $37,243,904 and the carrying amount of the assets, liabilities and non-controlling interests and redeemable non-controlling interest of WVAS and recorded music business of $23,682,817 and the corresponding cumulative translation difference of $10,344,330 was accounted for as a contribution by Shanda in additional paid in capital in 2010. No gain or loss was recognized in 2010.
A summary of the major financial information for the discontinued operations of the WVAS and recorded music businesses for the year ended December 31, 2009 and the eight month period ended August 31, 2010 is set out below:
Year ended December 31, 2009 | Eight months ended August 31, 2010 | |||||||
Net revenues: | ||||||||
Wireless value added services revenue | 20,169,110 | 5,385,985 | ||||||
Recorded music revenue | 14,473,185 | 9,458,423 | ||||||
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Total net revenues | 34,642,295 | 14,844,408 | ||||||
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Wireless value added services cost | (15,331,675 | ) | (3,799,581 | ) | ||||
Recorded music cost | (12,625,139 | ) | (6,118,305 | ) | ||||
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| |||||
Total cost of revenues | (27,956,814 | ) | (9,917,886 | ) | ||||
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| |||||
Gross profit | 6,685,481 | 4,926,522 | ||||||
Product development | (466,543 | ) | (444,581 | ) | ||||
Selling and marketing | (6,211,334 | ) | (3,397,797 | ) | ||||
General and administrative | (17,469,445 | ) | (4,544,460 | ) | ||||
Goodwill impairment | (3,592,933 | ) | — | |||||
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| |||||
Total operating expenses | (27,740,255 | ) | (8,386,838 | ) | ||||
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| |||||
Loss from operations | (21,054,774 | ) | (3,460,316 | ) | ||||
Interest income | 98,770 | 42,627 | ||||||
Interest expense | (13,681 | ) | — | |||||
Other income | 339,869 | 9,667 | ||||||
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| |||||
Loss before income tax benefit (expense), equity in (loss) earnings of affiliated company, impairment for investment in affiliated company | (20,629,816 | ) | (3,408,022 | ) | ||||
Income tax benefit (expense) | (234,286 | ) | 25,584 | |||||
Equity in loss and impairment of affiliated company | (914,072 | ) | — | |||||
Impairment for investment in affiliated company | — | — | ||||||
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| |||||
Net loss | (21,778,174 | ) | (3,382,438 | ) | ||||
Less: Net loss attributable to the non-controlling interests and redeemable non-controlling interest | 4,182,875 | 243,666 | ||||||
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| |||||
Net loss from discontinued operations, net of tax | (17,595,299 | ) | (3,138,772 | ) | ||||
Gain from disposal of Huayi Music, net of tax | — | 4,486,786 | ||||||
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| |||||
Total net (loss) income from discontinued operations | (17,595,299 | ) | 1,348,014 | |||||
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F-9According to ASC 205, the effect of discontinued operations has been accounted for retroactively in the consolidated statement of operations and comprehensive loss for all the periods presented.
(c) Liquidity
The VIEs haveCompany has incurred significant net losses and negative cash flows from operations in recent years. As of December 31, 2011, the accumulated deficit of the Company was ($132,449,371) and the excess of current assets over current liabilities (working capital) was $21,180,439. In April 2011, the Company entered into various agreements with oneShanda Media to issue 1,538,461,538 ordinary shares for an aggregate purchase price of Hurray!’s subsidiaries, including exclusive cooperation agreements. Under these agreements, Hurray! through a wholly owned PRC subsidiary, Beijing Hurray! Times,$50 million and $50 million of convertible debt (Note 1). Based on the Company’s working capital position, the Company redeemed the debt in September 2011. The Company has in the past obtained significant financing from its parent, Shanda, and may do so again in the future. As mentioned in Note 13, the Company’s forecasted revenue in 2012 is the exclusive provider of technicalprimarily derived from its primary agency and consulting services to the VIEs. In return, the VIEs are required to pay Beijing Hurray! Times’ service fees for the technical and consulting services received. The technical and consulting service fees can be, and are, adjusted at Hurray!’s discretioncash collection from this revenue source is primarily depending on the levelcontractual credit terms agreed with this agency.
The Company believes that there is sufficient cash to find operations and capital expenditures for at least the next 12 months, considering various changes in strategy and cost reduction measures that were adopted in 2011. Accordingly, the consolidated financial statements have been prepared on a going-concern basis.
(2) Use of service provided. Beijing Hurray! Times is entitledestimates
The preparation of consolidated financial statements in conformity with GAAP requires the Company to receive service feesmake 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 an amount up to allthe Company’s financial statements include accrual for sales rebates, allowances for doubtful accounts, assessment of impairment for long-lived assets and goodwill, assessment of the net incomerealizable value of licensed video copyrights, the VIEs In addition, Beijing Hurray! Times has been assigned all voting rights byuseful lives for intangible assets and property and equipment, share-based compensation expense, the directrecognition and indirect ownersmeasurement of deferred taxes, and loss contingencies. Actual amounts may differ from these estimates under different assumptions or conditions.
(3) Consolidation
The consolidated financial statements include the VIEs through agreements which are valid for ten years and are renewable indefinitely and cannot be amended or terminated except by written consent of all parties. Finally, Beijing Hurray! Times has the option to acquire the equity interest of the VIEs if and when it is legal to do so under PRC laws and regulations. The Company also has extended loans without interest to the registered shareholders to finance their investments in the VIEs. Each of the registered shareholders is a related partyfinancial statements of the Company, acting as de facto agentits subsidiaries and VIEs. All inter-company transactions and balances have been eliminated upon consolidation. Affiliated company in which the Company has partial ownership and controls more than 20% but less than 50% of the investment is accounted for using the Company.equity method of accounting. The directCompany’s share of earning (loss) of such equity interestinvestment is included in these entities has been pledged as collateral for the loansaccompanying consolidated statements of operations and when permitted under Chinese laws, the loans are to be repaid by transferring the direct equity interest in these entities to the Company. Therefore, no minority interest was recorded for the registered capital from the registered shareholders.
The Company controlled Freeland Music, Huayi Brothers Music, and Secular Bird through Hurray! Digital Media.
F-10
Pre-2010 Reorganization
Prior to the 2010 Reorganization, to comply with PRC laws and regulations that restrict direct foreign ownership of presentation
Hurray! was the considered the primary beneficiary of the entity ifVIEs of the WVAS and recorded music businesses because of all the variable interests held by Hurray! and the Company had the power to direct the activities of the VIEs. Therefore the Company consolidated the results of operations of the VIEs of the WVAS and recorded music businesses before they were disposed in 2010.
Post-2010 Reorganization
After the 2010 Reorganization, 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 Company conducts substantially all of its advertising business through its VIEs. The paid-in capitals of the Beijing Information and Ku6 Network were funded by the Company through loans extended to the authorized individuals (“nominee shareholders”) and Tianjin Information was incorporated by the 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 and Kusheng have granted interest-free loans to the nominee shareholders with the sole purpose of providing funds necessary for the capital injection of the Beijing Information and Ku6 Network. The portions of the loans for subsequent capital injection are eliminated with the capital of the Beijing Information and Ku6 Network during consolidation. The interest-free loans to the nominee shareholders of the Beijing Information and Ku6 Network as of December 31, 2011 were RMB9 million and RMB10 million, respectively. Beijing Technology and Kusheng are able to require the nominee shareholders to settle the loan amount through the entire equity interest of the Beijing Information and Ku6 Network and nominate someone else to hold the shares on Beijing Technology and Kusheng’s behalf.
Proxy Agreement: 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 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 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 investorsinterests 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 the technical, consulting and related services and information of 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.
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 Accounting Standards Codification (“ASC”) 810-10, Consolidation).
At December 31, 2011 and 2010 and for each of the three years in the entityperiod ended December 31, 2011, the summarized financial information of the VIEs is as follows:
| December 31, 2010 | December 31, 2011 | |||||||
Total assets | 14,021,798 | 8,159,494 | ||||||
Total liabilities | 26,520,629 | 47,309,685 | ||||||
Deficits | 12,498,831 | 39,150,191 | ||||||
| Year ended December 31, 2009 | Year ended December 31, 2010 | Year ended December 31, 2011 | ||||||||||
Net Revenue | 1,037,064 | 41,570,566 | 18,744,535 | |||||||||
Net loss | 6,278,115 | 8,037,455 | 25,011,099 | |||||||||
As of December 31, 2011, the total assets of the consolidated VIEs were $8.2 million (2010: $14.0 million), mainly comprising cash and cash equivalents, accounts receivable, other receivable, fixed assets, and other long term assets. These balances are reflected in Company’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 without any restrictions. 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 $3.3 million as of December 31, 2011 (2010: $4.0 million). As all the consolidated VIEs are incorporated as limited liability companies under the PRC Company Law, creditors of the VIEs do not have recourse to the characteristicsgeneral credit of the Company for any of the liabilities of the consolidated VIEs. As of December 31, 2011, the total liabilities of the consolidated VIEs were $47.3 million (2010: $26.5 million), mainly comprising accounts payable of $24.0 million (2010: $15.7 million), tax payables of $1.0 million (2010: $2.1 million), other payables and other accrued liabilities of $9.3 million (2010: $2.7 million) and long term borrowings from the intra-group entities and related parties of $13.1 million (2010: $6.1 million). As of December 31, 2011, the total deficits of the consolidated VIEs were $39.2 million (2010: $12.5 million).
For the year ended December 31, 2011, the total net revenue and net loss of the consolidated VIEs were $18.8 million and $25.0 million respectively. For the year ended December 31, 2010, the total net revenue and net loss of the consolidated VIE were $41.6 million and $8.0 million respectively. For the year ended December 31, 2009, the total net revenue and net loss of the consolidated VIE were $1.0 million and $6.3 million, respectively.
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 controlling financial interest or do not have sufficient equity at riskloss.
Please refer to “Contingencies” under Note 20 for the entityrisks relating to finance its activities without additional subordinated financial support from other parties.
(4) Significant risks and uncertainties
The Company participates in industries with rapid changes in regulations,a dynamic high technology trends, customer demand and competitionindustry and believes that changes in any of the following areas could have a material adverse effect on the Company’s future financial position, results of operations or cash flows: i) changes in the overall demand for entertainment-oriented wireless value-added services;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 keybandwidth suppliers; changes in certain strategic relationships or customer relationships;vi) relying on Shengyue as the primary advertisement agency; vii) regulatory or other factors; risks associated with the ability to maintain strategic relationships with the telecommunication operators; risks associated with attractingconsiderations; viii) copyright regulations; and retaining music artists, accessing songs and songwriters, and managing the Company’s new music businesses; andix) risks associated with the Company’s ability to attract and retain otheremployees necessary employees to support its growth
(5) Fair value
The Company adoptedfollows Accounting StandardStandards Codification (“ASC”) Topic 820 “Fair value measurementsValue Measurements and disclosures” (formerly referred to as the Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”)) on January 1, 2008.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.
F-11
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 the management’s judgments about the assumptions that market participants would use in pricing the asset. The managementassets or liabilities. Management develops these inputs based on the best information available, including their own data.
(6) Business combinations and non-controlling interests
The Company accounts for its 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 the Company acquired based on their estimated fair values.
The Company adoptedfollows ASC Topic 805 (formerly referredwith respect to as SFAS No. 141 (revised 2007), “Business combinations”). Following this adoption,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 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 interestinterest(s) in the acquiree over (ii) the fair value of the identifiable net assets of the acquiree is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognized directly in the income statement.
The determination and allocation of fair values to the identifiable assets acquired and liabilities assumed is based on various assumptions and valuation methodologies requiring considerable management judgment. The most significant variables in these valuations are discount rates, terminal values, the number of years on which to base the cash flow projections, as well as the assumptions and estimates used to determine the cash inflows and outflows. The Company determines discount rates to be used based on the risk inherent in the related activity’s current business model and industry comparisons. Terminal values are based on the expected life of assets and forecasted life cycle and forecasted cash flows over that period. Although the Company believes that the assumptions applied in the determination are reasonable based on information available at the date of acquisition, actual results may differ from the forecasted amounts and the difference could be material.
The Company follows guidance on non-controlling interests, previously issued as SFAS No. 160, “Non-controlling interests in Consolidated Financial Statements — an amendment of ARB No. 51”, now codified in ASC Topic 810, Consolidation, the Company also renamed minority“Consolidation,” regarding non-controlling interests. Non-controlling interests to non-controlling interests and reclassified it on the consolidated balance sheet from the mezzanine section between liabilities and equity toare classified as a separate line item incomponent within equity except for theany redeemable securities that are subject to the guidance in ASC Topic 268 (formerly referred to as EITF Topic D-98, “Classification and Measurement of Redeemable Securities”). The Company also expanded disclosures in the consolidated financial statements to clearly identify and distinguish the interests of the Company from the interests of the non-controlling owners of its subsidiaries.regarding redeemable securities. Consolidated net income on a total enterprise basis is adjusted to includewithin the statement of operations and comprehensive loss for net income attributed to the non-controlling interestinterests and consolidated comprehensive income is adjusted to includefor comprehensive income attributed to the non-controlling interest. The Company has applied the presentation and disclosure requirements retrospectively for all periods presented.
interests.
F-12
The functional currency and reporting currency of the Companyparent company is the United States dollar (“U.S. dollar”). The Company’s subsidiaries and VIEs with the exception of its subsidiaries of Seed Music Co., Ltd and Profita Publishing Limited, use Renminbi (“RMB”) as their functional currency. From January 1, 2009, the Company consolidated Seed Music into its consolidated financial statements upon consummation of the acquisition. Seed Music Co., Ltd and Profita Publishing Limited, the subsidiaries of Seed Music, mainly operate in Taiwan and use Taiwan dollar (“TWD”) as their functional currency.
Assets and liabilities of the Company’s 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 USD. Gains and lossesTranslation 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 RMBthe Company’s or TWDits subsidiaries’ or VIEs’ functional currencies are translated into the functional currencies at the exchange rates quoted by the People’s Bank of China or the Central Bank of the Republic of China (Taiwan) 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 income.loss. Monetary assets and liabilities denominated in foreign currencies are translated into the functional currencies using the applicable exchange rates quoted by the People’s Bank of China or the Central Bank of the Republic of China (Taiwan) at the balance sheet dates. All such exchange gains and losses are included in the statements of operations and comprehensive income.
Pursuant to the Company incurred lossesPeople’s Republic of $8,990,067 followingChina State Administration of Foreign Exchange (“SAFE”), the conversion into Eurosof United States dollars to Renminbi is governed as to amount and subsequenta uniform exchange rate is set by the People’s Bank of China on a daily basis pegged to a basket of major currencies. Correspondingly, Renminbi to USD conversion back into U.S dollars of a significant portion ofdoes not carry the Company’s U.S dollar deposits arising from the high volatility in the currency markets.
(8) 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 the cash and cash equivalents are cash balances denominated in Renminbi (“RMB”) of approximately RMB137,735,942 and RMB34,714,100 (equivalent to approximately $21,884,037 and $5,259,707) as of December 31, 2011 and 2010, respectively.
(9) Short-term investments
Restricted cash mainly represents cash that is pledged for the loan borrowed from a PRC bank with original maturities longer than three months(Note 11), and less than one year.
(10) Allowances for doubtful accounts
The Company determines the allowance for doubtful accounts when facts and circumstances indicate that the receivable is unlikely to be collected by taking into account of an aging analysis of the accounts receivable balances, historical bad debt records, repayment patterns in the prior year, and other factors such as the policies of operators.
(11) Inventories
Inventories represent music compact discs (“CDs”) and related music products and are stated at the lower of cost, determined using the first-in, first-out method, or market price. The Group providesCompany provided an estimated inventory allowance for excessive,excess, slow moving andand/or obsolete inventories, as well as inventory whose carrying value is in excess of net realizable value.
F-13
Affiliated companies (partially owned affiliates) are entities over which the Company has significant influence, but which it does not control. Investments in affiliated companies are accounted for by the equity method of accounting. Under this method, the Company’s share of the post-acquisition profits or losses of affiliated companies is recognized in the consolidated statements of operations. Unrealized gains on transactions between the Company and its affiliated companies are eliminated to the extent of the Company’s interest in the affiliated companies; unrealized losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. When the Company’s share of losses in an affiliated company equals or exceeds its interest in the affiliated company, the Company does not recognize further losses, unless the Company has incurred obligations or made payments on behalf of the affiliated company.
The Company 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 Company considers in its determination are the length of time that the fair value of the investment is below the Company’s carrying value and the financial condition, operating performance and near term prospects of the investee. In addition, the Company 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 Company’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. Impairment losses amounting to $1.9 million was recorded inThere were no impairments of such investments during the three year period ended December 31, 2008 (Note 8).
(13) 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:
Furniture and office equipment | 3 years | |||
Telecommunications equipment | 3 years | |||
Leasehold improvements | Lesser of original lease term or estimated useful life | |||
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.
(14) 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 (formerly referred to as SFAS No. 141 (revised 2007), “Business combinations”, (“SFAS No. 141(R)”)). Acquired intangible assets consistsconsist of intangible assets, as detailed in Note 7, acquired through direct purchases and various business acquisitions and are amortized on a straight-line basis over their estimated useful economic lives.
The estimated useful economic lives by major intangible asset category used by the Company are as follows.
Trademark | 20 years | |||
Technology | 7 years | |||
Customer List | 5 years | |||
Software technology | 5 years |
(15) Video production and acquisition costs and licensed video copyrights
The Company contracts third parties for the production of, self produces and self-generates video copyrights for content to exhibit on its websites, and also licenses copyrights from other parties for content distribution on its websites ku6.com.
Video production and acquisition costs
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, the Company has established capitalization criteria whereby until the Company can establish estimates of market revenues associated with a video, capitalized costs for each video produced are limited to the amount of revenues specifically contracted for that video. Revenues contracted for a video consist of advertising revenues specifically associated with particular videos. 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 Company 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 Company 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, 2011, video production and acquisition costs did not meet the criteria for capitalization (defined in the second paragraph above regarding capitalization limited to the amount of revenues contracted for a video) and as a result all the video production costs were expensed as incurred.
Licensed video copyrights
The licensed video copyrights are amortized over their respective licensing periods, which range from 1 to 3 years for all periods presented.
The licensed video copyrights are carried at the lower of amortized cost or net realizable value. Under the net realizable value approach, the Company determines the expected cash inflows that are directly attributed to the content category which comprise of the expected revenues directly attributable to the content category less the direct costs to deliver the content to derive the net realizable value of the asset. The Company writes down the carrying value of the licensed content if the estimated net future direct cash inflows from the licensed video copyrights over the licensing period are lower than the carrying amount.
Amortization and write-down expenses for the year ended December 31, 2011 were $2,200,535 (2010: $8,012,252) and $1,521,161 (2010: $7,739,562), respectively.
(16) 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 Company’s acquisitions.
F-14
An impairment provisionsprovision relating to goodwill amounting to approximately $38.8 million, $2.7 million and $3.6 million werewas recognized in discontinued operations (Note 2(1)) in the year ended December 31, 2007, 20082009. No goodwill impairment was recognized in the years ended December 31, 2010 and 2009, respectively.
(17) Impairment of long-lived assets
The Company reviews its long-lived 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 Company 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 flowflows is less than the carrying amount of the assets, the Company would recognize an impairment loss based on the fair value of the assets. The Company 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. As discussed in Note 7,An impairment provisionsprovision relating to intangible assets amounting to approximately $2.5 million and $2.9 million and $3.5 million werewas recognized in the year ended December 31, 2007, 2008 and 2009, respectively.
(18) Financial instruments
Financial instruments include cash and cash equivalents, short term investments, accounts receivable, prepayments and other current assets, amountamounts due from/to related parties, accounts payable and accrued expenses and other current liabilities. As of December 31, 20082010 and 2009,2011, their carrying values approximated their fair values because of their generally short maturities. There arewere no other financial assets or liabilities that are being measured at fair value at December 31, 20092010 or December 31, 2011, except for the contingent consideration in relation to the acquisition of Seed Music (Note 3), in January 2009 which iswas disposed of in full along with contingent consideration obligations in August 2010 (Note 2(1)). This contingent consideration was recorded at fair value and was classified within Level 3 of the fair value hierarchy.
(19) Revenue recognition and cost of revenues
In accordance with ASC Topic 605, Revenue Recognition, the Company recognizes revenues when the following criteria are met: persuasive evidence of an arrangement exists, the sales price is fixed or determinable, delivery has occurred and collectability is reasonably assured. Revenues are recorded net of sales taxes.
Online advertising services (post-2010 Reorganization business model)
The Company’s revenues are derived principally from online advertising services, where the advertisers (including third parties and related parties) pay to place their advertisements on the Company’s online video platform in different formats. Such formats include but are not limited to banners, buttons, links, pre-roll or post-roll video advertisements.
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 time.
Under the arrangements with advertisers where the advertisement placement includes different formats to be delivered over different periods of time, the Company’s revenue is accounted for using the guidance under ASC 605-25 “Multiple Element Arrangements” as such revenue arrangements involve multiple deliverables to the advertisers. The Company sells the advertising services over a broad price range. The Company uses its best estimate of the selling price of each component of bundled advertising arrangements for separate units of accounting.
Under the arrangement with the related party advertising agency (Note 1 & 13), components of the arrangement include an arrangement for guaranteed advertising revenue and an arrangement for sharing of excess advertising revenues after deducting commission fees earned by the related party advertising agency based upon increasing percentages for additional tiers (layers) of revenue. The guaranteed advertising revenues are recognized ratably over varying service periods as governed by the specific agreements with the affiliated advertising agency. Further, any excess advertising revenues realized from these arrangements, which are not subject to any refundability or contingency provisions from the Company to the affiliated advertising agency, would be recognized ratably over the remaining service periods when a reliable estimate of excess revenues above the minimum guarantee is established. The Company 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.
The Company makes credit assessments of customers to assess the collectability of contract amounts prior to entering into contracts. For those contracts for which collectability is assessed as not reasonably assured, the Company recognizes revenue only when cash is received and all revenue recognition criteria are met.
For revenue arrangements contracted with third-party advertising agencies, the Company 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, 2010 and 2011 were $5,440,054 and $1,374,030, respectively.
Costs of advertising revenues consist primarily of employee costs associated with platform operations and share based compensation, depreciation expense, internet bandwidth leasing costs, video production costs, and amortization and write-down of licensed video copyrights.
Wireless value-added services (pre-2010 Reorganization—discontinued operations (Note 2(1)
Wireless value-added service revenues arewere derived from providing personalized media, games, entertainment and communication services to mobile phone and personal handy phone (collectively “mobile phones”) customers of the various subsidiaries of the three major Chinese operators of telecommunication networks, China United Telecommunications Corporation (“China Unicom”), China Mobile Communications Corporation (“China Mobile”) and China Telecommunications Corporation (collectively, the “Telecom Operators”). Fees for these services, negotiated by a network service agreementagreements with the Telecom Operators and indicated in the messagemessages received on the mobile phone, arephones, were charged on a per-use basis or on a monthly subscription basis, and varyvaried according to the type of services delivered.
The Company contractscontracted with the Telecom Operators for the transmission of wireless services as well as for billing and collection services. The Telecom Operators provideprovided the Company with a monthly statementstatements that representsrepresented the principal evidence that service hashad been delivered and triggerstriggered revenue recognition for a substantial portion of the Company’s revenue. In certain instances, when a statement iswas not received within a reasonable period of time, the Company makesmade an estimate of the revenues and cost of services earned during the period covered by the statement based on its internally generated information, historical experience and/or other assumptions that arewere believed to be reasonable under the circumstances.
F-15
The Company evaluatesevaluated its cooperation arrangements with the Telecom Operators to determine whether to recognize the Company’s revenues on a gross basis or net of the service fees and net transmission charges paid to the Telecom Operators. The Company’s determination iswas based upon an assessment of whether it actsacted as a principal or agent when providing its services. The Company has concluded that it actsacted as a principal in each of the arrangement.arrangements. Factors that support the Company’s conclusion mainly include:
the Company iswas the primary obligor in the arrangement;
the Company iswas able to establish prices within price caps prescribed by the telecommunications operators to reflect or react to changes in the market;
the Company determined the service specifications of the services it will be rendering;
the Company was able to control the selection of its content suppliers; and
The Telecom Operators usually willwould not pay the Company if users cannotcould not be billed or if users dodid not pay the Telecom Operators for services delivered and, as a result, the Company bearsbore the delivery and billing risks for the revenues generated with respect to its services.
Based on these factors, the Company believesbelieved that recognizing revenues on a gross basis iswas appropriate. However, as noted above, the Company’s reported revenues arewere net of bad debt charges that havehad been deducted by the Telecom Operators.
Recorded Music (pre-2010 Reorganization—discontinued operations (Note 2(1)
The Company iswas in the business of artist development, music production, offline music distribution, and online distribution through wireless value-added servicesWVAS and the Internet. Recorded music revenues arewere derived from live performances, corporate sponsorship and advertising, online and wireless sales, and offline CD sales
The Company generatesgenerated revenues from the sale of CDs either by providing the CD master to a distributor or by directly arranging for the volume production and subsequent wholesale of the CDs. In the former case, the Company receivesreceived a fixed fee, hashad no further obligations and recognizesrecognized the fee as revenue when the master CD iswas provided. In the latter case, the Company shipsshipped the produced CDs to retail distributors and recognizesrecognized wholesale revenues at the time of shipment less a provision for future estimated returns.
The Company recognizesrecognized artist performance fees and corporate sponsorship or marketing event fees once the performance or the service hashad been completed. In accordance with the relevant accounting standards for revenue recognition, corporate sponsorship arrangements involving multiple deliverables are broken into single-element arrangements using residual method for revenue recognition purpose. The Company recognizesrecognized revenue on the service elements delivered and defersdeferred the recognition of revenue for larger of the contractual cash holdback or the fair value of the undelivered service elements until the remaining obligations havehad been satisfied. The Company determinesdetermined the fair value of undelivered service elements based on the price charged for the similar performance or marketing events on a standalone basis. Where the Company actsacted as the primary obligor in the transaction, revenues arewere recorded on a gross basis. Where the Company iswas considered an agent or where the artists separately contract with the event organizer, revenues arewere recorded on a net basis.
The Company licenseslicensed its music to third parties for guaranteed minimum royalty payments and normally receivesreceived non-refundable upfront licensing fees. In such cases the Company recognizesrecognized revenue on a straight-line basis over the license period and unrecognized revenues arewere included in liabilities. When the contract providesprovided for additional payments if revenues exceed the minimum amount guaranteed, such amounts arewere included in revenues when the Company iswas notified of its entitlement to additional payments.
F-16
Business tax and related surcharges
The Group’sCompany’s subsidiaries and its VIE subsidiariesVIEs are subject to business tax and related surcharges and value addedvalue-added tax on the revenues earned for services provided and products sold in the PRC. The applicable business tax rate varies from 3% to 5% for the WVAS and recorded music services except for the offline CD distribution and the rate of value added tax is 13% on revenues from offline CD distribution. The applicable business tax rate for advertising business is 5% based on the gross advertising revenue before deducting the advertising agencies rebate. In the accompanying consolidated statements of operations, and comprehensive income, business tax and related surcharges for revenues derived from wireless value-added servicesWVAS and recorded music revenues and advertising revenues are deducted from gross revenues to arrive at net revenues when incurred.
(20) Product development expenses
Product development expenses consist primarily of contentsalaries and benefits for product development expensespersonnel, including share-based compensation and related costs for employees associated with the development and programming of mobile data content related to WVAS business.costs. These costs are expensed as incurred until technological feasibility has been established, at which time any additional costs would be capitalized. To date, the Company has essentially completed its development concurrently with the establishment of technological feasibility, and, accordingly, no costs have been capitalized.
(21) General and administrative expenses
General and administrative expenses consist primarily of salary and benefits for general management, finance and administrative personnel, bad debt provision, litigation accrual, depreciation, amortization and impairment of intangible assets, professional service fees, share-based compensation, office rental fees, and other expenses.
(22) Sales and marketing expenses
Sales and marketing costsexpenses consist primarily of salariessales and benefits, share-basedmarketing personnel payroll compensation and related employee costs, advertising and market promotion expenses, and other overhead expenses incurred by the Company’s sales and marketing personnel.
(23) Advertising costs
The Company expenses advertising costs as incurred. Total advertising expenses were $5,269,550, $5,895,995$4,191,045 and $4,191,045$210,987 for the years ended December 31, 2007, 20082009 and 2009,2010 pertaining to discontinued operations, respectively, and have been included in selling and marketing expenses and cost of revenues.
(24) Stock-based compensation
The Company adoptedapplies ASC Topic 718, “Stock Compensation” (formerly referred to as Statement of Financial Accounting Standard 123(R) (“SFAS 123(R)”), 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 periodperiods of the awardawards based on the fair valuevalues of the awardawards determined at the grant date. The valuation provisions of ASC 718 apply to new 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. Under ASC 718 the number of share-based awards for which the service is not expectedrequires forfeitures to be rendered forestimated at the requisite period should be estimated,time of grant and the related compensation cost not recorded for that number of awards.
revised, if necessary, in subsequent period(s) if actual forfeitures differ from initial estimates.
F-17
(25) 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 Topic 840, “Leases,” are accounted for as capital leases. Payments made under operating leases, net of any incentives received by the Company from the leasing company, are charged to the consolidated statementsstatement of operations and comprehensive incomeloss on a straight-line basis over the lease periods, as specified in the lease agreements, with reference to the actual number of users of the leased assets, as appropriate.
(26) 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 Topic 740, (formerly referred to as SFAS No. 109, “Income Taxes”).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 (formerly referred to as Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109”) prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax positionpositions taken or expected to be taken in a tax return. The Company’s 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. The Company did not incur any interest or penalties related to potential underpaid income tax expenses, and also does not expect to have a significant increase or decrease in theany liabilities for unrecognized tax benefits within 12 months fromas of December 31, 2009.
(27) Statutory reserves
The Company’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 Company’s subsidiaries must make appropriations to (i) general reserve and (ii) 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 was mainly used to expand the production and operation; it also may be used for increasing the registered capital.
Appropriations to these funds are classified in the consolidated balance sheets as statutory reserves. During the year ended December 31, 2007, the Company made total appropriations to the statutory reserves of approximately $0.8 million. No appropriations were made during the yearyears ended December 31, 20082009, 2010 and 2009.2011. There are no legal requirements in the PRC to fund these reserves by transfer of cash to restricted accounts, and the Company does not do so.
F-18
In the normal course of business, the Company 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 20.
Basic net (loss) earningsloss attributable to Hurray!the Company’s ordinary shareholders’shareholders per share is computed by dividing net (loss) incomeloss attributable to Hurray!the Company’s ordinary shareholders by the weighted average number of ordinary shares outstanding during the year. Diluted net (loss) earningsloss attributable to Hurray!the Company’s ordinary shareholders’ per share is computed using the weighted average number of ordinary shares and, if dilutive, potential ordinary shares outstanding during the year. Potential ordinary shares consist of shares issuable upon the conversion of convertible debt (using the “if-converted method”) and upon the exercise of stock options for the purchase of ordinary shares and the settlement of restricted share units and are accounted for using(using the treasury“treasury stock method.method”). Potential ordinary shares are not included in the denominator of the diluted earningsloss per share calculation when inclusion of such shares would be anti-dilutive.
For each of the three years in the period ended December 31, 2011, the dilutive effect of potential ordinary shares was not factored into the calculation of diluted earnings per share as a consolidated net loss was incurred in each period.
(30) Comprehensive income (loss)
Comprehensive income (loss)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 adjustment.
(31) Recent accounting pronouncements
In May 2011, the FASB issued ASC320 (formerly referredAccounting Standards Update 2011-04, “Fair Value Measurement: Amendments to as FSP No. 115-2Achieve Common Fair Value Measurement and FSP 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments”), which amends the other-than-temporary impairment guidanceDisclosure Requirements in U.S. GAAP and IFRSs.” Key provisions of the amendments in ASU 2011-04 include: (1) a prohibition on grouping financial instruments for debt securities to makepurposes of determining fair value, except in limited cases; (2) an extension of the guidance more operational and to improveprohibition against the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. The ASC320 does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. The adoption of ASC320 has no material effect on the Company’s consolidated results of operations and financial condition.
In June 2011 the FASB issued Accounting Standards Update 2011-05, “Comprehensive Income: Presentation of Comprehensive Income”. The amendment requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance is effective retrospectively for interim periods and annual periods beginning after December 15, 2009,2011. While the Company will be subject to the guidance in accordance with the transition provisions, there will be no changes as a result of adoption as the Company already reports items of comprehensive income (loss) in a continuous statement of operations and comprehensive loss for all periods and plans to do so prospectively. Further, the component of the issued standard regarding detailed presentation reclassifications from other comprehensive income to net income has been subject to indefinite deferral by the FASB.
In September 2011, the FASB issued Accounting Standards Update 2011-08, “Testing Goodwill for Impairment” (ASU 2011-08). Under the revised guidance, entities testing for goodwill impairment have an option of performing a qualitative assessment before calculating the fair value for the reporting unit, (i.e., Step 1 of the traditional goodwill impairment test). If an entity determines, on a basis of qualitative factors, that the fair value of the reporting unit is more likely than not less than the carrying amount, the first step of the two-step impairment test would be required. If it is not more likely than not that the fair value of the reporting unit is less than the carrying value, then goodwill is not considered to be impaired. ASU 2011-08 does not change how goodwill is calculated or assigned to reporting units, nor does it revise the requirement to test goodwill at least annually for impairment. This ASU is effective for interim and annual periods beginning after December 15, 2011 with early adoption permittedpermitted. The Company early-adopted this guidance for periods ending after March 15, 2009 and shall be applied prospectively.its annual goodwill impairment test performed as of December 31, 2011. The early adoption of ASC820-10-65-4 hasthis guidance did not change, nor would it be expected to change, the conclusions reached in the impairment evaluation for goodwill, which is further described in the Goodwill footnote to the financial statements.
(32) Government Subsidies
Government subsidies represent discretionary cash subsidies granted by the local government to encourage the development of certain enterprises that are established in the local special economic region. The cash subsidies may be received in the form of (i) a fixed cash amount determined and provided by the 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 material effectdefined rules and regulations to govern the criteria necessary for companies to enjoy the benefits and are recognized as other income when received.
For the years ended December 31, 2009, 2010 and 2011, cash subsidies of $1,783, $58,025 and $1,265,182 were recognized as other income, respectively.
(33) Segment reporting
Based on the Company’s financial statements.
3. BUSINESS COMBINATIONS
(a) 2010 acquisition
On January 18, 2010, the FASBCompany completed the acquisition of Ku6 and its subsidiaries and VIEs, a leading online video portal in China, pursuant to the share purchase agreement entered into by and among Hurray!, Ku6 and the shareholders of Ku6 dated as of November 26, 2009 by issuing an aggregate of 723,684,204 ordinary shares, of which 44,438,100 replaced the options issued ASU 2010-09 which updates ASC 855by Ku6 and removesimmediately vested without substantive future service requirements. After the requirement to disclosecompletion of this acquisition, the date through which an entity has evaluated subsequent events. ASU 2010-09 became effective immediately.Company owned 100% of the equity interests of Ku6 and its subsidiaries and VIEs. The adoptiontotal fair value of ASC 855 did not have a material impactthe shares issued approximated $28.9 million based on the Company’s financial statements.
F-19
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition and the purchase price allocation.
Total purchase price: | ||||
Ordinary shares issued to acquired all of the outstanding shares of Ku6 | 27,101,920 | |||
Ordinary shares issued to replace the options issued by Ku6 | 1,773,080 | |||
Share based compensation related to post combination portion | (1,284,766 | ) | ||
| 27,590,234 | ||||
| Amortization period | ||||||||
Aggregate purchase price allocation –Ku6: | ||||||||
Cash and cash equivalents | 329,743 | |||||||
Accounts receivable | 3,264,513 | |||||||
Other current assets | 811,845 | |||||||
Acquired intangible assets: | ||||||||
Trademark | 24,901,940 | 20 years | ||||||
Software technology | 2,197,230 | 7 years | ||||||
Customer base | 1,464,820 | 5 years | ||||||
Non-current deferred tax liability | (4,826,059 | ) | ||||||
Goodwill | 6,232,770 | |||||||
Property and equipment, net | 3,652,599 | |||||||
Other non-current assets | 937,485 | |||||||
Current liabilities | (11,376,652 | ) | ||||||
Total | 27,590,234 | |||||||
Total identifiable intangible assets acquired upon consolidation mainly included trademark(s), software technology, and customer base, which have a weighted average amortization period of 18.2 years.
Goodwill primarily represented the expected synergies from combining operations of the Company and Ku6, which are complementary in a way to each other, and any other intangible benefits that are presented in conformity with generally accepted accounting principlesdo not qualify for separate recognition. Such goodwill is not deductible for tax purposes. The fair value of intangible assets was measured primarily by the income approach taking into consideration historical financial performance and estimates of future performance of Ku6’s business.
Ku6 is subject to claims and litigation which may arise in the United States. This Statement is effectivenormal course of business. As of and subsequent to the acquisition date on January 18, 2010, Ku6 was involved in a number of cases in various courts and arbitrations. These cases are substantially related to alleged copyright infringement arising before the acquisition. Accordingly, liabilities from contingencies assumed of $1,631,359 in relation to those cases have been recognized in the current liabilities upon acquisition. The compensation amount was based on judgments handed down by the court and out-of-court settlements or management’s best estimation based on the historical actual compensation amount in recent years and the advice from PRC counsel. There are no accruals for any additional losses related to unasserted claims as there was no manifestation of claims and the amount cannot be reasonably estimated.
The Company completed its acquisition of Ku6 on January 18, 2010 and began to consolidate the financial statements of Ku6 upon unilateral control from February 1, 2010. The amount of Ku6’s consolidated revenue and net loss for the reporting period ending on September 30, 2009. Beginning witheleven months ended December 31, 2010 included in the third fiscal quarterstatements of 2009,operations and comprehensive loss was $14,101,171 and $45,165,985.
The following unaudited pro forma consolidated financial information reflects the references made to U.S. GAAP use the new Codification numbering system prescribed by the FASB. As the Codification is not intended to change or alter existing U.S. GAAP, the Company does not expect ASC 105 to have any impact on the Company’s consolidated results of operations for the years ended December 31, 2009 and 2010, as if the acquisition of Ku6 had occurred as of January 1, 2009 and after giving effect to purchase accounting adjustments primarily relating to the amortization of intangibles. The following pro forma financial condition.
| Year Ended December 31, 2009 | Year Ended December 31, 2010 | |||||||
| (unaudited) | (unaudited) | |||||||
Net revenues | 7,261,708 | 16,787,493 | ||||||
Net loss attributable to Ku6 Media Co., Ltd. | (35,258,520 | ) | (56,033,640 | ) | ||||
Loss per ADS- Basic and Diluted: | (1.61 | ) | (1.81 | ) | ||||
The pro forma net losses for the years ended December 31, 2009 and 2010 include $1,851,951 and $1,851,951, respectively, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. The Company does not expect ASC860 to have any impact on the Company’s consolidated resultsamortization of operations and financial condition.
(b) 2009 for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited. The Company is currently evaluating the impact of the adoption of ASC 810 on its financial statements and does not expect a significant impact.
Acquisition of Seed Music Group Limited (disposed in August 2010 and presented in discontinued operations (Note 2(1))
In September 2008, the Company entered into a definitive agreement to acquire, through Hurray! Media Co., Ltd, a controlling stake in Seed Music Group Limited (“Seed Music”) and its subsidiaries including Seed Music Co., Ltd., Profita Publishing Limited and Leguan Seed (Beijing) Culture Consulting Co., Ltd. (collectively referred to as “Seed Music Group”), a Taiwan based company that focuses on artist development, music production and offline music distribution in Asia Pacific, especially in China. The Company paid an advance of $1,907,400 to the selling shareholders to acquire an approximately 47.58% equity interest of Seed Music in 2008 and such payment was recorded as prepaid acquisition cost as of December 31, 2008 as this transaction had not closed as of that date. Concurrent with this transaction, the Company subscribed for an additional 7,813 shares, representing a 13.5% ownership interest, from Seed Music for $600,038 in 2008, which was recorded as an investment at cost at December 31, 2008, as that portion of the transaction had been consummated by that date. The acquisition of the 47.58% equity interest was completed and the Company began to consolidate Seed Music on January 1, 2009. The Company’s total ownership in Seed Music iswas 61.08% after the closing of the acquisition and subscription of Seed Music shares.
F-20
The non-controlling shareholders havehad options to sell their shares to the Company at a price based on a formula which includesincluded Seed Music’s operating performance. Therefore, from the date of consolidation to the derecognition on disposal, the non-controlling interests arewere presented as redeemable non-controlling interests on the balance sheet and such amount will beamounts were accreted to the redemption value if the redemption iswas probable. Since the operating performance of Seed Music did not meet the specified target, the Company considered the redemption iswas not probable. In addition, the non-controlling shareholders have granted call options to the Company to subscribe for all or part of their remaining shares in Seed Music. The embedded put and call options arewere not derivatives that requirerequired bifurcation as separate financial instruments and arewere accounted for together with the non-controlling interest.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The purchase price allocation has beenwas finalized.
Total purchase price: | ||||
Cash consideration | 2,507,438 | |||
Contingent consideration (Note 10) | 352,217 | |||
Fair value of redeemable non-controlling interests | 1,569,808 | |||
| 4,429,463 | ||||
| Amortization period | ||||||||||
Aggregate purchase price allocation | ||||||||||
Cash and cash equivalents | 1,034,308 | |||||||||
Inventory | 53,504 | |||||||||
Other current assets | 891,723 | |||||||||
Acquired intangible assets: | ||||||||||
Artist contracts | 1,717,846 | 7.1~9.0 years | ||||||||
Trademarks | 1,569,808 | 20 years | ||||||||
Non-compete agreement | 183,218 | 4.5 years | ||||||||
Copyrights | 5,863 | 0.4 years | ||||||||
Non-current deferred tax liability | (869,184 | ) | ||||||||
Goodwill (allocated to music segment) | 2,535,523 | |||||||||
Property and equipment, net | 50,084 | |||||||||
Other non-current assets | 51,526 | |||||||||
Current liabilities | (2,216,292 | ) | ||||||||
Other non-current liabilities | (578,464 | ) | ||||||||
Total | 4,429,463 | |||||||||
Goodwill primarily representsrepresented the expected synergies from combining operations of the Company and Seed Music, which arewere complementary in a way to each other, and any other intangible benefits that would accrue to the Company that dodid not qualify for separate recognition. Such goodwill iswas not deductible for tax purposes. The fair value of intangible assets was measured primarily by the income approach taking into consideration of the historical financial performance and estimates of future performance of Seed Music’s business.
The fair value of redeemable non-controlling interests has beenwas determined using the income approach including discounted cash flow modelmodeling and unobservable inputs including assumptions of projected revenue, expenses, capital spending, other costs and a discount rate with regards to the non-controlling discount in recent share transactions made at armsarm’s length close to the acquisition date, taking into consideration other factors, as appropriate. The net fair value of the embedded call and put options was not material.
F-21
4. DISCONTINUED OPERATIONS
Disposal of WVAS and recorded music businesses (2010 Reorganization)
In May 2010, the beginningCompany disposed of Huayi Music to Huayi Media for RMB 34,450,000 (equivalent to $5,045,754) in cash and in August 2010, the year, management believes the presentationCompany disposed all of the pro forma financial information with regardits WVAS and remaining recorded music businesses to aShanda for $37,243,904 in cash. See Note 2(1).
A summary of the results ofmajor financial information for the discontinued operations of Seed Music GroupWVAS and recorded music businesses as of August 31, 2010 and for the year ended December 31, 2009 and eight months ended August 31, 2010 is not necessary. The following unaudited pro forma consolidated financial information reflects the results of operations for the years ended December 31, 2008, respectively, as if the acquisitions of Seed Music had occurred as of January 1, 2008, and after giving effect to purchase accounting adjustments. The following pro forma financial information has been prepared for comparative purpose only and is not necessarily indicative of the results that would have been had the acquisitions been completed at the beginning of the period presented, nor is it indicative of future operating results:
Current assets: | ||||
Cash | ||||
F-22
F-23
| Accounts receivable, net of allowance | ||||
Prepaid expenses and other current assets | ||||
Non-current assets: | ||||
Property and equipment, net | ||||
Intangible assets | 766,847 | |||
Goodwill | ||||
Other non-current assets | 300,532 | |||
| 4,009,458 | ||||
Current liabilities: | ||||
Accounts payable | 4,337,542 | |||
Accrued expenses and other current liabilities | ||||
Non-current liabilities: | ||||
Non-current deferred tax liabilities | 186,528 | |||
Other non-current liabilities | ||||
| 198,850 | ||||
Non-controlling interests and redeemable non-controlling interests: | 1,717,533 | |||
| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2007 | December 31, 2008 | December 31, 2009 | ||||||||||
| (in U.S. dollars) | ||||||||||||
| Revenues | 227,391 | — | — | |||||||||
| Operating loss | (643,151 | ) | — | — | ||||||||
| Income taxes | 178 | — | — | |||||||||
| Net loss from discontinued operations, net of tax | (612,170 | ) | — | — | ||||||||
| Gain from disposal of SSI | 192,943 | 412,530 | 221,899 | |||||||||
| Total net (loss) income from discontinued operations | (419,227 | ) | 412,530 | 221,899 | ||||||||
Year ended December 31, 2009 Total net revenues Loss from operations Income tax benefit (expense) Net loss Less: Net loss attributable to the non-controlling interests and redeemable non-controlling interests Net loss from discontinued operations, net of tax Gain from disposal of Huayi Music, net of tax Total net (loss) income from discontinued operations Eight months ended
August 31, 2010 34,642,295 14,844,408 (21,054,774 ) (3,460,316 ) (234,286 ) 25,584 (21,778,174 ) (3,382,438 ) 4,182,875 243,666 (17,595,299 ) (3,138,772 ) — 4,486,786 (17,595,299 ) 1,348,014
5. PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consist of:
| December 31, 2008 | December 31, 2009 | |||||||
| (in U.S. dollars) | ||||||||
| Staff advances and other receivables | 1,174,104 | 350,097 | ||||||
| Advances to suppliers | 1,492,019 | 681,670 | ||||||
| Prepaid expenses | 1,406,157 | 397,024 | ||||||
| Prepaid artist costs | 98,043 | 405,570 | ||||||
| 4,170,323 | 1,834,361 | |||||||
| December 31, 2010 | December 31, 2011 | |||||||
Prepaid expenses | 282,290 | 431,560 | ||||||
Advances to suppliers | 454,273 | 242,932 | ||||||
Staff advances and other receivables | 1,028,156 | 209,852 | ||||||
Prepaid licensing fee of video copyright | 1,722,608 | — | ||||||
|
|
|
| |||||
| 3,487,327 | 884,344 | |||||||
|
|
|
| |||||
F-24
Property and equipment, net, consistconsists of:
| December 31, 2008 | December 31, 2009 | |||||||
| (in U.S. dollars) | ||||||||
| Furniture and office equipment | 3,066,923 | 3,271,481 | ||||||
| Motor vehicles | 290,335 | 336,778 | ||||||
| Telecommunications equipment | 4,556,290 | 3,067,601 | ||||||
| Leasehold improvements | 663,307 | 611,011 | ||||||
| 8,576,855 | 7,286,871 | |||||||
| Less: accumulated depreciation and amortization | (7,596,795 | ) | (6,407,096 | ) | ||||
| 980,060 | 879,775 | |||||||
| December 31, 2010 | December 31, 2011 | |||||||
Furniture and office equipment | 1,208,434 | 1,055,377 | ||||||
Telecommunications equipment | 10,627,167 | 3,450,208 | ||||||
Leasehold improvements | 1,368,677 | 1,230,327 | ||||||
|
|
|
| |||||
| 13,204,278 | 5,735,912 | |||||||
Less: accumulated depreciation and amortization | (5,200,804 | ) | (2,143,167 | ) | ||||
|
|
|
| |||||
| 8,003,474 | 3,592,745 | |||||||
|
|
|
| |||||
Depreciation expense for the years ended December 31, 2007, 20082009, 2010 and 20092011 was $1,269,203, $990,072$881,633, $3,265,975, and $837,292$3,409,647 respectively.
The Company acquired $2,428,694 in additional property, plant, and equipment in 2011 in support of business strategy changes.
Total equipment disposal loss in 2011 was $3,043,006 (zero proceeds less remaining net book value), which was mainly comprised of computers and servers in relation to technological upgrades and replacements following the Company’s business strategy adjustment. The Company has recorded the disposal loss in general and administrative expenses.
7. ACQUIRED INTANGIBLE ASSETS, NET
| December 31, 2009 | ||||||||||||||||
| Gross carrying | Accumulated | Intangible assets | Net carrying | |||||||||||||
| amount | amortization | impairment | amount | |||||||||||||
WVAS Segment: | ||||||||||||||||
Amortizable intangible assets | ||||||||||||||||
| WVAS licenses | 518,114 | 400,847 | 117,267 | — | ||||||||||||
| Customer agreements with Telecom Operators | 2,849,884 | 780,129 | 2,069,755 | — | ||||||||||||
| Non-compete agreements | 988,882 | 355,413 | 633,469 | — | ||||||||||||
| Business transaction codes | 196,897 | 164,081 | 32,816 | — | ||||||||||||
Platform(1) | 473,784 | 434,427 | 39,357 | — | ||||||||||||
| Software | 95,226 | 95,226 | — | — | ||||||||||||
| Trademarks | 174,336 | 9,685 | 164,651 | — | ||||||||||||
| 5,297,123 | 2,239,808 | 3,057,315 | — | |||||||||||||
Recorded Music Segment: | ||||||||||||||||
Amortizable intangible assets | ||||||||||||||||
Artist contracts(2) | 6,700,617 | 2,653,318 | 3,840,082 | 207,217 | ||||||||||||
| Copyrights | 698,055 | 552,944 | 145,111 | — | ||||||||||||
| Exclusive WVAS agreements | 584,873 | 66,925 | 478,590 | 39,358 | ||||||||||||
| Exclusive copyright agreements | 12,543 | 11,498 | 1,045 | — | ||||||||||||
| WVAS contracts | 249,845 | 249,845 | — | — | ||||||||||||
| Non-compete agreements | 318,724 | 38,102 | 211,135 | 69,487 | ||||||||||||
| Software | 6,431 | 4,431 | — | 2,000 | ||||||||||||
| Trademarks | 2,264,634 | 176,610 | 1,324,124 | 763,900 | ||||||||||||
| 10,835,722 | 3,753,673 | 6,000,087 | 1,081,962 | |||||||||||||
| 16,132,845 | 5,993,481 | 9,057,402 | 1,081,962 | |||||||||||||
F-25
| December 31, 2008 | ||||||||||||||||
| Gross carrying | Accumulated | Intangible assets | Net carrying | |||||||||||||
| amount | amortization | impairment | amount | |||||||||||||
WVAS Segment: | ||||||||||||||||
Amortizable intangible assets | ||||||||||||||||
| WVAS licenses | 514,765 | 397,440 | 117,325 | — | ||||||||||||
| Customer agreements with Telecom Operators | 2,851,304 | 780,518 | 2,070,786 | — | ||||||||||||
| Non-compete agreements | 989,375 | 355,590 | 633,785 | — | ||||||||||||
| Business transaction codes | 196,995 | 164,163 | 32,832 | — | ||||||||||||
Platform(1) | 474,020 | 434,643 | 39,377 | — | ||||||||||||
| Software | 95,273 | 95,273 | — | — | ||||||||||||
| Trademarks | 174,423 | 9,690 | 164,733 | — | ||||||||||||
| 5,296,155 | 2,237,317 | 3,058,838 | — | |||||||||||||
Recorded Music Segment: | ||||||||||||||||
Amortizable intangible assets | ||||||||||||||||
Artist contracts(2) | 4,917,694 | 1,938,859 | 1,739,848 | 1,238,987 | ||||||||||||
| Copyrights | 692,435 | 527,163 | 145,147 | 20,125 | ||||||||||||
| Exclusive WVAS agreements | 584,873 | 52,465 | 214,000 | 318,408 | ||||||||||||
| Exclusive copyright agreements | 12,543 | 11,497 | 1,046 | — | ||||||||||||
| VAS contracts | 249,845 | 249,845 | — | — | ||||||||||||
| Non-compete agreements | 135,506 | 8,117 | 65,000 | 62,389 | ||||||||||||
| Software | 6,434 | 3,146 | — | 3,288 | ||||||||||||
| Trademarks | 694,826 | 100,701 | 292,000 | 302,125 | ||||||||||||
| 7,294,156 | 2,891,793 | 2,457,041 | 1,945,322 | |||||||||||||
| 12,590,311 | 5,129,110 | 5,515,879 | 1,945,322 | |||||||||||||
| December 31, 2011 | ||||||||||||||||
| Gross carrying amount | Accumulated amortization | Intangible assets impairment (Note 2(17)) | Net carrying amount | |||||||||||||
Online advertising segment: | ||||||||||||||||
Trademark | 24,901,940 | (2,386,436 | ) | — | 22,515,504 | |||||||||||
Technology | 2,197,230 | (601,623 | ) | — | 1,595,607 | |||||||||||
Customer list | 1,464,820 | (415,032 | ) | (1,049,788 | ) | — | ||||||||||
Software technology | 823,273 | (507,685 | ) | (315,588 | ) | — | ||||||||||
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| |||||||||
| 29,387,263 | (3,910,776 | ) | (1,365,376 | ) | 24,111,111 | |||||||||||
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| |||||||||
| December 31, 2010 | ||||||||||||
| Gross carrying amount | Accumulated amortization | Net carrying amount | ||||||||||
Online advertising segment: | ||||||||||||
Trademark | 24,901,940 | (1,141,339 | ) | 23,760,601 | ||||||||
Technology | 2,197,230 | (287,733 | ) | 1,909,497 | ||||||||
Customer list | 1,464,820 | (268,550 | ) | 1,196,270 | ||||||||
Software technology | 823,273 | (425,358 | ) | 397,915 | ||||||||
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| |||||||
| 29,387,263 | (2,122,980 | ) | 27,264,283 | |||||||||
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| |||||||
F-26
Following the Company’s wireless value-added business and introduced further uncertainties instrategy adjustment during the Company’s operating environment. By September 30, 2007, the market capitalization of Hurray! was lower than the Company’s net book value, which was an indicator of impairment. At that dateyear 2011, the Company testedappointed Shengyue as its primary agency of the carrying valueonline advertising services. As a result, the customer list intangible asset associated with the original business model was no longer of goodwill (See Note 9) and acquired intangible assets anduse to the Company; therefore the unamortised balance of the customer list was recorded as an impairment of acquired intangible assets of $575,205. In view of the further decline of Hurray!’s market capitalization at December 31, 2007 and continued difficult operating conditions, the Company recorded a further impairment of acquired intangible assets of $1,905,048. The impairment charges of acquired intangibles mainly relating to the customer agreements with Telecom Operators are primarily included in selling and marketing expenses according to their nature.
In relation to the deconsolidation of $390,247 forYisheng (Note 2(1)(a)), the software technology intangible assets mainly related to the trademark and customer agreements with Telecom Operators of WVAS segment for the year ended December 31, 2008 mainly included in selling and marketing expenses due to the continued operation losses.
expense in 2011.
F-27
| 2010 | 125,572 | |||
| 2011 | 117,575 | |||
| 2012 | 86,164 | |||
| 2013 | 78,511 | |||
| 2014 and later | 674,140 | |||
| 1,081,962 | ||||
2012 | 1,558,992 | |||
2013 | 1,558,992 | |||
2014 | 1,558,992 | |||
2015 | 1,558,992 | |||
2016 and later | 17,875,143 | |||
|
| |||
| 24,111,111 | ||||
|
|
8. INVESTMENTINVESTMENTS IN EQUITY AFFILIATE
In April 2007, the Company acquired a 30% equity interest in Beijing New Run Entertainment Development Co., Ltd. (“New Run”), an independent record label in China, and it has beenwas accounted for using the equity basismethod from April 1, 2007.2007 forward. The total acquisition cost iswas $2,483,277 in cash, including transaction costs. At December 31, 2009, the Company’s share of New Run’s loss since acquisition was $912,535.
In August 2011, the Company disposed of an 80% equity interest to related parties and a then-employee of the Company, and retained a 20% equity interest in the Yisheng online audio business (see Note 2(1)(a) for further details). The Company evaluated its remaining interest in Yisheng under relevant guidance in ASC 810 and ASC 323 pertaining to consolidation and equity method accounting, respectively. The Company determined that it does not have a controlling financial interest in the investee, but rather possesses significant influence. Accordingly, the Company has accounted for this investment under the equity method. The investment was recorded based on the interest percentage of Yisheng's equity fair value after reflecting a capital contribution by an affiliate of Shanda to Yisheng.
F-28
| Balance at December 31, 2010 | Equity investment | Share of loss | Translation Difference | Balance at December 31, 2011 | ||||||||||||||||
Equity interest in Yisheng | — | 522,252 | (263,313 | ) | (3,658 | ) | 255,281 | |||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
| Year ended December 31, 2009 | ||||||||||||
| Gross amount of goodwill | WVAS | Recorded Music | Total | |||||||||
| Balance as of January 1,2008 | 39,275,506 | 5,123,907 | 44,399,413 | |||||||||
| Goodwill arising from acquisitions during the year | 80,504 | 189,255 | 269,759 | |||||||||
| Effect of exchange rate changes | 2,554,011 | — | 2,554,011 | |||||||||
| Balance as of December 31, 2008 | 41,910,021 | 5,313,132 | 47,223,153 | |||||||||
| Goodwill arising from acquisitions during the year | — | 2,535,523 | 2,535,523 | |||||||||
| Effect of exchange rate changes | (19,630 | ) | — | (19,630 | ) | |||||||
| Balance as of December 31, 2009 | 41,890,391 | 7,848,655 | 49,739,046 | |||||||||
| Accumulated impairment | WVAS | Recorded Music | Total | |||||||||
| Balance as of January 1,2008 | (38,778,507 | ) | — | (38,778,507 | ) | |||||||
| Goodwill impairment | (518,714 | ) | (2,156,497 | ) | (2,675,211 | ) | ||||||
| Effect of exchange rate changes | (2,612,800 | ) | — | (2,612,800 | ) | |||||||
| Balance as of December 31, 2008 | (39,410,021 | ) | (2,156,497 | ) | (44,066,489 | ) | ||||||
| Goodwill arising from acquisitions during the year | — | 2,535,523 | 2,535,523 | |||||||||
| Goodwill impairment | — | (3,592,933 | ) | (3,592,933 | ) | |||||||
| Effect of exchange rate changes | — | 36 | 36 | |||||||||
| Balance as of December 31, 2009 | — | 2,099,290 | 2,099,290 | |||||||||
| Net carrying amount as of December 31, 2008 | — | 3,156,664 | 3,156,664 | |||||||||
| Net carrying amount as of December 31, 2009 | — | 2,099,290 | 2,099,290 | |||||||||
The following table portrays gross balances and accumulated amortization or impairments of goodwill for the Company’s reportable segments. Pre-2010 Reorganization, reportable segments included WVAS and Recorded Music. Post-2010 Reorganization, the Company’s single reportable segment is Online Advertising.
| Gross amount of goodwill | WVAS | Recorded Music | Online Advertising | Total | ||||||||||||
Balance as of January 1, 2010 | 41,890,391 | 7,848,655 | — | 49,739,046 | ||||||||||||
Goodwill arising from acquisitions | — | — | 6,232,770 | 6,232,770 | ||||||||||||
Goodwill contributed by Shanda | — | — | 663,570 | 663,570 | ||||||||||||
Goodwill transferred out due to disposal | (42,148,288 | ) | (7,848,655 | ) | — | (49,996,943 | ) | |||||||||
Effect of exchange rate changes | 257,897 | — | — | 257,897 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Balance as of December 31, 2010 | — | — | 6,896,340 | 6,896,340 | ||||||||||||
Goodwill distributed to Shanda due to disposal | — | — | (663,570 | ) | (663,570 | ) | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Balance as of December 31, 2011 | — | — | 6,232,770 | 6,232,770 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
| Accumulated goodwill impairment | WVAS | Recorded Music | Online Advertising | Total | ||||||||||||
Balance as of January 1, 2010 | (41,890,391 | ) | (5,749,365 | ) | — | (47,639,756 | ) | |||||||||
Impairment transferred out due to disposal | 42,148,288 | 5,749,365 | — | 47,897,653 | ||||||||||||
Effect of exchange rate changes | (257,897 | ) | — | — | (257,897 | ) | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Balance as of December 31, 2010 | — | — | — | — | ||||||||||||
Impairment | — | — | — | — | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Balance as of December 31, 2011 | — | — | — | — | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Net carrying amount as of December 31, 2010 | — | — | 6,896,340 | 6,896,340 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Net carrying amount as of December 31, 2011 | — | — | 6,232,770 | 6,232,770 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Goodwill arising from the business combinations completed in 2010 has been allocated to the single reporting unit of the Company. ASC 350 requires that the goodwill impairment assessment be performed at the reporting unit level. In
The Company performed an impairment test at the second quarter of 2007, the mobile operators introduced various new policiesreporting unit level relating to goodwill from acquisitions and concluded that adversely impacted the Company’s wireless value-added business and this resulted in further uncertainties in the Company’s operating environment. By September 30, 2007, the market capitalization of Hurray!there was lower than the Company’s net book value, which was an indicator of impairment. At that date the Company testedno impairment as to the carrying value of goodwill and acquired intangible assets and recorded a goodwill impairment charge of $9,613,954. In view of the further decline of Hurray!’s market capitalization at December 31, 2007 and continued difficult operating conditions, the Company recorded an additional goodwill impairment charge of $29,164,630.
F-29
When available, the carrying amount of the Company’s cash and short term investments approximates their fair value dueCompany uses observable market data, including pricing on recent closed market transactions, to the short maturity of those instruments. The carrying value of receivables and payables approximates their market value based on their short-term maturities. There are no other financial assets or liabilities that are being measured at fair value on a recurring basis except for the contingent consideration in relation to the acquisition of Seed Music (Note 3), which is classified within level 3. As of December 31, 2009,determine the fair value of the contingent receivable in relationits reporting unit(s) and compares such data with carrying amounts of its reporting unit(s) to the acquisition of Seed Music was zero.
10. FAIR VALUE MEASUREMENTS
As of December 31, 2010 and December 31, 2011, the carrying amount of the Company’s cash and restricted cash approximates fair value due to the short maturity of these instruments. The carrying value of the Company’s various receivable and payable balances approximate their market value based on their short-term maturities. There are no other financial assets or liabilities that are being measured at fair value on a recurring basis at December 31, 2010 or December 31, 2011. As described in the Discontinued Operations footnote, the level 3-classified contingent consideration liability arising out of the acquisition of Seed Music in 2009, which was $352,217 at December 31, 2009, was extinguished by June 30, 2010.
The Company tests its long-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of a long-lived asset may not be recoverable. The Company measures the fair value of long-lived assets based using discounted cash flow modelling and unobservable inputs including assumptions of projected revenue, expenses, capital spending, and other costs, as well as a discount rate calculated based on the risk profile. See Note 2(15) and Note 97 to the Consolidated Financial Statements for additional information of the impairment provision relating to goodwill.
the acquired intangible assets.
F-30
On September 28, 2011, the Company entered into an agreement with a PRC bank to borrow RMB20 million ($3,177,680) for the period from September 29, 2011 to September 28, 2012. Interest rate is 6.89% per annum. The loan is pledged by a certificate of deposit of $3.6 million.
Accrued expenses and other current liabilities consist of:
| December 31, 2008 | December 31, 2009 | |||||||
| Accrued payroll | 157,714 | 572,489 | ||||||
| Accrued welfare benefits | 165,402 | 667,756 | ||||||
| Accrued professional service fee | 230,958 | 1,214,404 | ||||||
| Advance from customers | 422,406 | 964,262 | ||||||
| Business tax payable | 955,901 | 441,235 | ||||||
| Value-added tax payable | 104,435 | 121,982 | ||||||
| Other taxes payable | 140,135 | 1,185,791 | ||||||
| Other accrued expenses | 841,252 | 1,092,930 | ||||||
| 3,018,203 | 6,260,849 | |||||||
| December 31, 2010 | December 31, 2011 | |||||||
Accrued litigation provision | 748,299 | 2,683,968 | ||||||
Accrued payroll | 2,127,951 | 2,675,282 | ||||||
Accrued welfare benefits | 1,731,403 | 1,297,147 | ||||||
Accrued professional service fees | 1,524,890 | 978,602 | ||||||
Advances from customers | 609,442 | 722,553 | ||||||
Other accrued expenses | 2,278,758 | 713,719 | ||||||
Other taxes payable | 718,668 | 472,845 | ||||||
Business tax payable | 1,722,830 | 472,534 | ||||||
|
|
|
| |||||
| 11,462,241 | 10,016,650 | |||||||
|
|
|
| |||||
13. RELATED PARTY TRANSACTIONS AND BALANCES
Related Parties of Ku6 Media Co., Ltd. (both pre- and post-2010 Reorganization)
Entity | Relationship to Ku6 Media Co., Ltd. | |
Shanda Interactive Entertainment Limited (“Shanda”) | Controlling shareholder | |
Shanda Computer (Shanghai) Co., Ltd. (“Shanda Computer”) | Wholly owned affiliate of Shanda | |
Shanghai Shulong Computer Technology Co., Ltd. (“Shanghai Shulong Computer”) | Wholly owned affiliate of Shanda | |
Shanghai Shulong Technology Co., Ltd. (“Shanghai Shulong”) | Wholly owned affiliate of Shanda | |
Chengdu Jisheng Technology Co., Ltd. (“Chengdu Jisheng”) | Wholly owned affiliate of Shanda | |
Shanghai Shengyue Advertising Co., Ltd. (“Shengyue”) | Wholly owned affiliate of Shanda | |
Shanda Media Group Ltd. (“Shanda Media”) | Wholly owned affiliate of Shanda | |
Shanda Games Ltd. (“Shanda Games”) | Affiliate under common control of Shanda | |
Hurray! Media Co., Ltd. | Wholly owned affiliate of Shanda | |
Seed Music Group Limited | Wholly owned affiliate of Shanda | |
Hurray! Solutions Ltd. | Wholly owned affiliate of Shanda |
Post-2010 Reorganization Related Party Activity
Following the Reorga2010 Reorganization, the Company provides advertising business to and receives promotional services from companies under common control by Shanda. Accordingly, certain revenues from the sale of advertising business to sister entities, and related costs of revenue, are separately classified in the consolidated statement of operations and comprehensive loss.
Pre-2010 Reorganization Related Party Activity
As a result of the purchasingacquisition of the equity interests in Huayi Brothers Music, Hurray! Freeland Digital Music Technology Co., Ltd. (“Freeland Music”) and New Run, Entertainment,which were disposed in August 2010 and presented in discontinued operations (Note 2(1)), the Company agreed to use the existing distribution and CD manufacturing operations, where appropriate, owned by the other shareholders, or their related parties, of these music companies. In addition, these parties maywere able to use the music or artists of these companies and makemade royalty and other payments to Huayi Brothers Music, Freeland Music or New Run Entertainment.Run. These agreements arewere for durationdurations of one year but may be extendedwere extendable by the mutual agreement of both parties.
Annual Related Party Activity
During the years ended December 31, 2007, 20082009, 2010 and 20092011, significant related party transactions occurring during the annual periods were as follows
| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2007 | December 31, 2008 | December 31, 2009 | ||||||||||
| Consulting, royalty and artist performance fee from Huayi Brothers Media Corporation | 26,087 | 281,795 | — | |||||||||
| Consulting, production and marketing service fee from Huayi Brothers Times Culture Broker Co., Ltd. | — | — | 281,580 | |||||||||
| Royalty revenue from Shanghai Haiyue Music Distribution Co., Ltd. | 185,510 | 120,129 | — | |||||||||
| Royalty revenue from Beijing Oriental Freeland Film Media Co., Ltd. | — | 128,995 | — | |||||||||
| CD distribution revenue from Beijing Century Freeland Film Media Co., Ltd. | 262,520 | 35,625 | 52,248 | |||||||||
| Royalty revenue from Guangdong Freeland Film Media Co., Ltd. | 64,450 | — | — | |||||||||
| Royalty revenue from New Run | 106,567 | — | — | |||||||||
| 645,134 | 566,544 | 333,828 | ||||||||||
| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2007 | December 31, 2008 | December 31, 2009 | ||||||||||
| Content purchase, minimum guarantee and trade-name usage fee to Huayi Brothers Media Corporation | 80,285 | 58,501 | 208,663 | |||||||||
| Content purchase and information service fee to New Run | 16,440 | 26,771 | 15,053 | |||||||||
| Expenses paid on behalf of Beijing Secular Bird Culture Art Development Center | — | 19,009 | — | |||||||||
| 96,725 | 104,281 | 233,716 | ||||||||||
| Year Ended December 31, 2009 | Year Ended December 31, 2010 | Year Ended December 31, 2011 | ||||||||||
Related party transactions in discontinued operations: | ||||||||||||
Consulting, production and marketing service fee from Huayi Brothers Times Culture Broker Co., Ltd. | 281,580 | — | — | |||||||||
CD distribution revenue from Beijing Century Freeland Film Media Co., Ltd. | 52,248 | — | — | |||||||||
Related party transactions in continuing operations: Advertising revenue received from companies under common control by Shanda Promotion service fee paid to companies under common control by Shanda Loan payable to Shanda Computer (Shanghai) Co., Ltd. Loan payable to Shanghai Shulong Computer Technology Co., Ltd. Loan payable to Shanghai Shulong Technology Co., Ltd. Loan repayment to Shanghai Shulong Technology Co., Ltd. Loan receivable from Shanda Games Limited Convertible Bond issued to Shanda Media (Note 1) Convertible Bond redeemed from Shanda Media (Note 1) Interest expense of Convertible Bond issued to Shanda Media (Note 1) Interest expense for loan from companies under common control by Shanda Year Ended
December 31, 2009 Year Ended
December 31, 2010 Year Ended
December 31, 2011 279,341 701,732 8,076,155 — 376,302 379,465 — 1,565,290 — — — 6,832,012 — 3,030,711 6,503,884 — — 3,189,527 — 3,200,000 14,108,019 — — 50,000,000 — — 50,000,000 — — 375,000 — — 688,952
The Company entered into a cooperative agreement with Shengyue, a wholly owned subsidiary of Shanda, in 2011. Under this agreement, Shengyue was appointed as Ku6’s primary agency to secure advertisements from various advertisers. Ku6 will provide advertising space (i.e. headlines, banners, short video, etc) to Shengyue on its online video portal. This cooperative agreement covers a period of 1 year and 9 months commencing April 1, 2011. During the fourth quarter of 2008 Freeland Music advanced $162,721testing period from April 1, 2011 to its non-controlling shareholder on an interest free basis which was settled in first quarter of 2009. The non-controlling shareholder of Seed Music gave $300,000 loan with an interest of 5% per annum, which is due on June 30, 2011.
Year-End Related Party Balances
At December 31, 20082010 and 2009,December 31, 2011, the amounts receivable from and payable to and receivable from related parties included in the consolidated balance sheet mainly represent the outstanding amounts arising from such transactions.
Accounts receivable balances due from related parties are mainly as follows:
F-31
| December 31, 2010 | December 31, 2011 | |||||||
Shanghai Shengyue Advertising Co., Ltd. | — | 2,649,385 | ||||||
Chengdu Jisheng Technology Co., Ltd. | 219,697 | — | ||||||
Other companies under common control by Shanda | 106,060 | 90,794 | ||||||
|
|
|
| |||||
| 325,757 | 2,740,179 | |||||||
|
|
|
| |||||
Other balances with related parties are mainly as follows:
| December 31, 2010 | December 31, 2011 | |||||||
Other receivables due from related parties | ||||||||
Shanda Games Limited | 3,200,000 | 17,308,019 | ||||||
Hurray! Media Co., Ltd. | 1,246,641 | 1,246,641 | ||||||
Seed Music Group Limited | 980,000 | 980,000 | ||||||
Other companies under common control by Shanda | 105,607 | 4,609 | ||||||
|
|
|
| |||||
| 5,532,248 | 19,539,269 | |||||||
|
|
|
| |||||
In December 2010, Ku6 Media Co., Ltd. provided a $3.2 million unsecured loan to Shanda Games Limited, a company controlled by Shanda Interactive, which carried an interest rate of 0.6% per year and was originally due in July 2011. In January 2011, Ku6 Media Co., Ltd. provided another $6.7 million unsecured loan to Shanda Games Limited, which carried an interest rate of 0.6% per year and was originally due in July 2011. The terms of these loans are in the process of being extended. In June 2011, Ku6 Media Co., Ltd. provided a further $7.3 million unsecured loan to Shanda Games Limited, which carries an interest rate of 1.37% per year and is due in May 2012.
| December 31, 2010 | December 31, 2011 | |||||||
Other payables due to related parties | ||||||||
Shanghai Shulong Computer Technology Co., Ltd | — | 6,832,012 | ||||||
Shanghai Shulong Technology Co. Ltd | 3,030,711 | 6,345,068 | ||||||
Shanda Computer (Shanghai) Co., Ltd. | 3,030,300 | — | ||||||
Hurray! Solutions Ltd. | 1,586,899 | — | ||||||
Other related parties | 128,788 | 375,000 | ||||||
|
|
|
| |||||
| 7,776,698 | 13,552,080 | |||||||
|
|
|
| |||||
In June 2011, Ku6 Information Technology borrowed $6.8 million on an unsecured basis from Shanghai Shulong Computer Technology Co., Ltd., pursuant to an entrusted loan agreement. This loan carries an interest rate of 6.31% per year and is due in June 2012.
In December 2010, Ku6 Information Technology borrowed $3.0 million on an unsecured basis from Shanghai Shulong Technology Co., Ltd., a company controlled by Shanda Interactive, pursuant to an entrusted loan agreement. This loan carried an interest rate of 5.05% per year and was originally due in June 2011. The term of the outstanding equity of Shanghai Magma, a leading developerloan was subsequently extended to December 2011 and publisher of wireless Java™ Games in China and Shanghai Magma has been consolidated since that date. Under the acquisition agreements, the Company made an initial cash payment of $4,185,009 and agreedinterest rate was revised to pay additional amounts based on Shanghai Magma’s financial performance in 2006 and 2007 with a maximum total consideration, including the initial payment, of $22,000,000. In September 2006, the Company agreed with the selling shareholders to fix the additional amounts at a total of $10,500,000 payable in two installments of $4,500,000 in October 2006 and $6,000,0005.68%. This loan was fully repaid in December 2007. As2011.
In February 2011, Ku6 Information Technology borrowed $6.4 million on an unsecured basis from Shanghai Shulong Technology Co., Ltd., pursuant to an entrusted loan agreement. This loan carried an interest rate of 5.05% per year and was originally due in August 2011. Ku6 Information Technology repaid $39,721 in 2011 and the term of the loan with respect to the remaining amount of $6.3 million was subsequently extended to February 2012. The interest rate was revised to 6.71% per year. In February 2012, $3.1 million was repaid. The term of the loan with respect to the remaining amount of $3.2 million was extended to August 2012 and the interest rate remained at 6.71% per year.
Amounts due to related parties are non-interest bearing, unsecured, and payable on demand (except as mentioned in the preceding paragraphs for specific borrowings) with interest rates ranging from 5.05% to 6.71%.
The payables to Hurray! Solutions Ltd. and other related parties amounting to $1,719,927 were waived and recorded as additional paid-in capital in 2011 as part of the amended agreements certain selling shareholders agreed to subscribe $1,250,000 of the payments received in the issue of Hurray!’s ordinary shares of all the additional amount of $10,500,000 at a price based on the 5 -day average price of Hurray!’s shares prior to signing the revised agreements. As of December 31, 2006, the Company had made the payment of $4,500,000 and selling shareholders subscribed $540,000 of the payments received in the issue of Hurray!’s ordinary shares. On December 31, 2007, the amount payable under these agreements was $6,000,000, out of which $710,000 was to be used by the selling shareholders for subscription of Hurray!’s shares at a price of $6.03 per share. In February 2008, the Company and the selling shareholders agreed to further amend the agreements to reduce the consideration payable to $1,000,000 and cancelled the option granted to the selling shareholders. The amount of $1,000,000 was paid in March 2008. The gain on reduction of $5,000,000 in the purchase liability was recognized as other operating income in the first quarter of 2008.
14. FOREIGN EXCHANGE LOSS
The Company is a tax exempted company incorporated in the Cayman Islands.
F-32
| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2007 | December 31, 2008 | December 31, 2009 | ||||||||||
| Current | 576,774 | 298,579 | 750,705 | |||||||||
| Deferred | (759,144 | ) | 187,671 | (516,419 | ) | |||||||
| (182,370 | ) | 486,250 | 234,286 | |||||||||
| Year ended December 31, 2009 | Year ended December 31, 2010 | Year ended December 31,2011 | ||||||||||
Current income taxes from discontinued operations | 750,705 | 6,229 | — | |||||||||
Deferred income taxes from discontinued operations | (516,419 | ) | (31,813 | ) | — | |||||||
Current income taxes from continuing operations | — | — | — | |||||||||
Deferred income taxes from continuing operations | (13,721 | ) | (41,172 | ) | (99,479 | ) | ||||||
|
|
|
|
|
| |||||||
| 220,565 | (66,756 | ) | (99,479 | ) | ||||||||
|
|
|
|
|
| |||||||
The principal components of the deferred tax assets and liabilities are as follows:
| December 31,2008 | December 31, 2009 | |||||||
| Deferred tax assets: | ||||||||
| Cost and expenses accruals | 363,330 | 2,709,145 | ||||||
| Less: valuation allowance | — | (2,709,145 | ) | |||||
| Current deferred tax assets | 363,330 | — | ||||||
| Depreciation and amortization | 330,035 | 170,828 | ||||||
| Net operating loss carry forwards | 2,690,142 | 5,502,682 | ||||||
| Less: valuation allowance | (2,541,258 | ) | (5,063,370 | ) | ||||
| Non-current deferred tax assets | $ | 478,919 | 610,140 | |||||
| Deferred tax liabilities: | ||||||||
| Revenue recognition | (497,283 | ) | (622,456 | ) | ||||
| Current deferred tax liabilities | (497,283 | ) | (622,456 | ) | ||||
| Intangible assets | (292,194 | ) | (262,665 | ) | ||||
| Non-current deferred tax liabilities | (292,194 | ) | (262,665 | ) | ||||
| December 31, 2010 | December 31, 2011 | |||||||
Current deferred taxes: | ||||||||
Cost and expense accruals | 4,714,262 | 2,810,508 | ||||||
Revenue recognition | (1,217,957 | ) | (173,502 | ) | ||||
Less: valuation allowance | (3,496,305 | ) | (2,637,006 | ) | ||||
|
|
|
| |||||
Current deferred tax assets | — | — | ||||||
|
|
|
| |||||
Non-current deferred taxes: | ||||||||
Depreciation and amortization | 1,899,375 | 1,748,889 | ||||||
Net operating loss carry forwards | 13,727,221 | 18,450,814 | ||||||
Less: valuation allowance | (15,626,596 | ) | (20,199,703 | ) | ||||
|
|
|
| |||||
Non-current deferred tax assets | — | — | ||||||
|
|
|
| |||||
Intangible assets | (4,925,538 | ) | (4,826,059 | ) | ||||
|
|
|
| |||||
Non-current deferred tax liabilities | (4,925,538 | ) | (4,826,059 | ) | ||||
|
|
|
| |||||
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 in each annual period are adjustments to the valuation allowance for deferred tax assets that are, as assessed under ASC Topic 740, more likely than not to not be realized.
| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2009 | December 31, 2010 | December 31, 2011 | ||||||||||
Statutory tax rate | 25.0 | % | 25.0 | % | 25.0 | % | ||||||
Differential statutory tax rates | 0.2 | % | (3.3 | %) | (7.9 | %) | ||||||
Non-deductible expenses | (6.2 | %) | 0.4 | % | (7.9 | %) | ||||||
Non-taxable income | — | — | — | |||||||||
Change in enterprise income tax rate | — | — | — | |||||||||
Change in valuation allowance | (19.8 | %) | (22.0 | %) | (9.0 | %) | ||||||
|
|
|
|
|
| |||||||
Effective tax rate | (0.8 | %) | 0.1 | % | 0.2 | % | ||||||
|
|
|
|
|
| |||||||
The movement of valuation allowances were as follows:
| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2007 | December 31, 2008 | December 31, 2009 | ||||||||||
| Statutory tax rate | 33.0% | 25.0% | 25.0% | |||||||||
| Differential statutory tax rates | 0.3% | 10.1% | 0.3% | |||||||||
| Non-deductible expenses | (47.5% | ) | (26.7% | ) | (6.5% | ) | ||||||
| Non-taxable income | 45.0% | 15.9% | 0.0% | |||||||||
| Change in enterprise income tax rate | (8.6% | ) | 0.0% | (0.0% | ) | |||||||
| Change in valuation allowance | (13.8% | ) | (37.3% | ) | (19.7% | ) | ||||||
| Effective tax rate | 8.4% | (13.0% | ) | (0.9% | ) | |||||||
| December 31, 2009 | December 31, 2010 | December 31, 2011 | ||||||||||
At beginning of year | (7,772,515 | ) | (8,309,621 | ) | (19,122,901 | ) | ||||||
Acquisition of Ku6 | — | (6,123,900 | ) | — | ||||||||
Acquisition of Yisheng | (167,418 | ) | — | — | ||||||||
Current year additions | (1,029,311 | ) | (14,292,925 | ) | (4,452,155 | ) | ||||||
Current year reversals | 655,761 | 1,404,205 | 1,591,018 | |||||||||
Transferred out due to disposal of WVAS and recorded music businesses | — | 8,433,935 | — | |||||||||
Effect of exchange rate changes | 3,862 | (234,595 | ) | (852,671 | ) | |||||||
|
|
|
|
|
| |||||||
| (8,309,621 | ) | (19,122,901 | ) | (22,836,709 | ) | |||||||
|
|
|
|
|
| |||||||
At December 31, 20082010 and 2009,2011, tax loss carry forwards (on a gross basis prior to measurement via the tax rate) amounted to approximately $14.2$54.9 million and $22.0$73.8 million, respectively, which will expire by various years through 2014.2016. The Company’s tax loss carry forwards exist only in the PRC, where the carry forward period is limited to five years. The Company determines whether or not a valuation allowance is required at the level of each taxable entity.entity within a tax jurisdiction. A valuation allowance of $2,541,258$19,122,901 and $7,772,515$22,836,709 has been established as of December 31, 20082010 and December 31, 2009,2011, respectively, in respect of certain deferred tax assets as it is considered more likely than not that the relevant deferred tax assets will not be realized in the foreseeable future.
At both December 31, 2010 and 2011, all of the Company’s net deferred tax assets, excluding the impact of non-current deferred tax liabilities associated with intangible assets which have indefinite reversal patterns, were fully reserved through valuation allowances.
F-33
Since there isare no undistributed earnings of the Company’s subsidiaries located in the PRC that are available for distribution to the Company at December 31, 20092010 and 2011 given the accumulated loss positions of the Company’s subsidiaries, no provision has been made for withholding taxes. Further, the Company does not have any present plan to pay any cash dividends on its ordinary shares in the foreseeable future and intends to retain most of its available funds and any future earnings for use in the operation and expansion of its business in the PRC. Accordingly, no provision has been made for withholding taxes that would be payable upon the distribution of undistributed earnings of the Company’s PRC subsidiaries to the Company.
15. EQUITY COMPENSATION PLANS
2004 Share (equivalent to $4.00 per ADS) in cash, without interest and subject to any applicable withholding taxes. Immediately after giving effect to the acquisition of Shares (including Shares represented by ADSs) in the tender offer, Shanda hold, through Shanda Music, approximately 51% of the Company’s total outstanding Shares calculated on a fully-diluted basis as of December 31, 2009. Subsequent in January 2010, Shanda’s equity interests in the Company was diluted to 41.97%. The professional service fees relating to the Shanda tender offer were $2.5 million. See Note 22.
Stock optionoptions
Ku6 Media’s 2004 stock option plans (the “Plans”Share Incentive Plan (“2004 Plan”) allowallows the Company to offer incentive awards to employees, directors, consultants or external service advisors of the Company. Under the terms of the Plans,Plan, options are 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 45,582,70044,584,700 and 47,367,70043,746,700 options outstanding as of December 31, 20092010 and 2011, respectively. Pursuant to the resolution of the Company’s Board on December 31, 2008, respectively. No stock options have been granted since January 1, 2006. As of December 31, 2009 and December 31, 2008,3, 2010, the 185,550,800 and 180,115,900remaining ordinary shares were available for future grants respectively.
| Ordinary shares | ||||||||
| Weighted average | ||||||||
| Number of options | exercise price | |||||||
| Options outstanding at January 1, 2007 | 80,506,600 | $ | 0.085 | |||||
| Exercised | (653,400 | ) | $ | 0.027 | ||||
| Cancelled/Expired | (5,587,000 | ) | $ | 0.106 | ||||
| Options outstanding at December 31, 2007 | 74,266,200 | $ | 0.084 | |||||
| Exercised | (60,000 | ) | $ | 0.025 | ||||
| Cancelled/Expired | (26,838,500 | ) | $ | 0.094 | ||||
| Options outstanding at December 31, 2008 | 47,367,700 | $ | 0.080 | |||||
| Exercised | (350,000 | ) | $ | 0.025 | ||||
| Cancelled/Expired | (1,435,000 | ) | $ | 0.115 | ||||
| Options outstanding at December 31, 2009 | 45,582,700 | $ | 0.080 | |||||
2004 Plan were terminated and unavailable for future use.
F-34
| Options outstanding and exercisable | ||||||||||||||||
| Weighted average | ||||||||||||||||
| remaining | Weighted average | Aggregated Intrinsic | ||||||||||||||
| Exercise Prices | Number outstanding | contractual life | exercise price | value | ||||||||||||
| $0.0250 | 9,514,700 | 2.58 | $ | 0.0250 | $ | 147,478 | ||||||||||
| $0.0705 | 16,418,000 | 3.49 | $ | 0.0705 | — | |||||||||||
| $0.1170 | 14,988,000 | 4.00 | $ | 0.1170 | — | |||||||||||
| $0.1025 | 4,662,000 | 5.00 | $ | 0.1025 | — | |||||||||||
| Total | 45,582,700 | $ | 147,478 | |||||||||||||
| Options Outstanding | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life | Aggregate Intrinsic Value | |||||||||||||
| $ | $ | |||||||||||||||
Outstanding at December 1, 2009 | 47,367,700 | 0.080 | — | — | ||||||||||||
Granted | — | — | — | — | ||||||||||||
Exercised | (350,000 | ) | 0.025 | — | — | |||||||||||
Cancelled or Expired | (1,435,000 | ) | 0.115 | — | — | |||||||||||
|
| |||||||||||||||
Outstanding at December 31, 2009 | 45,582,700 | 0.080 | 3.63 | 147,478 | ||||||||||||
Granted | — | — | — | — | ||||||||||||
Exercised | (450,000 | ) | 0.045 | — | — | |||||||||||
Cancelled or Expired | (548,000 | ) | 0.113 | — | — | |||||||||||
|
| |||||||||||||||
Outstanding at December 31, 2010 | 44,584,700 | 0.080 | 2.63 | 226,985 | ||||||||||||
Granted | — | — | — | — | ||||||||||||
Exercised | (150,000 | ) | 0.025 | — | — | |||||||||||
Cancelled or Expired | (688,000 | ) | 0.096 | — | — | |||||||||||
|
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|
|
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| |||||||||
Outstanding at December 31, 2011 | 43,746,700 | 0.079 | 1.62 | — | ||||||||||||
|
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| |||||||||
Vested and expected to vest at December 31, 2011 | 43,746,700 | 0.079 | 1.62 | — | ||||||||||||
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| |||||||||
Vested and exercisable at December 31, 2011 | 43,746,700 | 0.079 | 1.62 | — | ||||||||||||
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| |||||||||
The aggregate intrinsic value isvalues are calculated as the differencedifferences between the market value of US$4.05$0.0405, $0.0495 and $0.0120 of ordinary shares as of December 31, 2009, 2010, and 2011, respectively, and the exercise priceprices of the options.shares. The total intrinsic value of options exercised during the years ended December 31, 2007, 20082009, 2010 and 20092011 was approximately $0.8$0.5 million, nil and $0.5 million,nil, respectively.
Non-vested shares
Since 2006, the Company has granted restricted purchase share awards, in lieu of stock options, under Hurray!’sthe 2004 Share Incentive Plan (the “2004 Plan”) to certain officers and senior management.
Share-based compensation expense related to non-vested stock units to its employees pursuant togranted by the Company under the 2004 Plan at offering price of par value which resulted in stock-based compensation expense of $1.6 millionamounted to be recognized over$169,310, $84,233 and nil for the applicable vesting period. Theyears ended December 31, 2009, 2010 and 2011.
There are no outstanding non-vested stock units vest on an annual basis equally over three years.
A summary of non-vested shares’stock unit activity is as follows:
F-35
| Non-vested shares outstanding | ||||||||
| Number | Aggregate | |||||||
| outstanding | intrinsic value | |||||||
| Grant date | ||||||||
| November 23, 2007 | 3,000,100 | $ | 121,504 | |||||
| Total | 3,000,100 | $ | 121,504 | |||||
| Number outstanding | Weighted average grant date fair value | |||||||
| Non-vested stock units | $ | |||||||
Outstanding at January 1, 2009 | 13,500,300 | 0.0406 | ||||||
Granted | — | — | ||||||
Vested | (6,500,300 | ) | 0.0313 | |||||
Forfeited | (3,999,900 | ) | 0.0507 | |||||
|
| |||||||
Outstanding at December 31, 2009 | 3,000,100 | 0.0313 | ||||||
Granted | — | — | ||||||
Vested | (3,000,100 | ) | 0.0313 | |||||
Forfeited | — | — | ||||||
|
| |||||||
Outstanding at December 31, 2010 | — | — | ||||||
Granted | — | — | ||||||
Vested | — | — | ||||||
Forfeited | — | — | ||||||
|
|
|
| |||||
Outstanding at December 31, 2011 | — | — | ||||||
|
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| |||||
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 consultants or advisors (i) options to subscribe for ordinary shares, (ii) share appreciation rights to receive payment, in cash and/or the Company’ ordinary shares, equals to the excess of the fair market value of the underlying stockCompany’ ordinary shares, or (iii) other types of compensation based on the respectiveperformance of the Company’ ordinary shares.
On December 4, 2010, the Company granted stock options to purchase up to 516,750,000 ordinary shares under the 2010 Equity Compensation Plan at an exercise price of $0.0568 per share equivalent to the average market value in the previous fifteen trading days of the grant dates.dates to its employees, senior management and directors. Of all the stock options granted, 272,850,000 were granted to senior management and 243,900,000 were granted to directors and employees. The contract term of the options granted to the directors and employees is six years and the contract term of the options granted to senior management is seven years.
On February 24, 2011, the Company granted stock options to purchase up to 62,000,000 ordinary shares under the 2010 Equity Compensation Plan at an exercise price of $0.0392 per share to its employees, senior management and directors. Of all the stock options granted, 9,000,000 ordinary shares were granted to directors of the Company and 53,000,000 were granted to the senior management and employees of Shanda. The contract term of the options is six years.
On July 6, 2011, the Company granted stock options to purchase up to 147,643,000 ordinary shares under the 2010 Equity Compensation Plan at an exercise price of $0.03083 per share to its employees. The contract term of the options is six years.
On August 23, 2011, the Company granted stock options to purchase up to 162,500,000 ordinary shares under the 2010 Equity Compensation Plan at an exercise price of $0.0227 per share to its employees, senior management and directors. Of all the stock options granted, 112,000,000 were granted to senior management of the Company, 15,000,000 were granted to directors of the Company, and 35,500,000 were granted to the senior management and employees of Shanda. The contractual term of the options is six years.
On October 14, 2011, the Company granted stock options to purchase up to 21,000,000 ordinary shares under the 2010 Equity Compensation Plan at an exercise price of $0.0188 per share to its senior management. The contract term of the options is six years.
As of December 31, 2011, 295,555,300 ordinary shares were available for future grants under the 2010 Equity Compensation Plan.
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.
The options granted to senior management 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.
In relation to the business strategy adjustments in 2011 (Note 1), the Company significantly reduced its sales forces, and certain directors, senior management and employees resigned from the Company. Accordingly, the options granted to such directors, senior managements and employees were forfeited. Accordingly, in the fourth quarter of 2011, the Company recorded a $1.0 million reversal of amounts previously recorded in the first three quarters of 2011 in stock-based compensation expense to adjust the estimated forfeiture rate to the much higher actual forfeiture rate.
In accordance with ASC 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 target, the Company recognized share-based compensation expenses for the options earned in each quarter during the Performance Period using the graded-vesting attribution method when the Company concluded that it is probable that the performance targets will be achieved, net of a forfeiture rate.
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 $522,931 and $1,231,919 for the year ended December 31, 2010 and 2011, respectively. Share-based compensation expense related to the option awards granted by the Company to the senior management and employees of Shanda under the 2010 Equity Compensation Plan amounted to nil and $257,230 for the year ended December 31, 2010 and 2011, respectively, which was recognized as a dividend distributed to Shanda.
The movements in stock options under the 2010 Equity Compensation Plan as of and for the year ended December 31, 2011 are set out below.
| Options Outstanding | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life | Aggregate Intrinsic Value | |||||||||||||
| $ | $ | |||||||||||||||
Outstanding at January 1, 2010 | — | — | — | — | ||||||||||||
Granted | 516,750,000 | 0.0568 | — | — | ||||||||||||
Exercised | — | — | — | — | ||||||||||||
Cancelled or Expired | — | — | — | — | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Outstanding at December 31, 2010 | 516,750,000 | 0.0568 | 6.46 | — | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Granted | 393,143,000 | 0.0281 | — | — | ||||||||||||
Exercised | — | — | — | — | ||||||||||||
Cancelled or Expired | (507,067,000 | ) | 0.0517 | — | — | |||||||||||
|
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|
|
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|
|
| |||||||||
Outstanding at December 31, 2011 | 402,826,000 | 0.0352 | 5.47 | — | ||||||||||||
|
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|
|
|
|
| |||||||||
Vested and expected to vest at December 31, 2011 | 373,995,600 | 0.0342 | 5.49 | — | ||||||||||||
|
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|
|
|
|
|
| |||||||||
Vested and exercisable at December 31, 2011 | 18,742,500 | 0.0568 | 5.00 | — | ||||||||||||
|
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|
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|
|
| |||||||||
The intrinsic value as of December 31, 2010 and 2011 is determined based oncalculated as the difference between the market value of US$4.05$0.0495 and $0.0120 of ordinary shares as of December 31, 2009. The terms2010 and 2011 and the exercise prices of the issueoptions.
The weighted average grant-date fair value of options granted during the non-vested shares do not require the employees to make any payments. The Company recorded share-based compensation expenses of $442,975, $945,282 and $169,310 for the yearsyear ended December 31, 2007, 20082010 and 2009,2011 was $0.0483 and $0.0151, respectively. The amountOptions vested during the year ended December 31, 2010 and 2011 was nil and 27,142,500, respectively.
As of unvested stock-basedDecember 31, 2010 and 2011, there was $15.4 million and $5.43 million, respectively, of unrecognized compensation currentlycost, adjusted for estimated to be expensed through 2010forfeitures, related to unvested share-based payment awards at December 31, 2009 is $54,515.stock options granted by the Company to its employees, senior management and directors under the 2010 Equity Compensation Plan. This amount will be recognized in 2010.
The Black-Scholes option pricing model is used to determine the fair value of the stock options granted under the 2010 Equity Compensation Plan. The Black-Scholes model requires the input of highly subjective assumptions. The risk-free rate for periods within the contractual lives of the options is based on the U.S. Treasury yield curve in effect at the periodtime of change and will also impactgrant. The fair values of stock options were estimated using the amount of share-based compensation expense to be recognized in future periods.
Fair value of ordinary shares ($) Exercise price ($) Expected volatility (%) (4) Expected dividend yield (%) (3) Expected term (years) (2) Risk-free interest rate (per annum) (%) (1) Options Granted
in 2010 Options Granted
in 2011 0.0800 0.0186~0.0367 0.0568 0.0188~0.0392 60%~65% 75%~82% 0% 0% 4~5 3.5~5 1.9407%~2.6565% 1.2680%~1.9933%
| (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. |
| (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. |
16. SEGMENT INFORMATION
The Company follows the provisions of ASC 280,Segment Reporting, (formerly referred to as SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information”), 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.
Pre-2010 Reorganization
The Company’s chief operating decision maker has been identified as the Chief Executive Officer, who reviews consolidated results when making decisions about allocating resources and assessing performance of the Company. ThePrior to the disposal of the WVAS and recorded music businesses in August 2010 (Note 2(1)), which have been presented as discontinued operations for all the periods presented herein, the Company operatesoperated and managesmanaged two principal operating segments wireless value-added services (“WVAS”)(each of which were reportable segments), WVAS and recorded music.Recorded Music. The wireless value-added services areWVAS were delivered through the 2.5G mobile networks, which comprise Wireless Application Protocol (“WAP”) services, Multimedia Messaging Services (“MMS”), Java™ services, and WEB, and through 2G technology platforms, which comprise Short Messaging Services (“SMS”), Interactive Voice Response services (“IVR”), and Color Ring Back Tones (“CRBT”). Recorded musicMusic services arewere delivered through the Company’s majority-controlled music companies and their parent company, Hurray Digital Media Technology Co., Ltd., which contractscontracted with music artists and composers to perform and produce music. Corporate assets are related to the bank balancebalances of overseas companies that are not directly attributable to the other reportable segments. The Company uses gross profit as the key performance measure of each reportable segment. ExpensesCorporate expenses are not allocated to each segment.
F-36
| December 31, 2008 | December 31, 2009 | |||||||
Assets | ||||||||
| WVAS | 28,952,925 | 24,400,482 | ||||||
| Recorded music | 16,977,258 | 9,863,363 | ||||||
| Reconciling amounts | 42,394,219 | 33,904,432 | ||||||
| Total assets | 88,324,402 | 68,168,277 | ||||||
Reconciling assets: | ||||||||
| Corporate assets | 42,394,219 | 33,904,432 | ||||||
| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2007 | December 31, 2008 | December 31, 2009 | ||||||||||
Total expenditures for additions to long-lived assets | ||||||||||||
| WVAS | 755,921 | 228,431 | 599,254 | |||||||||
| Recorded music | 107,682 | 120,802 | 79,028 | |||||||||
| Total capital expenditure | 863,603 | 349,233 | 678,282 | |||||||||
| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2007 | December 31, 2008 | December 31, 2009 | ||||||||||
Revenues | ||||||||||||
| WVAS | 50,038,014 | 42,671,588 | 20,169,110 | |||||||||
| Recorded music | 10,488,613 | 11,286,812 | 14,473,185 | |||||||||
| Total net revenues | 60,526,627 | 53,958,400 | 34,642,295 | |||||||||
Cost of revenues | ||||||||||||
| WVAS | 36,394,300 | 32,839,642 | 15,331,675 | |||||||||
| Recorded music | 6,232,728 | 6,729,725 | 12,625,139 | |||||||||
| Total net revenues | 42,627,028 | 39,569,367 | 27,956,814 | |||||||||
Gross profit | ||||||||||||
| WVAS | 13,643,714 | 9,831,946 | 4,837,435 | |||||||||
| Recorded music | 4,255,885 | 4,557,087 | 1,848,046 | |||||||||
| Total net revenues | 17,899,599 | 14,389,033 | 6,685,481 | |||||||||
| Total assets by reportable segment | December 31, 2009 | December 31, 2010 | ||||||
WVAS | 24,400,482 | — | ||||||
Recorded music | 9,863,363 | — | ||||||
Corporate assets | 33,904,432 | — | ||||||
|
|
|
| |||||
Total assets | 68,168,277 | — | ||||||
|
|
|
| |||||
| Capital expenditures for additions to long-lived assets by reportable segment | Year ended December 31, 2009 | Year ended December 31, 2010 | ||||||
WVAS | 599,254 | 402,710 | ||||||
Recorded music | 79,028 | 84,613 | ||||||
|
|
|
| |||||
Total capital expenditures | 678,282 | 487,323 | ||||||
|
|
|
| |||||
| Revenues, cost of revenues, and gross profit by reportable segment | Year ended December 31, 2009 | Year ended December 31, 2010 | ||||||
Revenues | ||||||||
WVAS | 20,169,110 | 5,385,985 | ||||||
Recorded music | 14,473,185 | 9,458,423 | ||||||
|
|
|
| |||||
Total revenues | 34,642,295 | 14,844,408 | ||||||
|
|
|
| |||||
Cost of revenues | ||||||||
WVAS | 15,331,675 | 3,799,581 | ||||||
Recorded music | 12,625,139 | 6,118,305 | ||||||
|
|
|
| |||||
Total cost of revenues | 27,956,814 | 9,917,886 | ||||||
|
|
|
| |||||
Gross profit | ||||||||
WVAS | 4,837,435 | 1,586,404 | ||||||
Recorded music | 1,848,046 | 3,340,118 | ||||||
|
|
|
| |||||
Total gross profit | 6,685,481 | 4,926,522 | ||||||
|
|
|
| |||||
Revenues from the WVAS segment by product and service are shown in the table below:
| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2007 | December 31, 2008 | December 31, 2009 | ||||||||||
Revenues | ||||||||||||
| SMS | 10,948,524 | 13,319,011 | 5,307,435 | |||||||||
| IVR | 17,325,223 | 12,207,136 | 3,943,733 | |||||||||
| RBT | 3,719,470 | 4,960,624 | 4,447,918 | |||||||||
| 2G revenues | 31,993,217 | 30,486,771 | 13,699,086 | |||||||||
| WAP | 12,530,200 | 7,434,197 | 3,145,885 | |||||||||
| MMS | 1,313,397 | 1,355,441 | 1,692,585 | |||||||||
| JAVA | 1,399,193 | 2,244,010 | 1,541,618 | |||||||||
| WEB | 2,029,298 | 218,810 | 11,794 | |||||||||
| 2.5G revenues | 17,272,088 | 11,252,458 | 6,391,882 | |||||||||
| Other revenues | 772,709 | 932,359 | 78,142 | |||||||||
| Total WVAS revenue | 50,038,014 | 42,671,588 | 20,169,110 | |||||||||
| Recorded music revenue | 10,488,613 | 11,286,812 | 14,473,185 | |||||||||
| Total revenues | 60,526,627 | 53,958,400 | 34,642,295 | |||||||||
| Year ended December 31, 2009 | Year ended December 31, 2010 | |||||||
Revenues | ||||||||
SMS | 5,307,435 | 456,968 | ||||||
IVR | 3,943,733 | 545,890 | ||||||
RBT | 4,447,918 | 2,493,929 | ||||||
|
|
|
| |||||
2G revenues | 13,699,086 | 3,496,787 | ||||||
|
|
|
| |||||
WAP | 3,145,885 | 565,205 | ||||||
MMS | 1,692,585 | 170,281 | ||||||
JAVA | 1,541,618 | 902,194 | ||||||
WEB | 11,794 | — | ||||||
|
|
|
| |||||
2.5G revenues | 6,391,882 | 1,637,680 | ||||||
|
|
|
| |||||
Other revenues | 78,142 | 251,518 | ||||||
|
|
|
| |||||
Total WVAS revenue | 20,169,110 | 5,385,985 | ||||||
|
|
|
| |||||
Recorded music revenue | 14,473,185 | 9,458,423 | ||||||
|
|
|
| |||||
Total revenues | 34,642,295 | 14,844,408 | ||||||
|
|
|
| |||||
F-37
Post-2010 Reorganization
Following the 2010 Reorganization (the disposal of the WVAS and recorded music businesses (Note 2(1)) in August 2010 presented in discontinued operations for all the periods presented herein), the Company has only one operating segment (and reportable segment) made up of Ku6’s online advertising business (“Online Advertising”), which is presented in the continuing operations section of our consolidated statement of operations.
Geographic Information
The Company primarily operates in the PRC and all of the Company’s long-lived assets are located in the PRC.
Accordingly, enterprise-wide disclosures are not necessary.
F-38
The following table sets forth the computation of basic and diluted net (loss) incomeloss per share (1 ADS = 100 Shares):
| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2007 | December 31, 2008 | December 31, 2009 | ||||||||||
Numerator: | ||||||||||||
| Net loss attributable to Hurray! Holding Co., Ltd. from continuing operations for basic and diluted earnings per ADS | (41,530,968 | ) | (12,365,126 | ) | (22,879,791 | ) | ||||||
| Net loss (income) attributable to Hurray! Holding Co., Ltd. from discontinued operations for basic and diluted earnings per ADSs | (419,227 | ) | 412,530 | 221,899 | ||||||||
| Net loss attributable to Hurray! Holding Co., Ltd. | (41,950,195 | ) | (11,952,596 | ) | (22,657,892 | ) | ||||||
Denominator: | ||||||||||||
| Weighted-average ordinary shares outstanding for basic calculation | 2,172,208,190 | 2,185,615,129 | 2,196,291,947 | |||||||||
| Dilutive effect of restricted shares and stock options | — | — | — | |||||||||
| Weighted average ordinary shares outstanding for diluted calculation | 2,172,208,190 | 2,185,615,129 | 2,196,291,947 | |||||||||
| Loss from continuing operations attributable to Hurray! Holding Co., Ltd. ordinary shareholders per share — basic and diluted | (0.02 | ) | (0.01 | ) | (0.01 | ) | ||||||
| Loss (income) from discontinued operations attributable to Hurray! Holding Co., Ltd. ordinary shareholders per share — basic and diluted | (0.00 | ) | 0.00 | 0.00 | ||||||||
| Loss attributable to Hurray! Holding Co., Ltd. ordinary shareholders per share — basic and diluted | (0.02 | ) | (0.01 | ) | (0.01 | ) | ||||||
| Year ended December 31, 2009 | Year ended December 31, 2010 | Year ended December 31, 2011 | ||||||||||
Numerator: | ||||||||||||
Net loss attributable to Ku6 Media Co., Ltd. ordinary shareholders from continuing operations | (6,021,461 | ) | (52,858,278 | ) | (49,343,907 | ) | ||||||
Net income (loss) attributable to Ku6 Media Co., Ltd. ordinary shareholders from discontinued operations | (17,373,400 | ) | 1,348,014 | — | ||||||||
|
|
|
|
|
| |||||||
Net loss attributable to Ku6 Media Co., Ltd. | (23,394,861 | ) | (51,510,264 | ) | (49,343,907 | ) | ||||||
|
|
|
|
|
| |||||||
Denominator: | ||||||||||||
Weighted-average ordinary shares outstanding for basic calculation | 2,196,291,947 | 3,096,421,097 | 4,265,277,638 | |||||||||
Dilutive effect of restricted shares, convertible debt, and stock options | — | — | — | |||||||||
|
|
|
|
|
| |||||||
Weighted average ordinary shares outstanding for diluted calculation | 2,196,291,947 | 3,096,421,097 | 4,265,277,638 | |||||||||
|
|
|
|
|
| |||||||
Weighted-average ADS used in per basic ADS calculations | 21,962,919 | 30,964,211 | 42,652,776 | |||||||||
Dilutive effect of restricted shares, convertible debt, and stock options | — | — | — | |||||||||
|
|
|
|
|
| |||||||
Weighted-average ADS used in per diluted ADS calculations | 21,962,919 | 30,964,211 | 42,652,776 | |||||||||
|
|
|
|
|
| |||||||
Loss per share – basic and diluted | ||||||||||||
Loss from continuing operations attributable to Ku6 Media Co., Ltd. ordinary shareholders per share — basic and diluted | (0.00 | ) | (0.02 | ) | (0.01 | ) | ||||||
Income (loss) from discontinued operations attributable to Ku6 Media Co., Ltd. ordinary shareholders per share — basic and diluted | (0.01 | ) | 0.00 | — | ||||||||
|
|
|
|
|
| |||||||
Loss attributable to Ku6 Media Co., Ltd. ordinary shareholders per share — basic and diluted | (0.01 | ) | (0.02 | ) | (0.01 | ) | ||||||
|
|
|
|
|
| |||||||
Loss per ADS – basic and diluted | ||||||||||||
Loss from continuing operations attributable to Ku6 Media Co., Ltd. ordinary shareholders per ADS — basic and diluted | (0.27 | ) | (1.71 | ) | (1.16 | ) | ||||||
Income (loss) from discontinued operations attributable to Ku6 Media Co., Ltd. ordinary shareholders per ADS — basic and diluted | (0.79 | ) | 0.04 | — | ||||||||
|
|
|
|
|
| |||||||
Loss attributable to Ku6 Media Co., Ltd. ordinary shareholders per ADS — basic and diluted | (1.06 | ) | (1.67 | ) | (1.16 | ) | ||||||
|
|
|
| �� |
|
| ||||||
Incremental ordinary shareshares with dilutive effect are calculated using the treasury stock method.method with respect to restricted shares and stock options. Under the treasury stock method, the proceeds from the assumed conversion of options and non-vested shares are used to repurchase outstanding ordinary shares using the average fair valueshare price for the period.
For all periods presented, all potentially dilutive shares of approximately 15 million, 1 millionsecurities associated with the Company’s convertible bond which was issued in Q2 2011 and 3 million were excludedextinguished in Q3 2011 (Note 1) and all stock options (Note 15) have not been reflected in the computationdilutive calculations pursuant to ASC 260, “Earnings Per Share,” due to the presence of diluteda net loss per share for these periodsin each period as their effectthe inclusion of such potential common shares would have beenbe anti-dilutive.
18. CONCENTRATIONS
(1) Dependence on Telecom Operators
The Company entered into a cooperative agreement with Shengyue, a wholly owned subsidiary of Shanda in 2011. Under this agreement, Shengyue is appointed as Ku6’s primary agency to secure advertisement from various advertisers. In 2011, 38% of net revenues ofwere derived from Shengyue and the Company are substantially derived from network service agreements with the Telecom Operators. These companies are entitled to a service and network fee for the transmission of wireless value-added services as well as for the billing and collection of services.expects that this percentage will increase in 2012. If the contractual relationshipsrelationship with one or more of the Telecom Operators in the PRC areShengyue is terminated or scaled-back, or if these companiesShengyue alter the network service agreementsagency agreement in a way that is adverse to the Company, the Company’s wireless value-added service businessrevenue would be adversely affected.
(2) Credit risk
As of December 31, 2010 and 2011, accounts receivable of the online advertising business are typically unsecured and are derived from the mobile phonerevenue earned from customers through China Mobile, China Unicom and China Telecom, the principal operators thatagencies in China. The risk with respect to accounts receivable is mitigated by credit evaluations the Company dealt withperforms on its customers and its ongoing monitoring process of outstanding balances. No individual customer accounted for more than 10% of net advertising revenues, or related receivables, during the yearsyear ended and as of December 31, 20072010. Shengyue accounted for 38% and 200875% of net revenues and 2009 werenet account receivables during the year ended and as follows:
| Year ended December 31, 2007 | Year ended December 31, 2008 | Year ended December 31, 2009 | ||||||||||||||||||||||
| Revenues | % | Revenues | % | Revenues | % | |||||||||||||||||||
| China Mobile | 29,921,502 | 49 | % | 24,352,344 | 45 | % | 10,074,902 | 29 | % | |||||||||||||||
| China Unicom | 12,789,026 | 21 | % | 10,775,358 | 20 | % | 5,068,739 | 15 | % | |||||||||||||||
| China Telecom | 5,054,984 | 8 | % | 5,070,996 | 9 | % | 4,405,260 | 13 | % | |||||||||||||||
| Year ended December 31, 2010 | Year ended December 31, 2011 | |||||||
Accounts receivable | 10,572,374 | 5,194,099 | ||||||
Allowance for doubtful accounts | (2,437,179 | ) | (4,416,706 | ) | ||||
|
|
|
| |||||
Accounts receivable, net of allowance for doubtful accounts | 8,135,195 | 777,393 | ||||||
|
|
|
| |||||
F-39
| December 31, 2008 | December 31, 2009 | |||||||||||||||
| Accounts receivable | % | Accounts receivable | % | |||||||||||||
| China Mobile | 5,458,929 | 43 | % | 744,428 | 23 | % | ||||||||||
| China Unicom | 2,632,764 | 21 | % | 678,640 | 21 | % | ||||||||||
| China Telecom | 1,007,467 | 8 | % | 228,914 | 7 | % | ||||||||||
Movement of allowance for doubtful accounts
| Year ended | Year ended | |||||||
| December 31, 2008 | December 31, 2009 | |||||||
| Balance at beginning of the period | 699,525 | 826,026 | ||||||
| Consolidation of Seed Music | — | 425,065 | ||||||
| Provisions | 1,087,565 | 3,710,897 | ||||||
| Reversed | (190,860 | ) | (373,943 | ) | ||||
| Written off | (770,204 | ) | (969,918 | ) | ||||
| Balance at the end of the period | 826,026 | 3,618,127 | ||||||
The Company has not presented movements in the allowance for doubtful accounts for 2009 in the below table as such activity relates solely to discontinued operations for which there are no remaining receivable or allowance amounts.
| Year ended December 31, 2010 | Year ended December 31, 2011 | |||||||
Balance at beginning of the year | 4,015,145 | 2,437,179 | ||||||
Acquisition of Ku6 | 101,484 | — | ||||||
Provisions | 1,976,053 | 3,637,147 | ||||||
Reversed | (501,485 | ) | (177,321 | ) | ||||
Written off | (53,563 | ) | — | |||||
Transferred out due to disposal of WVAS and recorded music businesses | (3,100,455 | ) | — | |||||
Transferred out due to disposal of Yisheng | — | (1,480,299 | ) | |||||
|
|
|
| |||||
Balance at the end of the year | 2,437,179 | 4,416,706 | ||||||
|
|
|
| |||||
As part of the Group’s change in the business strategy (Note 1), the Company laid off majority of its sales force and appointed Shengyue as its primary advertisement agency. As a result of this change, the relationship with some of previous advertisement customers was terminated and the Group provided additional allowance for doubtful accounts to reflect the expected uncollectibilty.
19. MAINLAND CHINA CONTRIBUTION PLAN AND STATUTORY RESERVES
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 incomeloss for such employee benefits were $2,434,409, $2,157,825$2,692,679, $3,660,438 and $2,583,079$2,554,561 for the years ended December 31, 2007, 20082009, 2010 and 2009,2011, respectively.
20. COMMITMENTS AND CONTINGENCIES
Operating leases as lessee
The Company leases certainentered into leasing arrangements relating to office premises under non-cancelable leases, of which the principal one expiresarea and internet bandwidth in 2009. Rental expense under operating leases2009, 2010 and 2011. Leasing expenses for the years ended December 31, 2007, 20082009, 2010 and 20092011 were $1,862,610 $1,931,102$2,768,340, $11,785,743 and $1,829,715,$10,614,276, respectively.
Future minimum lease payments under non-cancelablenon-cancellable operating lease agreements are as follows:
| December 31 | ||||
| 2010 | 492,337 | |||
| 2011 | 262,538 | |||
| 2012 | 107,139 | |||
| Total | 862,014 | |||
Within 1 year | 6,132,154 | |||
Between 1 and 2 years | 429,706 | |||
Between 2 and 3 years | — | |||
Between 3 and 4 years | — | |||
Total | 6,561,860 | |||
F-40
| December 31, | ||||
| 2010 | 851,723 | |||
| 2011 | 872,586 | |||
| 2012 | 299,554 | |||
| Total | 2,023,863 | |||
The Company has recorded an accrual balance of $2,683,968 in Freeland Music from 60% to 56%, at“Accrued expenses and other liabilities” in the selling shareholders’ option, contingent upon the attainmentconsolidated balance sheet as of specific earnings objectives for the twelve-month period ending December 31, 2009. As Freeland did not achieve2011 (Note 12). The accrual was based on judgments handed down by the specified earnings target, the Companycourt and out-of-court settlements as of or after December 31, 2011 but related to alleged copyright infringement arising before December 31, 2011. The accrual was not required need to make additional payment.
There are obligatedno accruals for any additional losses related to transferunasserted claims or any other amounts.
Contingencies
The Company accounts for loss contingencies in accordance with ASC 450, “Contingencies,” and other related guidance. Set forth below is a description of certain shares or make cash paymentsloss contingencies as well as the opinion of management as to the Company. Althoughlikelihood of loss.
Current PRC laws and regulations place certain restrictions on foreign ownership of companies that engage in Internet business, including the maximum contingent consideration is material toprovision 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 payment of such amount is considered remote. The Company does not expect to make any contingent payments based onincorporated in the current performance of Seed Music.
Under the equity pledge agreements among Hurray!, Ku6our PRC subsidiaries, certain of our consolidated affiliated entities and the shareholders of Ku6 datedour 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. However, according to the PRC Property Rights Law, which became effective as of October 1, 2007, a pledge is not valid unless it is registered with the relevant local administration for industry and commerce. Ku6 Information Technology and Tianjin Ku6 Network have completed the registration of equity pledges on November 26, 2009 by issuing an aggregate13, 2008 and January 20, 2012, respectively. Ku6 Cultural and Tianjin information are in the process of 723,684,204 ordinary shares,registering the relevant equity pledges with the local administration for industry and commerce for the benefit of which 44,438,100 will be represented by American Depositary Sharesour PRC subsidiaries.
Beijing Information, Tianjin Information, Ku6 Cultural, Yisheng and Ku6 Network hold the licenses and permits necessary to conduct our online video, online advertising and related businesses in China. In the opinion of management, (i) the ownership structure of the Company, each representing 100 ordinary sharesits wholly owned PRC subsidiaries and the consolidated affiliated entities in the PRC are in compliance with existing PRC laws and regulations; (ii) the contractual arrangements with the consolidated affiliated entities in the PRC are valid and binding, and will not result in any violation of PRC laws or regulations currently in effect; and (iii) the Company’s business operations are in compliance with existing PRC laws and regulations in all material respects. However, there are substantial uncertainties regarding the interpretation and application of current and future PRC laws and regulations. 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. The total fair valueCompany 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 shares issued approximates $28.9 million based onrules. However, there are substantial uncertainties regarding the share price on the closing date. After the closinginterpretation and application of the acquisitionMOFCOM 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 Ku6,management and the Company’s equity interestPRC 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 Hurray! was dilutedthe 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 41.97%. Atrestructure its ownership structure, discontinuation or restriction of operations in the datePRC, or invalidation of issuance ofthe agreements that the wholly owned PRC subsidiaries have entered into with the consolidated affiliated entities in the PRC and their shareholders.
In such case, the Company may not be able to operate or control 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 initial purchase accounting was not complete.
Company (including restrictions on the Company to carry out business).
F-41If the consolidated affiliated entities in the PRC and their shareholders fail to perform their respective obligations under the current contractual arrangements, the Company may have to incur substantial costs and expend significant resources to enforce those arrangements and rely on legal remedies under PRC laws. The PRC laws, rules and regulations are relatively new, and because of the limited volume of published decisions and their non-binding nature, the interpretation and enforcement of these laws, rules and regulations involve substantial uncertainties. These uncertainties may impede the ability of the Company to enforce these contractual arrangements, or suffer significant delay or other obstacles in the process of enforcing these contractual arrangements and may materially and adversely affect the results of operations and the financial position of the Company.
In the opinion of management, the likelihood of loss in respect of the Company’s current ownership structure or the contractual arrangements with the consolidated affiliated entities in the PRC is remote.
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 reserve.reserves. The statutory general reserve fund requires annual appropriations of 10% of net after-tax income shouldto 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 $19.3$56.1 million, or 35.4%110.3% of the Company’s total consolidated net assets as of December 31, 2009.2011. Even though the Company currently does not require any such dividends, loans or advances from the PRC subsidiaries and affiliates for working capital and other funding purposes as all business is principally conducted inside the PRC, the Company may in the future require additional cash resources from our PRC subsidiaries and affiliates due to changes in business conditions, to fund future acquisitions and developments, or merely to declare and pay dividends to or distributions to the Company shareholder.Company’s ordinary shareholders. Accordingly, the Company has included Schedule I in accordance with Regulation S-X promulgated by the United States Securities and Exchange Commission.
F-42
)
ADDITIONAL INFORMATION — FINANCIAL STATEMENT SCHEDULE I
BALANCE SHEET
| December 31, 2010 | December 31, 2011 | |||||||
| (in U.S. dollars, except number of shares) | ||||||||
Assets | ||||||||
Current assets: | ||||||||
Cash | 11,048,500 | 7,754,457 | ||||||
Prepaid expenses and other current assets | 241,017 | 434,230 | ||||||
Amount due from related parties | 3,841,766 | 19,534,641 | ||||||
|
|
|
| |||||
Total current assets | 15,131,283 | 27,723,328 | ||||||
Investments in subsidiaries and variable interest entities | 31,959,213 | 27,155,056 | ||||||
|
|
|
| |||||
Total assets | 47,090,496 | 54,878,384 | ||||||
|
|
|
| |||||
Liabilities and shareholders’ equity | ||||||||
Accrued expenses and other current liabilities | 1,266,380 | 942,423 | ||||||
Amounts due to subsidiaries and variable interest entities | 77,833 | 2,707,933 | ||||||
Amount due to related parties | — | 375,000 | ||||||
|
|
|
| |||||
Total current liabilities | 1,344,213 | 4,025,356 | ||||||
|
|
|
| |||||
Shareholders’ equity: | ||||||||
Ordinary shares ($0.00005 par value; 12,000,000,000 shares authorized; 3,481,174,498 and 5,019,786,036 shares issued and outstanding as of December 31, 2010 and 2011, respectively) | 174,008 | 250,939 | ||||||
Additional paid-in capital | 130,100,153 | 184,874,259 | ||||||
Accumulated deficit | (83,105,464 | ) | (132,449,371 | ) | ||||
Accumulated other comprehensive income (loss) | (1,422,414 | ) | (1,822,799 | ) | ||||
|
|
|
| |||||
Total shareholders’ equity | 45,746,283 | 50,853,028 | ||||||
|
|
|
| |||||
Total liabilities and shareholders’ equity | 47,090,496 | 54,878,384 | ||||||
|
|
|
| |||||
KU6 MEDIA CO., LTD. (FOMERLY KNOWN AS HURRAY! HOLDING CO., LTD.BALANCE SHEETS(In U.S. dollars)
| December 31, 2008 | December 31, 2009 | |||||||
| (in U.S. dollars, except number of shares) | ||||||||
Assets | ||||||||
| Current assets: | ||||||||
| Cash | 39,519,423 | 23,760,844 | ||||||
| Short term investments | — | 10,000,000 | ||||||
| Prepaid expenses and other current assets | 168,233 | 134,436 | ||||||
Total current assets | 39,687,656 | 33,895,280 | ||||||
| Receivable on disposal of subsidiary | 46,860 | — | ||||||
| Prepaid investment cost | 1,907,400 | — | ||||||
| Investment at cost | 600,038 | — | ||||||
| Investments in subsidiaries and variable interest entities | 35,131,851 | 22,158,284 | ||||||
| Investment in equity affiliate | 150,000 | — | ||||||
Total assets | $ | 77,523,805 | 56,053,564 | |||||
Liabilities and shareholders’ equity | ||||||||
| Accrued expenses and other current liabilities | 272,844 | 1,280,994 | ||||||
| Amounts due to subsidiaries and variable interest entities | 341,676 | 376,605 | ||||||
Total current liabilities | 614,520 | 1,657,599 | ||||||
| Shareholders’ equity: | ||||||||
| Ordinary shares ($0.00005 par value; 4,560,000,000 shares authorized; 2,193,343,740 and 2,200,194,040 shares issued and outstanding as of December 31, 2008 and December 31, 2009, respectively) | 109,617 | 109,959 | ||||||
| Additional paid-in capital | 75,012,693 | 75,190,411 | ||||||
| Accumulated deficit | (8,200,339 | ) | (30,858,231 | ) | ||||
| Accumulated other comprehensive income | 9,987,314 | 9,953,826 | ||||||
Total shareholders’ equity | 76,909,285 | 54,395,965 | ||||||
Total liabilities and shareholders’ equity | 77,523,805 | 56,053,564 | ||||||
)
F-43
ADDITIONAL INFORMATION — FINANCIAL STATEMENT SCHEDULE I
STATEMENT OF OPERATIONS
| Year ended December 31, 2009 | Year ended December 31, 2010 | Year ended December 31, 2011 | ||||||||||
| (in U.S. dollars, except number of shares) | ||||||||||||
Operating expenses: | ||||||||||||
Product development | — | 150,584 | 603,879 | |||||||||
Selling and marketing | 118,521 | 160,231 | (31,880 | ) | ||||||||
General and administrative | 5,520,453 | 4,072,134 | 2,433,905 | |||||||||
|
|
|
|
|
| |||||||
Total operating expenses | 5,638,974 | 4,382,949 | 3,005,904 | |||||||||
|
|
|
|
|
| |||||||
Loss from operations | (5,638,974 | ) | (4,382,949 | ) | (3,005,904 | ) | ||||||
Interest income | 355,616 | 9,404 | 112,416 | |||||||||
Interest expense | — | — | (375,000 | ) | ||||||||
Other income | — | 205,043 | — | |||||||||
Foreign exchange loss (gain) | 1,085 | (38,767 | ) | (9 | ) | |||||||
Gain from disposal of subsidiary | 221,899 | — | — | |||||||||
Equity in loss of subsidiaries, VIEs and affiliate | (18,334,487 | ) | (47,302,995 | ) | (46,075,410 | ) | ||||||
|
|
|
|
|
| |||||||
Net loss | (23,394,861 | ) | (51,510,264 | ) | (49,343,907 | ) | ||||||
|
|
|
|
|
| |||||||
KU6 MEDIA CO., LTD. (FOMERLY KNOWN AS HURRAY! HOLDING CO., LTD.STATEMENT OF OPERATIONS(In U.S. dollars)
| Year ended | Year ended | Year ended | ||||||||||
| December 31, 2007 | December 31, 2008 | December 31,2009 | ||||||||||
| (in U.S. dollars, except number of shares) | ||||||||||||
Operating expenses: | ||||||||||||
| Product development | 9,385 | 105,283 | — | |||||||||
| Selling and marketing | 286,885 | 622,846 | 118,521 | |||||||||
| General and administrative | 2,440,417 | 1,666,532 | 5,520,453 | |||||||||
| Total operating expenses | 2,736,687 | 2,394,661 | 5,638,974 | |||||||||
Loss from operations | (2,736,687 | ) | (2,394,661 | ) | (5,638,974 | ) | ||||||
| Interest income | 2,082,629 | 1,429,837 | 355,616 | |||||||||
| Interest expense | (179,062 | ) | — | — | ||||||||
| Other income | 105,485 | 5,000,000 | — | |||||||||
| Foreign exchange loss (gain) | — | (8,990,067 | ) | 1,085 | ||||||||
| Gain from disposal of subsidiary | 192,943 | 412,530 | 221,899 | |||||||||
| Equity in loss of subsidiaries, VIEs and affiliate | (41,415,503 | ) | (7,410,235 | ) | (17,597,518 | ) | ||||||
Net loss | (41,950,195 | ) | (11,952,596 | ) | (22,657,892 | ) | ||||||
)
F-44
STATEMENTS OF CASH FLOWS(In U.S. dollars)
| Year ended | Year ended December | Year ended | ||||||||||
| December 31, 2007 | 31, 2008 | December 31, 2009 | ||||||||||
| (In U.S. dollars) | ||||||||||||
Operating activities: | ||||||||||||
| Net loss | (41,950,195 | ) | (11,952,596 | ) | (22,657,892 | ) | ||||||
| Adjustments for: | ||||||||||||
| Stock-based compensation | 442,975 | 945,282 | 169,310 | |||||||||
| Equity in profit of subsidiary companies | 41,415,503 | 7,410,235 | 17,447,518 | |||||||||
| Impairment for investment in equity affiliate | — | — | 150,000 | |||||||||
| Gain from disposal of subsidiary | (192,943 | ) | (412,530 | ) | (221,899 | ) | ||||||
| Receivable from disposal of subsidiary | (3,186,887 | ) | — | — | ||||||||
| Gain on reduction of acquisition payable | — | (5,000,000 | ) | — | ||||||||
| Prepaid expenses and other current assets | 226,001 | 56,064 | 40,047 | |||||||||
| Amount due from related parties | 5,843,380 | — | — | |||||||||
| Other payables and accruals | 403,512 | (322,804 | ) | 1,008,149 | ||||||||
| Amount due to related parties | 530,756 | (189,080 | ) | 34,929 | ||||||||
Net cash provided by (used in) operating activities | 3,532,102 | (9,465,429 | ) | (4,029,838 | ) | |||||||
Investing activities: | ||||||||||||
| Increase of short-term investments | — | — | (10,000,000 | ) | ||||||||
| Proceeds from disposal of subsidiary | — | 4,517,070 | 268,759 | |||||||||
| Payments related to acquisitions consummated | (2,833,658 | ) | (1,987,930 | ) | — | |||||||
| Payments related to acquisition not yet consummated | — | (1,907,400 | ) | — | ||||||||
| Investment in cost affiliate | — | (600,038 | ) | — | ||||||||
| Investment in subsidiary | (2,000,000 | ) | ||||||||||
| Purchase of equity affiliate | (150,000 | ) | — | — | ||||||||
Net cash used in (provided by) investing activities | (2,983,658 | ) | 21,702 | (11,731,241 | ) | |||||||
Financing activities: | ||||||||||||
| Proceeds from exercise of options | 16,334 | 1,500 | 2,500 | |||||||||
Net cash provided by financing activities | 16,334 | 1,500 | 2,500 | |||||||||
Effect of exchange rate changes on cash and cash equivalents | — | (99,879 | ) | — | ||||||||
Net increase (decrease) in cash and cash equivalents | 564,778 | (9,442,227 | ) | (15,758,579 | ) | |||||||
Cash and cash equivalents, beginning of year | 48,496,751 | 49,061,529 | 39,519,423 | |||||||||
Cash and cash equivalents, end of the year | 49,061,529 | 39,519,423 | 23,760,844 | |||||||||
| Year ended December 31, 2009 | Year ended December 31, 2010 | Year ended December 31, 2011 | ||||||||||
| (In U.S. dollars) | ||||||||||||
Operating activities: | ||||||||||||
Net loss | (23,394,861 | ) | (51,510,264 | ) | (49,343,907 | ) | ||||||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||||||
Stock-based compensation | 169,310 | 1,891,931 | 1,231,919 | |||||||||
Stock-based compensation cost in relation to disposition of Yisheng | — | — | 522,251 | |||||||||
Equity in profit of subsidiary companies | 18,334,487 | 47,302,995 | 46,075,410 | |||||||||
Gain from disposal of subsidiary | (221,899 | ) | — | — | ||||||||
Prepaid expenses and other current assets | 40,047 | (106,581 | ) | (193,214 | ) | |||||||
Amount due from related parties | — | (942,919 | ) | (1,692,875 | ) | |||||||
Other payables and accruals | 1,008,149 | 4,738 | (323,957 | ) | ||||||||
Amounts due to subsidiaries and variable interest entities | 34,929 | 2,381 | (77,833 | ) | ||||||||
Amounts due to related parties | — | — | 375,000 | |||||||||
|
|
|
|
|
| |||||||
Net cash provided by (used in) operating activities | (4,029,838 | ) | (3,357,719 | ) | (3,427,206 | ) | ||||||
|
|
|
|
|
| |||||||
Investing activities: | ||||||||||||
Decrease/(Increase) of short-term investments | (10,000,000 | ) | 10,000,000 | — | ||||||||
Proceeds from disposal of subsidiary | 268,759 | 37,243,901 | — | |||||||||
Loan to subsidiaries | — | (53,418,876 | ) | (5,762,569 | ) | |||||||
Loan to related parties | — | (3,200,000 | ) | (14,108,019 | ) | |||||||
Investment in subsidiary | (2,000,000 | ) | — | (30,000,000 | ) | |||||||
Purchase of equity affiliate | — | — | — | |||||||||
|
|
|
|
|
| |||||||
Net cash used in investing activities | (11,731,241 | ) | (9,374,975 | ) | (49,870,588 | ) | ||||||
|
|
|
|
|
| |||||||
Financing activities: | ||||||||||||
Proceeds from exercise of options | 2,500 | 20,350 | 3,750 | |||||||||
Proceeds from issuance of ordinary shares to Shanda | — | — | 50,000,000 | |||||||||
Proceeds from issuance of Convertible Bond to Shanda | — | — | 50,000,000 | |||||||||
Cash paid for redemption of Convertible Bond to Shanda | — | — | (50,000,000 | ) | ||||||||
|
|
|
|
|
| |||||||
Net cash provided by financing activities | 2,500 | 20,350 | 50,003,750 | |||||||||
|
|
|
|
|
| |||||||
Effect of exchange rate changes on cash and cash equivalents | — | — | — | |||||||||
Net decrease in cash and cash equivalents | (15,758,579 | ) | (12,712,344 | ) | (3,294,043 | ) | ||||||
Cash and cash equivalents, beginning of year | 39,519,423 | 23,760,844 | 11,048,500 | |||||||||
|
|
|
|
|
| |||||||
Cash and cash equivalents, end of the year | 23,760,844 | 11,048,500 | 7,754,457 | |||||||||
|
|
|
|
|
| |||||||
Note
Basis for Preparation
The Financial Information of the Parent Company has been prepared using the same accounting policies as set out in the Company’s consolidated financial statements except that the Company has used the equity method to account for its investment in its subsidiaries and its variable interest entities.
F-45F-60