UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
(Mark One)
o | REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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o | SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number: 000-51116
Ku6 Media Co., Ltd. |
(Exact name of Registrant as specified in its charter) |
Securities registered or to be registered pursuant to Section 12(b) of the
* Not for trading, but only in connection with the listing on the NASDAQ Global Market of American Depositary Shares, each representing 100 Ordinary Shares
Securities registered or to be registered pursuant to Section 12(g) of the
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes x No
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 o Yes x No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow. o Item 17 o Item 18
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by
o Yes o No
Except where the context otherwise requires and for purposes of this annual report on Form 20-F only:
· “ADSs” refers to our American depositary shares, each of which represents 100 ordinary shares;
· “Cayman Companies Law” refers to the Companies Law
· “China” and the “PRC” refer to the People’s Republic of China, excluding, for the purposes of this annual report on Form 20-F only, Taiwan and the special administrative regions of Hong Kong and Macau;
· “Huzhong” refers to Huzhong Advertising (Shanghai) Ltd., an independent third party; ·“Ku6 Holding” refers to Ku6 Holding Limited and its subsidiaries, affiliates and predecessor entities; ·“Mr. Xu” refers to Xudong Xu, our largest shareholder; ·“New Shengyue” refers to Shanghai Shengyue Advertising Co., Ltd., an independent third party, with respect to our agreements with it on or after April 1, 2014; ·“Old Shengyue” refers to Shanghai Shengyue Advertising Co., Ltd., then wholly owned by Shanda Interactive, with respect to our agreements with it on or prior to March 31, 2014;
· “ordinary shares” refers to our ordinary shares, par value $0.00005 per share;
· “our consolidated affiliated entities” refers to Ku6 (Beijing) Information Technology Co., Ltd., or Ku6 Information Technology, Tianjin Ku6 Zheng Yuan Information Technology Co., Ltd., or Tianjin Ku6 Zheng Yuan, Ku6 (Beijing) Cultural Media Co., Ltd., or Ku6 Cultural, and Tianjin Ku6 Network Communication Technology Co., Ltd., or Tianjin Ku6 Network;
· “our PRC subsidiaries” refers to Ku6 (Beijing) Technology Co., Ltd., or Beijing WFOE, WeiMoSanYi (Tianjin) Technology Co., Ltd., or Tianjin WFOE, and Kusheng (Tianjin) Technology Co., Ltd., or Tianjin Ku6 Network WFOE;
· “Qinhe” refers to Shanghai Qinhe Internet Technology Software Development Co., Ltd., a company controlled by Mr. Xu and a related party; ·“RMB” and “Renminbi” refer to the legal currency of China;
· “Shanda Interactive” refers to Shanda Interactive Entertainment Limited, a Cayman Islands company;
· “Shanda ·“Share Purchase Transaction” refers to the purchase of 1,938,360,784 of our ordinary shares by Mr. Xu from Shanda Media, our then controlling shareholder, which was completed on April 3, 2014. See Item 4.A. “History and
· “we,” “us,” “our company” and “our” refer to Ku6 Media Co., Ltd. and its subsidiaries, consolidated affiliated entities and predecessor entities.
This annual report on Form 20-F contains forward-looking statements that are based on our current expectations, assumptions, estimates and projections about us and our industry. All statements other than statements of historical fact in this form are forward-looking statements. These forward-looking statements can be identified by words or phrases such as “may,” “will,” “expect,” “anticipate,” “estimate,” “plan,” “believe,” “is/are likely to” or other similar expressions. The forward-looking statements included in this form relate to, among others:
· our goals and strategies;
· our future business development, financial condition and results of operations;
· our projected revenues, earnings, profits and other estimated financial information;
· expected changes in our margins and certain costs or expenditures;
· expected continued acceptance of our content;
· our plans to expand and diversify the sources of our revenues;
· expected changes in the respective shares of our revenues from particular sources;
· our plans for staffing, research and development and marketing;
· our plans to launch new products and services;
· our plans for strategic partnerships with other businesses;
· our acquisition and divestiture strategy, and our ability to successfully integrate past or future acquisitions with our existing operations and complete planned divestitures;
· competition in the PRC online video industry;
· the outcome of ongoing, or any future, litigation or arbitration;
· changes in PRC governmental preferential tax treatment and financial incentives we currently qualify for and expect to qualify for; and
· PRC governmental policies relating to media and the Internet and Internet content providers and to the provision of advertising over the Internet.
These forward-looking statements involve various risks and uncertainties. Although we believe that our expectations expressed in these
Item 1.Identity of Directors, Senior Management and Advisors
Not Applicable.
Item 2. Offer Statistics and Expected Timetable
Not Applicable.
A.Selected Financial Data
The following table presents certain selected consolidated financial information for our business. You should read the following information in conjunction with our audited consolidated financial statements, the notes thereto and Item 5. “Operating and Financial Review and Prospects” included elsewhere in this annual report on Form 20-F. The data as of December 31,
In May 2010, we sold all of our 51% interest in Beijing Huayi Brothers Music Co., Ltd., or Huayi Music, to Huayi Brothers Media Corporation. In August 2010, we completed the disposal of our remaining wireless value-added services, or WVAS, and recorded music businesses to Shanda Interactive and also acquired from Shanda Interactive the control of Shanghai Yisheng Network Technology Co., Ltd., or Yisheng, an online audio business. The initial acquisition of the online audio business from Shanda Interactive was accounted for as an acquisition under common control and the disposal of the WVAS and recorded music businesses, including Huayi Music, was accounted for as discontinued operations in accordance with U.S. GAAP in our consolidated financial statements. In August 2011, we disposed of a significant interest in Yisheng and retained a 20% interest. The disposal gain was recognized as an increase in additional paid-in capital for the year ended December 31, 2011.
Exchange Rate Information
We present our historical consolidated financial statements in U.S. dollars. Certain contractual amounts in Renminbi described in this annual report are translated into U.S. dollar amounts solely for the convenience of the reader. Except as otherwise specified, these amounts are translated at a rate of
The following table sets forth information regarding exchange rates between Renminbi and U.S. dollars for the periods indicated:
Source: Federal Reserve H.10 Statistical Release
(1) Annual averages were calculated by using the average of the exchange rates on the last day of each month during the relevant year. Monthly averages were calculated by using the average of the daily rates during the relevant month. B.Capitalization and Indebtedness
Not Applicable. C.Reasons for the Offer and Use of Proceeds
Not Applicable.
D.Risk Factors Risks Related to Our Business There is substantial doubt as to our ability to continue as a going concern. Substantial doubt exists as to our ability to continue as a going concern. See Item 5.B. “Liquidity and Capital Resources—Liquidity and Going Concern.” We have incurred significant net losses and negative cash flows from operations in recent years. For the years ended December 31, 2012, 2013 and 2014, our net loss was $9.5 million, $34.4 million and $10.7 million, respectively. As Our new business models may not be able to generate sufficient revenues and operating cash flows. Historically, we derived substantially all of our revenues from online advertising services, for which we collect service fees from advertisers through our advertising agencies. From April 2011 to March 2014, we relied on Old Shengyue, an affiliate wholly owned by Shanda Interactive during that period, as our primary advertising agency, which managed our sales to, and collected payments from, substantially all of our advertisers. Our advertising agency agreement with Old Shengyue expired on March 31, 2014, and we generated advertising revenue of $2.7 million from Old Shengyue during the first quarter of 2014 prior to its expiration. As a result of our management’s review and adjustment of our business strategies after the Share Purchase Transaction, this agreement was not further renewed and we started to explore new revenue sources, including advertising agreements with independent third parties and cooperation with Qinhe. In April 2014, we entered into a new advertising agency agreement with New Shengyue, which is no longer owned by Shanda Interactive and is an independent third party. In August 2014, we terminated this agreement with New Shengyue and entered into another new advertising agency agreement with Huzhong, an independent third party. We generated advertising revenue of $0.5 million in 2014 from New Shengyue. Pursuant to our agreement with Huzhong, Huzhong will act as our exclusive advertising agency for standard media resources and non-exclusive advertising agency for highly-interactive advertising resources. Under this agreement, we guarantee a certain amount of web traffic per day for webpages on which Huzhong posts advertisements, and in return, Huzhong guarantees to us a minimum amount of advertising revenues per day. If we fail to meet the web traffic target, the minimum amount guaranteed by Huzhong will be proportionally adjusted for the shortfall. Huzhong agreed to prepay 50% of the minimum guaranteed amounts within five business days prior to the beginning of each month and settle the balance within five business days after the end of each month. This advertising agency agreement with Huzhong will expire on December 31, 2017. We generated revenue of $2.8 million under our agreement with Huzhong from August 29, 2014 to December 31, 2014. Going forward, we will continue to rely In addition, we explored new revenue models in cooperation with Qinhe, a company controlled by Mr. Xu, our largest shareholder after the Share Purchase Transaction. In April 2014, we started to provide interactive entertainment marketing services to iSpeak, a social platform that allows users to engage in real-time online group activities through voice, text and video. Under our cooperation agreement with Qinhe, which operates the iSpeak platform, Qinhe will share a certain percentage of the revenues that it generates from the viewers who visit the iSpeak platform through advertisements on our website. Users on the Our cooperation with Qinhe is relatively new and subject to change from time to time. In September 2014, we amended the interactive entertainment marketing services agreement with Qinhe. Pursuant to the amended agreement, Qinhe agreed to pay certain additional guaranteed revenue amounts from July 2014 to December 2014, and the term of this agreement was extended to December 31, 2015. Other terms of the original agreements, including the revenue sharing arrangement, remained the same. On March 30, 2015, we further amended this agreement with Qinhe. Pursuant to the further amended cooperation agreement, the revenue sharing arrangement in the original agreement will be reinstated without the additional guaranteed revenue amounts. Any further changes to this agreement may affect our ability to generate revenues from Qinhe. The success of our As our revenue models for our advertising and marketing services are still relatively new and constantly changing, we cannot assure you that these arrangements will be successful or that we will be able to generate sufficient revenue and cash flows from these revenue models in the future. If We may not be able to continue to receive support from our major shareholders. Our online advertising business had benefited significantly from Shanda Interactive’s brand name and strong market position in China prior to the Share Purchase Transaction. From April 2011 to March 2014, we relied on Old Shengyue, an affiliate wholly owned by Shanda Interactive during that period, as our sole advertising agency, which managed our sales to, and collected payments from, substantially all of our advertisers. Our advertising agency agreement with Old Shengyue, as previously renewed, expired on March 31, 2014. As a result of our management’s review and adjustment of our business strategies after the Share Purchase Transaction, this agreement was not further renewed. Shanda Interactive also disposed of their equity interest in Old Shengyue after the Share Purchase Transaction. We cannot assure you that we will be able to receive any support from Shanda Interactive for our operations in the future. We have relied on Shanda Interactive to finance our capital needs, including the issuance of 1,538,461,538 ordinary shares to Shanda Media Group Limited, or Shanda Media, a wholly owned subsidiary of Shanda Interactive, for an aggregate purchase price of $50.0 million in April 2011, and the issuance of $50.0 million aggregate principal amount of senior convertible bonds to Shanda Media in June 2011. Furthermore, in connection with the Share Purchase Transaction, Shanda Interactive, through its affiliate, extended loans of RMB20.0 million to us in April 2014 and waived our obligation to repay the loan. In May 2014, Shanda Interactive, through its affiliates, extended loans of RMB21.4 million to us and waived our obligation to repay this loan. We have treated these transactions as capital contributions. See Item 7.B. “Related Party Transactions—Funding from Shanda Interactive.” As Shanda Interactive ceased to be our largest shareholder after the Share Purchase Transaction, we cannot assure you that we will be able to obtain additional financings from Shanda Interactive under terms acceptable to us or at all in the future.
In addition, we have relied and will continue to rely on Mr. Xu to operate our business and to finance our capital needs. In April 2014, as a result of our management’s review and adjustment of our business strategies after the Share Purchase Transaction, we adopted new revenue models in cooperation with Qinhe, a company controlled by Mr. Xu. In March 2015, we obtained loans from Mr. Xu, our largest shareholder, in the amount of RMB30.0 million. We cannot assure you that we will be able to continue to obtain additional financings from Mr. Xu under terms acceptable to us or at all in the future. Our cooperation arrangements with Qinhe are subject to considerable uncertainties. Historically, we derived substantially all of our revenues from online advertising services, for which we collect service fees from advertisers through our advertising agencies. In April 2014, as a result of our management’s review and adjustment of our business strategies after the Share Purchase Transaction, we adopted new revenue models in cooperation with Qinhe, a company controlled by Mr. Xu, our largest shareholder. Currently, we provide interactive entertainment marketing services to Qinhe. Under the relevant agreement, Qinhe will share with us a certain percentage of the revenues or profits that it generates from the viewers who visit its iSpeak platform and access Qinhe’s media content through the advertisements on our website. As a result, revenues we generate under these agreements will depend on the performance of the iSpeak platform operated by Qinhe, which will be affected by factors beyond our control. Performance of the iSpeak platform may be affected by, among others, Qinhe’s ability to: successfully monetize the user base of iSpeak; offer popular virtual items on the iSpeak platform; attract new users, retain and expand paying users, and encourage additional purchases by its paying users for the iSpeak platform; develop innovative technologies in response to user demand; and integrate new devices, platforms and operating systems. Our history with Qinhe is very short and the form of cooperation between Qinhe and us continues to change. The level of information that is available for Qinhe, a privately held company, is highly limited. Therefore, it is very difficult to effectively assess our future prospects with respect to our cooperation with Qinhe. You should consider our business and prospects in light of the risks and considerable uncertainties with respect to such arrangements. We require a significant amount of cash to fund our operations. We cannot assure you that we can meet our working capital requirements or other capital needs through improved operating
The operation of an online user-generated content, or UGC, video business requires continuous, substantial investment in content, technology, talent and infrastructure. In order to implement our development strategies to expand our infrastructure and optimize our services across Internet-enabled devices, and further expand and diversify our revenue sources, we may incur additional capital needs in the future. We will also need to fund our research and development activities in order to remain competitive on cost and technology. We
We cannot assure you that we can meet our working capital requirements or other capital needs through additional financings in
If we cannot meet our liquidity needs through improved operating results, we may need to obtain financings from financial institutions or issue debt securities.
· our future business development, financial condition and results of operations;
· changes in financial market conditions or our business condition that could limit our access to existing credit facilities or make new financings more costly or even unfeasible; ·changes in China’s currency exchange control regulations that could limit our ability to access cash in China to meet liquidity requirements for our operations in China or elsewhere; ·general market conditions for financing activities by companies in our industry; and
· macroeconomic, political and other conditions in China and elsewhere.
In the past, Shanda Interactive and Mr. Xu provided debt and equity financings for us in various situations. In March 2015, we obtained loans from Mr. Xu, our largest shareholder, in the amount of RMB30.0 million. However, we may not receive any support from Shanda Interactive and Mr. Xu in the future. See “—We may not be able to continue to receive support from our major shareholders.”Furthermore, the report of our independent registered public accounting firm expresses substantial doubt about our ability to continue as a going concern. This could impair our ability to finance our operations through the sale of equity, issuance of debt, or other financing alternatives. In the absence of support from our major shareholders, there is no assurance that we will be able to independently obtain any financing from any third party on terms acceptable to us or at all. If we cannot obtain sufficient funding to meet our working capital requirements or other capital expenditure needs, We have a history of losses, and we may be unable to achieve or sustain profitability.
We incurred net losses in each of the fiscal years from
· growth or decline of the online video
· the transition from long-form professional content to short-form UGC;
· the continued growth and maintenance of our user base;
· our ability to control our costs and
· our ability to provide new advertising services to meet the demands of our advertising
·brand advertisers’ allocation of more budgets to online video industry. Our ability to achieve profitability also depends on the success of our new Despite our cost reduction measures, we may continue to incur net losses in the future due to our continued investments in content, technology, bandwidth and talent. If we cannot The report of our independent registered public accounting firm expresses substantial doubt about our ability to continue as a going concern. Our independent registered public accounting firm indicated in its reports on our financial statements for the fiscal years ended December 31, 2013and 2014 that conditions exist that raise substantial doubt about our ability to continue as a going concern due to our working capital deficit and the uncertainty relating to the new business models. A “going concern” opinion could impair investor perceptions and our ability to finance our operations through the sale of equity, incurring debt, or other financing alternatives. Our ability to continue as a going concern will depend upon many factors beyond our control, including the availability and terms of future funding, growth in revenues from our agreements with Qinhe and Huzhong and the effectiveness of our cost reduction measures. See “—There is substantial doubt as to our ability to continue as going concern.” If we are unable to achieve these goals, our business would be jeopardized and we may not be able to continue. If we ceased operations, it is likely that all of our investors would lose their investment. We may implement further restructuring of our business, including through strategic acquisitions, in the future. In order to improve our business operations, we may implement further restructuring of our business in the future, including through strategic acquisitions. There could be a material adverse effect on our business, results of operations and prospect if we fail to successfully execute any such restructuring plans and acquisitions, or if the contemplated benefits from any such restructuring or acquisitions do not materialize. In addition, the success of any acquisition, if any, will depend upon a number of factors, including: ·our ability to acquire businesses on a cost-effective basis;
·our ability to obtain necessary financings for such acquisition; ·our ability to integrate acquired personnel, operations, products and technologies into our organization effectively; and ·our ability to retain and motivate key personnel and to retain the clients of acquired firms. Any such restructuring or strategic acquisition may require a significant commitment of management time, capital investment and other resources. Our business operation may also be severely disrupted by any such transactions. We may be unable to consummate such transactions, we may not be able to effectively integrate an acquired business or we may be required to incur significant expenses to complete a transaction. We may also experience increased employee turnovers in our existing workforce. As a result, our business, financial condition and results of operations may be materially and adversely affected. In addition, if we use debts to finance any such restructuring or acquisition, we may become highly leveraged. If we use our equity securities as consideration for transactions, the value of your ADSs may be substantially diluted. In addition, according to the amendments to Schedule 13D filed by Shanda Interactive on April 1, 2014 and the Schedule 13D filed by Mr. Xu on April 9, 2014, under the share purchase agreement relating to the Share Purchase Transaction, Shanda Media, a wholly owned subsidiary of Shanda Interactive, has agreed that if we propose to acquire Sky Profit Limited, a company controlled by Mr. Xu, our largest shareholder, and such transaction is recommended to the shareholders for approval by our board of directors and any special committee of disinterested directors, Shanda Media shall vote all its shares in line with such recommendation. Sky Profit Limited controls Qinhe, which operates iSpeak, a social platform that allows users to engage in real-time online group activities through voice, text and video. Shanda Media has a right under this share purchase agreement to subscribe to equity or equity-linked securities issued by affiliates of Mr. Xu for an amount up to $25,000,000 that is equal to, or convertible into, 20% of Sky Profit Limited on a fully diluted basis. However, this right is not available to other holders of our ADSs or ordinary shares. Currently, our company has no plan to acquire Sky Profit Limited. We operate in a highly competitive market and we may not be able to compete successfully against our competitors.
We face significant competition, primarily from those companies that operate online video websites in China, which our management estimates to currently number over one hundred. A large number of independent online video sites, such as
In addition, Internet streaming of content represents only one of many existing and potential new technologies for viewing video. Many users maintain simultaneous relationships with multiple video providers and can easily shift from one provider to another. For example, users may subscribe to cable, buy a DVD, and download a movie from Apple iTunes or other sources, or some combination thereof. New competitors may be able to launch new businesses at a relatively low cost.
We also face competition from other types of advertising media, such as newspapers, magazines, yellow pages, billboards and other forms of outdoor media, television and radio. Most large companies in China allocate, and will likely continue to allocate, most of their marketing budgets to traditional advertising media and only a small portion of their budgets to online marketing and other forms of advertising media. If these companies do not devote a larger portion of their marketing budgets to online marketing services provided by our online video business, or if our existing customers reduce the amount they spend on online marketing, our results of operations and future growth prospects could be adversely affected. The online video industry in China and user acceptance of our online video content may not grow as quickly as expected, which may adversely affect our revenues and business prospects.
Our business prospects depend on the continuing development of the online video industry in China. As an emerging industry, China’s online video industry has experienced substantial growth in recent years in terms of both users and content. We cannot assure you, however, that the online video industry will continue to grow as rapidly as it has in the past. With the development of technology, new forms of media may emerge and render online video websites less attractive to users. Growth of the online video industry is affected by numerous factors, such as users’ general online video experience, technological innovations, development of Internet and Internet-based services, regulatory changes, especially regulations affecting copyrights, and the macroeconomic environment. If the online video industry in China does not grow as quickly as expected or if we fail to benefit from such growth by successfully implementing our business strategies, our user traffic may decrease and our business and prospects may be adversely affected. We operate in a rapidly evolving industry. If we fail to keep up with the technological developments and users’ changing requirements, our business, results of operations and prospects may be materially and adversely affected.
The online video industry is rapidly evolving and subject to continuous technological changes and changes in industry standards. Our success will depend on our ability to keep up with the changes in technology and user behavior resulting from the technological developments. For example, the development of broadband enabled the enjoyment of high definition videos online. In addition, the number of people accessing the Internet via devices other than personal computers, including mobile phones and other hand-held devices, has increased in recent years. With the rapid development of 3G and 4G mobile communication services in China, we expect this trend to continue. If we do not adapt our products and services to such changes in an effective and timely manner, we may suffer from a decreased user traffic, which may result in a reduced number of advertisers using our online advertising services. Furthermore, changes in technologies may require substantial capital expenditures in product development as well as in modification of products, services or infrastructure. Failure in keeping up with technological development may result in our products and services being less attractive, which in turn, may materially and adversely affect our business, results of operations and prospects.
If we fail to continue to
Our success depends on our ability to generate sufficient user traffic through provision of attractive products and services. To attract and retain users and compete against our competitors, we must maintain high-quality UGC that provides our users with a satisfactory online video experience. With UGC, users can upload and share their own videos and spend a longer time on our website, and we believe a “community-like” environment will enhance users’ loyalty to our website and such network effect broadens advertisers’ reach of audience. Previously, we purchased the licensing rights to some popular UGC and shared advertising revenues with individual users whose number of uploads exceed certain thresholds. We also had a revenue sharing program to reward users for contents they uploaded in order to encourage more users to upload UGC to our website. In April 2014, in connection with the change of our business models after the Share Purchase Transaction, we announced a suspension of this revenue sharing program from May 1, 2014. This program has not been resumed and may not be resumed in the future.Historically, contracted users contributed approximately 50% of all the videos on our website. As a result of the suspension of this revenue sharing program, the quality and quantity of our UGC may deteriorate in the future, which, in turn, may materially and adversely affect our business, results of operations and prospects. We may not be able to continue to anticipate user preferences.
Based on the feedback on our website design and our statistics regarding users’ watching behavior, we keep developing new website features that appeal to users, such as designing more user-friendly content searching tools, creating additional interactive social functions or offering better website compatibility with new Internet-enabled devices. We need to continuously anticipate user preferences and industry changes and respond to such changes in a timely and effective manner. If we fail to cater to the needs and preferences of our users and, as a result, fail to deliver satisfactory user experience, we may suffer from reduced user traffic and our business and results of operations may be materially and adversely affected.
We You may not be able to rely on our quarterly operating results as an indication of our future performance because our quarterly operating results may be subject to significant fluctuations.
We may experience significant fluctuations in our quarterly operating results due to a variety of factors, many of which are beyond our control. Significant fluctuations in our quarterly operating results could be caused by many factors, including, but not limited to:
· our ability to retain existing users, attract new users at a steady rate and maintain user satisfaction;
· the creation of new content by our users and the popularity of such content;
· technical difficulties, system downtime or Internet failures for our websites;
· the amount and timing of operating costs and capital expenditures relating to expansion of our business, operations and
· the adoption of new, or changes to existing, governmental regulations; and
· economic conditions in general and specific to the online video industry in China.
As a result, you should not rely on quarter-to-quarter or
We may be subject to administrative actions by PRC regulatory authorities and other liabilities because of advertisements shown on our website.
Under PRC advertising laws and regulations, we are obligated to monitor the advertising content shown on our website to ensure that such content is true, accurate and in full compliance with applicable laws and regulations. In addition, where a special government review is required for specific types of advertisements prior to website posting, such as advertisements relating to pharmaceuticals, medical instruments, agrochemicals and veterinary pharmaceuticals, we are obligated to confirm that such review has been performed and approval has been obtained from competent governmental authority, which is generally the local branch of the State Administration for Industry and Commerce, or the SAIC. Violation of these laws and regulations may subject us to penalties, including fines, confiscation of our advertising income, orders to cease dissemination of the advertisements and orders to publish an announcement correcting the misleading information. In circumstances involving serious violations, such as posting a pharmaceutical product advertisement without approval, or posting an advertisement for fake pharmaceutical products, PRC governmental authorities may force us to terminate our advertising operation or revoke our licenses. Furthermore, advertisers, advertising operators or advertising distributors, including us, may be subject to civil liability if they infringe on the legal rights and interests of third parties.
Substantially all of the advertisements shown on our website are provided to us by our advertising agency on behalf of advertisers. We cannot assure you that all the content contained in such advertisements is true and accurate as required by the advertising laws and regulations, especially given the uncertainty in the application of these laws and regulations. For example, Article 38 of the Advertisement Law provides that an advertisement operator who knows or should have known the posted advertisement is false or fraudulent will be subject to joint and several liabilities. However, for the determination of the truth and accuracy of the advertisements and the actual or constructive knowledge of the website, there are no implementing rules or official interpretations, and such a determination is at the sole discretion of the relevant local branch of the SAIC, which results in uncertainty in the application of these laws and regulations.
If we are found to be in violation of applicable PRC advertising laws and regulations in the future, we may be subject to penalties and our reputation may be harmed, which may have a material and adverse effect on our business, financial condition, results of operations and prospects. See Item 4.B. “Business Overview—Government Regulation—Regulations on Advertisements.”
data protection breaches
We rely on the efficient and uninterrupted operation of complex information technology applications, systems and networks to operate our business. Our ability to provide users with a high-quality online video experience depends on the continuous and reliable operation of our systems. We cannot assure you that we will be able to procure sufficient bandwidth in a timely manner or on acceptable terms or at all. Failure to do so may significantly impair user experience on our website and decrease the overall effectiveness of our website to both users and advertisers. Disruptions, failures, unscheduled service interruptions or a decrease in connection speeds could hurt user experience and our reputation, causing our users and advertisers to switch to our competitors’ websites. Our systems and proprietary video content delivery network, or CDN, are vulnerable to damage or interruption as a result of fires, floods, earthquakes, power losses, telecommunications failures, cyber-attacks, undetected errors in software, computer viruses, hacking and other attempts to harm our systems. We have experienced service interruptions in the past which typically were caused by (i) overload of our servers, (ii) unexpected overflow of user traffic, and (iii) service malfunction of the telecommunications operators, such as power outage of Internet data centers or network transmission congestion. We may continue to experience similar interruptions in the future despite our continuous efforts to improve our systems. Since we host our servers at third-party Internet data centers, any natural disaster or unexpected closure of Internet data centers operated by third-party providers may result in lengthy service interruptions. If we experience frequent or persistent service disruptions, whether caused by failures of our own systems or those of third-party service providers, our users’ experience may be negatively affected, which in turn, may have a material and adverse effect on our reputation. We cannot assure you that we will be successful in minimizing the frequency or duration of service interruptions. In addition, the risks of cyber-attacks have increased significantly recently. Some of these attacks may originate from well organized, highly skilled organizations. Any such attack could result in a loss of our intellectual property, the release of commercially sensitive information, customer or employee personal data. Failures to protect the privacy of customer and employee confidential data against breaches of network security could result in damage to our reputation.
Undetected programming errors could adversely affect user experience and the market acceptance of our video programs, which may materially and adversely affect our business and results of operations.
The video programs, including advertising video programs, on our website may contain programming errors that may only become apparent after their release. We receive user feedback in connection with programming errors affecting their user experience from time to time, and such errors may also come to our attention during our monitoring process. We generally have been able to resolve such programming errors in a timely manner. However, we cannot assure you that we will be able to detect and resolve all these programming errors effectively. Undetected audio or video programming errors or defects may adversely affect user experience and cause our advertisers to reduce their use of our services, any of which could materially and adversely affect our business and results of operations. Our operations depend on the performance of the Internet infrastructure and telecommunications networks in China and third-party service providers.
Our products and services depend on the ability of our users to access the Internet. Therefore, the successful operation of our business depends on the performance of the Internet infrastructure and telecommunications networks in China. Almost all access to the Internet is maintained through state-owned telecommunications operators under the administrative control and regulatory supervision of China’s Ministry of Industry and Information Technology, or the MIIT. Moreover, we have entered into contracts with various subsidiaries of a limited number of telecommunications service providers in each province and rely on them to provide us with data communications capacity through local telecommunications lines and Internet data centers to host our servers. We have limited access to alternative networks or services in the event of disruptions, failures or other problems with China’s Internet infrastructure or the telecommunications networks provided by telecommunications service providers. Our Ku6.com website regularly serves a large number of users and advertisers. With the expansion of our business, we may be required to upgrade our technology and infrastructure to keep up with the increasing traffic on our websites. However, we have no control over the costs of the services provided by telecommunications service providers. If the prices we pay for telecommunications and Internet services rise significantly, our results of operations may be materially and adversely affected. If Internet access fees or other charges to Internet users increase, our user traffic may decline and our business may be hurt. Our servers, which are partly hosted at third-party Internet data centers, are vulnerable to break-ins, sabotage and vandalism. The occurrence of a natural disaster or a closure of an Internet data center by a third-party provider without adequate notice could result in lengthy service interruptions. Moreover, the agreements we have entered into with domestic telecommunications carriers to host our servers typically have terms of approximately one year and are renewable subject to early termination. If we are not able to renew such hosting services agreements with the telecommunications carriers when they expire and are not able to enter into agreements with alternative carriers at commercially reasonable terms or at all, the quality and stability of our services may be adversely affected. In addition, our domain names are resolved into Internet protocol (IP) addresses by systems of third-party domain name registrars and registries. Any interruptions or failures of those service providers’ systems, which are beyond our control, could significantly disrupt our own services.
If we experience frequent or persistent system failures on our websites, whether due to interruptions and failures of our own information technology and communications systems or those of third-party service providers we rely upon, our reputation and brand could be permanently harmed. The steps we take to increase the reliability and redundancy of our systems are expensive, may reduce our operating margin and may not be successful in reducing the frequency or duration of service interruptions.
We also depend significantly on relationships with leading technology providers and the licenses that the technology providers have granted to us. Our competitors may establish the same relationships as we have, which may adversely affect us. We may not be able to maintain these relationships or replace them on commercially attractive terms. We have been and expect to continue to be exposed to intellectual property infringement and other claims, including claims based on content posted on our
Our success depends, in large part, on our ability to operate our business without infringing third-party rights, including third-party intellectual property rights. Internet companies, technology and media industries own, and are seeking to obtain, a large number of patents, copyrights, trademarks and trade secrets, and they are frequently involved in litigation based on allegations of infringement or other violations of intellectual property rights or other related legal rights. There may be patents issued or pending that are held by others that cover significant aspects of our technologies, products, business methods or services.
We have been and may continue to be subject to claims for defamation, negligence, infringement of third-party copyright and other rights, such as privacy and image rights, or other claims based on the nature or content of videos or other information provided by
Due to the significant number of videos uploaded by users, which currently amounts to an average of approximately
It could be time-consuming and costly to defend these claims, which, with or without merit, may cause us to incur significant costs and liabilities and could materially and adversely affect our business, and also result in diversion of the attention of our management and our financial resources and negative publicity on our brand and reputation. The failure to successfully defend any of them may result in substantial damage awards and/or court orders that may prevent us from continuing to provide certain of our existing services. We may not be able to adequately protect our intellectual property rights, and any failure to protect our intellectual property rights could adversely affect our revenues and competitive position.
We believe that trademarks, trade secrets, patents, copyrights and other intellectual property we use are important to our business. We rely on a combination of trademark, copyright, patent and trade secret protection laws in China and other jurisdictions, as well as confidentiality procedures and contractual provisions to protect our intellectual property and our brand. We have invested significant resources to develop our own intellectual property and acquire licenses to use and distribute the intellectual property of others for our online video site; failure to maintain or protect these rights could harm our business. In addition, any unauthorized use of our intellectual property by third parties may adversely affect our current and future revenues and our reputation.
The validity, enforceability and scope of protection available under intellectual property laws with respect to the Internet industry in China are uncertain and still evolving. Implementation and enforcement of PRC intellectual property-related laws have historically been deficient and ineffective. Accordingly, protection of intellectual property rights in China may not be as effective as in the United States or other western countries. Furthermore, policing unauthorized use of proprietary technology is difficult and expensive, and we may need to resort to litigation to enforce or defend copyrights issued to us or our other intellectual property or to determine the enforceability, scope and validity of our proprietary rights or those of others. Such litigation and an adverse determination in any such litigation, if any, could result in substantial costs and diversion of resources and management attention.
Complexity, uncertainties and
Our online video business is subject to strict government regulations in China. The PRC government extensively regulates the Internet industry, including foreign ownership of, and the licensing and permit requirements pertaining to, companies in the Internet industry. Under the
In addition, actions by the PRC government,
We have limited business insurance coverage.
Insurance companies in China currently do not offer as extensive an array of insurance products as insurance companies do in more developed economies. We do not have any business liability or disruption insurance to cover our operations. We have determined that the costs of insuring for these risks and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. Any uninsured occurrence of business disruption may result in our incurring substantial costs and the diversion of resources, which could have an adverse effect on our results of operations and financial condition.
Regulation and censorship of information disseminated over the Internet in China may adversely affect our business and subject us to liability for information displayed on or linked to our websites.
The PRC government has adopted regulations governing Internet access and the distribution of news and other information over the Internet. Under these regulations, Internet content providers and Internet publishers are prohibited from posting or displaying over the Internet content that, among other things, violates PRC laws and regulations, impairs the national dignity of China, or is reactionary, obscene, superstitious, fraudulent or defamatory. Furthermore, Internet content providers are also prohibited from displaying content that may be deemed by relevant government authorities as “socially destabilizing” or leaking “state secrets” of the PRC. Failure to comply with these requirements may result in administrative penalties,
In addition, the MIIT has published regulations that subject website operators to potential liability for content displayed on their websites and the actions of users and others using their systems, including liability for violations of PRC laws and regulations prohibiting the dissemination of content deemed to be socially destabilizing. The Ministry of Public Security has the authority to order any local Internet service provider to block any Internet website at its sole discretion. From time to time, the Ministry of Public Security has stopped the dissemination over the Internet of information that it believes to be socially destabilizing. The State Secrecy Bureau is also authorized to block any website it deems to be leaking state secrets or failing to meet the relevant regulations relating to the protection of state secrets in the dissemination of online information. Furthermore, we are required to report any suspicious content to relevant governmental authorities, and to undergo computer security inspections. If we fail to implement the relevant safeguards against security breaches, our websites may be shut down and our business and ICP licenses may be revoked.
Although we attempt to monitor the content on our websites, we are not able to control or restrict the content of other Internet content providers linked to or accessible through our websites, or content uploaded to, or generated or placed on, our websites by our users. To the extent that PRC regulatory authorities find any content displayed on our websites objectionable, they may require us to limit or eliminate the dissemination of such information on our websites. If third-party websites linked to or accessible through our website operate unlawful activities such as online gambling on their websites, PRC regulatory authorities may require us to report such unlawful activities to relevant authorities and to remove the links to such websites, or they may suspend or shut down the operation of such websites. PRC regulatory authorities may also temporarily block access to certain websites for a period of time for reasons beyond our control. Any of these actions may reduce our user traffic and adversely affect our business. In addition, we may be subject to penalties for violations of those regulations arising from information displayed on or linked to our websites, including a suspension or shutdown of our online operations.
Concerns about collection, use and security of personal data could damage our reputation and deter current and potential users from using our services.
We have an extensive user base for our video platform, from which we collect personal data about our registered users. Under our privacy policy, without our users’ prior consent, we may not provide any of our users’ personal data to any unrelated third party. While we strive to comply with our privacy policies and other applicable data protection laws and regulations, any failure or perceived failure of compliance may result in proceedings or actions against us by our users, government authorities or other parties, and could damage our reputation. User and regulatory attitudes toward privacy are evolving, and their concerns about the extent to which personal data may be recorded, used or shared may adversely affect our ability to record, use or share such data, which may limit our advertising capabilities and the effectiveness of the marketing efforts of our advertising agencies.
Recently, the PRC government started to require, to certain extent, real name registration for Internet services. According to the Provisions on Administration of Internet User Account Names promulgated by the National Internet Information Office in February 2014, the Internet information service providers shall, pursuant to the principle of “mandatory real name registration at the back-office end, and voluntary real name display at the front-office end,” require the Internet information service users to sign up accounts after passing real identity information authentication. See Item 4.B. “Business Overview—Government Regulation—Regulations on Internet Privacy.” We currently do not require real name registration by our users, which may be deemed to violate relevant PRC laws and regulations, and the PRC regulatory authorities may impose administrative penalty or other sanctions on us. In addition, concerns about the security of personal data could also lead to a decline in general Internet usage, which could lead to lower user traffic on our platform.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud.
We are subject to reporting obligations under the U.S. securities laws. The Securities and Exchange Commission, or the SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, adopted rules requiring every public company to include a management report on the effectiveness of such company’s internal control over financial reporting in its annual report. Our management concluded that our internal control over financial reporting was effective as of December 31,
We believe that we were a passive foreign investment company (“PFIC”) for taxable years 2006, 2007, 2008 and 2009 and it was not clear whether we were a PFIC for taxable year 2011. Although we believe we were not a PFIC for taxable year
We will be a PFIC for U.S. tax purposes for a taxable year if either (a) 75% or more of our gross income for such taxable year is passive income or (b) 50% or more of the average quarterly value, generally determined by fair market value, of our assets during such taxable year consists of assets that either produce passive income or are held for the production of passive income. For such purposes, if we directly or indirectly own 25% or more of the shares of another corporation, we generally will be treated as if we (a) held directly a proportionate share of the other corporation’s assets and (b) received directly a proportionate share of the other corporation’s income. We believe that we were a PFIC for taxable years 2006, 2007, 2008 and 2009, and it was not clear whether we were a PFIC for taxable year 2011. The determination of our PFIC status is subject to uncertainty
Given the complexity of the issues regarding our classification as a PFIC, U.S. investors are urged to consult their own tax advisors for guidance as to the U.S. federal, state and local and other tax consequences of our status as a PFIC in light of their particular circumstances, as well as the availability of, and procedures for making, a mark-to-market or other available election. For further discussion of the adverse U.S. federal income tax consequences of our classification as a PFIC, see Item 10.E. “Taxation—U.S. Federal Income Taxation” below.
Risks Related to Our Corporate Structure
If the PRC government finds that the agreements that establish the structure for operating our businesses in China do not comply with PRC governmental restrictions on foreign investment in Internet business, we could be subject to severe penalties or be forced to relinquish our interests in those operations.
Current PRC laws and regulations place certain restrictions on foreign ownership of companies that engage in Internet business, including the provision of online video and online advertising services. Specifically, foreign ownership in an Internet content provider or other value-added telecommunication service providers may not exceed 50%. Moreover, a foreign investor must have certain track record in the value-added telecommunication business or advertisement business before it can obtain direct equity interests in a PRC company that operates in these industries. Since we are a Cayman Islands company without any track-record of value-added telecommunication service or advertisement operations, neither we nor our PRC subsidiaries are eligible to hold a license to operate our website or our advertisement business in China. As a result, we conduct our operations in China principally through contractual arrangements among our PRC subsidiaries, our consolidated affiliated entities, and their respective shareholders. These contractual arrangements enable us to exercise effective control over these entities and hence treat them as our consolidated affiliated entities and consolidate their results. For a detailed discussion of these contractual arrangements, see Item 4.C. “Organizational Structure.”
PRC laws and regulations governing the validity of these contractual arrangements are uncertain and the relevant government authorities have broad discretion in interpreting these laws and regulations. Although we believe we are in compliance with current PRC regulations, we cannot assure you that the PRC government would hold the same view with us or these contractual arrangements comply with regulations or policies that may be amended or adopted in the future.
On July 13, 2006, the MIIT issued the Notice of the MIIT on Intensifying the Administration of Foreign Investment in Value-added Telecommunications Services. This notice prohibits domestic telecommunication services providers from leasing, transferring or selling telecommunications business operating licenses to any foreign investor in any form, or providing any resources, sites or facilities to any foreign investor for their illegal operation of a telecommunications business in China. According to this notice, either the holder of a value-added telecommunication business operating license or its shareholders must legally own the domain names and trademarks used by such license holders in their provision of value-added telecommunication services. The notice further requires each license holder to have the necessary facilities, including servers, for its approved business operations and to maintain such facilities in the regions covered by its license. In addition, all In January 2015, MOFCOM published on its website for public comment on a draft Foreign Investment Law of the PRC, or the draft FIL. The draft FIL is believed to strengthen the regulation of PRC companies, such as our VIEs, which have contractual arrangements with foreign investors or foreign invested companies. Under the draft FIL, a company controlled by foreign investors through contractual arrangements is considered to be a foreign invested enterprise and as a result is explicitly subject to restrictions on foreign investment. If the current version of the draft FIL becomes effective, our VIEs could fall within the scope of foreign invested companies and be subject to restrictions on foreign investment in the telecommunication service industry including online video business, and the related contractual arrangements between our VIEs and us could be challenged. Under the draft FIL, it is unclear how “control” would be determined for such purpose, and the draft FIL is silent as to the enforcement actions that might be taken against existing companies, such as our VIEs, that operate in restricted industries. Ku6 Information Technology, one of our consolidated affiliated entities, holds the licenses and permits necessary to conduct our online video, online advertising and related businesses in China. However, the related trademarks are owned by Beijing WFOE, one of our wholly owned PRC subsidiaries. If the MIIT strictly enforces the notice, we may be required to transfer those trademarks from Beijing WFOE to Ku6 Information Technology. If the PRC government determines that we do not comply with the currently applicable laws and regulations or policies that may be adopted in the future such as the proposed Draft FIL, it could revoke our business and operating licenses, including our value-added telecommunication license and ICP license, require us to discontinue or restrict our operations, restrict our right to collect revenues, block our website, require us to restructure our operations, impose additional conditions or requirements with which we may not be able to comply, or take other regulatory or enforcement actions against us that could be harmful to our business. The imposition of any of these penalties would result in a material and adverse effect on our ability to conduct our business. Substantial uncertainties exist with respect to the enactment timetable, interpretation and implementation of the draft Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations. In January 2015, MOFCOM published the draft FIL aiming to, upon its enactment, replace the existing laws regulating foreign investment in the PRC, namely, the Sino-foreign Equity Joint Venture Enterprise Law, the Sino-foreign Cooperative Joint Venture Enterprise Law and the Wholly Foreign-invested Enterprise Law. The draft FIL is believed to embody a PRC regulatory trend to rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic investments. MOFCOM is currently soliciting comments on the draft FIL and substantial uncertainties exist with respect to its enactment timetable, interpretation and implementation. The draft FIL, if enacted as proposed, may materially impact the viability of our current corporate structure, corporate governance and business operations in many aspects. Among other things, the draft FIL expands the definition of foreign investment and introduces the principle of “actual control” in determining whether a company is considered a foreign-invested enterprise, or an FIE. The draft FIL specifically provides that entities established in the PRC but “controlled” by foreign investors will be treated as FIEs, whereas an entity set up in a foreign jurisdiction would nonetheless be, upon market entry clearance by MOFCOM, treated as a PRC domestic investor provided that the entity is “controlled” by PRC entities and/or citizens. “Control” is broadly defined in the draft FIL to cover the following categories: (i) holding, directly or indirectly, not less than 50% of shares, equities, share of voting rights or other similar rights of the subject entity; (ii) holding, directly or indirectly, less than 50% of the voting rights of the subject entity but having the power to secure at least 50% of the seats on the board or other equivalent decision making bodies, or having the voting power to materially influence the board, the shareholders’ meetings, or other equivalent decision making bodies; or (iii) having the power to exert decisive influence, via contractual or trust arrangements, over the subject entity’s operations, financial matters or other key aspects of business operations. Once an entity is determined to be an FIE, it will be subject to the foreign investment restrictions or prohibitions set forth in a catalogue of “special administrative measures” to be separately issued by the State Council, which will classify industries into the “catalogue of prohibitions” and the “catalogue of restrictions.” Foreign investors are not allowed to invest in any sector set forth in the catalogue of prohibitions. The “variable interest entity” structure, or the VIE structure, has been adopted by many PRC-based companies, including us, to obtain necessary licenses and permits in the industries that are currently subject to foreign investment restrictions in China. Under the draft FIL, variable interest entities that are controlled through contractual arrangements could also be deemed FIEs if they are ultimately “controlled” by foreign investors. If MOFCOM takes this position, our VIEs may be deemed FIEs and we may be deemed to operate FIEs in industries listed in the “catalogue of restrictions” based on the current catalogue relating to foreign investment, and our current corporate structure may be challenged. The draft FIL has not taken a position on what actions shall be taken with respect to the existing companies with a VIE structure and MOFCOM is soliciting comments from the public on this point. Moreover, it is uncertain whether the industry in which our variable interest entities operate will be subject to the foreign investment restrictions or prohibitions set forth in the “catalogue of special administrative measures” to be issued. We cannot assure you that the Foreign Investment Law and the final “catalogue of special administrative measures,” if enacted, will not mandate further actions to be completed by companies with an existing VIE structure like us or that we will be able to comply with such requirements within reasonable time, on commercially acceptable terms, or at all. The draft FIL, if enacted as proposed, may also materially impact our corporate governance practices and increase our compliance costs. For instance, the draft FIL imposes stringent ad hoc and periodic information reporting requirements on foreign investors and the applicable FIEs. Aside from an investment information report required at each investment, and investment amendment reports, which shall be submitted upon changes to investments, it is mandatory for entities established by foreign investors to submit an annual report, and large foreign investors meeting certain criteria are required to report on a quarterly basis. Any company found to be non-compliant with these reporting obligations may potentially be subject to fines and/or administrative or criminal liabilities, and the persons directly responsible may be subject to criminal liabilities.
Our existing contractual arrangements with our consolidated affiliated entities and their shareholders may be subject to national security review by MOFCOM, and the failure to pass the national security review could have a material adverse effect on our business, results of operations and reputation.
In August 2011, the Ministry of Commerce, or MOFCOM, promulgated the Rules of Ministry of Commerce on Implementation of Security Review System of Merger and Acquisition of Domestic Enterprises by Foreign Investors, or the MOFCOM Security Review Rules, to implement the Notice of the General Office of the State Council on Establishing the Security Review System for Merger and Acquisition of Domestic Enterprises by Foreign Investors promulgated on February 3, 2011, or Circular 6. The MOFCOM Security Review Rules became effective on September 1, 2011. Under the MOFCOM Security Review Rules, a national security review is required for certain mergers and acquisitions by foreign investors raising concerns regarding national defense and security. Foreign investors are prohibited from circumventing the national security review requirements by structuring transactions through proxies, trusts, indirect investments, leases, loans, control through contractual arrangements or offshore transactions. The application and interpretation of the MOFCOM Security Review Rules remain unclear. If MOFCOM or other PRC regulatory agency subsequently determines that we need to submit our existing contractual arrangements with our affiliated PRC entity and its shareholders for national security review by interpretation, clarification or amendment of the MOFCOM Security Review Rules or by any new rules, regulations or directives promulgated after the date of this report, we may face sanctions by MOFCOM or other PRC regulatory agency. These sanctions may include revoking the business or operating licenses of our PRC subsidiaries or our consolidated affiliated entities and its subsidiaries, discontinuing or restricting our operations in China, confiscating our income or the income of our PRC subsidiaries or our consolidated affiliated entities, requiring us to undergo a costly and disruptive restructuring such as forcing us to transfer our equity interest in our PRC subsidiaries to a domestic entity or invalidating the agreements that our PRC subsidiaries have entered into with our consolidated affiliated entities and their respective shareholders, and taking other regulatory or enforcement actions that could be harmful to our business. Any of these sanctions could cause significant disruption to our business operations, including rendering us unable to access cash and other assets of, exercise our ownership rights in and consolidate the results of operations of our affiliated entities in China, which would have a material adverse effect on our business, results of operations and reputation.
We rely on contractual arrangements with our consolidated affiliated entities in China and their shareholders for our operations, which may not be as effective as direct ownership in providing operational control.
Since PRC laws restrict foreign equity ownership in companies engaged in online video and advertising businesses in China, we rely on contractual arrangements with our consolidated affiliated entities and their respective shareholders to operate our business in China. If we had direct ownership of Ku6 Information Technology, Tianjin Ku6 Zheng Yuan, Ku6 Cultural and Tianjin Ku6 Network, we would be able to: (i) exercise our rights as a shareholder to effect changes in the board of directors of these entities, which in turn could effect changes at the management level, subject to any applicable fiduciary obligations, and (ii) derive economic benefits from the operations of these entities by causing them to declare and pay dividends. However, under the current contractual arrangements, we rely on our consolidated affiliated entities and their respective shareholders’ performance of their contractual obligations to exercise effective control. In general, neither our consolidated affiliated entities nor their respective shareholders may terminate the contracts prior to the expiration date. However, the shareholders of Ku6 Information Technology, Tianjin Ku6 Zheng Yuan, Ku6 Cultural or Tianjin Ku6 Network may not act in the best interests of our company or may not perform their obligations under these contracts, including the obligation to renew these contracts when their initial terms expire. Such risks exist throughout the period in which we intend to operate our business through the contractual arrangements with our consolidated affiliated entities. However, if any dispute relating to these contracts remains unresolved, we will have to enforce our rights under these contracts through the operations of PRC law and courts and therefore will be subject to uncertainties in the PRC legal system. See “—Any failure by our consolidated affiliated entities or their respective shareholders to perform their obligations under our contractual arrangements with them may have a material adverse effect on our business” below. Therefore, these contractual arrangements may not be as effective as direct ownership in providing us with control over these consolidated affiliated entities.
Any failure by our consolidated affiliated entities or their respective shareholders to perform their obligations under our contractual arrangements with them may have a material adverse effect on our business.
Our consolidated affiliated entities and their respective shareholders may fail to take certain actions required for our business or follow our instructions despite their contractual obligations to do so. If they fail to perform their obligations under their respective agreements with us, we may have to rely on legal remedies under PRC law, including seeking specific performance or injunctive relief, which may not be effective.
All of our contractual arrangements with them are governed by PRC law and provide for the resolution of disputes through arbitration in China. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in China is not as developed as in certain other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements, which may make it difficult to exert effective control over our consolidated affiliated entities, and our ability to conduct our business may be adversely affected.
Contractual arrangements with our consolidated affiliated entities may result in adverse tax consequences to us.
Under applicable PRC tax laws and regulations, arrangements and transactions among related parties may be subject to audit or scrutiny by the PRC tax authorities within ten years after the taxable year when the arrangements or transactions are conducted. We could face material and adverse tax consequences if the PRC tax authorities were to determine that the contractual arrangements among our PRC subsidiaries, our consolidated affiliated entities in China and their respective shareholders were not entered into on an arm’s-length basis and therefore constituted unfavorable transfer pricing arrangements. Unfavorable transfer pricing arrangements could, among other things, result in an upward adjustment to our tax liability. In addition, the PRC tax authorities may impose interest on late payments on our consolidated affiliated entities for the adjusted but unpaid taxes. Our results of operations may be materially and adversely affected if our consolidated affiliated entities’ tax liabilities increase significantly or if they are required to pay interest on late payments.
According to Circular 16, any expense paid by an enterprise to its overseas affiliated party, which fails to perform functions, bear risks or conduct substantial business activities, shall not be deducted in calculating corporate income tax. When an enterprise pays expenses to its overseas affiliated party for the services rendered thereby, such services shall help the enterprise gain directly or indirectly economic interests. The expenses paid by an enterprise to its overseas affiliated party for the following services shall not be deducted in calculating corporate income tax: (i) services irrelevant to the risks that the enterprise bears or businesses that the enterprise carries out, (ii) services such as control, management and supervision conducted by the affiliated party over the enterprise for the purpose of protecting the nterests of direct or indirect investors in the enterprise, (iii) services rendered by the affiliated party that the enterprise has purchased or carried out by itself, (iv) specific services carried out by the affiliated party within the group specially for the enterprise, although the enterprise has gained extraneous earnings due to the affiliation to a group, (v) services that have been compensated in other affiliated transactions; and (vi) other services that cannot bring about direct or indirect economic interests to the enterprise. When an enterprise needs to pay royalties to its overseas affiliated party for using an intangible asset provided thereby, it shall determine the economic interests to which each affiliated party is entitled by taking into account the degree of contribution made by each affiliated party to the value of the intangible asset. If the royalties paid by the enterprise to the affiliated party, which only owns the legal ownership of the intangible asset but does not contribute to the value thereof, are not in compliance with the arm’s length principle, such royalties shall not be deducted in computing the corporate income tax payable by the enterprise. Where an enterprise establishes an overseas holding company or financing company for the purpose of financing for going public, the royalties paid to its overseas affiliated party for the carried interests generated from the activities of financing for going public, shall not be deducted in calculating corporate income tax. WeareaholdingcompanyincorporatedoutsideofthePRCandanypotentialincomewouldbebasedonthedividends,servicefees,royaltiesorotherdistributionsfromourPRCsubsidiariesandourconsolidatedaffiliatedentities.WemayneedtorelyonourPRCsubsidiariesandourconsolidatedaffiliatedentitiestofundourcashandfinancingrequirementsthroughcertainofthetransactionsdescribedinCircular16.Therefore,Circular16maysignificantlyincreaseourtaxliabilityifwedecidetocarryonanyofsuchtransactionsinthefuture.
The shareholders of our consolidated affiliated entities may have potential conflicts of interest with us, which may materially and adversely affect our business.
We conduct substantially all of our operations, and generate substantially all of our revenues, through our consolidated affiliated entities. Our control over these entities is based upon contractual arrangements with our consolidated affiliated entities and their shareholders that provide us with the substantial ability to control these entities. We provide no incentives to any of the shareholders of our consolidated affiliated entities for the purpose of encouraging them to act in the best interest of our company in such capacity. These shareholders may breach their contractual arrangements, or cause our consolidated affiliated entities to breach their contractual arrangements, with us or cause these contracts to be amended in a manner contrary to the interest of our company, if they believe such action furthers their own interest, or if they otherwise act in bad faith. We cannot assure you that, when conflicts arise, these shareholders will act in the best interest of our company or that conflicts will be resolved in our favor. If we cannot resolve any conflicts of interest or disputes between us and any of these shareholders, we would have to rely on legal proceedings, which may be expensive, time-consuming and disruptive to our operations. There is also substantial uncertainty as to the outcome of any such legal proceedings.
We rely on our PRC subsidiaries and our consolidated affiliated entities to fund our cash and financing requirements. Any limitation on the ability of our PRC subsidiaries and our consolidated affiliated entities to transfer funds to us could have a material adverse effect on our ability to grow or otherwise fund our cash and financing requirements.
We are a holding company and our operations are principally conducted through our PRC subsidiaries and our consolidated affiliated entities. As a result, the ability of our company to pay dividends and to finance debts depends upon the service fees and license fees paid by our consolidated affiliated entities to our PRC subsidiaries and dividends and other distributions paid by our PRC subsidiaries to our company. If any of our subsidiaries or consolidated affiliated entities incurs debt on its own behalf, the instruments governing the debt may restrict its ability to pay service fees or dividends directly or indirectly to our company.
Under PRC laws and regulations, our PRC subsidiaries and our consolidated affiliated entities may pay dividends only out of their retained earnings as determined in accordance with PRC accounting standards and regulations. There is no significant difference between retained earnings as determined in accordance with PRC accounting standards and in accordance with U.S. GAAP. In addition, our PRC subsidiaries and our consolidated affiliated entities are required to set aside at least 10% of their after-tax net income each year, if any, to fund certain statutory reserves, which are not distributable as cash dividends, until the aggregate amount of such funds reaches 50% of their respective registered capital. As of December 31,
Any limitation on the ability of our PRC subsidiaries to pay dividends or make other distributions to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends, or otherwise fund and conduct our business.
We may be unable to collect long-term loans extended to the shareholders of our consolidated affiliated entities.
As of December 31,
The
Under the equity pledge agreements among our PRC subsidiaries, certain of our consolidated affiliated entities and the shareholders of our consolidated affiliated entities, the shareholders of our consolidated affiliated entities have pledged all of their equity interests in these entities to our relevant subsidiaries by recording the pledge on the shareholder registers of the respective entities. According to the PRC Property Rights Law,
As of
We may have conflicts of interest with
As of
· Our board members or executive officers may have conflicts of
· Agreements with
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Risks Related to Doing Business in China
Substantially all of our assets are located in China and substantially all of our revenues are derived from our operations in China. Accordingly, our business, financial condition, results of operations and prospects are subject, to a significant extent, to economic, political and legal conditions and developments in China.
The PRC legal system embodies uncertainties which could limit the legal protections available to you and could also adversely affect our ability to operate our business.
The PRC legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases have little precedential value. Although legislation in China over the past 20 years has significantly improved the protection afforded to various forms of foreign investment and contractual arrangements in China, these laws, regulations and legal requirements are relatively new and their interpretation and enforcement involve uncertainties, which could limit the legal protection available to us, and foreign investors, including you. In addition, the PRC government may enact new laws or amend current laws that may be detrimental to our current contractual arrangements with respect to our consolidated affiliated entities, which may in turn have a material adverse effect on our ability to operate our business.
PRC regulations relating to the establishment of offshore special purpose vehicles, or SPVs, by PRC residents may subject our PRC resident beneficial owners or our PRC subsidiaries to liability or penalties, limit our ability to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to increase their registered capital or distribute profits to us, or may otherwise adversely affect us.
It is unclear how SAFE Circular 37 and any future regulation concerning offshore or cross-border transactions will be interpreted, amended and implemented by the relevant government authorities. We cannot predict how these regulations PRC regulation of loans to, and direct investment in, PRC entities by offshore holding companies and governmental control of currency
In August
In light of
On February 15, 2012, SAFE issued the Notices on Issues concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly-Listed Company, or Circular 7, In addition, the State Administration for Taxation has issued circulars concerning employee share options or restricted shares. Under these circulars, employees working in the PRC who exercise share options (i.e. our existing equity compensation plans), or whose restricted shares vest, will be subject to PRC individual income tax. The PRC subsidiaries of an overseas listed company have obligations to file documents related to employee share options or restricted shares with relevant tax authorities and to withhold individual income taxes of those employees related to their share options or restricted shares. Although we currently withhold income tax from our PRC employees in connection with their exercise of options and the vesting of their restricted shares, if the employees fail to pay, or the PRC subsidiaries fail to withhold, their income taxes according to relevant laws, rules and regulations, the PRC subsidiaries may face sanctions imposed by the tax authorities or other PRC government authorities.
The PRC tax authorities’ enhanced scrutiny of PRC enterprise income tax on offshore equity transfers may have a negative impact on your investment in our ADSs.
In
The State Administration of Taxation subsequently released public notices to clarify issues relating to Circular 698, including the Announcement on Several Issues Concerning the Enterprise Income Tax on the Indirect Transfers of Properties by Non-Resident Enterprises, or SAT Notice 7, which became effective on February 3, 2015. SAT Notice 7 abolished the compulsory reporting obligations originally set out in Circular 698. Under SAT Notice 7, if a non-resident enterprise transfers its shares in an overseas holding company that directly or indirectly owns PRC taxable properties, including shares in a PRC company, via an arrangement without reasonable commercial purpose, such transfer shall be deemed a direct transfer of the underlying PRC taxable properties. Accordingly, the transferee shall be deemed a withholding agent with the obligation to withhold and remit the income tax to the competent PRC tax authorities. SAT Notice 7 also establishes safe harbors for the “reasonable commercial purpose” test. There is limited guidance and practical experience regarding the application of Circular 698 and the related SAT notices. We, our non-PRC resident enterprise subsidiaries and our PRC subsidiaries may be subject to these regulations for our previous and future restructuring or disposal of shares in our offshore subsidiaries, in which case we may have disputes with tax authorities and need to incur expenses to establish that we are not
We may be deemed a PRC resident enterprise under the EIT Law and be subject to PRC taxation on our worldwide income.
The PRC Enterprise Income Tax Law, or the EIT Law, includes a provision specifying that legal entities organized outside China will be considered residents for PRC income tax purposes if their place of effective management or control is within China. If legal entities organized outside China were considered residents for PRC income tax purposes, they would be subject to the 25% enterprise income tax imposed by the EIT Law on their worldwide income. The implementation rules to the EIT Law provide that non-resident legal entities will be considered China residents if substantial and overall management and control over the manufacturing and business operations, personnel, accounting, properties, etc. reside within China. Although substantially all of our operational management is currently based in China, it is uncertain whether our company and our offshore intermediate holding company would be deemed as PRC tax resident enterprises under the EIT Law and other related PRC laws and regulations. If our company and our offshore intermediate holding company were deemed as PRC tax resident enterprises and have earned income other than dividends from our PRC subsidiaries, a 25% enterprise income tax on our global income could increase our tax burden and negatively affect our financial condition and results of operations.
Dividends that we receive from our PRC subsidiaries are subject to PRC withholding tax.
In accordance with the EIT Law and its implementation rules, dividends which arise from profits of foreign invested enterprises earned after January 1, 2008 are subject to a 10% withholding tax. As of December 31,
The enforcement of the PRC labor contract law may materially increase our costs and
The PRC National People’s Congress promulgated the Labor Contract Law and its implementation rules, both of which became effective on January 1, 2008. Compared to previous labor laws, the Labor Contract Law and its implementation rules provides stronger protection for employees and imposes more stringent obligations on employers with regard to, among others, minimum wages, severance payments upon permitted termination of employment by an employer and non-fixed term employment contracts, time limits for probation period as well as the duration and the times that an employee can be placed on a fixed-term employment contract. Compliance with the Labor Contract Law and its implementation rules may increase our operating expenses, in particular our personnel expenses. In the event that we decide to terminate some of our employees or otherwise change our employment or labor practices, the Labor Contract Law and its implementation rules may also limit our ability to effect those changes in a manner that we believe to be cost-effective or desirable, and could result in a material decrease in our profitability. In addition, pursuant to the Labor Contract Law and its amendments, dispatched employees are intended to be a supplementary form of employment, and the fundamental form should be direct employment by enterprises and organizations that require employees. Further, it is expressly stated in the Interim Provisions on Labor Dispatch, which became effective on March 1, 2014, that the number of dispatched employees and employer uses may not exceed 10% of its total labor force and the employer has a two-year transition period to comply with such requirement. A significant number of our employees are contracted through third-party human resources companies that are responsible for managing, among others, payrolls, social insurance contributions and local residency permits of these employees. We may be held jointly liable if such human resources companies fail to pay such employees their wages and other benefits or otherwise become liable to these employees for labor law violations.
Restrictions on currency exchange may limit our ability to utilize our revenues effectively.
Substantially all of our revenues and operating expenses are denominated in Renminbi. The PRC government imposes controls on currency conversion between Renminbi and foreign currencies and, in certain cases, the remittance of currency out of and into China. Under existing PRC foreign exchange regulations, payments of current account items, including payment of dividends, interest payments and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior SAFE approval by complying with certain procedural requirements. Our PRC subsidiaries may also retain foreign exchange in their current accounts, subject to a ceiling approved by SAFE, to satisfy foreign exchange liabilities or to pay dividends. In addition, approval of the appropriate governmental authorities is required if Renminbi is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of offshore bank loans denominated in foreign currencies. However, we cannot assure you that the relevant PRC governmental authorities will not limit or eliminate our ability to purchase and retain foreign currencies in the future. Under our current corporate structure, the income of our company will be primarily derived from dividend payments from
Our business, financial condition and results of operations could be materially and adversely affected by a severe and prolonged global economic downturn and a corresponding slowdown of the PRC economy.
Recent global market and economic conditions have been unprecedented and challenging and have caused persisting recession in most major economies in 2008 and 2009 and significant market volatility since 2010. Continued concerns about the systemic impact of a potentially long-term and widespread recession, energy costs, geopolitical issues and the availability and cost of credit have contributed to increased market volatility and diminished expectations for economic growth around the world. The difficult economic outlook has negatively affected business and consumer confidence and contributed to volatility at unprecedented levels. The PRC economy also faces challenges. In 2014, China’s gross domestic product expanded by only 7.4%, which was its slowest rate in the past 20 years and below the PRC government’s growth target. Since we derive substantially all of our revenues in China, any prolonged slowdown in the growth of the PRC economy could have a material adverse effect on our business, financial condition and results of operations. Disruptions of the financial markets could also significantly restrict our ability to obtain financing in the capital markets or from financial institutions.
Changes in China’s political and economic policies could harm our business.
The economy of China has historically been a planned economy subject to governmental plans and quotas and has, in certain aspects, been transitioning to a more market-oriented economy. Although we believe that the economic reform and the macroeconomic measures adopted by the PRC government have had a positive effect on the economic development of China, we cannot predict the future direction of these economic reforms or the effects these measures may have on our business, financial position or results of operations. In addition, the PRC economy differs from the economies of most countries belonging to the Organization for Economic Cooperation and Development, or OECD. These differences include:
· economic structure;
· level of government involvement in the economy;
· level of development;
· level of capital reinvestment;
· control of foreign exchange;
· methods of allocating resources; and
· balance of payments position.
As a result of these differences, our business may not develop in the same way or at the same rate as might be expected if the PRC economy were similar to those of the OECD member countries.
Inflation in China and measures to contain inflation could negatively affect our profitability and growth.
While the PRC economy has experienced rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas of the country. Rapid economic growth can lead to growth in the money supply and rising inflation. If prices for our advertising services rise at a rate that is insufficient to compensate for the rise in our costs, our business may be materially and adversely affected. In order to control inflation in the past, the PRC government has imposed controls on bank credits, limits on loans for fixed assets and restrictions on state bank lending. Such austerity measures can lead to a slowing of economic growth. A slowdown in the PRC economy could also materially and adversely affect our business and prospects.
Auditors of companies This lack of PCAOB inspections in China prevents the PCAOB from
Any occurrence of pandemic avian influenza, Ebola or other widespread public health problem, or any recurrence of severe acute respiratory syndrome, or SARS, could adversely affect our business and results of operations.
An outbreak of pandemic avian influenza or other widespread public health problem, or a renewed outbreak of SARS in China, where most of our revenues are derived, and in Beijing, where our operations are headquartered, could have a negative effect on our operations. There have been recent reports of outbreaks of an avian flu caused by the H7N9 virus, including confirmed human cases, in China. In 2014, the outbreak of Ebola fever in West Africa received considerable worldwide media attention. Experts warn that China is at serious risk of Ebola because of the large numbers of travelers from Africa as well as poor hospital standards. Our operations may be affected by a number of health-related factors, including the following:
· quarantines or closures of some of our offices which would severely disrupt our operations,
· the sickness or death of our key officers and employees, and
· a general slowdown in the PRC economy caused by any public health problems.
Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our business and results of operations.
Risks Related to Our ADSs If we fail to meet continued listing standards of NASDAQ, our ADSs may be delisted, which could have a material adverse effect on the liquidity of our ADSs. Our ADSs are currently traded on the Nasdaq Global Market. The NASDAQ Stock Market LLC has requirements that a company must meet in order to remain listed on NASDAQ Global Market, including maintain a minimum bid price of $1.0 per share of our ADSs and a minimum $50.0 million market value of our company. If we fail to meet any continued listing requirement, our ADSs could be subject to delisting procedures. If our ADSs were to be delisted, the liquidity of our ADSs would be adversely affected and the market price of our ADSs could decrease. Recently, the bid price of our ADSs frequently fell below $1.0 per share and the total market value of our company frequently fell below $50.0 million. There can be no assurance that we will be able to continue to meet the minimum requirements for listing in the future or that, had we failed to do so, we will be able to regain compliance within the period prescribed by NASDAQ.
The price of our ADSs has been volatile historically and may continue to be volatile, which may make it difficult for holders to resell the ADSs when desired or at attractive prices.
The trading price of our ADSs has been and may continue to be subject to wide fluctuations. The sale price of our ADSs on the NASDAQ Global Market ranged from
Our ADS price may fluctuate in response to a number of events and factors, including among other factors:
· announcements of technological or competitive developments;
· regulatory developments in our target markets affecting us, our customers or our competitors;
· announcements of share repurchase program;
· actual or anticipated fluctuations in our quarterly operating results;
· changes in financial estimates by securities research analysts;
· changes in the economic performance or market valuations of our website;
· addition or departure of our executive officers and key research personnel; and
· sales or perceived sales of additional ordinary shares or ADSs.
In addition, the financial markets in general, and the market prices for Internet-related companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of such companies. These broad market and industry fluctuations may adversely affect the price of our ADSs, regardless of our operating performance.
Future sales or perceived sales of substantial amounts of our ordinary shares or ADSs by our
If any of our
As a foreign private issuer with ADSs listed on the NASDAQ Global Market, we follow home country corporate governance practices instead of certain NASDAQ requirements.
As a foreign private issuer whose ADSs are listed on the NASDAQ Global Market, we are permitted to follow home country corporate governance practices instead of certain NASDAQ requirements. A foreign private issuer that elects to follow its home country practice must submit to the NASDAQ Stock Market LLC a written statement from an independent counsel in such issuer’s home country certifying that the issuer’s practices are not prohibited by the home country’s laws. In addition, a foreign private issuer must disclose in its annual reports filed with the SEC each NASDAQ requirement with which it does not comply followed by a description of its applicable home country practice.
As a company incorporated in the Cayman Islands with ADSs listed on the NASDAQ Global Market, we intend to follow our home country practice instead of NASDAQ requirements that mandate that:
· our board of directors be comprised of a majority of independent directors;
· our directors be selected or nominated by a majority of the independent directors or a nomination committee comprised solely of independent directors;
· our board adopt a formal written charter or board resolution addressing the director nominations process and such related matters as may be required under the U.S. federal securities laws;
· the compensation of our executive officers be determined or recommended by a majority of the independent directors or a compensation committee comprised solely of independent directors; and
· issuances of securities in connection with equity-based compensation of officers, directors, employees or consultants be approved by shareholders.
As we are a Cayman Islands company, our shareholders may face difficulties in protecting their interests, and our ability to protect our rights through the U.S. federal courts may be limited.
Our corporate affairs are governed by our memorandum and articles of association, by the Cayman Companies Law and the common law of the Cayman Islands. The rights of shareholders to take action against the directors, actions by minority shareholders, and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law in the Cayman Islands is derived in part from comparatively limited judicial precedents in the Cayman Islands as well as from English common law, the decisions of whose courts are of persuasive authority but are not binding on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law in this area may not be as clearly established as they would be under statutes or judicial precedents in existence in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities laws as compared to the United States, and some states, such as Delaware, have more developed and judicially interpreted bodies of corporate laws. Moreover, under the Cayman Companies Law, for mergers and consolidations involving two Cayman Islands companies or a Cayman Islands company and an overseas company, dissenting shareholders have the right to be paid the fair value of their shares (which, if not agreed to by the parties, will be determined by the Cayman Islands court) if they follow the required procedures, subject to certain exceptions, and such rights may not be comparable to the appraisal rights that would ordinarily be available to dissenting shareholders of a U.S. company. Finally, Cayman Islands companies may not have standing to initiate shareholder derivative actions before any federal court of the United States. As a result, our shareholders may have more difficulties in protecting their interests in the face of actions by our management, directors or
Our shareholders may have difficulties in enforcing judgments obtained against us.
We are a Cayman Islands company and substantially all of our assets are located outside of the United States. Substantially all of our current operations are conducted in China. In addition, most of our directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons are located outside the United States. As a result, it may be difficult for our shareholders to effect service of process within the United States upon these persons. It may also be difficult for our shareholders to enforce judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents in the United States and the substantial majority of whose assets are located outside of the United States.
There is uncertainty as to whether the courts of the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the United States or any state due to the lack of reciprocal treaty in the PRC providing statutory recognition of judgments obtained in the United States. Furthermore, it is uncertain whether such PRC courts would be competent to hear original actions brought in the PRC against us or such persons who reside outside the United States predicated upon the securities laws of the United States or any state.
Although there is some uncertainty as to the enforcement in the Cayman Islands, in original actions or in actions for enforcement of judgments of United States courts, of liabilities predicated upon U.S. federal securities laws, a final and conclusive judgment in personam of a competent foreign court, including a competent United States court, against our company based upon the agreements under which a definite sum of money is payable other than a sum payable in respect of taxes or other charges of a like nature of a fine or other similar penalty, may be the subject of enforcement proceedings in the Grand Court of the Cayman Islands under the common law doctrine of obligation by action on the debt evidenced by the judgment of such competent foreign court. A final opinion as to the availability of this remedy should be sought when the facts surrounding the foreign court’s judgment are known, but, on general principles, it would be expected that such proceedings would be successful provided that (a) the court which gave the judgment was competent to hear the action in accordance with private international law principles as applied in the Cayman Islands and (b) the judgment is not contrary to public policy in Cayman Islands, has not been obtained by fraud or in proceedings contrary to natural justice and is not based on an error in Cayman Islands law.
Anti-takeover provisions in our organizational documents may discourage our acquisition by a third party, which could limit your opportunity to sell your shares at a premium.
Our memorandum and articles of association include provisions that could limit the ability of others to acquire control of us, modify our structure or cause us to engage in change of control transactions, including, among other things, provisions that authorize our board of directors, without action by our shareholders, to issue preferred shares and to issue additional ordinary shares, including ordinary shares represented by ADSs.
These provisions could have the effect of depriving you of an opportunity to sell your ADSs at a premium over prevailing market prices by discouraging third parties from seeking to acquire control of us in a tender offer or similar transactions.
The voting rights of holders of ADSs are limited by the terms of the deposit agreement.
A holder of our ADSs may only exercise the voting rights with respect to the underlying ordinary shares in accordance with the provisions of the deposit agreement. Upon receipt of voting instructions of a holder of ADSs in the manner set forth in the deposit agreement, the depositary will endeavor to vote the underlying ordinary shares in accordance with these instructions. Under our memorandum and articles of association and Cayman Islands law, the minimum notice period required for convening a general meeting is five days. When a general meeting is convened, you may not receive sufficient notice of a general meeting to permit you to withdraw your ordinary shares to allow you to cast your vote with respect to any specific matter. In addition, the depositary and its agents may not be able to send voting instructions to you or carry out your voting instructions in a timely manner. We will make all reasonable efforts to cause the depositary to extend voting rights to you in a timely manner, but we cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote your shares. Furthermore, the depositary and its agents will not be responsible for any failure to carry out any instructions to vote, for the manner in which any vote is cast, or for the effect of any such vote. As a result, you may not be able to exercise your right to vote and you may lack recourse if your ordinary shares are not voted as you requested.
We may be required to withhold PRC income tax on the dividends we pay you (if any), and any gain you realize on the transfer of our ordinary shares and ADSs may also be subject to PRC tax if we are treated as a PRC resident enterprise.
Pursuant to the EIT Law, we may be treated as a PRC resident enterprise for PRC tax purposes. See “—Risks Related to Doing Business in China—We may be deemed a PRC resident enterprise under the EIT Law and be subject to PRC taxation on our worldwide income” above. If we were so treated by the PRC tax authorities, we would be obligated to withhold PRC income tax on payments of dividends on our ordinary shares and ADSs to investors that are non-resident enterprises, provided that such dividends are deemed as China-sourced income. A non-resident enterprise is an enterprise that does not have an establishment or place of business in China or that has such establishment or place of business but its income is not effectively connected with the establishment or place of business. In addition, any gain realized by investors that are non-resident enterprises from the transfer of our ordinary shares or ADSs may be deemed as China-sourced income and generally be subject to PRC tax. Such dividends and gains to investors that are non-resident enterprises would generally be subject to a 10% PRC withholding tax, unless a reduced tax rate is provided by any applicable tax treaty and the holders have completed the relevant procedures prescribed by the PRC tax authorities to prove their beneficial owner status.
Moreover, under the PRC Individual Income Tax Law, or the IITL, if we are treated as a PRC resident enterprise, non-resident individual investors would be subject to PRC individual income tax on dividends paid to such investors and any capital gains realized from the transfer of our ordinary shares and ADSs, provided that such dividends and gains are deemed as China-sourced income. A non-resident individual is an individual who has no domicile in China and does not stay within China or has stayed within China for less than one year. Pursuant to the IITL and its implementation rules, for purposes of the PRC capital gains tax, the taxable income will be based on the total income obtained from the transfer of our ordinary shares or ADSs after deducting all the costs and expenses that are permitted under PRC tax laws to be deducted from the income. If we were considered a PRC resident enterprise and dividends paid with respect to our ordinary shares and ADSs and the gains realized from the transfer of our ordinary shares and ADSs were considered China-sourced income by relevant PRC tax authorities, such dividends and gains earned by non-resident individuals would generally be subject to PRC tax at a rate of 20%, unless a reduced tax rate is provided by any applicable tax treaty and the holders have completed the relevant procedures prescribed by the PRC tax authorities to prove their beneficial owner
The foregoing PRC taxes may reduce your investment return on our ordinary shares and ADSs and may also affect the price of our ordinary shares and ADSs.
You may be subject to limitations on transfer of your ADSs.
Your ADSs are transferable on the books of the depositary. However, the depositary may close its books at any time or from time to time when it deems expedient in connection with the performance of its duties. The depositary may close its books for a number of reasons, including in connection with corporate events such as a rights offering, during which time the depositary needs to maintain an exact number of ADS holders on its books for a specified period. 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, any government, governmental body or commission or the NASDAQ Global Market, or under any provision of the deposit agreement, or because of a meeting of shareholders of our company, 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 nor is it our current intention to do so. Moreover, we may not be able to rely on an exemption from registration under the Securities Act. Accordingly, ADS holders may be unable to participate in future rights offerings, if any, and may experience dilution in their holdings. In addition, if the depositary is unable to sell rights that are not exercised or not distributed or if the sale is not lawful or reasonably practicable, it will allow the rights to lapse, in which case you will receive no value for these rights.
If additional remedial measures are imposed on the Big Four PRC-based accounting firms, including our independent registered public accounting firm, in administrative proceedings brought by the SEC alleging the firms’ failure to meet specific criteria set by the SEC, we could be unable to timely file future financial statements in compliance with the requirements of the Securities Exchange Act of 1934. In December 2012, the SEC instituted administrative proceedings against the “Big Four” PRC-based accounting firms, including our independent registered public accounting firm, alleging that these firms had violated U.S. securities laws and the SEC’s rules and regulations thereunder for failing to provide to the SEC such firms’ audit work papers with respect to certain PRC-based companies that are publicly traded in the United States. In January 2014, the administrative law judge presiding over the matter rendered an initial decision that each of the firms had violated the SEC’s rules of practice for failing to produce audit workpapers to the SEC. The initial decision censured each of the firms and barred them from practicing before the SEC for a period of six months. The Big Four PRC-based accounting firms appealed the judge’s initial decision to the SEC. As a result, the decision will not take effect unless and until it is endorsed by the SEC. In February 2015, the four PRC-based accounting firms each agreed to a censure and to pay a fine to the SEC to settle the dispute and avoid suspension of their ability to practice before the SEC and audit U.S.-listed companies. The settlement required the firms to follow detailed procedures and to seek approval from the CSRC to provide the SEC with access to such firms’ audit documents in response to future document requests by the SEC made through the CSRC. If the Big Four PRC-based accounting firms, including our independent registered public accounting firm, fail to comply with the document production procedures that are in the settlement agreement or if there is a failure of the process between the SEC and CSRC, the SEC retains authority to impose a variety of additional remedial measures on the accounting firms, such as imposing penalties on such firms and restarting the proceedings against such firms, depending on the nature of the failure. The principal auditor of our financial statements, PricewaterhouseCoopers Zhong Tian LLP, is one of the Chinese affiliates of the “Big Four” global networks of accounting firms and is subject to the proceedings and the initial decision. If the accounting firms are subject to additional remedial measures, our ability to file our financial statements in compliance with SEC requirements could be impacted. A determination that we have not timely filed financial statements in compliance with SEC requirements could ultimately lead to the delisting of our ADSs from NASDAQ or the termination of the registration of our ADSs under the Securities Exchange Act of 1934, or both, which would substantially reduce or effectively terminate the trading of our ADSs in the United States. Item 4.Information on the Company
A.History and Development of the Company
We became an independent company in September 1999 when we were spun-off from UT Starcom Inc., a NASDAQ-listed company that manufactures telecommunication equipment in China. In April 2002, we established a new holding company, Hurray! Holding Co., Ltd., in the Cayman Islands. In
Our principal executive offices are located at Building 6, Zhengtongchuangyi Centre, No. 18, Xibahe Xili, Chaoyang District, Beijing
B.Business Overview Introduction
We
Our online video business focuses on UGC and community-based
Due to PRC legal restrictions on foreign ownership and investment in value-added telecommunications services and advertising businesses in China, we operate our business primarily through our consolidated affiliated entities in China. We do not hold equity interests in our consolidated affiliated entities. However, through a series of contractual arrangements with these consolidated affiliated entities and their respective shareholders, we effectively control, and are able to derive substantially all of the economic benefits from, these consolidated affiliated entities.
Our Video Platform
Our Website
In 2011, we moved our content focus from long-form videos to short-form videos. Users can access our website for short-form videos, including hot news and reports, first-hand information and entertainment videos, which can be provided by users or our content partners or produced in-house.
Our website has a series of user-friendly functions such as search tools and recommendations.
In addition, users can download our proprietary P2P software, “Speed Ku6,” and install it on their personal computers to enhance their viewing experience with high-quality videos and smooth connections. We also provide an application, “Upload Speed,” for users to upload video clips from their personal computers.
In January 2012, we entered into an agreement with YouTube, a renowned international video-sharing website owned by Google, which allowed our international users to view original videos from China on a new channel on YouTube’s website. In March 2012, we established a partnership arrangement with Channel V, a music video entertainment TV channel, to bring its content to our users on our website.
Mobile Platform
We significantly expanded our product portfolio for mobile platforms in
Our Content
UGC (User-Generated Content)
Our website allows Internet users to easily upload, watch and share UGC video clips. We offer creative talents, particularly the younger Chinese generation, channels for artistic expression outside the traditional mainstream content formats such as television. Our UGC
Our editorial team is responsible for communicating with users on the types of UGC we believe are popular and well demanded.
In-house Developed Content
In addition to UGC, our content includes in-house developed content that we produce from time to time, such as online talk shows, celebrity interviews and reality shows to our viewers. We select the types of content to be produced generally based on our assessment of users’ preferences and information gathered by us from analyzing user data collected through our video platform. We typically cooperate with third parties engaged in in-house production, taking advantage of talents of local production teams and their relatively low production costs.
Licensed Content
In June 2011, we ceased purchasing copyrights of movies and TV dramas from professional studios and their distributors. Previously purchased movies and TV drama will be shown on ku6.com through the end of their license periods.
Our Users
We have an extensive user base for our video platform. Our user base consists primarily of young urban educated users, between ages 18 and 44, which is a particularly attractive demographic to advertisers. Online viewers in China also represent a more affluent and better-educated segment of the population in China. We have tracked and maintained extensive user data, including viewing history and information voluntarily provided by registered users. We use sophisticated statistical tools to analyze user data, to better understand users’ viewing preference and habits. This greatly facilitates our efforts in providing service to our advertising customers.
Our online
· Innovative Targeting. Some targeting solutions are unique to the online video platform and cannot be transplanted into other media platforms. We are able to track and monitor an advertiser’s campaign on a real-time basis and can make adjustments to enhance its effectiveness within parameters specified by the advertiser upfront. Our targeting strategies enable advertisers to reach targeted users based on any or a combination of standards, including the demographic information about the user, the nature of the video’s content, the geographic location of the user, the time of day at which a video is being watched, or the keywords associated with the video. Our video channels also help segregate videos based on users’ interested content, which allows us to deliver advertisements tailored to the viewers of different channels; and
· Product Placements. As an online video provider with a permit for radio and television program production and operation, we are able to produce web-based content, such as web serial dramas, interviews and variety shows, with embedded product placements. If a program’s storyline is consistent with a brand’s or product’s marketing initiatives, a product placement can have strong branding effects on viewers.
Advertising Sales We have an advertising tracking system which records and maintains the traffic statistics and other data relating to the effectiveness of advertisements. Our system tracks the reach, delivery duration and frequency, targeting and quantity of advertisements delivered by our website. It supports monitoring of our advertising efforts by enabling retrieval of real-time advertisement delivery data using certain system application interfaces. We have also introduced an advertising results forecasting system that is used in an increasing number of large advertising campaigns on our website. This system is designed to help optimize our advertisers’ strategy by forecasting the results of a given campaign, factoring in the covered audience and the frequency and reach of such campaign. After the broadcasting of a customer’s advertisement, we will provide them with a report of advertising effectiveness either prepared in-house or by an independent research firm upon their request. The list prices of our advertising services depend on various factors, including the form of advertising, specific targeting requirements, duration of the time slot purchased and popularity of the content that the advertisements would be associated with. Prices for the aggregate time slots purchased by each advertiser or advertising agency are fixed under sales contracts, typically at a discount to our list prices. We review the list prices quarterly. In addition, we employ a cost per 1,000 impressions (CPM)-based model for our in-video advertisements. This approach is similar to that of traditional television in that the advertisements are priced based in part on the user reach and viewing frequency. It allows advertisers to better compare the online and offline advertising services at their disposal. It also enables us to better monetize our growing user base and provide measurable results to our advertisers.
We engage in advertising sales primarily through advertising agencies. Historically, we derived substantially all of our revenues from online advertising services, for which we collect service fees from advertisers through our advertising agencies. From April 2011 to March 2014, we relied on Old Shengyue, an affiliate wholly owned by Shanda Interactive during that period, as our primary advertising agency, which managed our sales to, and collected payments from, substantially all of our advertisers. Our advertising agency agreement with Old Shengyue expired on March 31, 2014, and we generated advertising revenue of $2.7 million from Old Shengyue during the first quarter of 2014 prior to its expiration. As a result of our management’s review and adjustment of our business strategies after the Share Purchase Transaction, this agreement was not further renewed.
Pursuant to our agreement with Huzhong, Huzhong will act as our exclusive advertising agency for standard media resources and non-exclusive advertising agency for highly-interactive advertising resources. Under this agreement, we guarantee a certain amount of web traffic per day for webpages on which Huzhong posts advertisements, and in return, Huzhong guarantees to us a minimum amount of advertising revenues per day. If we fail to meet the web traffic target, the minimum amount guaranteed by Huzhong will be proportionally adjusted for the shortfall. Huzhong agreed to prepay 50% of the minimum guaranteed amounts within five business days prior to the beginning of each month and settle the balance within five business days after the end of each month. This advertising agency agreement with Huzhong will expire on December 31, 2017. We generated revenue of $2.8 million under our agreement with Huzhong from August 29, 2014 to December 31, 2014. We expect to continue to engage third party advertising agencies for our advertising sales in the future. Marketing Cooperation In April 2014, as a result of our management’s review and adjustment of our business strategies after the Share Purchase Transaction, we started to explore new revenue models in cooperation with Qinhe, a company controlled by Mr. Xu, our largest shareholder. In April 2014, we started to provide interactive entertainment marketing services to iSpeak, a social platform that allows users to engage in real-time online group activities through voice, text and video. Under our cooperation agreement with Qinhe, which operates the iSpeak platform, Qinhe will share a certain percentage of the revenues that it generates from the viewers who visit the iSpeak platform through advertisements on our website. Users on the iSpeak platform may spend on virtual items during real-time video broadcasting, including gifts and avatars, and purchase other value-added services. In April 2014, we also started to provide game marketing services for Qinhe under a similar revenue sharing arrangement as the one for interactive entertainment marketing cooperation. We generated revenues of $1.6 million from Qinhe for the year ended December 31, 2014. Our cooperation with Qinhe is relatively new and subject to changes from time to time. In September 2014, we amended the interactive entertainment cooperation agreement with Qinhe. Pursuant to the amended agreement, Qinhe agreed to pay certain additional guaranteed revenue amounts from July 2014 to December 2014, and the term of this agreement is extended to December 31, 2015. Other terms of the original agreements, including the revenue sharing arrangment, remained the same.In March 2015, our game marketing cooperation agreement with Qinhe expired and our management decided not to renew this agreement to focus on interactive entertainment marketing services. On March 30, 2015, we further amended our interactive entertainment cooperation agreement with Qinhe. Pursuant to the further amended cooperation agreement, the revenue sharing arrangement in the original agreement will be reinstated without the additional guaranteed revenue amounts.
Marketing and Brand Promotion
We have initiated various marketing activities to further promote our brand awareness among existing and potential users and customers, which include:
· Direct Advertising. We engage in direct advertising in print, radio and TV media to market and promote our online video products. We believe that direct advertising is one of the most effective ways to market and promote our services to Internet users.
· Online
· Promotional
· We also market our products and services by displaying our name and logo in Ku6 media player screens when users embed our content on third-party websites.
Technology and Infrastructure
We believe our proprietary technologies and infrastructure are critical to our success. With a dedicated research and development department, we have made significant investments in developing a proprietary, scalable technology platform that differentiates our online video distribution system.
Architecture
Since 2011, we have invested significantly in CDN infrastructure to support faster delivery of our online video content. As a pioneer in implementing this technology, we have established a more stable and scalable CDN and gained valuable CDN operations experience.
Our CDN technology utilizes distributed data storage to maintain copies of popular content at the “edge” of the network, which enables end-users to more quickly access that content. CDN technology facilitates faster responses to users’ requests for content, avoids buffering and associated delays caused by low bandwidth and user congestion of Internet traffic, and is therefore critical to the success of online video providers.
By hosting our Internet data centers along the major nodes of the transmission backbones operated by the local subsidiaries of China’s telecommunications carriers, we seek to maintain high standards in terms of delivery quality and speed as video content is transmitted from our servers to users throughout China. We have established a large number of servers nationwide, which contribute significantly to our fast streaming speeds and reliable viewing experience. Our servers are located at service sites of the local subsidiaries of the major domestic telecommunications carriers, which provide a stable power supply and maintenance for our servers.
Content Monitoring and Copyright Protection
We are committed to the protection of third-party copyrights. We are required to monitor our website for content prohibited by the PRC laws and regulations. See “—Government Regulation—Regulations on Internet Content Services.”
We have invested significantly in content monitoring and copyright protection technologies. We have a content screening team
When infringing content is discovered, we may take action under the agreement with our users. After a user registers and before each upload, we require the user to click a check box to confirm that the content to be uploaded is in compliance with the terms and conditions set forth in the user agreement, and to guarantee that he or she is the copyright owner or has obtained all necessary consents and authorizations for such content and that he or she is responsible for such content. Pursuant to the user agreement, each user agrees to indemnify us for all damages arising from third-party claims against us caused by violating or infringing content uploaded or linked by the user. In addition, if we find a user has violated applicable laws or regulations or infringed other parties’ legal rights, we may terminate the user account and block the user’s future uploads without prior notice under the user agreement.
Despite our efforts, due to the large amount of content uploaded by our users, we may not be able to identify all infringing content. See Item 3.D. “Risks Related to Our Business—We have been and expect to continue to be exposed to intellectual property infringement and other claims, including claims based on content posted on our website” and “—Regulation and censorship of information disseminated over the Internet in China may adversely affect our business and subject us to liability for information displayed on or linked to our websites.”
Privacy Protection and Information Security
Intellectual Property
We rely primarily on intellectual property laws and our contractual arrangements with our employees, clients, business partners and others to protect our intellectual property rights. We require our employees to enter into agreements requiring them to keep confidential all information relating to our customers, methods, business and trade secrets during and after their employment with us. Our employees are required to acknowledge and recognize that all inventions, trade secrets, works of authorship, developments and other processes generated by them on our behalf, whether or not patentable or copyrightable, made by them during their employment are our property. They also sign agreements to
Competition
The online video industry in China is rapidly evolving and highly competitive. We believe the key competitive factors in the online video industry in China include brand recognition, demographic composition of users, robust technology platform, ability to acquire popular premium licensed content at a reasonable cost and create differentiated content in-house, ability to source creative UGC, ability to provide innovative advertising services to customers, relationships with advertising customers, advertising prices, as well as the range of services provided to advertising customers.
We face competition from other major online video companies. Among the independent or “pure-play” online video sites, our major competitors in China include
Certain international online video sites, such as YouTube and Hulu, have large content portfolios and high brand recognition, particularly among users outside China. Currently, YouTube is not accessible by viewers in China. If China lifts the restrictions, YouTube may become our major competitor in China.
We also compete with traditional advertising media, such as television, radio, newspapers and magazines, and major out-of-home media, such as billboards, for advertisers’ advertising budgets. Large enterprises currently spend a relatively small percentage of their advertising budgets on online advertising as compared to the percentage they spend on traditional advertising media, but we expect the percentage spent on online advertising to increase in the future.
Seasonality
We experience seasonality in our online advertising business. Historically, in the China market, the fourth calendar quarter represents the best season for the general advertising market. This is followed by the third and second calendar quarters. The first calendar quarter is usually the worst season in China due to the Chinese New Year holidays.
Government Regulation
The following is a summary of the principal governmental laws and regulations that are or may be applicable to companies such as ours in China. The scope and enforcement of many of the laws and regulations described below are uncertain. We cannot predict the effect of further developments in the PRC legal system, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement of laws. For a description of the regulatory risks related to our business, see Item 3.D. “Risk Factors—Risks Related to Our Business—Complexity, uncertainties and changes in government policies or regulations of Internet industry may have a material and adverse effect on our business, financial condition, results of operations and
Regulation on catalogue relating to foreign investment Investment activities in the PRC by foreign investors are subject to the Catalogue for the Guidance of Foreign Investment Industry, or the Catalogue, which was promulgated and is amended from time to time by the Ministry of Commerce and the National Development and Reform Commission, or the NDRC. The Catalogue divides industries into three categories: encouraged, restricted and prohibited. Industries not listed in the Catalogue are generally open to foreign investment unless specifically restricted by other PRC regulations. Pursuant to the latest Catalogue amended in 2015, the provision of value-added telecommunications services falls in the restricted category, and the percentage of foreign ownership cannot exceed 50%. The provision of internet cultural operating services (including online game operation services), internet news, and production and online transmission of audio-visual programs fall in the prohibited category, and foreign investors are prohibited from engaging in such services. We conduct our operations in China principally through contractual arrangements among our PRC subsidiaries, our consolidated affiliated entities, and their respective shareholders. These contractual arrangements enable us to exercise effective control over these entities and hence treat them as our consolidated affiliated entities and consolidate their results. For a detailed discussion of these contractual arrangements, see Item 3.D.”Risk Factors—Risks Related to Our Corporate Structure” and Item 4.C. “Organizational Structure.” Regulations on Value-Added Telecommunications Services
Ku6 Information Technology, as our ICP service operator, holds an ICP license issued by Beijing Telecommunications Administration Bureau, which will expire in November 2016.
Regulations on Internet Content Services
National security considerations are an important factor in the regulation of Internet content in China. The National People’s Congress, the national legislature of the PRC, has enacted laws with respect to maintaining the security of Internet operation and Internet content. According to these laws, as well as the Internet Measures, violators may be subject to penalties, including criminal sanctions, for Internet content that:
· opposes the fundamental principles stated in the PRC constitution;
· compromises national security, divulges state secrets, subverts state power or damages national unity;
· harms the dignity or interests of the state;
· incites ethnic hatred or racial discrimination or damages inter-ethnic unity;
· undermines China’s religious policy or propagates heretical teachings or feudal superstitions;
· disseminates rumors, disturbs social order or disrupts social stability;
· disseminates obscenity or pornography, encourages gambling, violence, murder or fear or incites the commission of a crime;
· insults or slanders a third party or infringes upon the lawful rights and interests of a third party; or
· is otherwise prohibited by law or administrative regulations.
ICP service operators are required to monitor their websites. They may not post or disseminate any content that falls within these prohibited categories and must remove any such content from their websites. The PRC government may shut down the websites of ICP license holders that violate any of the above-mentioned content restrictions, order them to suspend their operations, or revoke their ICP licenses.
Restrictions on Foreign Ownership in Value-Added Telecommunications Services
According to the Provisions on Administration of Foreign Invested Telecommunications Enterprises, or the FITE Provisions, promulgated by the State Council
In January 2015, MIIT issued the Announcement on Lifting Restrictions on Foreign Equity Ratio in Online Data Processing and Transaction Processing Business (For-profit E-commerce) in China (Shanghai) Pilot Free Trade Zone, or the MIIT 2015 Circular. The MIIT 2015 Circular provides that in Shanghai FTZ, foreign investors in those companies engaging in the business of providing online data processing and transactions processing services (E-commerce) would be permitted to hold up to 100% of equity interests in such companies. However, restrictions on foreign investments in companies engaging in value-added telecommunications services other than online data processing and transaction processing business are not affected. In January 2015, MOFCOM published on its website for public comment on a draft Foreign Investment Law of the PRC, or the draft FIL. The draft FIL is believed to strengthen the regulation of PRC companies, such as our VIEs, which have contractual arrangements with foreign investors or foreign invested companies. Under the draft FIL, a company controlled by foreign investors through contractual arrangements is considered to be a foreign invested enterprise and as a result is explicitly subject to restrictions on foreign investment. If the current version of the draft FIL becomes effective, our VIEs could fall within the scope of foreign invested companies and be subject to restrictions on foreign investment in the telecommunication service industry including online games, and the related contractual arrangements between our VIEs and us could be challenged. Under the draft FIL, it is unclear how “control” would be determined for such purpose, and the draft FIL is silent as to the enforcement actions that might be taken against existing companies, such as our VIEs, that operate in restricted industries. Ku6 Information Technology, one of our consolidated affiliated entities, holds the licenses and permits necessary to conduct our online video, online advertising and related businesses in China. We currently operate our website through Ku6 Information Technology through a series of contractual arrangements. We believe that it would be impracticable for us to acquire any equity interest in Ku6 Information Technology without diverting management attention and resources. We believe that our contractual arrangements with Ku6 Information Technology and its respective individual shareholders provide us with sufficient and effective control over it. Accordingly, we currently do not plan to acquire any equity interest in Ku6 Beijing Information Technology. In addition, the related trademarks are owned by Beijing WFOE, one of our wholly owned PRC subsidiaries, and we may be required to transfer the related trademarks from Beijing WFOE to Ku6 Information Technology. These contractual arrangements may be subject to challenges by the PRC government authorities. See Item 3.D. “Risk Factors—Risks Related to Our Corporate Structure—If the PRC government finds that the agreements that establish the structure for operating our businesses in China do not comply with PRC governmental restrictions on foreign investment in Internet business, we could be subject to severe penalties or be forced to relinquish our interests in those operations” and Item 3.D. “Risk Factors—Risks Related to Our Corporate Structure—Substantial uncertainties exist with respect to the enactment timetable, interpretation and implementation of the draft Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations.”
Regulations on Broadcasting Audio/Video Programs through the Internet
We
Regulations on Internet News Publication
Publishing and disseminating news through the Internet are highly regulated in China.
Regulations on Internet Publication
The GAPP is responsible for nationwide supervision and administration of publishing activities in China.
The Internet Publication Measures were promulgated in June 2002, which is approximately three years prior to the establishment of China’s first group of online audio/video websites. At the time of promulgation, these measures were intended to regulate the traditional audio/video products and online gaming and did not consider the issues directly relevant to online audio/video business. Furthermore, the definition of “Internet publication” under these measures is very broad and the GAPP has not provided any implementing rule or official interpretation as to the applicability of the Internet Publication Measures to a website such as Ku6.com that exclusively distributes audio/video content.
In December 2012, the GAPP published a proposed rule relating to Internet publication. The proposal is intended to, among other things, clarify the meaning of the “Internet publication service” and “Internet publication” as well as modify the application procedures for the license. We plan to apply for the license with respect to certain services provided by Ku6 Information Technology once the final rule is issued. However, we cannot assure you that such application would be approved by the relevant governmental agencies in a timely manner or at all. See Item 3.D. “Risk Factors—Risks Related to Our Business—Complexity, uncertainties and changes in government policies or regulations of Internet industry may have a material and adverse effect on our business, financial condition, results of operations and prospects.”
Regulations on Internet Medical and Health Information Services
Regulations on Advertisements
The SAIC, including its local branches, is the government agency responsible for regulating advertising activities in China.
Advertisers, advertising operators and advertising distributors are required by PRC advertising laws and regulations to ensure that the contents of the advertisements they prepare or distribute are true and in full compliance with applicable laws and regulations. In addition, where a special government review is required for certain categories of advertisements before publishing, the advertisers, advertising operators and advertising distributors are obligated to confirm that such review has been performed and that relevant approval has been obtained. Violation of these regulations may result in penalties, including fines, confiscation of advertising income, orders to cease dissemination of the advertisements and orders to publish an advertisement correcting the misleading information. In circumstances involving serious violations, the SAIC or its local branches may force the violator to terminate its advertising operation or even revoke its business license. Furthermore, advertisers, advertising operators or advertising distributors may be subject to civil liability if they infringe on the legal rights and interests of third parties.
Regulations on Foreign Ownership in Advertising Business
The principal regulations governing foreign ownership in advertising businesses in China include:
· The Administrative Regulations on Foreign-invested Advertising Enterprises; and
· The Circular Regarding Investment in the Advertising Industry by Foreign Investors through Equity Acquisition.
These regulations require foreign entities that directly invest in the PRC advertising industry to have at least a two-year track record with a principal business in the advertising industry outside China. Since December 2005, foreign investors have been permitted to directly own a 100% interest in advertising companies in China, but such foreign investors are also required to have at least a three-year track record with a principal business in the advertising industry outside China. PRC laws, rules and regulations do not permit the transfer of any approvals or licenses, including business licenses containing a scope of business that permits engagement in the advertising business.
Regulations on Internet Culture Activities
In August 2013, the Ministry of Culture issued the Notice of the Ministry of Culture on Implementing the Administrative Measures for the Content Self-examination of Internet Culture Business Entities. According to this notice, any cultural product or service shall be reviewed by the provider before being released to the public and the review process shall be done by persons who have obtained the relevant content review certificate. To comply with these laws and regulations, our content examination team reviews the music videos on our website as well as certain other
Regulations on Producing Audio/Video Programs
Regulations on Software Products
The State Council promulgated the Computer Software Protection Regulations
Regulations on Intellectual Property Rights
China has adopted legislation governing intellectual property rights, including trademarks, patents and copyrights. China is a signatory to the main international conventions on intellectual property rights and became a member of the Agreement on Trade Related Aspects of Intellectual Property Rights upon its accession to the World Trade Organization in December 2001.
Patent. The National People’s Congress adopted the Patent Law in 1984, and amended it in 1992, 2000 and 2008. The purpose of the Patent Law is to protect lawful interests of patent holders, encourage invention, foster applications of invention, enhance innovative capabilities and promote the development of science and technology. To be patentable, invention or utility models must meet three conditions: novelty, inventiveness and practical applicability. Patents cannot be granted for scientific discoveries, rules and methods for intellectual activities, methods used to diagnose or treat diseases, animal and plant breeds, substances obtained by means of nuclear transformation or a design which has major marking effect on the patterns or colors of graphic print products or a combination of both patterns and colors. The Patent Office under the State Intellectual Property Office, or SIPO, is responsible for receiving, examining and approving patent applications. A patent is valid for a term of twenty years in the case of an invention and a term of ten years in the case of utility models and designs. A third-party user must obtain consent or a proper license from the patent owner to use the patent. Otherwise, the use constitutes an infringement of patent rights.
Copyright. The National People’s Congress adopted the Copyright Law in 1990 and amended it in 2001 and 2010, respectively. The Copyright Law extends copyright protection to Internet activities, products disseminated over the Internet and software products. In addition, there is a voluntary registration system administered by the China Copyright Protection Center.
In December 2012, the PRC Supreme People’s Court adopted the Provisions on Some Issues Concerning Applicable Laws for Trial of Disputes of Infringement of Rights to Communication through Information Networks, which became effective on January 1, 2013 and replaced the previous interpretations on the same topic. Under the provisions, Internet users or service providers are subject to civil liabilities if they provide
In May
In each of the years since 2005, the
Trademark. The PRC Trademark Law, adopted in 1982 and revised respectively in 1993, 2001 and
“
Domain Name. In
Regulations on Information Security
The National People’s Congress has enacted legislation that prohibits use of the Internet that breaches the public security, disseminates socially destabilizing content or leaks state secrets. Breach of public security includes breach of national security and infringement on legal rights and interests of the state, society or citizens. Socially destabilizing content includes any content that incites defiance or violations of PRC laws or regulations or subversion of the PRC government or its political system, spreads socially disruptive rumors or involves cult activities, superstition, obscenities, pornography, gambling or violence. State secrets are defined broadly to include information concerning PRC national defense, state affairs and other matters as determined by the PRC authorities.
According to the Protection and Management Regulations for Computer Information Network and Internet Security promulgated by the Ministry of Public Security
According to the PRC Law on Protection of State Secrets, which became effective on October 1, 2010, an ICP service operator must not disseminate any information that may be deemed to be state secrets and must promptly report any relevant events to the state and public security authorities. Failure to do so may subject the ICP service operator to liability and certain penalties by the State Secrecy Bureau, the Ministry of Public Security and the MIIT or their respective local branches.
In addition, the State Secrecy Bureau has issued provisions authorizing the blocking of access to any website it deems to be leaking state secrets or failing to comply with the relevant legislation regarding the protection of state secrets during online information distribution.
In August 2014, the Supreme People’s Court of the PRC promulgated the Provisions of the Supreme People’s Court on Several Issues Concerning the Application of Law to Trial of Civil Dispute Cases over Infringement upon Personal Rights and Interests by Using Information Networks, which provides that if an ICP operator uses the network to disclose the genetic information, medical records, health examination data, criminal records, home address, private events and other personal privacy and information of a natural person causing damages, the aggrieved party will be entitled to hold the ICP operator liable unless: (i) the natural person has given written consent and the disclosure is within the agreed scope; (ii) the information is disclosed in order to promote the public interest and it is within the necessary extent; (iii) the information is disclosed for the purposes of public interest of academic research or statistics by schools and research institutions that is consented by the natural person in a written form, and the way of disclosure is not sufficient to identify the specific individuals; (iv) the information is self-disclosed by the natural person or has been lawfully disclosed on the Internet; or (v) the personal information is obtained in a lawful manner.
As an ICP service operator, we are subject to the regulations relating to information security. We have taken measures to comply with such regulations. We are registered with the relevant government authority in accordance with the mandatory registration requirement. Our policy is to remove links to web pages and any content which to its knowledge contain information that would be in violation of PRC laws or regulations. In addition, we monitor our websites to ensure our compliance with such laws and regulations.
Regulations on Internet Privacy
The PRC Constitution states that PRC law protects the freedom and privacy of communications of citizens and prohibits infringement of such rights. In recent years, PRC government authorities have enacted legislation on Internet use to protect personal information from any unauthorized disclosure.
The Internet Measures prohibit an ICP service operator from producing, reproducing, disseminating or broadcasting illegal information, including information that insults or slanders a third party or infringes the lawful rights and interests of a third party. Pursuant to the BBS Measures, ICP service operators that provide electronic messaging services must keep users’ personal information confidential and must not disclose such personal information to any third party without the users’ consent or unless required by law. The regulations further authorize the relevant telecommunications authorities to order ICP service operators to rectify unauthorized disclosure. ICP service operators are subject to legal liability if the unauthorized disclosure results in damages or losses to users. The PRC government, however, has the power and authority to order ICP service operators to turn over personal information if an Internet user posts any prohibited content or engages in illegal activities on the Internet.
In December 2011,
In July 2013, the MIIT issued the Order for the Protection of Telecommunication and Internet User’s Personal Information. Any collection or use of a user’s personal information must be subject to the consent of such user. An ICP service operator must keep such information strictly confidential, and it is prohibited from divulging, tampering or destroying any such information, and from selling or providing such information to other parties. Any violation may subject the ICP service operator to warnings, fines, confiscation of illegal gains, revocation of licenses, cancellation of registrations , shutdown of websites or even criminal liabilities. We have required our users to consent to our collection and use of their personal information, and have taken information security measures to protect our users’ privacy. In February 2014, the National Internet Information Office promulgated the Provisions on Administration of Internet User Account Names, which became effective on March 1, 2015. According to the Provisions, the Internet information service providers shall, pursuant to the principle of “mandatory real name registration at the back-office end, and voluntary real name display at the front-office end,” require the Internet information service users to sign up accounts after passing real identity information authentication. When signing up accounts, the Internet information service users shall enter into agreements with the Internet information service providers to undertake to abide by the seven bottom lines in terms of laws and regulations, which are the socialist system, national interests, citizens’ legitimate rights and interests, public order, social morality and the truthfulness of information. Where any Internet information service user falsifies information to get the account name registered or includes any illegal or unfavorable information in the head portrait, profile or any other registration information of the account, the Internet information service provider shall take measures such as issuing an notice to require such user to rectify within specified time limit, suspending the use of the account name by such user or deregistering the account of such user.
We currently do not require real name registration by our users, which may be deemed to violate relevant PRC laws and regulations, and the PRC regulatory authorities may impose administrative penalty on us, such as warning, fines, confiscation of illegal gains, revocation of website registration, or shutdown of our website. In addition, we may be liable for damages caused to our users.
Regulations on Foreign Exchange Controls
For information regarding relevant foreign exchange controls, please refer to Item 10.D. “Exchange Controls.”
Regulations on Dividend Distribution
The principal regulations governing dividend distributions by wholly foreign owned enterprises and Chinese-foreign equity joint ventures include the:
· Wholly Foreign-Owned Enterprise Law (1986), as amended;
· Wholly Foreign-Owned Enterprise Law Implementing Rules (1990), as amended;
· Chinese-foreign Equity Joint Venture Enterprise Law (1979), as amended;
· Chinese-foreign Equity Joint Venture Enterprise Law Implementing Rules (1983), as amended;
· The Companies Law
· The Notice on Implementation of Enterprise Income Tax Transition Preferential Policy under the PRC Enterprise Income Tax Law (2007);
· PRC Enterprise Income Tax Law (2007); and
· Implementation Rules of the PRC Enterprise Income Tax Law (2007).
Under these regulations, wholly foreign owned enterprises and Chinese-foreign equity joint ventures in China may pay dividends only out of their accumulated after-tax profits, if any, as determined in accordance with PRC accounting standards and regulations. Additionally, all enterprises are required to set aside at least 10% of their after-tax net income each year, if any, to fund their statutory capital reserves, until the aggregate amount of such reserves reaches 50% of their registered capital. These reserves are not distributable as cash dividends.
Labor Laws and Social Insurance
Pursuant to the PRC Labor Law, which became effective on January 1, 1995, the PRC Labor Contract Law, which became effective on January 1, 2008, and their implementation rules, employers must execute written labor contracts with their employees. All employers must compensate their employees with wages equal to at least the local minimum wage standards. All employers are required to establish a system for labor safety and sanitation, strictly abide by state national labor rules and standards and provide employees with workplace safety training. Employers are also obliged to provide employees with welfare schemes covering pension insurance, unemployment insurance, maternity insurance, work-related injury insurance, medical insurance and housing funds. Violations of the PRC Labor Law and the PRC Labor Contract Law may result in the imposition of fines and other administrative liabilities. Criminal liability may arise for serious violations.
The PRC Labor Contract Law and its implemental rules also allow third-party human resource companies to enter into employment contracts with employers on behalf of dispatched employees. The dispatched positions are typically temporary and complementary in nature, and the employment contracts should state the position, term and compensation of the employee, including social insurance fees. The employers must protect the rights and interests of the dispatched employees.
We have entered into labor contracts with most of our employees. We provide our employees with the proper welfare and employment benefits. We employ the remaining employees through third-party human resources companies that are qualified to dispatch such employees to our PRC entities. These third-party human resources companies are responsible for managing, among others, payrolls, social insurance contributions of these employees. Pursuant to the PRC Labor Contract Law and its latest amendments effective on July 1, 2013, dispatched employees are intended to be a supplementary form of employment and shall only apply to provisional, auxiliary or substitutive positions, and the fundamental form should be direct employment by enterprises and organizations that require employees. It is expressly stated that the number of dispatched employees an employer uses may not exceed a “certain percentage” of its total labor force. The Interim Provisions on Labor Dispatch which came into force on March 1, 2014, further set such percentage at 10% and provide a two-year transitional period for compliance with such requirement. Failure to comply with these requirements may result in orders of rectification and imposition of fines. See Item 3.D. “Risk Factors—Risks Related to Doing Business in China—The enforcement of the PRC labor contract law may materially increase our costs and decrease our net income.”
Regulations on Concentration in Merger and Acquisition Transactions
According to the Implementing Rules Concerning Security Review on the Mergers and Acquisitions by Foreign Investors of Domestic Enterprises issued by the MOFCOM in August 2011, mergers and acquisitions by foreign investors involved in “an industry related to national security” are subject to strict review by MOFCOM. These rules also prohibit any transactions attempting to bypass such security review, including by controlling entities through contractual arrangements. We believe that our business is not in an industry related to national security, but we cannot preclude the possibility that the MOFCOM or other government agencies may publish explanations contrary to our understanding or broaden the scope of such security reviews in the future.
C.Organizational Structure
We conduct our operations in China principally through contractual arrangements among our PRC subsidiaries, our consolidated affiliated entities in the PRC, and their respective shareholders. We hold no ownership interest in any of our consolidated affiliated entities in China.
· Ku6 Information Technology is 98% owned by Mr. Yingfeng Zhang and 2% owned by Mr. Mingfeng Chen;
· Tianjin Ku6 Zheng Yuan, which is wholly owned by Ku6 Information Technology, is 98% owned by Mr. Yingfeng Zhang and 2% owned by Mr. Mingfeng Chen;
· Ku6 Cultural is 98% owned by Mr. Yingfeng Zhang and 2% owned by Mr. Mingfeng Chen; and
· Tianjin Ku6 Network is 90% owned by Ms. Dongxu Wang and 10% owned by Mr. Qing Zhang.
Through our contractual arrangements with these consolidated affiliated entities, we have the power to vote all the shares held by the shareholders of these entities, through our PRC subsidiaries, as well as the right to enjoy the economic benefits derived from these entities and the exclusive right to purchase equity interests from the shareholders of these entities to the extent permitted by PRC law. For a detailed description of the regulatory environment that necessitates the adoption of our corporate structure, see Item 4.B. “Business Overview—Government Regulation.” For a detailed description of the risks associated with our corporate structure and the contractual arrangements that support our corporate structure, see Item 3.D. “Risk Factors—Risks Related to Our Corporate Structure.”
Under the guidance relating to the consolidation of consolidated affiliated entities, we are the primary beneficiary of the economic benefits of our consolidated affiliated entities, namely, Ku6 Information Technology, Tianjin Ku6 Zheng Yuan, Ku6 Cultural and Tianjin Ku6 Network. Transactions among our consolidated affiliated entities, our company and our subsidiaries are eliminated in consolidation.
The following diagram illustrates the corporate structure of our company, our subsidiaries, and our consolidated affiliated entities, as well as our shareholding in Yisheng, as of
D.Property, Plant and Equipment
Our principal executive offices are located on premises with a gross floor area of approximately 5,640 square meters in Beijing. We also have branch and representative offices in
Not Applicable.
Item 5.Operating and Financial Review and Prospects
The following discussion of our financial condition and results of operations is based upon and should be read in conjunction with our consolidated financial statements and their related notes included elsewhere in this annual report on Form 20-F. This discussion contains
A.Operating Results
Overview
We entered into the online video business through the acquisition of Ku6 Holding in January 2010.
In July 2012, we repurchased an aggregate of 269,409,276 ordinary shares from certain former officers, Mr. Shanyou Li, Mr. Zhizhong Hao and Ms. Xingye Zeng, and Kumella Holdings Limited, a company controlled by Mr. Shanyou Li, at a price of $0.0291 per share, and repurchased 79,717 ADSs from Mr. Shanyou Li at a price of $2.91 per ADS. The repurchase was approved by shareholders at our annual general meeting of shareholders on July 12, 2012 and consummated on July 13, 2012. All the repurchased ordinary shares and ADSs were cancelled upon repurchase. On March 31, 2014, Mr. Xu entered into a share purchase agreement with our then controlling shareholder, Shanda Media, a wholly owned subsidiary of Shanda Interactive, to purchase 1,938,360,784 of our ordinary shares, amounting to approximately 41% of our issued and outstanding share capital. The Share Purchase Transaction was completed on April 3, 2014, and the aggregate consideration for these ordinary shares was $47,350,831.05. Mr. Xu funded the purchase price through a loan from Shanda Media, which is secured by a charge of all of our ordinary shares beneficially owned by Mr. Xu.
For the years ended December 31,
Factors Affecting Our Results of Operations
Our business, financial condition and results of operations have been and will continue to be subject to general conditions affecting the online video and online In addition, our business, financial condition and results of operations are affected by a number of company-specific factors including our ability to:
· maintain and expand our user base;
· obtain and produce popular video content cost-effectively;
· procure Internet bandwidth cost-effectively;
· provide effective
· control sales and marketing expenses; and
· maintain
Furthermore, substantial doubt exists as to our ability to continue as a going concern. See Item 5.B. “Liquidity and Capital Resources—Liquidity and Going Concern,” Item 3.D. “Risk Factors—Risks Related to Our Business—There is substantial doubt as to our ability to continue as a going concern” and notes 1 and 2 to our audited consolidated financial statements included elsewhere in this annual report on Form 20-F.
Description of Certain Statement of Operations Items
Net Revenues
For the years ended December 31,
As the revenue models are relatively new, there is no assurance that they would generate sufficient revenues and operating cash flows in the future. See Item 3.D. “Risk Factors—Risks Related to Our Business—Our new business models may not be able to generate sufficient revenues and operating cash flows.”
Cost of Revenues
Our cost of revenues
(1)Include primarily advertisement production costs, platform operation costs and outside service
Internet bandwidth costs. Internet bandwidth costs are the fees we pay to telecommunications carriers and other service providers for telecommunications services and for hosting our servers at their Internet data centers. Bandwidth is a significant component of our cost of revenues and therefore an important factor affecting our profitability. The bandwidth costs as a percentage of our net revenues increased from
Payroll
Depreciation of servers and other
In-house developed content costs. In-house developed content costs represent costs related to the production of our news, reports and interactive entertainment programs, but do not include any salaries and benefits paid to our employees.
Operating Expenses
The following table sets forth certain historical consolidated operating expenses data,
Product Development
Selling and Marketing
General and Administrative Impairment of Goodwill and Intangible assets. We recorded significant impairment charges of $6.2 million and $21.0 million for goodwill and for definite-lived intangible assets (mainly trademark), respectively, for the year ended December 31, 2013. See Item 5.A. “Operating Results—Critical Accounting Policies—Goodwill and Intangible Assets Impairment.” Furthermore, in order to reduce operating cash outflows, we have carried out a plan to reduce our headcount by approximately 40% in various departments in April 2014. See Item 6.D. “Employees.” As a result, we expect the payroll expenses included in the above items to decrease in 2015.
Critical Accounting Policies
The methods, estimates and judgments we use in applying our accounting policies have a significant impact on the results we report in our financial statements. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. We have summarized our accounting policies below that we believe are both important to an understanding of our financial results and involve the need to make estimates about the effect of matters that are inherently uncertain. We also have other policies that we consider to be key accounting policies. However, these policies do not meet the definition of critical accounting policies because they do not generally require us to make estimates or judgments that are difficult or subjective.
Business Combinations and Non-controlling Interests
We account for our business combinations using the purchase method of accounting. This method requires that the acquisition cost to be allocated to the assets, including separately identifiable intangible assets, and liabilities we acquired based on their estimated fair values. Any non-controlling interest was reflected at historical cost. Where the consideration in an acquisition includes contingent consideration the payment of which depends on the achievement of certain specified conditions post-acquisition, contingent consideration was not recorded until the contingency was resolved.
From January 1, 2009, we adopted ASC 805 (formerly referred to as SFAS No. 141 (revised 2007),
Revenue Recognition
In accordance with
Online advertising services We derive part of our revenue from online advertising
Advertising contracts are signed to establish the price and advertising services to be provided. Advertisements are charged either based on the agreed
Under our previous agreement with Old Shengyue, which expired in March 2014, guaranteed minimum advertising revenues were not subject to downward adjustments. Under our previous agreement with New Shengyue, which was terminated in August 2014, guaranteed minimum advertising revenues must be proportionally adjusted downward if there was a shortfall relative to web traffic or video view targets. Under these two agreements, excess advertising revenues were calculated after deducting commission fees earned by Old Shengyue and New Shengyue based upon increasing percentages for additional tiers or layers of Table of
We report the Promotional advertising services
We
Promotional advertising service revenues are recognized as services delivered for interactive entertainment marketing and online game. Shortly after the end of each month, with sufficient frequency to enable timely preparation of financial statements, we received a statement from Qinhe detailing the amount of shared revenue We report the revenue earned from Qinhe based on
Allowances for Doubtful Accounts
We determine the allowance for doubtful accounts when facts and circumstances indicate that During the years ended December 31,
Goodwill and Intangible Assets Impairment
We test goodwill for impairment by performing a two-step goodwill impairment test,
We measure impairment of intangible assets whenever events or changes in circumstances indicate that the carrying amount of an asset may no longer be recoverable. When these events occur, we assess impairment by comparing the carrying value of the intangible assets to the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flow is less than the carrying amount of the assets, we would recognize an impairment loss based on the fair value of the intangible assets. We measure the fair value of intangible assets
During the annual
During the annual impairment test on December 31, 2013, we performed an impairment test relating to goodwill and intangible assets. The reporting unit for goodwill assessment was the same as the asset group for the assessment of intangible assets, of which the trademark is the primary asset. Following the Share Purchase Transaction in April 2014, our management reviewed and adjusted our business strategies and adopted new revenue models in cooperation with Qinhe, a company controlled by Mr. Xu, our largest shareholder. As a result of substantial uncertainties regarding our ability to generate revenue and operating cash flow prospectively due to such fundamental changes to our business model, our management concluded that the carrying value of our goodwill and intangible assets was impaired. We recorded significant impairment charges of $6.2 million and $21.0 million for goodwill and for definite-lived intangible assets, respectively, for the year ended December 31, 2013, and the remaining carrying value of goodwill and intangible assets were reduced to nil and nil, respectively, as of December 31, 2013. See notes 5 and 7 to our audited consolidated financial statements included elsewhere in this annual report on Form 20-F.
Turnover Tax and Related Surcharges
Our subsidiaries and consolidated affiliated entities are subject to business tax and related surcharges or value-added tax, as the case may be, on the revenues earned for services provided in China. These business tax and related surcharges or value-added tax are deducted from gross
In 2012, the relevant PRC authorities introduced a turnover tax reform pilot program (the “Pilot Program”) in selected pilot cities in China for selected industries to gradually expand the scope of VAT. The Pilot Program was implemented in Beijing and Tianjin, in which our advertising revenues are sourced, effective September 1 and December 1, 2012, respectively. Prior to the implementation of the Pilot Program, the business tax rate on our advertising sales was 5% based on the gross advertising revenue before deducting advertising
Selling and Marketing Expenses. Selling and marketing expenses consist primarily of sales and marketing personnel payroll compensation and related employee costs, advertising and market promotion expenses, and other overhead expenses incurred by our sales and marketing personnel. General and Administrative Expenses. General and administrative expenses consist primarily of salary and benefits, including share-based compensation, for general management, finance and administrative personnel, bad debt provisions (reversals), litigation accruals (and related reversals), depreciation, amortization of intangible assets and goodwill, professional service fees, office rental fees, and other expenses. Impairment of Goodwill and Intangible assets. We recorded significant impairment charges of $6.2 million and $21.0 million for goodwill and for definite-lived intangible assets (mainly trademark), respectively, for the year ended December 31, 2013. See Item 5.A. “Operating Results—Critical Accounting Policies—Goodwill and Intangible Assets Impairment.” Furthermore, in order to reduce operating cash outflows, we have carried out a plan to reduce our headcount by approximately 40% in various departments in April 2014. See Item 6.D. “Employees.” As a result, we expect the payroll expenses included in the above items to decrease in 2015. Critical Accounting Policies The methods, estimates and judgments we use in applying our accounting policies have a significant impact on the results we report in our financial statements. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. We have summarized our accounting policies below that we believe are both important to an understanding of our financial results and involve the need to make estimates about the effect of matters that are inherently uncertain. We also have other policies that we consider to be key accounting policies. However, these policies do not meet the definition of critical accounting policies because they do not generally require us to make estimates or judgments that are difficult or subjective. Business Combinations and Non-controlling Interests We account for our business combinations using the purchase method of accounting. This method requires that the acquisition cost to be allocated to the assets, including separately identifiable intangible assets, and liabilities we acquired based on their estimated fair values. Any non-controlling interest was reflected at historical cost. Where the consideration in an acquisition includes contingent consideration the payment of which depends on the achievement of certain specified conditions post-acquisition, contingent consideration was not recorded until the contingency was resolved. From January 1, 2009, we adopted ASC 805 (formerly referred to as SFAS No. 141 (revised 2007), “Business combinations”). Following this adoption, the cost of an acquisition is measured as the aggregate of the fair values at the date of exchange of the assets given, liabilities incurred, and equity instruments issued as well as the contingent considerations and all contractual contingencies as of the acquisition date. The costs directly attributable to the acquisition are expensed as incurred. Identifiable assets, liabilities and contingent liabilities acquired or assumed are measured separately at their fair value as of the acquisition date, irrespective of the extent of any non-controlling interests. The excess of (i) the total of cost of acquisition, fair value of the non-controlling interests and acquisition date fair value of any previously held equity interest in the acquiree over and (ii) the fair value of the identifiable net assets of the acquiree is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognized directly in the income statement. We follow the guidance in ASC Topic 810 regarding non-controlling interests. Non-controlling interests are classified as a separate component within equity. Consolidated net income on a total enterprise basis is adjusted within the statement of operations and comprehensive loss for net income attributed to non-controlling interests and consolidated comprehensive income is adjusted for comprehensive income attributed to non-controlling interests. Revenue Recognition In accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 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 or performance has occurred, and collectability is reasonably assured. Revenues are recorded net of indirect taxes. We make credit assessments of customers to assess the collectability of contract amounts prior to entering into contracts. For those contracts for which the collectability is assessed as not reasonably assured, we recognize revenue only when cash is received and all revenue recognition criteria are met. Online advertising services We derive part of our revenue from online advertising services, where advertisers (including third parties and related parties) pay to place their advertisements on our online video platform in different formats. Such formats include but are not limited to banners, buttons, links, and 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 thresholds, 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 the relevant thresholds are achieved. In the latter case, the delivery is not conditioned on any threshold but occurs over the lapse of time. Our online advertising services revenue is principally generated from fixed contracts with specific advertising agent customers serving as intermediaries between us and ultimate advertisers. We derived substantially all of our online advertising services revenue from such contracts in 2012 and 2013, and all of our online advertising services revenue from such contracts in 2014. Under two previous agreements with Old Shengyue and New Shengyue, respectively, each of which served as our previous exclusive advertising agents for standard advertising resources and non-exclusive advertising agents for highly interactive advertising resources, and under our current arrangement with Huzhong, our exclusive advertising agent for standard advertising resources and non-exclusive advertising agent for highly interactive advertising resources, the relevant arrangements include guaranteed minimum advertising revenues and sharing of excess advertising revenues, as well as web traffic or video view targets to be met by us. Under our previous agreement with Old Shengyue, which expired in March 2014, guaranteed minimum advertising revenues were not subject to downward adjustments. Under our previous agreement with New Shengyue, which was terminated in August 2014, guaranteed minimum advertising revenues must be proportionally adjusted downward if there was a shortfall relative to web traffic or video view targets. Under these two agreements, excess advertising revenues were calculated after deducting commission fees earned by Old Shengyue and New Shengyue based upon increasing percentages for additional tiers or layers of revenues in excess of the guaranteed amount. There were no commission fees incurred for any historical periods, as we earned only the minimum guaranteed revenues in 2012, 2013 and 2014 under these arrangements. Under our current agreement with Huzhong, the guaranteed minimum daily advertising revenues are based upon the agreed daily web traffic targets, and revenues are proportionally adjusted downward or upward relative to the guaranteed minimums if web traffic falls short of or exceeds the agreed upon targets. In 2014, we exceeded such targets on certain occasions resulting in an insignificant additional amount of revenue. Unlike our previous agreements with Old Shengyue and New Shengyue, which provided for settlement of service fees in arrears, our current agreement with Huzhong provides for prepayment of 50% of the guaranteed amounts prior to the beginning of the month and settlement of the balance as determined between the parties at the end of the month. The prepayments are recorded as advances from customers until recognised as revenue. Guaranteed advertising revenues and any excess advertising revenues net of commission fees are recognized ratably over varying service periods as governed by the specific agreements, as we are able to timely obtain information to determine historical advertising revenues as a basis for preparing financial statements. We report the revenue earned from both related and third party advetising agencies based on the net amount after considering the indicators to record revenue gross versus set forth in ASC 605-45, “Principal Agent Considerations.” A principal factor considered is the fact that the advertising agents establish prices with ultimate end customers wishing to place advertisements, which we are not able to influence. Promotional advertising services We derive a portion of our revenue from Qinhe, a related party, in exchange for interactive media and entertainment promotional advertising services provided to Qinhe. We provide interactive entertainment marketing services to Qinhe from April 2014. In return, Qinhe shares a certain percentage of its revenues generated from our video viewers who visit its proprietary social media platform through advertisements on our website and spend monies with Qinhe. In September 2014, we amended the relevant agreement with respect to the interactive entertainment marketing services. Pursuant to the amended agreement, Qinhe agreed to pay us additional guaranteed revenue amounts from July 2014 to December 2014 on a monthly basis in addition to the revenue sharing arrangement under the original agreement. We also provided online game marketing services to Qinhe from April 2014 to March 2015. In return, we share a portion of its profits that are generated from our video viewers who play Qinhe’s games through advertisements on our website. Profits are calculated as revenues from the games operated by Qinhe, net of licensing fees payable to game developers. Promotional advertising service revenues are recognized as services delivered for interactive entertainment marketing and online game. Shortly after the end of each month, with sufficient frequency to enable timely preparation of financial statements, we received a statement from Qinhe detailing the amount of shared revenue for each type of services. Once amounts have been reconciled to our records and agreed to, shared revenues were paid within 30 days. With respect to the additional guaranteed revenue amounts mentioned in the foregoing paragraph, such amounts are recognized on a monthly basis as they are not dependent on underlying video viewer referrals. We report the revenue earned from Qinhe based on the net amount after considering the indicators to record revenue gross versus set forth in ASC 605-45, “Principal Agent Considerations.” A principal factor considered is the fact that Qinhe establishes all pricing to end customers and we are not responsible for providing the contents or services. Allowances for Doubtful Accounts
We
We We measure impairment of intangible assets whenever events or changes in circumstances indicate that the carrying amount of an asset may no longer be recoverable. When these events occur, we assess impairment by comparing the carrying value of the intangible assets to the estimated undiscounted future cash flows expected to result from During the annual impairment test on December 31, 2012, we performed an impairment test for our single reporting unit relating to goodwill and compared the market value of our publicly traded equity to the carrying value of our equity and concluded that there was no impairment as of December 31, 2012. As we incurred net losses in each of the fiscal years from 2007 to 2012, we assessed impairment for intangible assets by comparing the carrying value of the intangible assets to the estimated undiscounted future cash flows. We used the market value of our publicly traded equity as a conservative proxy for undiscounted cash flows, as the market value theoretically includes a discount factor. We concluded there was no impairment indicated for intangible assets as of December 31, 2012. During the annual impairment test on December 31, 2013, we performed an impairment test relating to goodwill and
Product Development Expenses. Product development expenses consist primarily of salaries and benefits for product development personnel, including share-based compensation costs. Selling and Marketing Expenses. Selling and marketing expenses consist primarily of sales and marketing personnel payroll compensation and related employee costs, advertising and market promotion expenses, and other overhead expenses incurred by our sales and marketing personnel. General and Administrative Expenses. General and administrative expenses consist primarily of salary and benefits, including share-based compensation, for general management, finance and administrative personnel, bad debt provisions (reversals), litigation accruals (and related reversals), depreciation, amortization of intangible assets and goodwill, professional service fees, office rental fees, and other expenses. Impairment of Goodwill and Intangible assets. We recorded significant impairment charges of $6.2 million and $21.0 million for goodwill and for definite-lived intangible assets (mainly trademark), respectively, for the year ended December 31, 2013. See Item 5.A. “Operating Results—Critical Accounting Policies—Goodwill and Intangible Assets Impairment.” Furthermore, in order to reduce operating cash outflows, we have carried out a plan to reduce our headcount by approximately 40% in various departments in April 2014. See Item 6.D. “Employees.” As a result, we expect the payroll expenses included in the above items to decrease in 2015. Critical Accounting Policies The methods, estimates and judgments we use in applying our accounting policies have a significant impact on the results we report in our financial statements. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. We have summarized our accounting policies below that we believe are both important to an understanding of our financial results and involve the need to make estimates about the effect of matters that are inherently uncertain. We also have other policies that we consider to be key accounting policies. However, these policies do not meet the definition of critical accounting policies because they do not generally require us to make estimates or judgments that are difficult or subjective. Business Combinations and Non-controlling Interests We account for our business combinations using the purchase method of accounting. This method requires that the acquisition cost to be allocated to the assets, including separately identifiable intangible assets, and liabilities we acquired based on their estimated fair values. Any non-controlling interest was reflected at historical cost. Where the consideration in an acquisition includes contingent consideration the payment of which depends on the achievement of certain specified conditions post-acquisition, contingent consideration was not recorded until the contingency was resolved. From January 1, 2009, we adopted ASC 805 (formerly referred to as SFAS No. 141 (revised 2007), “Business combinations”). Following this adoption, the cost of an acquisition is measured as the aggregate of the fair values at the date of exchange of the assets given, liabilities incurred, and equity instruments issued as well as the contingent considerations and all contractual contingencies as of the acquisition date. The costs directly attributable to the acquisition are expensed as incurred. Identifiable assets, liabilities and contingent liabilities acquired or assumed are measured separately at their fair value as of the acquisition date, irrespective of the extent of any non-controlling interests. The excess of (i) the total of cost of acquisition, fair value of the non-controlling interests and acquisition date fair value of any previously held equity interest in the acquiree over and (ii) the fair value of the identifiable net assets of the acquiree is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognized directly in the income statement. We follow the guidance in ASC Topic 810 regarding non-controlling interests. Non-controlling interests are classified as a separate component within equity. Consolidated net income on a total enterprise basis is adjusted within the statement of operations and comprehensive loss for net income attributed to non-controlling interests and consolidated comprehensive income is adjusted for comprehensive income attributed to non-controlling interests. Revenue Recognition In accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 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 or performance has occurred, and collectability is reasonably assured. Revenues are recorded net of indirect taxes. We make credit assessments of customers to assess the collectability of contract amounts prior to entering into contracts. For those contracts for which the collectability is assessed as not reasonably assured, we recognize revenue only when cash is received and all revenue recognition criteria are met. Online advertising services We derive part of our revenue from online advertising services, where advertisers (including third parties and related parties) pay to place their advertisements on our online video platform in different formats. Such formats include but are not limited to banners, buttons, links, and 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 thresholds, 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 the relevant thresholds are achieved. In the latter case, the delivery is not conditioned on any threshold but occurs over the lapse of time. Our online advertising services revenue is principally generated from fixed contracts with specific advertising agent customers serving as intermediaries between us and ultimate advertisers. We derived substantially all of our online advertising services revenue from such contracts in 2012 and 2013, and all of our online advertising services revenue from such contracts in 2014. Under two previous agreements with Old Shengyue and New Shengyue, respectively, each of which served as our previous exclusive advertising agents for standard advertising resources and non-exclusive advertising agents for highly interactive advertising resources, and under our current arrangement with Huzhong, our exclusive advertising agent for standard advertising resources and non-exclusive advertising agent for highly interactive advertising resources, the relevant arrangements include guaranteed minimum advertising revenues and sharing of excess advertising revenues, as well as web traffic or video view targets to be met by us. Under our previous agreement with Old Shengyue, which expired in March 2014, guaranteed minimum advertising revenues were We report the revenue earned from both related and third party advetising agencies based on the net amount after considering the indicators to record revenue gross versus set forth in ASC 605-45, “Principal Agent Considerations.” A principal factor considered is the fact that the advertising agents establish prices with ultimate end customers wishing to place advertisements, which we are not able to influence. Promotional advertising services We derive a portion of our revenue from Qinhe, a related party, in exchange for interactive media and entertainment promotional advertising services provided to Qinhe. We provide interactive entertainment marketing services to Qinhe from April 2014. In return, Qinhe shares a certain percentage of its revenues generated from our video viewers who visit its proprietary social media platform through advertisements on our website and spend monies with Qinhe. In September 2014, we amended the relevant agreement with respect to the interactive entertainment marketing services. Pursuant to the amended agreement, Qinhe agreed to pay us additional guaranteed revenue amounts from July 2014 to December 2014 on a monthly basis in addition to the revenue sharing arrangement under the original agreement. We also provided online game marketing services to Qinhe from April 2014 to March 2015. In return, we share a portion of its profits that are generated from our video viewers who play Qinhe’s games through advertisements on our website. Profits are calculated as revenues from the games operated by Qinhe, net of licensing fees payable to game developers. Promotional advertising service revenues are recognized as services delivered for interactive entertainment marketing and online game. Shortly after the end of each month, with sufficient frequency to enable timely preparation of financial statements, we received a statement from Qinhe detailing the amount of shared revenue for each type of services. Once amounts have been reconciled to our records and agreed to, shared revenues were paid within 30 days. With respect to the additional guaranteed revenue amounts mentioned in the foregoing paragraph, such amounts are recognized on a monthly basis as they are not dependent on underlying video viewer referrals. We report the revenue earned from Qinhe based on the net amount after considering the indicators to record revenue gross versus set forth in ASC 605-45, “Principal Agent Considerations.” A principal factor considered is the fact that Qinhe establishes all pricing to end customers and we are not responsible for providing the contents or services. Allowances for Doubtful Accounts We determine the allowance for doubtful accounts when facts and circumstances indicate that receivables are unlikely to be collected by taking into account an aging analysis of receivable balances, historical bad debt records, repayment patterns in the prior year and other factors such as the policies of operators and financial condition of the customers. Our allowance for doubtful accounts principally relates to long-aged receivables resulted from our business model prior to 2011 when Old Shengyue was appointed as our primary advertising agency. For further information, see Note 17 to our audited consolidated financial statements included elsewhere in this annual report on Form 20-F. During the years ended December 31, 2012, 2013 and 2014, we recorded benefits from the reversal of the allowance for doubtful accounts of $2.3 million, $0.3 million and $0.1 million, respectively, due to the collection of accounts receivable that were previously fully written down. During the year ended December 31, 2014, we recorded a provision for doubtful accounts of $1.0 million relating to uncollectible amounts from Old Shengyue and New Shengyue. As of December 31, 2014, the balance of our allowance for doubtful accounts was $0.4 million. Goodwill and Intangible Assets Impairment We test goodwill for impairment by performing a two-step goodwill impairment test, which can be preceded by an optional qualitative assessment to determine if the two-step goodwill impairment test needs to be followed. The optional qualitative assessment relies upon qualitative factors to determine if it is “more likely than not” that the fair value of a reporting unit is less than the carrying value of the reporting unit. We did not apply the qualitative assessment and proceeded directly to the two-step test. The first step compares the calculated fair value of a reporting unit to its carrying amount, including goodwill. If and only if the carrying amount of a reporting unit exceeds its fair value as per step one, the second step is executed to compare the implied fair value of the affected reporting unit’s goodwill to the carrying value of that goodwill. The implied fair value of goodwill is determined in a manner similar to accounting for a business combination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. This allocation process is only performed for purposes of evaluating goodwill impairment and does not result in an entry to adjust the value of any assets or liabilities. An impairment loss is recognized for any excess in the carrying value of goodwill over the implied fair value of goodwill. When available, we use observable market data, including pricing on recent closed market transactions, to determine the fair value of our single reporting unit and compare that with the carrying amount of the reporting unit to assess any goodwill impairment. The fair value of our single reporting unit was determined based on our market capitalization as of the valuation date in 2012. When there is little or no observable market data, we measure the fair value of a 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 includes using financial metrics and ratios of comparable public companies. In 2013, we relied on the income approach to evaluate our goodwill. When goodwill is determined to be impaired, we use the income approach including discounted cash flow modeling 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 assess impairment by comparing the carrying value of the intangible assets to the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flow is less than the carrying amount of the assets, we would recognize an impairment loss based on the fair value of the intangible assets. We measure the fair value of intangible assets 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. During the annual impairment test on December 31, 2012, we performed an impairment test for our single reporting unit relating to goodwill and compared the market value of our publicly traded equity to the carrying value of our equity and concluded that there was no impairment as of December 31, 2012. As we incurred net losses in each of the fiscal years from 2007 to 2012, we assessed impairment for intangible assets by comparing the carrying value of the intangible assets to the estimated undiscounted future cash flows. We used the market value of our publicly traded equity as a conservative proxy for undiscounted cash flows, as the market value theoretically includes a discount factor. We concluded there was no impairment indicated for intangible assets as of December 31, 2012. During the annual impairment test on December 31, 2013, we performed an impairment test relating to goodwill and intangible assets. The reporting unit for goodwill assessment was the same as the asset group for the assessment of intangible assets, of which the trademark is the primary asset. Following the Share Purchase Transaction in April 2014, our management reviewed and adjusted our business strategies and adopted new revenue models in cooperation with Qinhe, a company controlled by Mr. Xu, our largest shareholder. As a result of substantial uncertainties regarding our ability to generate revenue and operating cash flow prospectively due to such fundamental changes to our business model, our management concluded that the carrying value of our goodwill and intangible assets was impaired. We recorded significant impairment charges of $6.2 million and $21.0 million for goodwill and for definite-lived intangible assets, respectively, for the year ended December 31, 2013, and the remaining carrying value of goodwill and intangible assets were reduced to nil and nil, respectively, as of December 31, 2013. See notes 5 and 7 to our audited consolidated financial statements included elsewhere in this annual report on Form 20-F. Turnover Tax and Related Surcharges Our subsidiaries and consolidated affiliated entities are subject to business tax and related surcharges or value-added tax, as the case may be, on the revenues earned for services provided in China. These business tax and related surcharges or value-added tax are deducted from gross receipts to arrive at net revenues. In 2012, the relevant PRC authorities introduced a turnover tax reform pilot program (the “Pilot Program”) in selected pilot cities in China for selected industries to gradually expand the scope of VAT. The Pilot Program was implemented in Beijing and Tianjin, in which our advertising revenues are sourced, effective September 1 and December 1, 2012, respectively. Prior to the implementation of the Pilot Program, the business tax rate on our advertising sales was 5% based on the gross advertising revenue before deducting advertising agency rebates. After the implementation of the Pilot Program, our advertising business is subject to value-added tax at a rate of 6%. Share-based Compensation We apply Accounting Standards Codification Topic 718, “Stock Compensation,” or ASC 718, which requires all share-based payments to employees and directors, including grants of employee stock options and restricted shares, to be recognized as compensation expense in the financial statements over the vesting period of the award based on the fair value of the award determined at the grant date. The valuation provisions of ASC 718 apply to new awards, to awards granted to employees and directors before the adoption of ASC 718 whose related requisite services had not been provided, and to awards which were subsequently modified or cancelled. Under ASC 718, the number of share-based awards for which the service is not expected to be rendered for the requisite period should be estimated, and the related compensation cost not recorded for that number of awards. In accordance with ASC 718, we have recognized share-based compensation expenses, net of a forfeiture rate, using the straight-line method for awards with graded vesting features and service conditions only and using the graded-vesting attribution method for awards with graded vesting features and performance conditions. We grant equity incentive awards to our employees. We recorded share-based compensation expense of $0.5 million, $1.0 million and $0.6 million in 2012, 2013 and 2014, respectively. The increase in share-based compensation in 2013 compared to Income Taxes and Valuation allowances Current income taxes are provided for on the taxable income of each subsidiary on the separate tax return basis in accordance with the relevant tax laws. Our PRC subsidiaries and consolidated affiliated entities are generally subject to a corporate income tax rate of 25% under the EIT Law. We are not subject to income tax under the Cayman Islands law. Deferred income taxes are provided using the liability method in accordance with Accounting Standards Codification Topic 740, “Income Taxes,” or ASC 740. Under this method, deferred income taxes are recognized for temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements, net operating loss carry forwards and credits, by applying enacted statutory tax rates applicable to future years. The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. The effect on deferred taxes of a change in tax rates is recognized in income in the period of change. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Accounting Standards Codification Topic 740-10-25 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The adoption of ASC 740-10-25 did not result in a cumulative adjustment to the opening balance of retained earnings as of January 1, 2007. We do not have any liabilities for unrecognized tax benefits as of December 31, 2012, 2013 or 2014. Were we to have such liabilities, interest and penalties would be recognized for the tax purpose. Contingencies We are subject to contingencies, such as legal proceedings and claims arising out of our business, that cover a wide range of matters in the normal course of our business. Liabilities for such contingencies are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated by us. As of December 31, 2014, we had estimated and accrued $1.7 million for liabilities arising from alleged copyright infringements, which reflected a reduction of $0.3 million from the prior year. The accrual is based on judgments rendered by courts and out-of-court settlements with respect to alleged copyright infringement arising before December 31, 2014 relating to videos uploaded to our website. The accrual is based upon management’s best estimation according to the historical actual compensation amount per video for similar legal actions and advice from PRC counsel. The accrual also takes into account the time it takes to file a claim related to alleged infringement, which in some cases may occur more than a year after the underlying event. Furthermore, while claims for alleged infringement may be term limited in certain cases, parties alleging infringement may be able to renew their claims by re-filing them upon expiry, leading to continuation of the claim resolution process. We are in the process of appealing certain judgments for which the loss has been accrued. Adverse results in these lawsuits 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. Results of Operations The following discussion of our results of operations for the years ended December 31, 2012, 2013 and 2014 should be read in conjunction with our audited consolidated financial statements included elsewhere in this annual report on Form 20-F. In April 2014, as a result of our management’s review and adjustment of our business strategies after the Share Purchase Transaction, we started to explore new revenue sources, including advertising agreements with independent third parties and cooperation with Qinhe. See “—Description of Certain Statement of Operations Items—Net Revenues.” As the revenue models are relatively new, the following discussion may not be meaningful for you to understand the trends of our operations going forward. Year Ended December 31, 2014 Compared to Year Ended December 31, 2013 Net Revenues. Net revenues decreased by 34.4% to $8.6 million in Cost of Revenues. Cost of revenues decreased by 24.4% to $12.1 million in 2014 from $16.0 million in 2013. This decrease was mainly attributable to the UGC Entertainment Awards production costs incurred in 2013, which did not recur in 2014. In addition, we optimized our bandwidth usage to improve its efficiency which resulted in a decrease of Internet band width costs by $1.5 million in 2014. Depreciation expenses also decreased by $0.6 million from 2013 to 2014. Such decreases were partially offset by an increase of our payroll costs in the amount of Gross Loss. As a result of the foregoing, our gross loss increased from Operating Expenses. Operating expenses decreased significantly to $9.4 million in 2014 from $40.6 million in 2013, primarily due to an impairment charge for goodwill and intangible assets of $27.2 million in 2013, which did not recur in 2014, as well as decreases in our product development expenses, selling and marketing expenses and general and administrative expenses. ·Product Development Expenses. Product development expenses decreased by 60.4% to $1.4 million in 2014 from $3.5 million in 2013. This decrease was primarily due to the decrease in labor costs as a result of
· Selling and Marketing Expenses. Selling and marketing expenses decreased by
· General and Administrative Expenses. General and administrative expenses decreased ·Impairment of Goodwill and Intangible Assets. We recorded significant impairment charges of $6.2 million
Operating Loss
Interest
Interest
Other Income, Gain from disposal of equity interest in affiliate. In June 2014, we disposed of 10% of the equity interests in Bale to
Income Tax Net Loss. Net loss decreased significantly from $34.4 million in 2013 to $10.7 million in 2014. Year Ended December 31, 2013 Compared to Year Ended December 31, 2012 Net Revenues. Net revenues decreased by 6.9% to $13.1 million in 2013 from $14.1 million in 2012. This decrease was primarily due to a decrease in revenues from third-party advertisers. Revenues from our previous advertising agency agreement with Old Shengyue contributed approximately 88.4% and 94.4% of our total net revenues in 2012 Cost of Revenues. Cost of revenues increased by 9.5 % to $16.0 million in 2013 from $14.6 million in 2012. This increase was mainly attributable to a cost of $1.4 million for the UGC Entertainment Awards we launched in 2013. Gross Loss. As a result of the foregoing, our gross loss increased from $0.5 million in 2012 to $2.8 million in 2013. Operating Expenses. Operating expenses increased significantly to $40.6 million in 2013 from $10.5 million in 2012, as a result of a significant impairment charge and increases in our product development expenses, selling and marketing expenses and general and administrative expenses. ·Product Development Expenses. Product development expenses increased by 77.3% to $3.5 million in 2013 from $2.0 million in 2012. This increase was primarily due to the increase in labor costs as we recruited more talents to strengthen our research and development team. ·Selling and Marketing Expenses. Selling and marketing expenses increased by 6.4 % to $1.8 million in 2013 from $1.7 million in 2012. This increase was primarily attributable to expenses for promotional campaigns and marketing events held in 2013. ·General and Administrative Expenses. General and administrative expenses increased from $6.8 million in 2012 to $8.1 million in 2013. This increase was primarily attributable to (i) an increase of $1.9 million in bad debt provision, because we reversed a large amount of provision in 2012 for collection of accounts receivable previously written down, which did not occur in 2013, and (ii) an increase of $0.5 million in share-based compensation expenses due to stock options awards granted to newly joined management and talents and expenses associated with the conversion of certain performance-based stock option awards to service-based option awards. ·Impairment of Goodwill and Intangible Assets. We recorded significant impairment charges of $6.2 million and $21.0 million for goodwill and for definite-lived intangible assets (mainly trademark), respectively, for the year ended December 31, 2013. See Item 5.A.” Operating Results—Critical Accounting Policies—Goodwill and Intangible Assets Impairment.” Operating Loss. As a result of the foregoing, operating loss increased significantly from $11.0 million in 2012 to $43.5 million in 2013. Interest Income. Interest income decreased to $0.1 million in Interest Expenses. Interest expense decreased to $0.02 million in 2013 from $0.6 million in 2012 primarily due to the repayment of interest-bearing loans from related parties in early 2013. Other Income, Net. Other income, net increased to $4.1 million in 2013 from $1.7 million in 2012, primarily due to (i) $2.9 million in gains from writing-off of various third-party liabilities related to our previous advertising sales model for which settlement was judged to be remote based upon our policies and past settlement experience and for which legal obligation has expired, and (ii) $0.2 million of reimbursements related to the ADR program from our depositary. This increase was partially offset by a charge of $1.0 million relating to a provision for a receivable due from Seed Music, a related party not under common control, based on an updated assessment of the collectability of this receivable. Income Tax Benefit. Income tax benefit was $4.8 million for in 2013 and nil in 2012.
Equity in Loss of Affiliated Company, Net of Tax. Equity in loss of affiliated company, net of tax, was nil in 2013 compared to $0.2 million as a result of our share of losses in Yisheng in Net Loss. Net loss increased significantly from $9.5 million in
In order to reduce operating cash outflows, we executed a plan to reduce our headcount by approximately 40% in various departments in 2014. See Item 6.D. “Employees.” We have also taken other cost reduction measures, including improving the efficiency of our CDN network to reduce infrastructure costs, as well as reducing our content acquisition costs. Based on our current cash flow projections, we expect that cash inflows from operating activities, together with our current cash balances, may not be sufficient to satisfy our cash requirements in the near term. See Item 3.D. “Risk Factors—Risks Related to Our Business—We require a significant amount of cash to fund our operations. We cannot assure you that we can meet our working capital requirements or other capital needs through improved operating results.” As a result, we may need to seek additional revenue sources and additional financing in the near future to fund our daily operations. In connection with the Share Purchase Transaction, Shanda Interactive, through its affiliate, provided additional capital of RMB20.0 million ($3.2 million) to us in April 2014. In connection with the capital injection in April 2014, certain existing related party receivables due from an affiliate of Shanda Interactive in the amount of $1.2 million were waived by us, and we received a net amount of $2.0 million in cash from Shanda Interactive in April 2014. Subsequent to the Share Purchase Transaction, Shanda Interactive provided additional capital of RMB21.4 million ($3.4 million) to us in May 2014. In connection with the capital injection in May 2014, certain existing related party payables to companies controlled by Shanda Interactive, amounting to RMB5.3 million ($0.8 million), were waived, and we received a net amount of RMB16.1 million ($2.6 million) in cash from Shanda Interactive in May 2014. However, these capital contributions have not fully alleviated the pressure on our working capital and liquid resources. In March 2015, we received a loan of RMB30.0 million ($4.8 million) from Mr. Xu, our current largest shareholder, with a one-year term and bearing interests at 6.5% per annum. There is still considerable uncertainty as to if and when any other financings will occur on terms acceptable to us or at all. See Item 3.D. “Risk Factors—Risks Related to Our Business—We cannot assure you that we can meet our working capital requirements or other capital needs through additional financings in amounts or on terms acceptable to us, or at all.”
Operating Activities Our net cash used in operating activities in 2014 was $5.2 million. This was primarily attributable to (i) our net loss of $10.7 million, (ii) gain from disposal of equity interest in affiliate of $1.5 million, (iii) a decrease of accrued expenses and other current liabilities of $1.2 million, (iv) an increase in accounts receivable of $1.0 million and (v) a decrease of accounts payable of $0.7 million, which were offset by (i) a decrease of $6.6 million in amounts due from related parties resulting from the receipt of receivables related to advertising revenues from Old Shengyue in 2014, (ii) $1.0 million in depreciation and amortization, (iii) $1.0 million bad debt provision, (iv) an increase in amount due to related parties of $0.8 million and (v) $0.6 million in share-based compensation. Our net cash used in operating activities in 2013 was $11.5 million. This was primarily attributable to (i) our net loss of $34.4 million, (ii) a decrease in deferred taxes of $4.8 million, (iii) derecognition of long-aged operating liabilities of $2.9 million, (iv) an increase of $2.1 million in amounts due from related parties resulting from the delayed receipt of receivables (subsequently collected after December 31, 2013) related to advertising revenues from Old Shengyue and (v) a decrease of accrued expenses and other current liabilities of $1.1 million, which were adjusted by (i) non-cash charges of $21.0 million and $6.2 million for impairment loss of intangible assets and impairment of goodwill, respectively, (ii) $3.4 million in depreciation and amortization, (iii) an increase in accounts payable of $1.3 million and (iv) $1.0 million in share-based compensation.
Our net cash used in operating activities in 2012 was $8.1 million. This was primarily attributable to (i) our net loss of $9.5 million, (ii) a reversal of $2.3 million in bad debt provision due to collection of accounts receivable previously written down, (iii) an increase of $1.7 million in amounts due from related parties resulting from the delayed receipt of receivables (subsequently collected after December 31, 2012) related to advertising revenues from Old Shengyue, (iv) a decrease of $1.5 million in accounts payable due to more settlement of cash incentives to advertising agencies in 2012, which were adjusted by (i) non-cash expenses of $3.5 million in depreciation and amortization and $0.5 million in share-based compensation, and (ii) a decrease of $3.0 million in accounts receivable as a result of increased collection of advertising revenues from third parties in 2012.
Investing Activities Our net cash provided by investing activities was $1.7 million in 2014. This was primarily attributable to (i) proceeds of $1.5 million from the disposal of a 10% equity interest in Bale, (ii) the repayment by a company controlled by Shanda Interactive of an interest-bearing loan of $0.5 million, and (iii) expenditures for property and equipment of $0.2 million. Our net cash provided by investing activities was $3.4 million in 2013. This was primarily attributable to (i) the repayment by Shanda Games Limited of an interest-bearing loan of $3.3 million in 2013, and (ii) the proceeds of $0.2 million from disposal of property and equipment.
Our net cash provided by investing activities was $15.6
Financing Activities Our net cash provided by financing activities was $6.2 million in 2014. This mainly consisted of $5.8 million of capital contributions received from Shanda Interactive. Our net cash used in financing activities was $3.3 million in 2013. This consisted mainly of the repayment to Shanda Games Limited of an interest-bearing loan of $3.3 million.
Our net cash used in financing activities was $21.2 million in 2012. This consisted mainly of (i) the repayments to Shanda Games Limited of interest-bearing loans with an aggregate amount of $9.9 million, (ii) repurchase of ordinary shares with an aggregate amount of $8.2 million,
Restrictions on Cash Transfers to our Company
We are a holding company and our operations are principally conducted through our PRC subsidiaries and our consolidated affiliated entities. As a result, the ability of our company to pay dividends and to finance debts depends upon service fees paid by our consolidated affiliated entities to our PRC subsidiaries and dividends and other distributions paid by our PRC subsidiaries to our company. If any of our subsidiaries or consolidated affiliated entities incurs debt on its own behalf, the instruments governing the debt may restrict its ability to pay service fees or dividends directly or indirectly to our company.
In addition, under PRC laws and regulations, our PRC subsidiaries and our consolidated affiliated entities may pay dividends only out of their retained earnings as determined in accordance with PRC accounting standards and regulations. There is no significant difference between retained earnings as determined in accordance with PRC accounting standards and in accordance with U.S. GAAP. In addition, our PRC subsidiaries and our consolidated affiliated entities are required to set aside at least 10% of their after-tax net income each year, if any, to fund certain statutory reserves, which are not distributable as cash dividends, until the aggregate amount of such funds reaches 50% of their respective registered capital. As a result of these and other restrictions under PRC laws and regulations, our PRC subsidiaries and consolidated affiliated entities are restricted in their ability to transfer a portion of their net assets to our company either in the form of dividends, loans or advances, which restricted portion amounted to approximately $
Cash transfers from our PRC subsidiaries to our offshore subsidiary and our company are also subject to restrictions imposed by the PRC government’s currency conversion policy. See Item 3.D. “Risk Factors—Risks Related to Our Corporate Structure—Restrictions on currency exchange may limit our ability to utilize our revenues effectively.”
C.Research and Development, Patents and Licenses
See Item 4.B. “Business Overview—Technology and Infrastructure” and “—Intellectual Property.”
Our research and development expenditures were
D.Trend Information
Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events
E.Off-Balance Sheet Arrangements
We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. In addition, we have not entered into any derivative contracts that are indexed to our own shares and classified as shareholders’ equity, or that are not reflected in our financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. Moreover, we do not have any variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.
F.Contractual Obligations
The following table sets forth certain information with respect to our contractual obligations as of December 31,
We did not have any long-term debt obligations as of December 31,
Item 6.Directors, Senior Management and Employees
A.Directors and Senior Management
The names of our current directors and executive officers, their ages as of
(1) Member of the compensation and leadership development
(2) Member of the corporate development and finance
(3) Member of the audit
Biographical Information
Feng Gao. Mr. Gao has served as our
Terms of Directors and Executive Officers
Each of our directors shall be re-elected annually by our shareholders at a general meeting and shall serve until his
Employment Agreements
We have entered into employment agreements with each of our executive officers. The initial term of these employment agreements is generally two to three years. Under these agreements, we may terminate the employment of an executive officer for cause at any time in case of certain acts by the executive officer. An executive officer may terminate the employment at any time upon thirty days
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
B.Compensation
Compensation of Directors and Executive Officers
For the year ended December 31,
Summary of Stock Plans
2010 Equity Compensation Plan
Our board of directors adopted the 2010 Equity Compensation Plan, or the 2010 Plan, which became effective in December 2010. A total of 698,381,300 ordinary shares of our company are reserved for issuance under the 2010 Plan. A general description of the terms of the 2010 Plan is set forth below:
Plan Administration. Our board of directors or one or more committees appointed by our board acts as
Types of Awards. The principal features of the various awards that may be granted under the 2010 Plan are as follows:
· Options. Options provide for the right to purchase a specified number of our ordinary shares at a specified exercise price subject to vesting.
· Share Appreciation Rights. Share appreciation rights provide for the right to receive a payment, in cash or ordinary shares, equal to the excess of the fair market value of a specified number of our ordinary shares on the date the share appreciation right is exercised over the base price as set forth in the award document.
· Restricted
· Restricted Share Units. Restricted share units represent the right to receive a specified number of our ordinary shares, subject to vesting. Restricted share units will be settled upon vesting, subject to the terms of the award agreement, either by our delivery to the holder of the number of ordinary shares represented by the vested restricted share units or by a cash payment to the holder that equals the then fair market value of the underlying ordinary shares.
Award Document. Awards granted under the 2010 Plan are evidenced by an award document that sets forth the terms and conditions applicable to each of these awards, as determined by the administrator in its sole discretion.
Termination of the 2010 Plan. Without further action by our board of directors, the 2010 Plan will terminate in December 2020. Our board of directors may amend, suspend or terminate the 2010 Plan at any time, provided, however, that our board of directors must first seek the approval of the participants of the 2010 Plan if such amendment, suspension or termination would materially adversely affect the rights of participants with respect to any of their existing awards.
In December 2013, our board of directors approved certain modifications of the vesting conditions of certain outstanding options granted to senior management under the 2010 Plan to waive the performance condition under the relevant options with respect to a certain period from 2011 to 2013. Other terms of the relevant options remain unchanged. See note 14 to our consolidated financial statements included elsewhere in this annual report on Form 20-F. The table below sets forth the options that had been granted to our directors and executive officers pursuant to the 2010 Plan as of March 31,
* Upon exercise of all vested options, this person would beneficially own less than 1% of our outstanding ordinary shares as of March 31,
(1)
(2) (3)Wenwen Niu ceased to be our director in December 2014. (4)Frank Feng resigned as our chief financial officer
C.Board Practices
Our board of directors currently consists of
There are, however, no specific requirements under Cayman Islands law that the board must be comprised of a majority of independent directors.
We do not have regularly scheduled meetings at which only independent directors are present, or executive sessions. This home country practice of ours was established by our board of directors by reference to similarly situated issuers and differs from the NASDAQ Stock Market Rules that require the company to have regularly scheduled executive sessions at which only independent directors are present. There are, however, no specific requirements under Cayman Islands law on executive sessions.
We have established three committees under our board of directors: an audit committee, a compensation and leadership development committee and a corporate development and finance committee. We have adopted a charter for each of the three committees. Each committee’s composition and functions are described below.
The members of the audit committees are
The members of the compensation and leadership development committee are
The members of the corporate development and finance committee are
None of our directors have service contracts that provide for benefits upon termination of employment.
Duties of Directors
Under Cayman Islands law, our directors have a fiduciary duty to act honestly, in good faith and with a view to our best interests. Our directors also have a duty to exercise the skills they actually possess and such care and diligence that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our memorandum and articles of association, as amended from time to time. A shareholder has the right to seek damages if a duty owed by our directors is breached.
The functions and powers of our board of directors include, among others:
· convening shareholders’ annual general meetings and reporting its work to shareholders at such meetings;
· declaring dividends and distributions;
· appointing officers and determining the term of office of officers; and
· exercising the borrowing powers of our company and mortgaging the property of our company.
Interested Transactions
A director may vote in respect of any contract or transaction in which he or she is interested, provided that the nature of the interest of any directors in such contract or transaction is disclosed by him or her at or prior to its consideration and any vote in that matter.
D.Employees
As of December 31,
E.Share Ownership
The following table sets forth certain information known to us with respect to the beneficial ownership of our ordinary shares as of March 31,
· all persons who are beneficial owners of five percent or more of our ordinary shares; and
· our executive officers and directors.
Percentage of beneficial ownership is based on
* Upon exercise of all vested options, this person would beneficially own less than 1% of our outstanding ordinary shares as of March 31,
(1)According to the Schedule 13D filed with the SEC on April 9, 2014, Mr. Xu, beneficially owned 1,938,360,784 of our ordinary shares as of April 3, 2014, including shares represented by our ADSs. We do not have further information with respect to any changes in Mr. Xu’s beneficial ownership of our shares subsequent to April 3, 2014. Mr. Xu’s business address is Building 5, No. 628 Hongqiao Road, Shanghai, P.R. China. (2) According to the amendment to the Schedule 13D filed with the SEC on
As of March 31,
Our company’s major shareholders do not have different voting rights from each other or other shareholders of our company. To our knowledge, there are no arrangements the operation of which may at a subsequent date result in our undergoing a change in control.
Item 7.Major Shareholders and Related Party Transactions
A.Major Shareholders
Please refer to Item 6.E. “Directors, Senior Management and Employees—Share Ownership.”
B.Related Party Transactions
Contractual Arrangements with Respect to Our Consolidated Affiliated Entities
We conduct our operations in China principally through contractual arrangements among our PRC subsidiaries, our consolidated affiliated entities in China, and their respective shareholders. See Item 4.C. “Organizational Structure.” The principal terms of the agreements with respect to our consolidated affiliated entities are described as follows.
Loan
Exclusive Business Cooperation
Exclusive Consulting and Service Agreements or Exclusive Technology Consulting and Service Framework Agreement: Certain of our PRC subsidiaries (Beijing WFOE, Tianjin WFOE and Tianjin Ku6 Network WFOE) entered into exclusive consulting and service agreements with the relevant consolidated affiliated entities (Ku6 Information Technology, Ku6 Cultural and Tianjin Ku6 Network), pursuant to which these consolidated affiliated entities agreed to respectively engage our PRC subsidiaries as their exclusive provider of consulting and other services. The amount of service fees payable by these consolidated affiliated entities to our PRC subsidiaries shall be agreed upon by the parties based on the scope and complexity of the technologies involved, the content and duration of the services provided, and the prevailing market price for similar services. Our PRC subsidiaries will exclusively own any intellectual property arising from the performance of these agreements. Unless terminated earlier by our PRC subsidiaries, these agreements have an initial term of 20 years expiring in December 2031, and will be renewable upon the request of our PRC subsidiaries. Our consolidated affiliated entities may not terminate these agreements without cause unless they compensate our PRC subsidiaries for all losses caused by such early termination.
Business Operation
Equity Pledge
Powers of
Exclusive Option Agreements or Equity Disposition
Exclusive Intellectual Property Option Agreement: Beijing WFOE entered into an exclusive intellectual property option agreement with Ku6 Information Technology, pursuant to which Ku6 Information Technology irrevocably granted to Beijing WFOE or its designee an exclusive right, exercisable at any time during the term of this agreement, to purchase from Ku6 Information Technology, in accordance with the price agreed upon by the parties and to the extent permitted under PRC laws and regulations, certain intellectual property rights. Without Beijing WFOE’s prior consent, Ku6 Information Technology may not transfer any of these intellectual property rights to any third party. This agreement has an initial term of 10 years expiring in June 2018 and will be automatically renewed for another 10 years unless terminated by Beijing WFOE.
Cooperation Agreements with Qinhe In April 2014, we started to provide interactive entertainment marketing services to iSpeak, a social platform that allows users to engage in real-time online group activities through voice, text and video. Under our cooperation agreement with Qinhe, which operates the iSpeak platform, Qinhe will share a certain percentage of the revenues that it generates from the viewers who visit the iSpeak platform through advertisements on our website. Users on the iSpeak platform may spend on virtual items during real-time video broadcasting, including gifts and avatars, and purchase other value-added services. We settle the shared revenue amounts with Qinhe on a monthly basis. In September 2014, we amended the interactive entertainment marketing agreement with Qinhe. Pursuant to the amended agreement, Qinhe agreed to pay certain additional guaranteed revenue amounts from July 2014 to December 2014, and the term of this agreement was extended to December 31, 2015. Other terms of the original agreements, including the revenue sharing arrangement, remained the same. On March 30, 2015, we further amended this agreement with Qinhe. Pursuant to the further amended cooperation agreement, the revenue sharing arrangement in the original agreement will be reinstated without the additional guaranteed revenue amounts. In April 2014, we also started to provide game marketing services for Qinhe under a similar revenue sharing arrangement as the one for interactive entertainment marketing cooperation. This agreement expired in March 2015 and was not renewed. We have generated revenues of $1.6 million from Qinhe for the year ended December 31, 2014. Previous Advertising Agency Agreement with Old Shengyue
In April 2011, we entered into an advertising agency agreement with Old Shengyue, an affiliate then wholly owned by Shanda Interactive, pursuant to which Old Shengyue agreed to act as our exclusive advertising
March 31, 2014. For the years ended December 31,
Loans to
In March 2012, our company provided a $0.5 million unsecured loan to Shanda Capital Limited, a company controlled by Shanda Interactive, which carries an interest rate of 3% per year and was due on March 25, 2013. The term of this loan was subsequently extended to March 25, 2014. This loan was fully repaid in March 2014. Funding from Shanda Interactive In connection with the Share Purchase Transaction, Shanda Interactive, through its affiliate, extended a loan of RMB20.0 million to us in April 2014. This loan did not bear any interest and was due on April 2, 2015. Shanda Interactive has waived our obligation to repay this loan in order to satisfy one of the closing conditions under the share purchase agreement for the Share Purchase Transaction. We have treated this transaction as a capital contribution. In May 2014, Shanda Interactive, through its affiliates, extended a loan of RMB21.4 million to us. This loan did not bear any interest and was due within twelve months. However, Shanda Interactive has waived our obligation to repay this loan. In connection with this loan, certain existing related party payables to companies controlled by Shanda Interactive, amounting to RMB5.3 million, were waived by us, and we received a net amount of RMB16.1 million in cash from Shanda Interactive in May 2014. We have treated this transaction as a capital contribution. Funding from Mr. Xu In February 2015, we entered into a loan agreement with Mr. Xu, pursuant to which Mr. Xu agreed to provide a loan of RMB30.0 million to us within 20 business days from the date thereof. The term of the loan is one year, and the loan bears interest at a rate of 6.5% per annum. We received RMB30.0 million from Mr. Xu in
A.Consolidated Financial Statements and Other Financial Information
See Item 18. “Financial Statements” for our audited consolidated financial statements filed as part of this annual report on Form 20-F.
Legal Proceedings
From time to time, we have been involved in litigation relating to copyright infringement and other matters in the ordinary course of our business. We had an accrued litigation provision balance of $
Our video content library may contain content in which others may claim to own copyrights or image rights or which others may claim to be defamatory or objectionable. Adverse results in legal proceedings against us may include awards of damages and may also result in, or even compel, a change in our business practices, which could impact our future financial results. Regardless of the outcome, however, any litigation can result in substantial costs and diversion of management resources and attention.
Although we have implemented and strengthened standard procedures to delete video content, especially our UGC, that allegedly infringes on intellectual property rights of third parties, we have limited control over the nature or types of the content posted by our users. The infringement of intellectual property rights by our users may result in litigation against us and harm our business and reputation. See Item 3.D. “Risk Factors—Risks Related to Our Business—We have been and expect to continue to be exposed to intellectual property infringement and other claims, including claims based on content posted on our website.”
Dividend Policy
We have never declared or paid any dividends on our ordinary shares. We do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain future earnings, if any, to finance operations and for the expansion of our business. Payments of dividends by our PRC subsidiaries to our company are subject to restrictions including primarily the restriction that foreign invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents. There are no such similar foreign exchange restrictions in the Cayman Islands.
B.Significant Changes
Not applicable except for Item 9.A.4. and Item 9.C.
American Depositary Shares, or ADSs, each representing 100 of our ordinary shares, have been listed on the NASDAQ Global Market since February 4, 2005. Our ADSs were traded under the symbol “HRAY” until August 16, 2010. On August 17, 2010, we changed our name to “Ku6 Media Co., Ltd.” and changed our trading symbol on the NASDAQ Global Market from “HRAY” to “KUTV.”
The following table provides the high and low prices for our ADSs on the NASDAQ Global Market for (1) the five most recent full financial years, (2) each full financial quarter in the two most recent full financial years and the subsequent period, and (3) each of the most recent six months.
Item 10.Additional Information
A.Share Capital
Not applicable.
B.Memorandum and Articles of Association
The following are summaries of material terms and provisions of our current memorandum and articles of association, as well as certain provisions of the Cayman Companies Law insofar as they relate to the material terms of our ordinary shares. This summary is not complete and some of the terms in our memorandum and articles of association are subject to other rights, restrictions and obligations set out therein, and you should read in full our memorandum and articles of association, which was included as Exhibit 3.1 to our registration statement on Form F-1 (File No. 333-121987) filed with the SEC on January 12, 2005, as amended by (i) the amendment passed by our shareholders by way of a special resolution on October 16, 2009, which was included as Exhibit 1.2 to our annual report on Form 20-F for the year ended December 31, 2009 (File No.
General
We are a Cayman Islands company and our affairs are governed by our memorandum and articles of association, the Cayman Companies Law and the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as that from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities law as compared to the United States, and provides significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in the federal courts of the United States.
The holders of ADSs will not be treated as our shareholders and will be required to surrender their ADSs for cancellation and withdrawal from the depositary facility in which the ordinary shares are held in order to exercise shareholders’ rights in respect of the ordinary shares. The depositary will agree, so far as it is practical, to vote or cause to be voted the amount of ordinary shares represented by ADSs in accordance with the non-discretionary written instructions of the holder of such ADSs.
Directors
Interested
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.
Rights, Preferences and Restrictions of our Ordinary Shares
Voting
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
Calls on our Ordinary Shares and Forfeiture of our Ordinary
Redemption and Repurchase of our Ordinary
A Cayman Islands company may redeem or purchase its own shares out of profits, out of its share premium account, out of the proceeds of a fresh issue of shares made for the purposes of the redemption or purchase or, provided the company will remain solvent, out of capital. A payment out of capital by a company for the redemption or purchase of its own shares is not lawful unless, immediately following the date on which the payment is proposed to be made, the company shall be able to pay its debts as they fall due in the ordinary course of business. If and to the extent that a premium is to be paid on the redemption or purchase of a company’s shares, the premium must have been provided for out of either or both of the profits of the company or out of the company’s share premium account before or at the time the shares are redeemed or purchased, or, subject to the same solvency test, out of capital.
Shares that have been purchased or redeemed by a Cayman Islands company or surrendered to the company pursuant to the Cayman Companies Law shall not be treated as cancelled but shall be classified as treasury shares if (i) the memorandum and articles of association of the company do not prohibit it from holding treasury shares, (ii) the relevant provisions of the memorandum and articles of association (if any) are complied with, and (iii) the company is authorized in accordance with the its articles of association or by a resolution of the directors to hold such shares in the name of the company as treasury shares prior to the purchase, redemption or surrender of such shares. Shares held by a company as treasury shares shall continue to be classified as such until such shares are either cancelled or transferred pursuant to the Cayman Companies Law. The company shall not be treated as a member for any purpose and shall not exercise any right in respect of the treasury shares, and any purported exercise of such a right shall be void. A treasury share shall not be voted, directly or indirectly, at any meeting of the company and shall not be counted as issued shares at any given time, whether for the purposes of the company’s articles of association or the Cayman Companies Law. No dividend may be declared or paid, and no other distribution (whether in cash or otherwise) of the company’s assets (including any distribution of assets to members on a winding up) may be made to the company, in respect of a treasury share.
Shares with Preferred Rights
Our memorandum and articles of association provide for the authorization of issuance of shares with preferred rights. Subject to any direction that may be given by us in general meetings, and without prejudice to any special rights previously conferred on the holders of existing shares, our directors may allot, issue, grant options over or otherwise dispose of shares of our company, with or without preferred rights or restrictions, whether in regard to dividend, voting, return of capital or otherwise and to such persons, at such times and on such other terms as they think proper. We have no immediate plans to issue any shares with preferred rights. The issuance of any of our shares with preferred rights could provide needed flexibility in connection with possible acquisitions and other corporate purposes. However, the issuance could also make it more difficult for a third party to acquire a majority of our outstanding voting shares or discourage an attempt to gain control of us. In addition, the board of directors, without shareholder approval, can issue shares with preferred rights with voting and conversion rights which could adversely affect the voting power and other rights of the holders of ordinary shares. These shares with preferred rights may be used for a variety of corporate purposes including future public offerings, to raise additional capital or to facilitate acquisitions. The listing maintenance requirements of the NASDAQ Global Market, which apply so long as our ADSs are quoted on that market, require shareholder approval of certain issuances of our securities equal to or exceeding 20% of the then outstanding voting power of all our securities or the then outstanding number of our ordinary shares.
Variations of Rights of Shares
All or any of the special rights attached to any class of shares
General Meetings of Shareholders
The directors may, whenever they think fit, and shall, on the requisition of our shareholders holding at the date of the deposit of the requisition not less than one-tenth of our paid-up capital, which as at the date of the deposit carries the right of voting at our general meetings, proceed to convene a general meeting of our company. If the directors do not, within 21 days from the date of the deposit of the requisition, duly proceed to convene a general meeting, the requisitionists, or any of them representing more than one-half of the total voting rights of all of them, may themselves convene a general meeting, but any meeting so convened shall not be held after the expiration of three months after the expiration of such 21 days.
At least five days’ notice shall be given of an annual general meeting or other general meeting. Every notice shall be exclusive of the day on which
Limitations on the Right to Own Shares
There are no limitations on the right to own our shares, provided that we are prohibited from making any invitation to the public in the Cayman Islands to subscribe for any of our securities.
Limitations on Transfer of Shares
There are no provisions in our memorandum or articles of association that would have an effect of delaying, deferring or preventing a change in control and that would operate only with respect to a merger, acquisition or corporate restructuring.
Disclosure of Shareholder Ownership
There are no provisions in our memorandum or articles of association governing the ownership threshold above which shareholder ownership must be disclosed.
Changes in Capital
We may, from time to time and by ordinary resolution, increase the share capital by such sum, to be divided into shares of such amount, as the resolution shall prescribe. The new shares shall be subject to the same provisions with reference to the payment of calls, lien, transfer, transmission, forfeiture and otherwise as the shares in the original share capital. We may by ordinary resolution:
(a) consolidate and divide all or any of our share capital into shares of larger amount than our existing shares;
(b) subdivide our existing shares, or any of them, into shares of smaller amount than is fixed by our memorandum of association, subject nevertheless to the provisions of Section 13 of the Cayman Companies Law; or
(c) cancel any shares which, at the date of the passing of the resolution, have not been taken or agreed to be taken by any person.
We may, by special resolution, reduce our share capital and any capital redemption reserve fund, in any manner authorized by the Cayman Companies Law.
Differences in Corporate Law
The company law of the Cayman Islands is historically derived, for the most part, from the laws of England, and comprises the provisions of the Cayman Companies Law, many of which are drawn from pre-1948 Companies Acts of the United Kingdom. Other provisions are original Cayman Islands provisions, some of which relate to a certain class of companies, which are commonly used for the conduct of international business from the Cayman Islands. These provisions create the concept of the “exempted” company, which is a special corporate vehicle, the business and operation of which are required to be conducted mainly outside the Cayman Islands. Decisions of the superior courts of England constitute persuasive authority in the Cayman Islands courts. The Cayman Companies Law differs from laws applicable to United States corporations and their shareholders. Set forth below is a summary of the significant differences between the provisions of the Companies Law applicable to us and the laws applicable to companies incorporated in the United States and their shareholders.
Scheme of Arrangements, Compulsory Acquisition and Merger and Consolidation.
Schemes of arrangement are governed by specific statutory provisions under the Cayman Companies Law, whereby such arrangements may be approved by a majority in number representing 75% in value of members or classes of members, or creditors or classes of creditors, depending on the circumstances, as are present at a meeting called for such purpose and thereafter sanctioned by the courts.
Where an offer is made by a company for the shares of another company incorporated under the laws of the Cayman Islands and, within four months of the offer, the holders of not less than 90% of the shares which are the subject of the offer accept, the
Two or more companies limited by shares and incorporated under the Cayman Companies Law, may, subject to any express provisions to the contrary in the memorandum and articles of association of any of such companies as well as certain requirements under the Cayman Companies Law, merge or consolidate. One or more companies incorporated under the Cayman Companies Law may also merge or consolidate with one or more overseas companies, subject to certain requirements. The directors of each constituent company that proposes to participate in a merger or consolidation are required, on behalf of the constituent company of which they are directors, to approve a written plan of merger or consolidation. A plan of merger or consolidation shall give particulars of matters as set forth in the Cayman Companies Law, and be authorized by each constituent company by way of: (a) a special resolution of the members of each such constituent company; and (b) such other authorization, if any, as may be specified in such constituent company’s articles of association. The consent of each holder of a fixed or floating security interest of a constituent company in a proposed merger or consolidation will be required, or as determined by the Grand Court of the Cayman Islands. A dissenting member is required to give to the constituent company written objection before the vote on the merger or consolidation, and is entitled to payment of the fair value of his or her shares as determined in accordance with the procedures set forth under the Cayman Companies Law. Such objection shall include a statement that the member proposes to demand payment for his or her shares if the merger or consolidation is authorized by the vote.
Indemnification. Cayman Islands law does not (other than as set forth hereafter) limit the extent to which a company’s organizational documents may provide for indemnification of officers and directors, except to the extent any such provision may be held by the Cayman Islands courts to be contrary to public policy, such as to provide indemnification against civil fraud or the consequences of committing a crime. Our articles of association provide for indemnification of officers and directors for losses, damages, costs and expenses incurred in their capacities as such, except through their own willful neglect or default.
C.Material Contracts
We have not entered into any material contracts other than in the ordinary course of business and other than those described in Item 4., “Information on the Company,” and Item 7.B., “Related Party Transactions,” or elsewhere in this annual report on Form 20-F.
D.Exchange Controls
Foreign currency exchange regulation in China is primarily governed by the following rules:
· Notice on Issues Relating to the Administration of Foreign Exchange in Fundraising and Return Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies;
· Foreign Currency Administration Rules
· Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), or the Administration Rules; and
· the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of the Payment and Settlement of Foreign Currency Capital of Foreign Invested Enterprises, or Circular 142.
Under the Exchange Rules, the Renminbi is convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions. Conversion of Renminbi for capital account items, such as direct investment, loan, security investment and repatriation of investment, however, is subject to the approval of or registration with SAFE.
Under the Administration Rules, foreign-invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents and, in the case of capital account item transactions, obtaining approval from SAFE. Capital investments by foreign-invested enterprises outside of China are also subject to limitations, which include approvals by MOFCOM, SAFE and the National Development and Reform Commission of the PRC.
On August 29, 2008, SAFE promulgated Circular 142, regulating the conversion by a foreign-invested enterprise of foreign
In November 2012, SAFE promulgated the Circular of Further Improving and Adjusting Foreign Exchange Administration Policies on Foreign Direct Investment which substantially amends and simplifies the current foreign exchange procedure. Pursuant to this circular, the opening of various special purpose foreign exchange accounts (e.g. pre-establishment expenses account, foreign exchange capital account, guarantee account), the reinvestment of lawful incomes derived by foreign investors in the PRC (e.g. profit, proceeds of equity transfer, capital reduction, liquidation and early repatriation of investment), and purchase and remittance of foreign exchange as a result of capital reduction, liquidation, early repatriation or share transfer in a foreign-invested enterprise no longer require SAFE approval and multiple capital accounts for the same entity may be opened in different provinces, which was not allowed before November 2012. In May 2013, SAFE promulgated the Circular on Printing and Distributing the Provisions on Foreign Exchange Administration over Domestic Direct Investment by Foreign Investors and the Supporting Documents, which specifies that the administration by SAFE or its local branches over direct investment by foreign investors in the PRC shall be conducted by way of registration and banks shall process foreign exchange business relating to the direct investment in the PRC based on the registration information provided by SAFE and its branches. On July 4, 2014, SAFE promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Offshore Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, which replaced the former circular commonly known as “SAFE Circular 75” promulgated by SAFE on October 21, 2005. SAFE Circular 37 requires PRC residents to register with local branches of SAFE in connection with their direct establishment or indirect control of an offshore entity, for the purpose of overseas investment and financing, with such PRC residents’ legally owned assets or equity interests in domestic enterprises or offshore assets or interests, referred to in SAFE Circular 37 as a “special purpose vehicle.” SAFE Circular 37 further requires amendment to the registration in the event of any significant changes with respect to the special purpose vehicle, such as increases or decreases of capital contributed by PRC individuals, share transfer or exchange, merger, division or other material event. In the event that a PRC shareholder holding interests in a special purpose vehicle fails to fulfill the required SAFE registration, the PRC subsidiaries of that special purpose vehicle may be prohibited from making profit distributions to the offshore parent and from carrying out subsequent cross-border foreign exchange activities, and the special purpose vehicle may be restricted in its ability to contribute additional capital into its PRC subsidiary. Furthermore, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for evasion of foreign exchange controls. Under the Administration Measures on Individual Foreign Exchange Control issued by the PBOC on December 25, 2006, all foreign exchange matters involved in employee share ownership plans and share option plans in which PRC citizens participate require approval from SAFE or its authorized branch. Pursuant to SAFE Circular 37, PRC residents who participate in share incentive plans in overseas non-publicly-listed companies may submit applications to SAFE or its local branches for the foreign exchange registration with respect to offshore special purpose companies. In addition, under the Notices on Issues concerning the Foreign Exchange Administration for Domestic Individuals Participating in Share Incentive Plans of Overseas Publicly-Listed Companies, or the Share Option Rules, issued by SAFE on February 15, 2012, PRC residents who are granted shares or share options by companies listed on overseas stock exchanges under share incentive plans are required to (i) register with SAFE or its local branches, (ii) retain a qualified PRC agent, which may be a PRC subsidiary of the overseas listed company or another qualified institution selected by the PRC subsidiary, to conduct the SAFE registration and other procedures with respect to the share incentive plans on behalf of the participants, and (iii) retain an overseas institution to handle matters in connection with their exercise of share options, purchase and sale of shares or interests and funds transfers. We will make efforts to comply with these requirements upon completion of our initial public offering. E.Taxation
The following summary of the material Cayman Islands, PRC and U.S. federal income tax consequences relevant to the purchase, ownership or sale of our ordinary shares or ADSs is based upon laws and relevant interpretations thereof as of the date of this annual report on Form 20-F, which are subject to change. The summary does not purport to be a comprehensive description of all of the tax considerations that may be relevant to any particular investor depending on its individual circumstances. Accordingly, holders of ordinary shares or ADSs should consult their own tax advisors regarding the application of the considerations discussed below to their particular situations and the consequences of the purchase, ownership or sale of our ordinary shares or ADSs, including those arising under U.S. federal estate or gift tax laws, foreign, state, or local laws, and tax treaties.
Cayman Islands Taxation and Exchange Control
Pursuant to Section 6 of the Tax Concessions Law (1999 Revision) of the Cayman Islands (as amended by the Tax Concessions Law (2011 Revision) of the Cayman Islands), our company has obtained an undertaking from the Governor-in-Council:
(i) that no law which is enacted in the Cayman Islands imposing any tax to be levied on profits, income, gains or appreciations shall apply to our company or its operations; and
(ii) in addition, that no tax to be levied on profits, income, gains or appreciations or which is in the nature of an estate duty or inheritance tax shall be payable by our company:
(a) on or in respect of the shares, debentures or other obligations of our company; or
(b) by way of withholding, in whole or in part, of any relevant payment as defined in Section 6(3) of the Tax Concessions Law (1999 Revision).
The undertaking for our company is for a period of twenty years starting from May 7, 2002.
The Cayman Islands currently levies no taxes on individuals or corporations based upon profits, income, gains or appreciation and there is no taxation in the nature of an estate duty or inheritance tax. There are no other taxes likely to be material to us levied by the Government of the Cayman Islands except for stamp duties, which may be applicable on instruments. There are no exchange control regulations or currency restrictions in the Cayman Islands.
PRC Taxation
Under the PRC Individual Income Tax Law, or the IITL, if we are treated as a PRC resident enterprise, non-resident individual investors would be subject to PRC individual income tax on dividends paid to such investors and any capital gains realized from the transfer of our ordinary shares and ADSs, provided that such dividends and gains are deemed as China-sourced income. A non-resident individual is an individual who has no domicile in China and does not stay within China or has stayed within China for less than one year. Pursuant to the IITL and its implementation rules, for purposes of the PRC capital gains tax, the taxable income will be based on the total income obtained from the transfer of our ordinary shares or ADSs after deducting all the costs and expenses that are permitted under PRC tax laws to be deducted from the income. If we were considered a PRC resident enterprise and dividends paid with respect to our ordinary shares and ADSs and the gains realized from the transfer of our ordinary shares and ADSs were considered China-sourced income by relevant PRC tax authorities, such dividends and gains earned by
U.S. Federal Income Taxation
The following is a summary of the material U.S. federal income tax consequences of the ownership and disposition of ordinary shares or ADSs by a U.S. Holder. The following summary is not exhaustive of all possible tax considerations. This summary is based upon the Internal Revenue Code of 1986, as amended (the “Code”), regulations promulgated under the Code by the U.S. Treasury Department (including proposed and temporary regulations), rulings, current administrative interpretations and official pronouncements of the Internal Revenue Service (the “IRS”), judicial decisions and the double taxation treaty between the PRC and the United States (the “Treaty”), all as of the date hereof and all of which are subject to differing interpretations or to change, possibly with retroactive effect. Such change could materially and adversely affect the tax consequences described below. No assurance can be given that the IRS will not assert, or that a court will not sustain, a position contrary to any of the tax consequences described below.
This summary does not address state, local, or foreign tax consequences of the ownership and disposition of ordinary shares or ADSs. The United States does not have an income tax treaty with the Cayman Islands.
This summary is for general information only and does not address all aspects of U.S. federal income taxation that may be important to a particular holder in light of its investment or tax circumstances, including the potential application of the provisions of the Code known as the Medicare contribution tax, or to holders subject to special tax rules, such as: certain financial institutions; insurance companies; dealers in stocks, securities, or currencies; traders in securities that elect to use a mark-to-market method of accounting for their securities holdings; entities classified as partnerships for U.S. federal income tax purposes; tax-exempt organizations; real estate investment trusts; regulated investment companies; qualified retirement plans, individual retirement accounts, Roth IRAs and other tax-deferred accounts; expatriates of the United States; persons subject to the alternative minimum tax; persons holding ordinary shares or ADSs as part of a straddle, hedge, conversion transaction or other integrated transaction; persons who enter into a constructive sale with respect to ordinary shares or ADSs; persons who acquired ordinary shares or ADSs pursuant to the exercise of any employee stock option or otherwise as compensation for services; persons actually or constructively holding 10% or more of our voting stock; U.S. persons whose functional currency for U.S. federal income tax purposes is not the U.S. dollar; and persons holding ordinary shares or ADSs in connection with a trade or business conducted outside of the United States.
This summary is not a comprehensive description of all of the U.S. federal tax consequences that may be relevant with respect to the ownership and disposition of ordinary shares or ADSs. We urge you to consult your own tax advisor regarding your particular circumstances and the U.S. federal income and estate tax consequences to you of owning and disposing of ordinary shares or ADSs, as well as any tax consequences arising under the laws of any state, local, foreign or other tax jurisdiction and the possible effects of changes in U.S. federal or other tax laws.
This summary is directed solely to U.S. Holders who hold their ordinary shares or ADSs as capital assets for U.S. federal income tax purposes, which generally means as property held for investment. For purposes of this summary, the term “U.S. Holder” means a beneficial owner of ordinary shares or ADSs that is, for U.S. federal income tax purposes:
· a citizen or individual resident of the United States;
· a corporation, or other entity taxable as a corporation, created or organized in or under the laws of the United States, any state therein or the District of Columbia; or
· an estate or trust, the income of which is subject to U.S. federal income taxation regardless of its source.
If a partnership (including for this purpose any entity treated as a partnership for U.S. federal income tax purposes) is a beneficial owner of ordinary shares or ADSs, the U.S. federal income tax consequences to a partner in the partnership will generally depend on the status of the partner and the activities of the partnership. A holder of ordinary shares or ADSs that is a partnership, and the partners in such partnership, should consult their own tax advisors regarding the U.S. federal income tax consequences of the ownership and disposition of ordinary shares or ADSs.
This summary is based in part upon the representations of the depositary and the assumption that each obligation in the deposit agreement and any related agreement will be performed in accordance with its terms.
Generally, a U.S. Holder who owns ADSs will be treated as the owner of the underlying ordinary shares represented by those ADSs for U.S. federal income tax purposes. Accordingly, no gain or loss will be recognized if the U.S. Holder exchanges ADSs for the underlying ordinary shares represented by those ADSs. The U.S. Holder’s adjusted tax basis in the ordinary shares will be the same as the adjusted tax basis of the ADSs surrendered in exchange
The U.S. Treasury has expressed concern that parties to whom American depositary shares are released before shares are delivered to the depositary (“pre-release”), or intermediaries in the chain of ownership between holders and the issuer of the security underlying the American depositary shares, may be taking actions that are inconsistent with the claiming of foreign tax credits by holders of the American depositary shares. Accordingly, the creditability of any PRC taxes described below could be affected by actions taken by such parties or intermediaries.
Taxation of U.S. Holders
Passive Foreign Investment Company
Although we believe that we were not a PFIC for taxable 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 under the income test or (b) 50% or more of the average quarterly value, generally determined by fair market value, of our assets during such taxable year consists of assets that either produce passive income or are held for the production of passive income under the asset test. “Passive income” includes, for example, dividends, interest, certain rents and royalties, certain gains from the sale of stock and securities and certain gains from commodities transactions.
Certain “look through” rules apply for purposes of the income and asset tests described above. If we own, directly or indirectly, 25% or more of the total value of the outstanding shares of another corporation, we generally will be treated as if we (a) held directly a proportionate share of the other corporation’s assets, and (b) received directly a proportionate share of the other corporation’s income.
In addition, we may, directly or indirectly, hold equity interests in subsidiaries or other entities which are PFICs (“Lower-tier PFICs”). Under attribution rules, if we are a PFIC, U.S. Holders will be deemed to own their proportionate shares of Lower-tier PFICs and will be subject to U.S. federal income tax according to the rules described below on (i) certain distributions by a Lower-tier PFIC and (ii) a disposition of shares of a Lower-tier PFIC, in each case, as if the U.S. Holder held such shares directly, even though holders have not received the proceeds of those distributions or dispositions directly.
If we are a PFIC for any taxable year during which a U.S. Holder holds ordinary shares or ADSs, we will generally continue to be treated as a PFIC with respect to those ordinary shares or ADSs for all succeeding years during which such U.S. Holder holds them, regardless of whether we actually continue to be a PFIC. Because we believe that we were a PFIC for taxable years 2006, 2007, 2008 and 2009, if you held ordinary shares or ADSs during any of those taxable years (or during the 2011 taxable year if we were a PFIC for that year), we would continue to be treated as a PFIC with respect to those ordinary shares or ADSs for all succeeding years during which you hold them. Similarly, if you first acquired ordinary shares or ADSs in
If we are treated as a PFIC with respect to the ordinary shares or ADSs that you hold, the U.S. federal income tax consequences to you of the ownership and disposition of ordinary shares or ADSs will depend on whether you make a mark-to-market election. If you owned or own ordinary shares or ADSs while we were or are a PFIC and have not made a mark-to-market election, you will be referred to in this summary as a “Non-Electing U.S. Holder.”
If you are a Non-Electing U.S. Holder, you will be subject to the default PFIC rules with respect to:
· any “excess distribution” paid on ordinary shares or ADSs (or by a Lower-tier PFIC to its shareholders that is deemed to be received by a U.S. Holder), which means the excess (if any) of the total distributions received (or deemed received) by you during the current taxable year over 125% of the average distributions received (or deemed received) by you during the three preceding taxable years (or during the portion of your holding period for the ordinary shares or ADSs prior to the current taxable year, if shorter); and
· any gain realized on the sale or other disposition (including a pledge) of ordinary shares or ADSs (or on an indirect disposition of shares of a Lower-tier PFIC).
Under these default tax rules:
· any excess distribution or gain will be allocated ratably over your holding period for the ordinary shares or ADSs;
· the amount allocated to the taxable year of receipt of proceeds from the excess distribution or disposition and any period prior to the first day of the first taxable year in which we were a PFIC will be treated as ordinary income in the taxable year to which it is allocated;
· the amount allocated to each other taxable year will be treated as ordinary income and taxed at the highest tax rate for individuals or corporations, as applicable, in effect for that year; and
· the resulting tax liability from any such other taxable years will be subject to the interest charge applicable to underpayments of tax.
If the ordinary shares or ADSs are “regularly traded” on a “qualified exchange,” a U.S. Holder of ordinary shares or ADSs may make a mark-to-market election that would result in tax treatment different from the default PFIC rules described above. The ordinary shares or ADSs will be treated as “regularly traded” in any calendar year in which more than a de minimis quantity of the ordinary shares or ADSs are traded on a qualified exchange on at least 15 days during each calendar quarter. NASDAQ, on which the ADSs are listed, is a qualified exchange for this purpose. U.S. Holders should consult their tax advisors regarding the availability and advisability of making a mark-to-market election in their particular circumstances. In particular, U.S. Holders should consider carefully the impact of a mark-to-market election with respect to their ordinary shares or ADSs, given that the election may not be available with respect to any Lower-tier PFICs.
If a U.S. Holder makes the mark-to-market election, the holder generally will recognize as ordinary income any excess of the fair market value of the ordinary shares or ADSs at the end of each taxable year over their adjusted tax basis, and will recognize an ordinary loss in respect of any excess of the adjusted tax basis of the ordinary shares or ADSs over their fair market value at the end of the taxable year (but only to the extent of the net amount of income previously included as a result of the mark-to-market election). If a U.S. Holder makes the election, the holder’s tax basis in the ordinary shares or ADSs will be adjusted to reflect the income or loss amounts recognized. Any gain recognized on the sale or other disposition of ordinary shares or ADSs in a year when we are a PFIC will be treated as ordinary income and any loss will be treated as an ordinary loss (but only to the extent of the net amount of income previously included as a result of the mark-to-market election). Distributions paid on ordinary shares or ADSs will be treated as discussed below under “Distributions on Ordinary Shares or ADSs.”
We do not intend to provide information necessary for U.S. Holders to make a qualified electing fund election, which, if available, could result in a materially different tax treatment of the ownership and disposition of ordinary shares or ADSs to an electing U.S. Holder.
Furthermore, if we were a PFIC or, with respect to a particular U.S. Holder, were treated as a PFIC for the taxable year in which we paid a dividend or the prior year, the reduced tax rates applicable to dividends paid to certain non-corporate U.S. Holders, as discussed below, would not apply.
If we were a PFIC for any taxable year during which a U.S. Holder held ordinary shares or ADSs, such U.S. Holder
Because the PFIC rules are complex, you should consult your own tax advisor regarding them and how they may affect the U.S. federal income tax consequences of the ownership and disposition of ordinary shares or ADSs.
Distributions on Ordinary Shares or ADSs
Subject to the discussion in “Passive Foreign Investment Company” above, if you actually or constructively receive a distribution on ordinary shares or ADSs (other than certain pro rata distributions of ordinary shares), you must include the distribution in gross income as a taxable dividend on the date of your (or in the case of ADSs, the depositary’s) receipt of the distribution, but only to the extent of our current or accumulated earnings and profits, as calculated under U.S. federal income tax principles. Such amount must be included without reduction for any foreign tax withheld. Dividends paid by us will not be eligible for the dividends received deduction allowed to corporations with respect to dividends received from certain domestic
To the extent a distribution exceeds our current and accumulated earnings and profits, it will be treated first as a non-taxable return of capital to the extent of your adjusted tax basis in the ordinary shares or ADSs, and thereafter as capital gain.
The amount of any dividend paid in Renminbi or any other foreign currency will be the U.S. dollar amount calculated by reference to the exchange rate in effect on the date of your (or in the case of ADSs, the depositary’s) receipt, regardless of whether the payment is in fact converted into U.S. dollars. If the dividend is converted into U.S. dollars on the date of receipt, a U.S. Holder should not be required to recognize foreign currency gain or loss in respect of the dividend income. A U.S. Holder may have foreign currency gain or loss if the dividend is converted into U.S. dollars after the date of receipt.
As discussed above in “PRC Taxation,” dividends paid with respect to our ordinary shares or ADSs may be subject to PRC withholding tax, and the amount of a dividend will include any amounts withheld in respect of PRC taxes. The amount of the dividend will be treated as foreign-source dividend income to U.S. Holders. Subject to applicable limitations, some of which vary depending upon a U.S. Holder’s circumstances and subject to the discussion above regarding concerns expressed by the U.S. Treasury, PRC income taxes withheld from dividends on ordinary shares or ADSs at a rate not exceeding the rate provided by the Treaty will be creditable against the U.S. Holder’s U.S. federal income tax liability. PRC taxes withheld in excess of the rate applicable under the Treaty will not be eligible for credit against a U.S. Holder’s federal income tax liability. The rules governing foreign tax credits are complex, and U.S. Holders should consult their tax advisors regarding the creditability of foreign taxes in their particular circumstances.
Dispositions of Ordinary Shares or ADSs
Subject to the discussion in “Passive Foreign Investment Company” above, you generally will realize taxable gain or loss on the sale or other disposition of ordinary shares or ADSs equal to the difference between the U.S. dollar value of (i) the amount realized on the disposition (i.e., the amount of cash plus the fair market value of any property received), and (ii) your adjusted tax basis in the ordinary shares or ADSs disposed of. Such gain or loss will be capital gain or loss.
If you have held the ordinary shares or ADSs for more than one year at the time of disposition, such capital gain or loss will be long-term capital gain or loss. Preferential tax rates for long-term capital gain will apply to non-corporate U.S. Holders. If you have held the ordinary shares or ADSs for one year or less, such capital gain or loss will be short-term capital gain or loss, taxable as ordinary income at your marginal income tax rate. The deductibility of capital losses is subject to limitations.
As discussed above in “PRC Taxation,” gains realized on the disposition of our ordinary shares or ADSs could be subject to PRC tax. Any gain or loss recognized by a U.S. Holder on a disposition of our ordinary shares or ADSs will generally be treated as U.S.-source income or loss for foreign tax credit limitation purposes. A U.S. Holder that is eligible for the benefits of the Treaty may be able to elect to treat disposition gain that is subject to PRC taxation as foreign-source gain and claim a credit in respect of the tax. The rules governing foreign tax credits are complex, and U.S. Holders should consult their tax advisors regarding the creditability of foreign taxes in their particular circumstances.
You should consult your own tax advisor regarding the U.S. federal income tax consequences if you receive currency other than U.S. dollars upon the disposition of ordinary shares or ADSs.
Information Reporting and Backup Withholding
Generally, information reporting requirements will apply to distributions on ordinary shares or ADSs or proceeds from the disposition of ordinary shares or ADSs paid within the United States (and, in certain cases, outside the United States) to a U.S. Holder unless such U.S. Holder is an exempt recipient. Furthermore, backup withholding may apply to such amounts unless such U.S. Holder (i) is an exempt recipient that, if required, establishes its right to an exemption, or (ii) provides its taxpayer identification number, certifies that it is not currently subject to backup withholding, and complies with other applicable requirements. A U.S. Holder may generally avoid backup withholding by furnishing a properly completed IRS Form W-9.
Backup withholding is not an additional tax. Amounts withheld under the backup withholding rules may be credited against your U.S. federal income tax liability. Furthermore, you may obtain a refund of any excess amounts withheld by filing an appropriate claim for refund with the IRS and furnishing any required information in a timely manner.
Certain U.S. Holders who are individuals may be required to report information relating to their ownership of an interest in certain foreign financial assets, including stock of a non-U.S. person, subject to certain exceptions (including an exception for stock held in custodial accounts maintained by a U.S. financial institution). Certain U.S. Holders who are entities may be subject to similar rules in the future. U.S. Holders should consult their tax advisors regarding their reporting obligations with respect to the ordinary shares or ADSs.
F.Dividends and Paying Agents
Not applicable.
G.Statement by Experts
Not applicable.
H.Documents on Display
We have filed this annual report, including exhibits, with the SEC. As allowed by the SEC, in Item 19 of this annual report, we incorporate by reference certain information we filed with the SEC. This means that we can disclose important information to you by referring you to another document filed separately with the SEC. The information incorporated by reference is considered to be part of this annual report.
We are subject to periodic reporting and other informational requirements of the Exchange Act as applicable to foreign private issuers. Accordingly, we will be required to file reports, including annual reports on Form 20-F, and other information with the SEC. As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of quarterly reports and proxy statements, and officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act. Our annual reports and other information so filed can be inspected and copied at the public reference facility maintained by the SEC at 100 F. Street, N.E., Washington, D.C. 20549. You can request copies of these documents upon payment of a duplicating fee by writing to the SEC. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference facility. Our SEC filings will also be available to the public on the SEC’s Internet Web site at http://www.sec.gov.
Our financial statements have been prepared in accordance with US GAAP.
We will make available to our shareholders annual reports, which will include a review of operations and annual audited consolidated financial statements prepared in conformity with US GAAP.
I.Subsidiary Information
Not applicable.
Item 11.Quantitative and Qualitative Disclosures
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to the interest income generated by our cash deposits in banks. We have not used derivative financial instruments in our investment portfolio. Interest-earning instruments and floating rate debt carry a degree of interest rate risk. We have not been exposed, nor do we anticipate being exposed, to material risks due to changes in interest rates. Our future interest income may fluctuate in line with changes in interest rates. However, the risk associated with fluctuating interest rates is principally confined to our cash deposits in banks, and, therefore, our exposure to interest rate risk is minimal and immaterial.
Foreign Exchange Risk
While our reporting currency is the U.S. dollar, to date, virtually all of our revenues and costs are denominated in Renminbi and substantially all of our assets
If the Renminbi had been 1% and 5% less valuable against the U.S. dollar than the actual rate as of December 31,
Inflation
Since our inception, inflation in China has not materially impacted our results of operations. According to the National Bureau of Statistics of China, the consumer price index in China increased by
Item 12.Description of Securities
D.American Depositary Shares
Citibank, N.A. is the depositary of our ADSs. The depositary’s office is located at 111 Wall Street, New York, NY 10043, U.S.A. Each of our ADSs, evidenced by American depositary receipts, or ADRs, represents 100 ordinary shares, par value $0.00005 per share.
ADR Fees Payable by Investors
The Depositary collects its fees for delivery and surrender of ADSs directly from investors depositing ordinary shares or surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them. The depositary collects fees for making distributions to investors by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees. The depositary may collect its annual fee for depositary services by deductions from cash distributions or by directly billing of investors or by charging the book-entry system accounts of participants acting for them. The depositary may generally refuse to provide fee-attracting services until its fees for those services are paid.
Payments Received
Item 13.Defaults, Dividend Arrearages and Delinquencies
Not Applicable.
Item 14.Material Modifications to the Rights of Security Holders and Use of Proceeds
Not Applicable.
Item 15.Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this annual report on Form 20-F, our Chief Executive Officer and Acting Chief Financial Officer have performed an evaluation of the effectiveness of our disclosure controls and procedures as defined and required under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended. Based upon this evaluation, our Chief Executive Officer and Acting Chief Financial Officer concluded our company’s disclosure controls and procedures were effective.
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with U.S. GAAP. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that receipts and expenditures are made only in accordance with authorizations of management; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including our Chief Executive Officer and
Changes in Internal Control over Financial Reporting
During the year ended December 31,
Item 16A.Audit Committee Financial Expert
Our board of directors has determined that Mr.
We have adopted a Code of Business Conduct which applies to our employees, officers and non-employee directors, including our Chief Executive Officer and
The Code of Business Conduct is available on our investor relations website at http://www.mzcan.com/us/KUTV/irwebsite. To the extent required by law, any amendments to, or waivers from, any provision of the Code of Business Conduct will be promptly disclosed to the public. Copies of the Code of Business Conduct will be provided to any shareholder upon written request to: Legal Counsel, Building 6, Zhengtongchuangyi Centre, No. 18, Xibahe Xili, Chaoyang District, Beijing 100028, People’s Republic of China.
Item 16C.Principal Accountant Fees and Services
Disclosure of Fees Charged by Independent Accountants
The following table summarizes the fees charged by PricewaterhouseCoopers Zhong Tian
(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 Committee Pre-approval Policies and Procedures
Our audit committee has adopted procedures which set forth the manner in which the committee will review and approve all audit and non-audit services to be provided by PricewaterhouseCoopers Zhong Tian
· Any audit or non-audit service to be provided to us by the independent accountant must be submitted to the audit committee for review and approval, with a description of the services to be performed and the fees to be charged.
· The audit committee in its sole discretion then approves or disapproves the proposed services and documents such approval, if given, through written resolutions or in the minutes of meetings, as the case may be.
Item 16D.Exemptions from the Listing Standards for Audit Committees
We have not been granted an exemption from the applicable listing standards for the audit committee of our board of directors.
Item 16E.Purchases of Equity Securities by the Issuer and Affiliated Purchasers
In December 2011, we approved a share repurchase program to purchase up to an aggregate of $3.2 million of our outstanding ADSs from time to time based on market conditions. The repurchases may be effected through open market transactions or block trades, including the use of derivative instruments, and will be financed with our cash balance.
Item 16F.Changes in Registrant’s Certifying Accountant
Not applicable.
Pursuant to the NASDAQ Stock Market Rules, foreign private issuers such as our company may follow home-country practice in lieu of certain NASDAQ corporate governance requirements. We have notified NASDAQ that a majority of our directors do not qualify as independent directors, we do not have a nominations committee, nor is independent director involvement required in the selection of director nominees or in the determination of executive compensation. Issuances of securities in connection with equity-based compensation of officers, directors, employees or consultants will be permitted without obtaining prior shareholder approval and we will post our annual reports to shareholders in lieu of mailing physical copies to record holders and beneficial owners of our ADSs and ordinary shares. This home-country practice of ours differs from Rules 5605(b), (d) and (e), 5635(c) and 5615(a)(3) of the NASDAQ Stock Market Rules, because there are no specific requirements under Cayman Islands law on director independence or on the establishment of a nominations committee, and neither are there any requirements on independent directors’ involvement in the selection of director nominees nor in the determination of executive compensation.
Item 16H.Mine Safety Disclosure
Not applicable.
Not applicable.
The consolidated financial statements for Ku6 Media Co., Ltd. and its subsidiaries are included at the end of this annual report on Form 20-F.
* Filed or furnished herewith
†
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
Date: April
KU6 MEDIA CO., LTD.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations and comprehensive loss, of changes in equity (deficit) and of cash flows present fairly, in all material respects, the financial position of Ku6 Media Co., Ltd. (the “Company”) and its subsidiaries at December 31,
/s/ PricewaterhouseCoopers Zhong Tian
PricewaterhouseCoopers Zhong Tian Shanghai, the People’s Republic of China April
KU6 MEDIA CO., LTD.
The accompanying notes are an integral part of these consolidated financial statements.
KU6 MEDIA CO., LTD. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
The accompanying notes are an integral part of these financial statements.
KU6 MEDIA CO., LTD. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
The accompanying notes are an integral part of these financial statements.
KU6 MEDIA CO., LTD. CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (DEFICIT) (in U.S. dollars, except share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
KU6 MEDIA CO., LTD. CONSOLIDATED STATEMENTS OF CASH FLOWS
(in U.S. dollars)
KU6 MEDIA CO., LTD. CONSOLIDATED STATEMENTS OF CASH FLOWS (in U.S. dollars)
The accompanying notes are an integral part of these consolidated financial statements. *Refer to Note 2(31). KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, (all amounts in U.S. dollars (US$) unless otherwise stated)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES
Ku6 Media Co., Ltd. (the “Company”), Organization
As of December 31,
Historically, including through early 2014, Shanda Interactive Entertainment Limited (“Shanda”), a leading interactive entertainment media company in China,
On March 31, 2014, Shanda Media, the affiliate of Shanda directly owning Shanda’s share of the Company’s equity, entered into an agreement with Mr. Xudong Xu (“Mr. Xu”) to transfer approximately 41% of the Company’s total outstanding ordinary shares, or 1,938,360,784 shares, to Mr. Xu in exchange for a contemporaneously dated promissory note with a maturity of three years pursuant to which Mr. Xu committed to repay, in cash, the purchase value of the shares approximating $47 million (based upon an average of share prices immediately preceding the share transfer) to Shanda Media (the “Share Purchase Transaction”). The promissory note which was used by Mr. Xu to finance the purchase of the shares was accompanied by a share pledge in favor of Shanda Media. Additionally, Mr. Xu has granted powers of attorney and voting proxy to Shanda Media, which may be exercised only upon occurrence of an event of default which is continuing, in order to more effectively secure the obligations under the promissory note. The share transfer was completed on April 3, 2014 and decreased Shanda’s ownership percentage to 29.5%, thus discontinuing Shanda’s controlling majority shareholder status. While Shanda is no longer the controlling shareholder of the Group,
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, (all amounts in U.S. dollars (US$) unless otherwise stated) In connection with the Share Purchase Transaction, Shanda, through its affiliate, extended a loan of $3.2 million (RMB20.0 million) to the Group on April 3, 2014. This loan was interest-free and originally due on April 2, 2015. Shanda waived the Group’s obligation to repay this loan in order to satisfy one of the closing conditions under the share purchase agreement for the Share Purchase Transaction. Also, existing related party receivables due from an affiliate of Shanda, amounting to $1.2 million, were forgiven by the Group as part of the $3.2 million (RMB20.0 million) promised monies. The total net benefit, amounting to $2.0 million, from the aforementioned transactions was reflected as an equity contribution in the accompanying consolidated statement of shareholders’ deficit. On April 10, 2014, the Group received cash of RMB20.0 million from Shanda. On May 19, 2014, Shanda, through its affiliate, entered into an agreement to provide a loan of $3.4 million (RMB21.4 million) to the Group. This loan was interest-free and originally due within twelve months. Similar to the previous loan in early April, this loan was immediately waived as to repayment. As part of the loan transaction, existing related party payables to certain affiliates of Shanda, amounting to $0.8 million (RMB5.3 million), were waived as to repayment as part of the $3.4 million (RMB21.4 million) promised loan monies. The total benefit from the waived loans and payables of $3.4 million (RMB21.4 million) was reflected as an equity contribution in the accompanying consolidated statement of shareholders’ deficit. On May 30, 2014, the Group received cash of $2.6 million (RMB16.1 million) from Shanda, representing the promised monies of $3.4 million (RMB21.4 million) less the forgone existing related party payables of $0.8 million (RMB5.3 million). The $3.2 million received as described in the foregoing paragraph and the $2.6 million received in May were characterized as a financing cash inflow in the accompanying consolidated statement of cash flows. In connection with the Share Purchase Transaction, Mr. Xu committed to procure additional equity or debt financing of no less than $10.0 million by October 30, 2014. In light of improvements in operating cash flows in the fourth quarter of 2014, the Group opted to borrow RMB30.0 million ($4.8 million) instead from Mr. Xu. Therefore, on February 2, 2015, the Group entered into a loan agreement with Mr. Xu, pursuant to which Mr. Xu agreed to provide a loan of RMB30.0 million to the Group. The term of the loan is one year, with principal repayable at the maturity date of February 2, 2016. The loan bears interest at a rate of 6.5% per annum, which is payable at maturity. The Group received RMB30.0 million on March 4, 2015. The Share Purchase Transaction was undertaken in the context of adopting fundamental changes to the Group’s business strategy, with the following major changes having occurred since that time. (a) Advertising Agency Agreement with Shengyue ·On April 30, 2014, the Group entered into a new advertising agency agreement with Shengyue, which was no longer owned by Shanda Interactive following Shanda Interactive’s sale of the business to an outside party (after the transfer of ownership, “New Shengyue”); accordingly, New Shengyue became an independent third party. Pursuant to the new agreement, the minimum guaranteed advertising revenue amount was substantially lower than that under the previous advertising agency agreement with Shengyue prior to March 31, 2014 (when Shengyue was a related party). This new advertising agency agreement was effective from April 25 and was to expire on December 31, 2014. ·On August 14, 2014, the Group sent a written notice to New Shengyue terminating the new advertising agency agreement. According to the notice of termination, the advertising agency agreement was terminated on August 28, 2014. There were no financial penalties associated with the termination payable by the Group. Contemporaneous with the termination of the new advertising agency agreement with New Shengyue, the Group re-evaluated the collectability of the remaining receivables from Shengyue associated with both the old and new advertising agency agreements (pre-April 2014 and post-April 2014) and concluded that such receivables were likely not collectible. This evaluation excluded amounts received in cash during the second quarter of 2014. Accordingly, the remaining accounts receivable associated with the two advertising agency agreements are fully provided for. The Group recorded a provision of $0.92 million (RMB5.71 million) for all remaining receivables under the old advertising agency agreement with Shengyue (emanating from the time Shengyue was owned by Shanda Interactive) during the second quarter of 2014 given the subsequent termination in August. Following the termination, the Group further evaluated remaining receivables due pursuant to the new Shengyue advertising agreement and recorded a provision of $0.05 million (RMB0.35 million) in the third quarter of 2014 for all remaining receivables under the this advertising agency agreement with Shengyue that was terminated August 28, 2014. KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) (b) Advertising Agency Agreement with Third Party Huzhong ·On August 29, 2014, the Group entered into an advertising agency agreement with Huzhong Advertising (Shanghai) Ltd. (“Huzhong”), an unrelated third party, pursuant to which Huzhong has agreed to act as the Group’s exclusive advertising agent for standard media resources and as a non-exclusive advertising agent for highly interactive advertising resources. According to the agreement, the Group has agreed to guarantee a certain amount of web traffic per day. In return, Huzhong guarantees to the Group a minimum amount of advertising revenues per day. The minimum guarantee amount under this agreement is higher than that under the agency agreement with New Shengyue terminated on August 28, 2014. If the Group fails to meet the web traffic target, the minimum guarantee amount will be adjusted downward proportionally. Huzhong will prepay 50% of the minimum guaranteed amounts with the Group prior to the beginning of each month, and the balance will be settled monthly. The advertising agency agreement started on August 29, 2014 and will expire on December 31, 2017. (c) Revenue Sharing Cooperation with Related Party Qinhe ·On April 30, 2014, the Group entered into an agreement with related party Shanghai Qinhe Internet Technology Software Development Co., Ltd., (“Qinhe”), a company controlled by Mr. Xu, which operates iSpeak, a social platform that allows users to engage in real-time online group activities through voice, text and video. This agreement stipulates that the Group will assist Qinhe by providing online game marketing services. Qinhe will share a portion of its profits that are generated from the Group’s video viewers who play Qinhe’s games after linking to them through advertisements on the Group’s websites. Profits are calculated as revenues from the games operated by Qinhe, net of licensing fees payable to game developers. The Group has provided these game marketing services to Qinhe from April 3, 2014 onward. This agreement expired on March 31, 2015 and was not renewed. ·On May 4, 2014, the Group entered into a separate agreement with Qinhe to provide interactive entertainment marketing services under a similar arrangement to that described above. Pursuant to this agreement, the Group will share a certain percentage of Qinhe’s revenues generated from its video viewers who visit the iSpeak platform by linking thereto from advertisements on the Group’s website and spend monies with iSpeak. On May 4, 2014, the Group started to provide these marketing services to Qinhe. ·On September 15, 2014, the Group signed a supplemental agreement to the interactive entertainment marketing services agreement mentioned in the preceding paragraph. The purpose of the supplemental agreement was to permit Qinhe greater operational capabilities to manage and operate the ishow.ku6.com subdomain of domain ku6.com on its own in order to drive further user referrals from Ku6 to Qinhe. Pursuant to this supplemental agreement, Qinhe agreed to pay additional guaranteed revenue amounts, stated in monthly terms, from July 2014 to December 2014. The guaranteed amounts, which are intended to compensate Ku6 for its resource costs in operating the relevant infrastructure, are in addition to the sharing amounts described in the preceding paragraph and do not result in any changes to the sharing terms in the original agreement. In addition, the original interactive entertainment marketing services agreement was extended to December 31, 2015. Under the extended agreement Qinhe will not be required to pay any guaranteed revenue amounts from January 1, 2015. KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(1) Basis of
The accompanying consolidated financial statements of the Group have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”).
The preparation of consolidated financial statements in conformity with US GAAP requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities at the dates of the financial statements. Significant accounting estimates reflected in the Company’s financial statements include The Group has incurred significant net losses and negative cash flows from operations in each of the three most recent years. As of December 31, 2014, the Group had cash and cash equivalents of $4.4 million, had an accumulated deficit of $187.1 million, reported a working capital deficit of $4.8 million, and had negative operating cash flows of $5.2 million for the year then ended. Despite suffering a gross loss for the full year of 2014, the Group achieved gross profit in the fourth quarter of 2014, following a protracted period of gross losses. The Group continues to generate operating losses and net losses. Despite recent improvements, substantial doubt exists as to the Group’s ability to continue as a going concern, primarily due to uncertainties regarding (1) the Group’s ability to generate improvements in operating cash inflows, which depend on growth in revenues from (i) Huzhong, the Group’s new third party advertising agency since late August 2014, and (ii) two cooperation agreements with related party Qinhe; (2) the Group’s ability to reduce its operating cash outflows, such as through further administrative and headcount-related cost control measures; and (3) the availability and timing of additional financing with terms acceptable to the Group. Growth in the Group’s operating cash inflows is principally dependent upon successful execution with Huzhong and Qinhe resulting in growth in revenues therefrom, and may also benefit from diversification to other sources of revenue. The Group expects to derive its 2015 revenues from Huzhong and revenue sharing agreements with Qinhe described in the foregoing footnote. Cash collection from these sources depends on achievement of the guaranteed amounts of web traffic per day, the performance of the iSpeak platform, the performance of the games operated by Qinhe, and contractual terms agreed to with Qinhe and Huzhong. The Group will need to obtain further new revenue sources and additional near-term financing to fund its daily operations, as its current cash flow projections indicate that cash inflows from operating activities will be insufficient in the near term. In order to reduce operating cash outflows, the Group reduced its headcount by approximately 40% in various departments in April 2014. The Group has also taken other cost reduction measures, including improving the efficiency of its network to reduce infrastructure costs, and has reduced its content acquisition costs. Note 1 contains further descriptions of recent equity contributions from Shanda Interactive and a 2015 borrowing arranged with Mr. Xudong Xu. While these additional financing measures have assisted in alleviating pressure on the Group’s working capital and liquid resources, all the aforementioned factors raise substantial doubt about the Group’s ability to continue as a going concern. In order to continue its operations, the Group must generate sufficient revenues, raise more funds, and/or curtail its operational and capital expenditures to achieve profits and positive cash flows.
The consolidated financial statements include the financial statements of the Company, its subsidiaries, and VIEs. All inter-company transactions and balances have been eliminated upon consolidation. Affiliated companies in which the Company has partial ownership and controls more than 20% but less than 50% of the investment are accounted for using the equity method of accounting. The Company’s share of earnings (losses) of such equity investments KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated)
The Company follows the guidance relating to the consolidation of VIEs in ASC 810-10, which requires certain VIEs to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.
The Company has various agreements with its VIEs, through which the Company holds all the variable interests of the VIEs and has the power to direct the activities of the VIEs. Consequently the Company is the primary beneficiary of these VIEs. Details of certain key agreements with the VIEs are as follows:
Loan Agreements: Beijing Technology, Kusheng and Tianjin Technology (the “Subsidiaries”) have granted interest-free loans to the nominee shareholders with the sole purpose of providing funds necessary for the equity capital
Proxy
Equity Interest Pledge Agreements: The nominee shareholders of the VIEs have pledged their respective equity interests in the VIEs as collateral to secure the nominee shareholders’ obligations under other agreements and for the payment by the VIEs under the exclusive technical consulting and services agreements and the loan agreements. The Pledge Agreements have been registered with the applicable local branches of the State Administration for Industry and Commerce. The nominee shareholders of the VIEs cannot sell or pledge their equity interests to others without the approval from the Subsidiaries, and the nominee shareholders of the VIEs cannot receive any dividends without the approval of the Subsidiaries.
Exclusive Call Option Agreements: The nominee shareholders of the VIEs granted the Subsidiaries the exclusive and irrevocable right to purchase from the nominee shareholders, to the extent permitted under PRC laws and regulations or at the request of the Company, all of the equity interests in these entities for a purchase price equal to the amount of the registered capital or at the lowest price permitted by PRC laws and regulations. The Subsidiaries may exercise such options at any time. In addition, the VIEs and their nominee shareholders agreed that without the Subsidiaries’ prior written consent, they will not transfer or otherwise dispose of the equity interests or declare any dividends.
Exclusive Business Cooperation Agreements: The Subsidiaries are the exclusive provider of KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated)
As a result of the above contractual agreements, the Company determined that it has the power to control the economic activities most significant to the VIEs and is the primary recipient of the economic rewards or risks, as the case may be. As such, the Company consolidates the VIEs as required by ASC 810-10.
As of December 31,
These balances are reflected in the Group’s consolidated financial statements with intercompany transactions eliminated. Under the contractual arrangements with the VIEs, the Company has the power to direct activities of the VIEs, and can have assets freely transferred out of the VIEs. Therefore, the Company considers that there is no asset in any of its consolidated VIEs that can be used only to settle obligations of the VIEs, except for registered capital and PRC additional paid-in capital of the VIEs in the amount of $4.9 million as of December 31,
As all the VIE subsidiaries are incorporated as limited liability companies under PRC Company Law, creditors thereof do not have recourse to the general credit of the Group for any of the liabilities of the VIE subsidiaries. As of December 31, 2013
As of December 31,
For the years ended December 31,
Currently there is no contractual arrangement that requires the Company to provide additional financial support to the VIEs. However, as the Company is conducting the online advertising business substantially through the VIEs, the Company has, in the past, provided and will continue to provide financial support to the VIEs considering the business requirements of the VIEs and the Company’s own business objectives in the future, which could expose the Company to a loss. For the year ended December 31, 2014, the net revenue of VIEs included charges from the VIEs to the wholly owned subsidiaries of the Company in the amount of $2.6 million for services provided by the VIEs as requested by the local authorities (2012 and 2013: nil and $2.3 million). The VIE revenue charge and derecognition of liabilities resulted in the net profit of the VIEs for the year ended December 31, 2013.
Please refer to “Contingencies” under Note
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) (3) Significant risks and uncertainties
The Group participates in a dynamic high technology industry and believes that, in addition to the factors resulting our conclusions with respect to going concern, changes in any of the following areas could have a material adverse effect on the
The Group follows ASC Topic 820, “Fair Value Measurements and Disclosures”. This guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The guidance outlines a valuation framework and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. Under US GAAP, certain assets and liabilities must be measured at fair value, and the guidance details the disclosures that are required for items measured at fair value.
Financial assets and liabilities are to be measured and disclosed using inputs from the following three levels of the fair value hierarchy. The three levels are as follows:
Level 1 inputs are unadjusted quoted prices in active markets for identical assets that the management has the ability to access at the measurement date.
Level 2 inputs include quoted prices for similar assets in active markets, quoted prices for identical or similar assets in markets that are not active, inputs other than quoted prices that are observable for the asset (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).
Level 3 includes unobservable inputs that reflect management’s judgments about the assumptions that market participants would use in pricing the assets or liabilities. Management develops these inputs based on the best information available, including their own data.
The Group accounts for its business combinations using the purchase method of accounting. This method requires that the acquisition cost be allocated to the assets, including separately identifiable intangible assets, and liabilities the Company acquired based on their estimated fair values.
The Group follows ASC 805, “Business Combinations,” with respect to business combinations. Pursuant thereto, the cost of an acquisition is measured as the aggregate of the fair values at the date of exchange of the assets given, liabilities incurred, and equity instruments issued as well as the contingent
The Group follows guidance in ASC Topic 810 regarding non-controlling interests. Non-controlling interests are classified as a separate component within
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) (6) Foreign currency translation
The functional currency and reporting currency of the parent company is the United States dollar (“U.S. dollar”). The
Assets and liabilities of the
Transactions denominated in currencies other than the Company’s or its
Pursuant to the People’s Republic of China State Administration of Foreign Exchange (“SAFE”), the conversion of U.S. dollars to RMB is governed as to amount and a uniform exchange rate is set by the People’s Bank of China on a daily basis pegged to a basket of major currencies. Correspondingly, RMB to U.S. dollar conversion does not carry the same ease as conversion may with other major currencies. The rates of exchange for the U.S. dollar quoted by the Federal Reserve Bank of New York were RMB
Cash and cash equivalents consist of cash on hand, demand deposits and highly liquid investments placed with bank or other financial institutions with no restriction to withdrawal or use, which have original maturities of three months or less.
Included in
The KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated)
(
Affiliated companies
The
(1
Property and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated on a straight-line basis over the following estimated useful lives:
Expenditures for maintenance and repairs are expensed as incurred. Gain or loss on the disposal of property and equipment is the difference between the net sales proceeds and the carrying amount of the relevant assets and is recognized in the consolidated statements of operations.
(1
An intangible asset is required to be recognized separately from goodwill based on its estimated fair value if such asset arises from contractual or legal right or if it is separable as defined by ASC 805. Acquired intangible assets
The estimated useful economic lives by major intangible asset category used by the Company
KU6 MEDIA CO., LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014 (all amounts in U.S. dollars (US$) unless otherwise stated) |
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(142) Video production and acquisition costs and licensed video copyrights
The Company contracts third parties for the production of and 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 websiteswebsite ku6.com.
Video production and acquisition costs
Following the guidance under ASC 926-20-25, video production (which mainly includeincludes direct production costs and production overhead) and acquisition costs are capitalized, if the capitalization criteria are met, and are stated at the lower of unamortized cost or estimated fair value.
With respect to production and acquisition costs, until the CompanyGroup can establish estimates of secondary market revenues, capitalized costs for each video produced are limited to the amount of revenues contracted for that video. The costs in excess of revenues contracted for that video are expensed as incurred on an actual basis, and are not restored as assets in subsequent periods. Once the CompanyGroup 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 CompanyGroup 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, 2012,2014, video production and acquisition costs did not meet the criteria for capitalization 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.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
Amortization and write-down expenses for the year ended December 31, 2012 were nil (2011: $2,200,535) and nil (2011: $1,521,161), respectively.
(153) Goodwill
Goodwill represents the excess of the purchase price over the fair value of the identifiable assets acquired and liabilities assumed as a result of the Group’s acquisitions. The Group’s goodwill iswas subject to a full impairment charge in 2013. The Group’s goodwill was associated with the Group’s single reporting unit as of December 31, 2012.unit.
The Group tests goodwill for impairment by performing a two-step goodwill impairment test, which can be preceded by an optional qualitative assessment to determine if the two-step goodwill impairment test needs to be followed. The optional qualitative assessment relies upon qualitative factors to determine if it is “more likely than not” (more than 50% probable) that the fair value of a reporting unit is less than the carrying value of the reporting unit. The Group did not apply the qualitative assessment and proceeded directly to the two-step test. The first step compares the calculated fair value of a reporting unit to its carrying amount, including goodwill. If, and only if, the carrying amount of a reporting unit exceeds its fair value as per step one, the second step is executed to compare the implied fair value of the affected reporting unit’s goodwill to the carrying value of that goodwill. The implied fair value of goodwill is determined in a manner similar to accounting for a business combination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. This allocation process is only performed for purposes of evaluating goodwill impairment and does not result in an entry to adjust the value of any assets or liabilities. An impairment loss is recognized for any excess in the carrying value of goodwill over the implied fair value of goodwill.
Based upon application of the two step impairment evaluation approach at the Group’s annual evaluation dates, no impairment losses were recorded in the year ended December 31, 2012. In the quarter ended December 31, 2013, based upon the same approach at the Group’s annual evaluation date, considering the facts and circumstances regarding future revenues and cash flows described in Note 1 underpinning substantial doubt about the Group’s abilities to continue as a going concern, which had developed adversely by that time, the Group recorded an impairment charge to write off, in its entirety, the reporting unit’s (the entire Group)’s goodwill by $6.2 million. See Note 7 for additional information.
three-year period ended DecemberTable of Contents
KU6 MEDIA CO., LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2012, fair value exceeded carrying value for the Group’s reporting unit and no further impairment evaluation was necessary2013 AND 2014
(all amounts in U.S. dollars (US$) unless otherwise stated)
(164)Impairment of long-lived assets
The Group reviews its long-lived assets including property, plant and equipment and finite-lived intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may no longer be recoverable. When these events occur, the CompanyGroup measures impairment by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flows is less than the carrying amount of the assets, the CompanyGroup would recognize an impairment loss based on the fair value of the assets. The CompanyGroup uses estimates and judgments in its impairment tests and if different estimates or judgments are utilized, the timing or the amount of the impairment charges could be different.
No impairment provision was recognized in the year ended December 31, 2010; impairment of $1.4 million for a customer list intangible asset was recognized in the year ended December 31, 2011 as further discussed in Note 7; no impairment was recognized in the year ended December 31, 2012. In 2013, based upon substantial uncertainties surrounding future revenues and cash flows, and the concomitant uncertainty associated with recovering various assets regarding future net cash inflows and an assessment of reduced expectations for the Group’s future projected results of operations, the Group recognized a full impairment loss of $21.0 million for its acquired intangible assets. No impairment was provided on fixed assets as the carrying value of fixed assets was less than fair value. There was no impairment loss recorded in the year ended December 31, 2014.
(175)Financial instruments
Financial instruments include cash and cash equivalents, accounts receivable, prepayments and other current assets, amounts due from/to related parties, short-term borrowings, accounts payable, and accrued expenses and other current liabilities. As of December 31, 20112013 and 2012,2014, their carrying values approximated their fair values because of their generally short maturities. There were no financial assets or liabilities that were measured at fair value at December 31, 20112013 or 2012.2014.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
(186)Revenue recognition and cost of revenues
In accordance with ASC Topic 605, “Revenue Recognition,” the CompanyGroup 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 salesindirect taxes.
The Group makes credit assessments of customers to assess the collectability of contract amounts prior to entering into contracts. For those contracts for which the collectability is assessed as not reasonably assured, the Group recognizes revenue only when cash is received and all revenue recognition criteria are met.
Online advertising services (post-2010 Reorganization business model)
The Group’s revenues are derived principallyGroup derives part of its revenue from online advertising services, where 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, and 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 the lapse of time.
Under arrangementThe Group’s online advertising services revenue is principally generated under fixeds-term contracts with specific advertising agent customers serving as intermediaries between the advertisers that includes different formats to be delivered over different periodsGroup and ultimate advertisers; these fixed-term contracts were responsible for substantially all of time, the Group’s revenue is accounted for using the guidance under ASC 605-25, “Multiple Element Arrangement,” as such revenue arrangements involve multiple deliverables. The Group sells theonline advertising services over a broad price range. The Group usesrevenue in 2012 and 2013 and all of its best estimate ofonline advertising services revenue in 2014. Under two prior arrangements with Shengyue, the selling price of each component of a bundledGroup’s previous exclusive ad agent for standard advertising arrangements to allocateresources and non-exclusive ad agent for highly interactive advertising resources, which terminated by August 2014 (Note 1), and the arrangement consideration to the separate units of accounting (deliverables).
Under anGroup’s current arrangement with a related partyad agent Huzhong (exclusive for standard advertising agencyresources and non-exclusive for highly interactive advertising resources), which started on August 29, 2014 and will expire on December 31, 2017 (Note 1 & 13)1), components of the arrangement include an arrangement forarrangements included (include) guaranteed minimum advertising revenues and an arrangement for sharing of excess advertising revenues, as well as web traffic or video view targets to be met by the Group.
KU6 MEDIA CO., LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014
(all amounts in U.S. dollars (US$) unless otherwise stated)
In the case of Shengyue, guaranteed minimum advertising revenues were not subject to downward adjustment under the old agreement which expired in early 2014 (Note 1). Under a new agreement with Shengyue consummated in April 2014 but terminated in August 2014 (Note 1), guaranteed minimum advertising revenues were proportionally adjusted downward if there was a shortfall relative to web traffic or video view targets. For the Shengyue arrangements, excess advertising revenues were calculated after deducting commission fees earned by the related party advertising agencyShengyue based upon increasing percentages for additional tiers (layers) of revenuesrevenues in excess of the guaranteed amount. There were no commission fees incurred for any historical periods, as the Group enjoyed a commission-free period in 2011 and earned only the minimum guaranteed revenues in 2012. The2012, 2013 and 2014. In the case of Huzhong, the guaranteed minimum daily advertising revenues are based upon daily web traffic targets agreed to by the Group and Huzhong, and revenues are proportionally adjusted downward or upward relative to the guaranteed minimums should web traffic fall short of or exceed the agreed upon targets. During 2014, the Group did exceed targets on certain occasions resulting in an insignificant additional amount of revenue. Unlike the Shengyue arrangements, which were settled in arrears, the Huzhong arrangement provides for payment of 50% of the guaranteed amounts prior to the beginning of the month, with final settlement determined between the parties at the end of the month. These prepayments are recorded as advances from customers until recognised as revenue. Guaranteed advertising revenues and any excess advertising revenues net of commission fees are recognized ratably over varying service periods as governed by the specific agreements, with the affiliated advertising agency, as the Group is able to timely obtain information to determine historical advertising revenues as a basis for preparing financial statements.
The CompanyGroup reports the revenue earned from both related and third party ad agencies based on the net amount after considering the indicators to record revenue gross versus set forth in ASC 605-45, “Principal Agent Considerations.”
The Company makes credit assessments of A principal factor considered is the fact that the advertising agents establish prices with ultimate end customers wishing to assessplace advertisements and the collectability of contract amounts priorGroup is not able to entering into contracts. For those contracts for which the collectability is assessed as not reasonably assured, the Company recognizes revenue only when cash is received and all revenue recognition criteria are met.influence such pricing.
For revenue arrangements contracted with third-party advertising agencies (excluding the Companyfixed arrangement with Huzhong), the Group provides cash incentives in the form of rebates based on volume and performance, and accounts for such incentives as a reduction of revenue in accordance with ASC 605-50-25. The cash incentives to third-party advertising agencies in the years ended December 31, 20112012, 2013 and 20122014 were, $1,374,030$72,464, nil and $72,464,nil, respectively.
CostsPromotional advertising services
The Group derives a portion of its revenue from related party Qinhe in exchange for interactive media and entertainment promotional advertising services provided by the Group to Qinhe. The Group provides online game marketing services to Qinhe; in exchange, Qinhe shares a portion of its profits that are generated from the Group’s video viewers who play Qinhe’s games after linking to them through advertisements on the Group’s websites. Profits are calculated as revenues consist primarilyfrom the games operated by Qinhe, net of employee costs associatedlicensing fees payable to game developers. The Group also provides interactive entertainment marketing services to Qinhe; in exchange, Qinhe shares a certain percentage of Qinhe’s revenues generated from its video viewers who visit its proprietary social media platform by linking thereto from advertisements on the Group’s website and spend monies with platform operationQinhe.
Further to the interactive entertainment marketing services arrangement (but not the online game marketing arrangement), in September 2014 (Note 1) the Group signed a supplemental agreement providing Qinhe greater operational capabilities to manage and share-based compensation, depreciation expenses, internet bandwidth leasing costs,operate the ishow.ku6.com subdomain of domain ku6.com on its own in order to drive further user referrals. Pursuant to this supplemental agreement, Qinhe agreed to pay additional guaranteed revenue amounts, stated on a monthly basis and incremental to the revenue sharing determined on a percentage basis referenced in the foregoing paragraph.
Promotional advertising services revenues are recognized as services are delivered for online game and interactive entertainment marketing. Shortly after the end of each month, with frequency sufficient to enable timely preparation of financial statements, the Group timely receives a statement from Qinhe detailing the amount of shared revenue for each type of services. Once amounts are reconciled to the Group’s records and agreed to, shared revenues are to be paid within 30 days. With respect to the additional guaranteed revenue amounts mentioned in the foregoing paragraph, such amounts are recognized on a monthly basis as they are not dependent on underlying video production costs,viewer referrals. The Group reports the revenue earned from Qinhe based on the net amount after considering the indicators to record revenue gross versus set forth in ASC 605-45, “Principal Agent Considerations.” A principal factor considered is the fact that Qinhe establishes all pricing to end customers and amortization and write-downs of licensedthe Group is not responsible for providing the content or services, only for driving video copyrights.viewer referrals to Qinhe.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
Wireless value-added services (pre-2010 Reorganization - discontinued operations (Note 2(1))
Wireless value-added serviceCosts of revenues were derived from providing personalized media, games, entertainment and communication services(applicable 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 network service agreements with the Telecom Operators and indicated in the messages received on mobile phones, were charged on a per-use basis or on a monthly subscription basis, and varied according to the type of services delivered.
The Company contracted with the Telecom Operators for the transmission of wireless services as well as for billing and collection services. The Telecom Operators provided the Company with monthly statements that represented the principal evidence that service had been delivered and triggered revenue recognition for a substantial portion of the Company’s revenue. In certain instances, when a statement was not received within a reasonable period of time, the Company made an estimate of theboth online advertising revenues and costpromotional revenues) consist primarily of services earned during the period covered by the statement based on its internally generated information, historical experience and/or other assumptions that were believed to be reasonable under the circumstances.
The Company measureemployee salaries and benefits associatedd its revenues based on the total amount paid by mobile phone customers, for which the Telecom Operators billed and collected on the Company’s behalf. Accordingly, the service fees paid to the Telecom Operators were included in the cost of revenues. In addition, in respect of 2G services, the Telecom Operators charged the Company network fees based on a per message fee, which varied depending on the volume of messages sent in the relevant month, multiplied by the excess of messages sent over messages received. These network fees were likewise retained by the Telecom Operators and were reflected as cost of revenues. The cost of revenues also included fees paid to content providers and marketing partners, maintenance costs with platform operations, related to equipment used to provide the services,share-based compensation, depreciation expenses, internet bandwidth leasing chargescosts, and data center services, alternative channels, media and related Internet costs, operator imposed penalty charges, and certain distributionvideo production costs.
The Company evaluated 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 was based upon an assessment of whether it acted as a principal or agent when providing its services. The Company concluded that it acted as a principal in each of the arrangements. Factors that support the Company’s conclusion mainly included:
·the Company was the primary obligor in the arrangement;
·the Company was 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 would not pay the Company if users could not be billed or if users did not pay the Telecom Operators for services delivered and, as a result, the Company bore the delivery and billing risks for the revenues generated with respect to its services.
Based on these factors, the Company believed that recognizing revenues on a gross basis was appropriate. However, as noted above, the Company’s reported revenues were net of bad debt charges that had been deducted by the Telecom Operators.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
Recorded Music (pre-2010 Reorganization - discontinued operations (Note 2(1))
The Company was in the business of artist development, music production, offline music distribution, and online distribution through WVAS and the Internet. Recorded music revenues were derived from live performances, corporate sponsorship and advertising, online and wireless sales, and offline CD sales.
The Company generated 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 received a fixed fee, had no further obligations and recognized the fee as revenue when the master CD was provided. In the latter case, the Company shipped the produced CDs to retail distributors and recognized wholesale revenues at the time of shipment less a provision for future estimated returns.
The Company recognized artist performance fees and corporate sponsorship or marketing event fees once the performance or the service had 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 recognized revenue on the service elements delivered and deferred the recognition of revenue for larger of the contractual cash holdback or the fair value of the undelivered service elements until the remaining obligations had been satisfied. The Company determined 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 acted as the primary obligor in the transaction, revenues were recorded on a gross basis. Where the Company was considered an agent or where the artists separately contract with the event organizer, revenues were recorded on a net basis.
The Company licensed its music to third parties for guaranteed minimum royalty payments and normally received non-refundable upfront licensing fees. In such cases the Company recognized revenue on a straight-line basis over the license period and unrecognized revenues were included in liabilities. When the contract provided for additional payments if revenues exceed the minimum amount guaranteed, such amounts were included in revenues when the Company was notified of its entitlement to additional payments.
The Company incurred costs in producing CD masters, volume CD production, artist and songwriter royalties based on certain percentage of the revenue, and royalties payable to other parties for the use of their work. The cost of record masters, volume CD productions, and royalties paid in advance were recorded in prepaid expenses and other current assets when the sales of the recording were expected to recover the cost and amortized as expenses over the revenue generating period, typically within one year. The decision to capitalize an advance to an artist, songwriter or other party required significant judgment as to the recoverability of these advances. Advances for royalties and other capitalized costs were regularly assessed for recoverability. The costs of ongoing royalties relating to the live performance, corporate sponsorship and advertising, online and wireless sales and offline CD sales to retail distributors were recognized as incurred.
Turnover taxes and related surcharges
The China subsidiaries and VIEs are subject to business tax or value added tax (“VAT”) and related surcharges on the revenues earned for services provided.
Relevant PRC authorities introduced a turnover tax reform pilot program (the “Pilot Program”) in selected pilot cities in China for selected industries in 2012, to gradually expand the scope of VAT. The turnover tax reform pilot program was first implemented in Shanghai effective 1 January 2012. According to Circular Caishui [2012] No.71 (“Circular 71”), the Pilot Program was expanded to Beijing (effective September 1, 2012) and Tianjin (effective December 1, 2012) where the Group’sadvertisingGroup’s online advertising revenues are generated. Prior to the implementation of the Pilot Program, the Group’s business tax rate for advertising sales was 5% based on the gross advertising revenue before deducting the advertising agencies’ rebate.agent rebates. After the implementation of the Pilot Program in Beijing and Tianjin, the advertising business is now subject to VAT rate at 6%. VAT payable on revenues generated by a general VAT taxpayer for a taxable period is the net balance of the output VAT for the period after crediting the input VAT for the period. If any of the Company’s subsidiaries is recognized as a small-scale VAT payer, the applicable VAT rate shall be 3%, and no creditable input VAT can be recognized. Business tax and related surcharges or VAT, as the case may be, are deducted from gross revenues to arrive at net revenues.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
(1917)Product development expenses
Product development expenses consist primarily of salaries and benefits for product development personnel, including share-based compensation costs. These costs, and 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.incurred.
(2018)General and administrative expenses
General and administrative expenses consist primarily of salaries and benefits for general management, finance and administrative personnel, bad debt provision, litigation accrual,accruals, depreciation, amortization and impairment of intangible assets, professional service fees, share-based compensation, office rental fees, and other expenses.
(2119) SalesSelling and marketing
SalesSelling and marketing expenses consist primarily of sales and marketing personnel payroll compensation and related employee costs, advertising and market promotion expenses, and other overhead expenses incurred by the Group’s sales and marketing personnel.
(220)Advertising costs
The Group expenses advertising costs as incurred. Total advertising expenses were $210,987$553,380, $287,070 and nil for the years ended December 31, 2010 pertaining to discontinued operations,2012, 2013 and have been included in selling and marketing expenses and cost of revenues in discontinued operations. Total advertising expenses related to continuing operations were $6,086,030, $2,493,901 and $553,380 for the years ended December 31, 2010, 2011 and 2012,2014, respectively, and were included in selling and marketing expenses within continuing operations.expenses.
KU6 MEDIA CO., LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014
(all amounts in U.S. dollars (US$) unless otherwise stated)
(231)Share-based compensation
The Group applies ASC 718, which requires all share-based payments to employees and directors, including grants of employee stock options and restricted shares, to be recognized as compensation expense in the financial statements over the vesting periods of the awards based on the fair values of the awards determined at the grant date. The valuation provisions of ASC 718 apply to awards granted after the adoption of ASC 718, to awards granted to employees and directors before the adoption of ASC 718 whose related requisite services had not been provided, and to awards which were subsequently modified or cancelled. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent period(s) if actual forfeitures differ from initial estimates.
In accordance with ASC 718, the Group has recognized share-based compensation expenses, net of a forfeiture rate, using the straight-line method for awards with graded vesting features and service conditions only and using the graded-vesting attribution method for awards with graded vesting features and performance conditions. See Note 1614 for further information on stock-based compensation.
(242)Leases
Leases where substantially all the rewards and risks of ownership of assets remain with the leasing company are accounted for as operating leases. Other leases, meaning those meeting the capitalization criteria in ASC 840, “Leases”, are accounted for as capital leases. Payments made under operating leases, net of any incentives received by the CompanyGroup from the leasing company, are charged to the consolidated statement of operations and comprehensive loss 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.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
(253)Taxation
Current income taxes are provided for on the taxable income of each subsidiary on the separate tax return basis in accordance with the relevant tax laws.
Deferred income taxes are provided using the liability method in accordance with ASC 740, “Income Taxes”. Under this method, deferred income taxes are recognized for temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements, net operating loss carry forwards and credits by applying enacted statutory tax rates applicable to future years. The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. The effect on deferred taxes of a change in tax rates is recognized in income in the period of change. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
ASC 740-10-25 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. The CompanyGroup does not have any liabilities for unrecognized tax benefits as of December 31, 20112013 or 2012.2014. Were the CompanyGroup to have such liabilities, interest and penalties would be recognized in tax expenseexpenses.
KU6 MEDIA CO., LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014
(all amounts in U.S. dollars (US$) unless otherwise stated)
(264)Statutory reserves
The Company’sGroup’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’sGroup’s subsidiaries must make appropriations to (i) the general reserve and (ii) the enterprise expansion fund in accordance with the Law of the PRC on Enterprises Operated Exclusively with Foreign Capital. The general reserve fund requires annual appropriations of 10% of after-tax profit (as determined under PRC GAAP at each year-end) until such fund has reached 50% of the company’s registered capital; enterprise expansion fund appropriation is at the PRC subsidiaries’ directors’ discretion. The Company’s VIEs, in accordance with the China Company Laws, must make appropriations to a (i) statutory reserve fund and (ii) discretionary surplus fund. The statutory reserve fund requires annual appropriations of 10% of after-tax profit (as determined under PRC GAAP at each year-end) until such fund has reached 50% of the company’s registered capital; other fund appropriation is at the VIEs’ directors’ discretion.
The general reserve fund and statutory reserve fund can only be used for specific purposes, such as setting off the accumulated losses, enterprise expansion or increasing the registered capital. The enterprise expansion fund can be used to expand production and operations; it also may be used for increasing registered capital.
Appropriations to these funds, if they occur, are classified in the consolidated balance sheets as statutory reserves.reserves; however, such reserves are zero. No appropriations were made during the years ended December 31, 2010, 201112, 2013 and 2012.2014. There are no legal requirements in the PRC to fund these reserves by transfer of cash to restricted accounts, and the CompanyGroup does not do so.
(275)Contingencies
In the normal course of business, the CompanyGroup 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 21.1
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
(286)EarningsEarnings (loss) per share
Basic earnings (loss) attributable to the Company’s ordinary shareholders per share is computed by dividing earnings (loss) attributable to the Company’s ordinary shareholders by the weighted average number of ordinary shares outstanding during the year. Diluted earnings (loss) attributable to the Company’s ordinary shareholders’ per share is computed using the weighted average number of ordinary shares and, if dilutive, potential ordinary shares outstanding during the year. Potential ordinary shares consist of shares issuable upon the conversion of convertible debt (using the “if-converted method”) and upon the exercise of stock options (using the “treasury stock method”). Potential ordinary shares are not included in the denominator of the diluted loss per share calculation when inclusion of such shares would be anti-dilutive.
For each of the three years in the period ended December 31, 2012,2014, the dilutive effect of potential ordinary shares was not factored into the calculation as a net loss was incurred in each period.
(2927)Comprehensive loss
Comprehensive loss is defined as the change in equity of a company during the period from transactions and other events and circumstances excluding transactions resulting from investments from owners and distributions to owners. Accumulated other comprehensive loss, as presented on the accompanying consolidated balance sheets, consists of cumulative foreign currency translation adjustments included in other comprehensive income (loss), which are presented net of tax.tax (zero tax effect).
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
(3028)Recent accounting pronouncements
In May 2011,2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-09 (“ASU 2014-09”), “Revenue from Contracts with Customers (Topic 606)”. ASU 2014-09 will eliminate transaction-specific and industry-specific revenue recognition guidance under current U.S. GAAP and replace it with a principle-based approach for determining revenue recognition. ASU 2014-09 will require that companies recognize revenue based on the value of transferred goods or services as they occur in the contract. The ASU also will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective, for public companies, for reporting periods beginning after December 15, 2016, including interim periods within that reporting period and therefore would impact the Group starting January 1, 2017 (however, the FASB has recently voted in April 2015 to delay the effective date by one year, and a deferral is not absolutely certain). Early adoption is not permitted under ASU 2014-09. Entities can transition to the standard either retrospectively or as a cumulative effect adjustment as of the date of adoption. Management is currently assessing the impact of the adoption of ASU 2014-09 and the effect of the standard on the Group’s ongoing financial reporting.
In August 2014, the FASB issued Accounting Standards Update 2011-04, “Fair Value Measurement:No. 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern”, which will explicitly require management to assess an entity’s ability to continue as a going concern and to provide related footnote disclosures in certain circumstances. The issued guidance will require management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, the amendments (1) provide a definition of the term “substantial doubt”, (2) require an evaluation every reporting period including interim periods, (3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated and (6) require the assessment cover a period of one year after the date that the financial statements are issued (or available to be issued). This guidance is effective for the first annual period ending after December 15, 2016 (hence, calendar 2016 for the Group), and for annual periods and interim periods thereafter. Early application is permitted. The Group anticipates that this guidance will result in expanded disclosures in its financial statements to provide further analysis regarding its existing going concern uncertainty (Note 1).
In February 2015, the FASB issued ASU No. 2015-02, “Consolidation (Topic 810): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.the Consolidation Analysis,” Key provisions ofor ASU 2015-02. ASU 2015-02 focuses on the amendments in ASU 2011-04 include: (1) a prohibition on grouping financial instrumentsconsolidation evaluation for purposes of determining fair value, except in limited cases; (2) an extension of the prohibition against the use of a blockage factor to all fair value measurements; and (3) a requirementreporting organizations that for recurring Level 3 fair value measurements, entities disclose quantitative information about unobservable inputs, a description of the valuation process used and qualitative details about the sensitivity of the measurements. For items not carried at fair value but for which fair value is disclosed, entities are required to discloseevaluate whether they should consolidate certain legal entities. The ASU simplifies consolidation accounting by reducing the level withinnumber of consolidation models from four to two. In addition, the fair value hierarchy that applies tonew standard simplifies the fair value measurement disclosed. ThisFASB Accounting Standards Update isCodification and improves current guidance by: (i) placing more emphasis on risk of loss when determining a controlling financial interest; (ii) reducing the frequency of the application of related-party guidance when determining a controlling financial interest in a VIE; and (iii) changing consolidation conclusions for public and private companies in several industries that typically make use of limited partnerships or VIEs. The ASU will be effective for interim and annual periods beginning after December 15, 2011 and was adopted effective January 1, 2012. The adoption of this guidance did not have an impact on the consolidated financial statements other than minimal additional qualitative disclosures in the footnote regarding fair value measurements.
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. In December 2011, the FASB issued Accounting Standards Update 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items out of Accumulated Other Comprehensive Income.” This Update indefinitely deferred only the specific requirement in ASU 2011-05 to present reclassification adjustments for each component of other comprehensive income on the face of the financial statements. ASU 2011-05 and ASU 2011-12 were effective retrospectively for interim and annual periods beginning after December 15, 2011 and were adopted by the group effective January 1, 2012. In February 2013, the FASB issued Accounting Standards Update 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income,” which closed the indefinite deferral. Specifically, ASU 2013-02, which is effective, with only prospective disclosure required,2015, for public companies, or calendar 2016 for the Group. Early adoption is permitted, including adoption in an interim and annual periods beginning after December 15, 2012, provides reporting entities the option to present the effect of reclassification adjustments either parenthetically on the face of the financial statements or in a separate dedicated footnote.period. The adoption of ASU 2011-05 did not impact the consolidated financial statements as the Group already presented, and presents, a continuous statement of operations and comprehensive income (loss). The adoption of ASU 2013-02 (beginning January 1, 2013) is expected to have minimal impact as the Group does not experience recurring reclassifications.
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,anticipate that the fair valueASU will impact its consolidation conclusions and is in the process 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, and the Company adopted the guidance effective January 1, 2012. The adoption of this guidance did not change, nor would it be expected to change, the conclusions reached in periodic impairment evaluations for goodwill; moreover, the Company utilized the traditional two-step quantitative approach forfinalizing its single reporting unit.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)evaluation.
(3129)GovernmentGovernment Subsidies
Government subsidies represent discretionary cash subsidies granted by local governments to encourage the development of certain enterprises that are established in local special economic regions. The cash subsidies may be received in the form of (i) a fixed cash amount determined and provided by a municipal government to an operating subsidiary for product and service innovation, or (ii) an amount determined as a percentage of the income tax and business tax actually paid by an operating subsidiary.
Cash subsidies have no defined rules and regulations to govern the criteria necessary for companies to enjoy the benefits and are recognized as other income when received.
For the years ended December 31, 2010, 2011 and 2012, cash subsidies of $58,025, $1,265,182 and $1,514,570 were recognized as other income, respectively.
(32)Segment reporting
Based on the criteria established by ASC 280, the authoritative accounting guidance for segment reporting, prior to the 2010 Reorganization, the Company operated and managed two principal operating segments, “WVAS” and “Recorded Music”; post 2010 Reorganization, the Company currently operates and manages its business as a single operating segment “Online Advertising” (Note 17).
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
3. BUSINESS COMBINATIONS
2010 acquisitions
On January 18, 2010, the predecessor entity Hurray! completed the acquisition of Ku6 Holding 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 Holding and the shareholders of Ku6 Holding 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 by Ku6 Holding and immediately vested without substantive future service requirements. After the completion of this acquisition, the Company owned 100% of the equity interests of Ku6 Holding and its subsidiaries and VIEs. The total fair value of the shares issued approximated $28.9 million based on the share price on the closing date and the difference amounting to $1,284,766 between the fair value of the 44,438,100 shares issued and the fair value of options issued by Ku6 Holding at acquisition date attributable to the pre-combination portion was recorded as share-based compensation expense in the consolidated statement of operations and comprehensive loss.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition and the purchase price allocation.
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Total identifiable intangible assets acquired upon consolidation mainly included trademark(s), software technology, and customer base, which have a weighted average amortization period of 18.2 years.
Goodwill primarily represented the expected synergies from combining operations of the Company and Ku6 Holding, which are complementary in a way to each other, and any other intangible benefits that do not qualify for separate recognition. Such goodwill is not deductible for tax purposes. The fair value of intangible assets was measured primarily by the income approach taking into consideration historical financial performance and estimates of future performance of Ku6 Holding’s business.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
Ku6 Holding is subject to claims and litigation which may arise in the normal course of business. As of and subsequent to the acquisition date on January 18, 2010, Ku6 Holding 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 were 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 Holding on January 18, 2010 and began to consolidate the financial statements of Ku6 Holding upon unilateral control from February 1, 2010. The amount of Ku6 Holding’s consolidated revenue and net loss for the eleven months ended December 31, 2010 included in the statements of operations and comprehensive loss was $14,101,171 and $45,165,985.
The following unaudited pro forma consolidated financial information reflects the results of operations forFor the years ended December 31, 2010,2012, 2013 and 2014, cash subsidies of $1,514,570, $1,484,789 and $135,265 were recognized as if the acquisition of Ku6 Holding had occurred as of January 1, 2010 and after giving effect to purchase accounting adjustments primarily relating to the amortization of intangibles. 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.other income, respectively.
(30)Segment reporting | |||
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The pro forma net lossBased on the criteria established by ASC 280, the authoritative accounting guidance for segment reporting, the Group currently operates and manages its business as a single operating segment, “Advertising Services” (Note 15).
(31)Revisions to previously reported amounts
Certain amounts in the accompanying consolidated statement of cash flows for the year ended December 31, 2010 includes $1,851,9512013 have been revised to reflect the corrections of errors. All corrected amounts are within the adjustments to reconcile net loss to net cash used in operating activities. Specifically, the line item “gain on derecognition of aged operating liabilities” was corrected from an inflow of $2,938,250, as previously reported, to an outflow of $2,938,250. The line item “change in accounts payable” was corrected from an outflow of $2,496,787, as previously reported, to an inflow of $1,295,525. Lastly, the line item “change in accrued expenses and other current liabilities” was revised from an outflow of $3,207,948, as previously reported, to an outflow of $1,123,760. These errors in previously reported 2013 amounts were the result of computational errors in the calculation of adjustments to arrive at net cash used in operating activities. These errors impacted only the respective line items within net cash used in operating activities and did not impact any other categories of cash flows, or any other financial statements, or any other reported amounts.
Management evaluated the impact of the identified errors, considering both quantitative and qualitative factors, and concluded that the errors did not result in a material misstatement of the previously issued financial statements for the amortization of identifiable intangible assets arising from the acquisition of Ku6 Holding.
Table of Contentsyear ended December 31, 2013 taken as whole, but are being corrected herein to appropriately reflect that comparative period.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)3
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
4. DISCONTINUED OPERATIONS
Disposal of WVAS and recorded music businesses (2010 Reorganization)
In May 2010, the Company disposed of Huayi Music to Huayi Media for RMB 34,450,000 (equivalent to $5,045,754) in cash and in August 2010, the Company disposed all of its WVAS and remaining recorded music businesses to Shanda for $37,243,904 in cash. See Note 2(1).
A summary of the major financial information for the discontinued operations of WVAS and recorded music businesses as of August 31, 2010 and for the eight month period ended August 31, 2010 is set out below:
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KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
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5. PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consist of:
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| December 31, 2011 |
| December 31, 2012 |
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| December 31, 2013 |
| December 31, 2014 |
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Prepaid expenses |
| 431,560 |
| 309,503 |
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| 218,420 |
| 192,379 |
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Staff advances and other receivables |
| 54,254 |
| 186,950 |
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Advances to suppliers |
| 242,932 |
| 158,825 |
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| 113,293 |
| 111,026 |
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Staff advances and other receivables |
| 209,852 |
| 55,053 |
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| 884,344 |
| 523,381 |
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| 385,967 |
| 490,355 |
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6.4. PROPERTY AND EQUIPMENT, NET
Property and equipment, net, consists of:
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| December 31, 2011 |
| December 31, 2012 |
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| December 31, 2013 |
| December 31, 2014 |
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Furniture and office equipment |
| 1,055,377 |
| 696,780 |
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| 866,517 |
| 844,028 |
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Telecommunications equipment |
| 3,450,208 |
| 4,699,800 |
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| 4,835,937 |
| 4,715,398 |
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Leasehold improvements |
| 1,230,327 |
| 1,344,800 |
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| 1,405,933 |
| 1,371,744 |
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| 5,735,912 |
| 6,741,380 |
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| 7,108,387 |
| 6,931,170 |
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Less: Accumulated depreciation and amortization |
| (2,143,167 | ) | (3,823,268 | ) |
| (5,740,027 | ) | (6,637,603 | ) |
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| 3,592,745 |
| 2,918,112 |
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| 1,368,360 |
| 293,567 |
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Depreciation expense for the years ended December 31, 2010, 2011 and 2012 was $3,265,975, $3,409,647 and $1,941,761, respectively.
The Company acquired $1,231,013 in additional property and equipment in 2012 (2011: $2,428,694).
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
Depreciation expense for the years ended December 31, 2012, 2013 and 2014 was $1,941,761, $1,829,963 and $1,048,398, respectively.
7.5. ACQUIRED INTANGIBLE ASSETS, NET
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| Net carrying |
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Trademark |
| 24,901,940 |
| (2,386,436 | ) | — |
| 22,515,504 |
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Technology |
| 2,197,230 |
| (601,623 | ) | — |
| 1,595,607 |
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Customer list |
| 1,464,820 |
| (415,032 | ) | (1,049,788 | ) | — |
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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, 2012 |
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| December 31, 2013 |
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| Gross carrying |
| Accumulated |
| Net carrying |
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| Gross carrying |
| Accumulated |
| Impairment |
| Net carrying |
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Trademark |
| 24,901,940 |
| (3,631,533 | ) | 21,270,407 |
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| 24,901,940 |
| (4,876,630 | ) | (20,025,310 | ) | — |
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Technology |
| 2,197,230 |
| (915,513 | ) | 1,281,717 |
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| 2,197,230 |
| (1,229,403 | ) | (967,827 | ) | — |
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| 27,099,170 |
| (4,547,046 | ) | 22,552,124 |
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| 27,099,170 |
| (6,106,033 | ) | (20,993,137 | ) | — |
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At December 31, 2013 and 2014, net book value of intangible assets was zero. Amortization expenses for the years ended December 31, 2010, 20112012, 2013 and 20122014 were $2,000,237, $1,787,796$1,558,987, $1,558,987 and $1,558,987,nil, respectively. As of December 31, 2013, based upon the evolution by that time of the facts and circumstances described in Note 1 (related to the Group’s going concern uncertainty) which involve significant uncertainty regarding future net cash inflows and an assessment of reduced expectations for the Group’s future projected results of operations, the trademark and technology intangible assets were determined to be fully impaired. This assessment was reached after determining that the future undiscounted cash flows expected to be recovered from these the assets were significantly less than the carrying value thereof. In arriving at this conclusion, the Group considered the persuasive evidence of future discounted cash flows implied by the Group’s public share price and its market capitalization (a market based approach, as a per-share price can be interpreted as evidence of discounted future cash flows). However, management concluded, given the significant changes commenced with respect to the Group’s business model (changes to the Shengyue advertising arrangements and cost reductions) in early 2014, that an income approach was warranted as it related to the Group’s intangible assets and goodwill. The Group’s public share price and market capitalization at December 31, 2013 did not fully incorporate the reduced expectations and/or significant uncertainties regarding future revenues and cash flows associated with the strategic changes commenced in early 2014. Therefore, in management’s judgment, an income approach to valuation was necessary to adequately take into account the Group’s business challenges and associated liquidity concerns, regardless of the positive evidence supplied by a market capitalization view.
FollowingProjections of future cash flows related to the Company’s business strategy adjustment during 2011,asset group (the entire company, or the Company appointed Shengyue as itsGroup’s sole reporting unit, where the trademark intangible is the primary agency for online advertising sales. As a result,asset) were prepared; these projections took into account the customer list intangibleuncertainties associated with future revenues and cash flows from advertising revenue and the originalthen-recent collaboration with Qinhe described in Note 1. The analysis indicated that the future undiscounted cash flows were significantly less than the Group’s carrying value. Accordingly, further analysis, using a discount rate representing the Group’s cost of equity capital plus an appropriate risk premium calibrated to the significant uncertainties associated with future cash flows and unproven changes to the business model, was abandoned byundertaken to compute the Company, and the unamortised balance was written off through general and administrative expenses.
In relation to the disposition of 80%present value of the equity interests in Yisheng (Note 2(1)(a)) during 2011,undiscounted cash flows. Based on this analysis, it was indicated that the software technology intangible assets related to Yisheng was fully impaired. The unamortised balance was written off through general and administrative expenses.
Assuming no subsequent impairment of the identified intangible assets recorded as of December 31, 2012, amortization expenses for the net carryingentire amount of intangible assets was impaired. However, considering relevant U.S. GAAP provides that impairment charges are expected to beallocated amongst the assets comprising an asset group on the basis of relative carrying value, the Group did not provide any impairment on other long lived assets or fixed assets as follows in future years.available market evidence indicated that those assets had fair values which exceeded their carrying values and were therefore individually recoverable. The Group recorded a further significant impairment charge for goodwill (Note 7).
2013 |
| 1,558,987 |
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2014 |
| 1,558,987 |
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2015 |
| 1,558,987 |
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2016 |
| 1,558,987 |
|
2017 and later |
| 16,316,176 |
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| 22,552,124 |
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6. INVESTMENTS IN AFFILIATES
|
| December 31, 2011 |
| Share of loss |
| Foreign currency |
| December 31, 2012 |
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Equity interest in Yisheng |
| 255,281 |
| (252,585 | ) | (2,696 | ) | — |
|
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
8. INVESTMENTS IN EQUITY AFFILIATES
In August 2011, the Company disposed of an 80% equity interest to related parties and a then employee of the Company, and retainedThe Group owns a 20% equity interest in Yisheng, (Note 2(1)(a)). The Company evaluated its remaining interestan online audio business originally acquired from Shanda in Yisheng under relevant guidance in ASC 810a transaction which at the time was a common control transaction accounted for at carryover basis, 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.influence thereover. Accordingly, the CompanyGroup 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 Shanda to Yisheng. As of December 31, 2012, the investment in Yisheng had been reduced to nilzero as a result of the Group’s equity share of losses, and after giving effecttherefore, the preceding table depicts only 2012 activity as there has been no equity share of income since then. The Group is not obligated to continue funding Yisheng or to provide for incurred losses.
Disposal of Bale
On April 10, 2012, Yisheng disposed of a portion of its equity interest in Bale, an underlying company in which Yisheng maintained an investment, to the impactGroup, resulting in the Group receiving 20% of foreign currency translation.Bale and having significant influence thereover. This investment was originally classified as an equity method investment. The transfer was recorded at carrying value as, at the time, Yisheng and the Group were under the common control of Shanda. The original cost basis recorded was zero due to the presence of accumulated losses. Since the initial receipt of the investment, the carrying basis continued to be zero. On June 16, 2014, the Group entered into an agreement with YiYangLianDong (Beijing) Investment Consulting Co., Ltd (“YiYang”), owned by Mr. Yao Jianjiang, the founder and controlling shareholder of YiYang, to sell half of its interest (or 10% of the total equity interests) in Bale to YiYang at a price of RMB 9 million. The Group collected such amount on July 4, 2014 and the registration of this change with the local Administration for Industry & Commerce was completed on July 25, 2014. A net $1,451,979 (RMB 9,000,000) gain from the disposal of the Group’s equity interest in Bale to YiYang was realized. Subsequent to this transaction, Bale issued additional shares to other parties, resulting in further dilution of the Group’s equity interest to 7%. Following the sale of half of the Group’s interest and a reduction in the Group’s involvement with Bale, the investment was re-classified as a cost method investment; the carrying value is zero.
|
| December 31, 2010 |
| Equity |
| Share |
| Foreign |
| December 31, 2011 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity interest in Yisheng |
| — |
| 522,252 |
| (263,313 | ) | (3,658 | ) | 255,281 |
|
|
| December 31, 2011 |
| Share of loss |
| Foreign currency |
| December 31, 2012 |
|
|
|
|
|
|
|
|
|
|
|
Equity interest in Yisheng |
| 255,281 |
| (252,585 | ) | (2,696 | ) | — |
|
9.7. GOODWILL
The changes in the carrying amount of goodwill from significant acquisitions are as follows.
|
| ||
|
|
| |
December 31, 2011 |
| 6,232,770 |
|
|
| — |
|
December 31, 2012 |
| 6,232,770 |
|
Impairment | (6,232,770 | ) | |
December 31, 2013 | — | ||
Impairment | — | ||
December 31, 2014 | — |
ASC Topic 350 requires that the goodwill impairment assessment be performed at the reporting unit level. The CompanyGroup performed an impairment test at the reporting unit level and concluded that there was no impairment as to the carrying value of goodwill as of December 31, 2010, 2011 and 2012.
When available, This impairment test principally considered the Company uses observable market data, including pricing on recent closed market transactions, to determine the fair valueexcess of its reporting unit(s) and compares such data with carrying amounts of its reporting unit(s) to assess any potential goodwill impairment. The fair value of reporting units was determined based on the market capitalization of the respective entitiesGroup’s equity as compared to the carrying value thereof, considering the Group’s business constitutes the entire reporting unit.
As of December 31, 2013, based upon the evolution by that time of the valuation date. When there is little or nofacts and circumstances described in Note 1 (related to the Group’s going concern uncertainty) which involved (and continue to involve) significant uncertainty regarding future net cash inflows and an assessment of reduced expectations for the Group’s future projected results of operations, management concluded that observable market data the Company measures thewas of substantially reduced relevance in terms of indicating a fair value of eachthe reporting unit primarily usingunit. Regardless of the income approachGroup’s public share price at that time, the existence of liquidity difficulties and using the necessity of adopting changes to the business model to enhance the Group’s prospects were more compelling than a pure market approach analysis. The Group’s public share price at December 31, 2013 did not incorporate the reduced expectations and uncertainties regarding the amount and timing of future revenues and cash flows associated with the early 2014 significant shifts in business strategy (such as a validationchanges to the Shengyue arrangements and cost reduction measures) described in Note 1. Given the substantial dependence of the value derived from income approach. The market approach included using financial metricsGroup’s future revenues and ratios of comparable public companies. When the goodwill is determinedcash flows upon changes to be impaired, the Company usesits business model and new agreements with different parties providing for future revenues, an income approach including discounted cash flow modelingwas adopted as the basis 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 related industry to determine the amount of any impairment.evaluation.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
In estimating the fair value of the reporting unit in the first step of the impairment test, significant management judgement was required. The underlying assumptions used in the first step of the impairment test considered the forecasted cash flows of the Group, which were subject to further significant reduction through a discount rate in excess of 20% which considered the Group’s cost of capital and a risk premium calibrated to the significant uncertainty associated with the Group’s future revenue generating plans and business model. The most significant computational factors were the future projected revenues and the discount rate. The Group determined that the fair value of the reporting unit was less than the carrying value, which required performance of the second step of the impairment test. In the performance of the second step of the impairment test, it was determined that the fair values of other assets subsumed the fair value of the reporting unit, implying the fair value of goodwill was zero. As a result, the Group impaired all of the goodwill and recorded $6,232,770 of impairment expense as of December 31, 2013.
10.8. FAIR VALUE MEASUREMENTS
As of December 31, 20112013 and December 31, 2012,2014, the carrying amountamounts of the Company’s cash and cash equivalents, accounts receivable, prepayments and other current assets, amounts due from/to related parties, short-term borrowings, accounts payable, and accrued expenses and other current liabilities approximated fair value due to their short maturities. Accounts receivable, prepayments and other current assets, amounts due from/to related parties, accounts payable, and accrued expenses and other current liabilities, which are measured at carrying value, would represent Level 3 fair value measurementmeasurements if carried at fair value due to the presence of significant unobservable inputs. In a similar fashion,As of the same dates, the Company’s cash and cash equivalents and short-term borrowings would representhave represented either Level 1 or Level 2 measurements due todepending on the presence of significant observable inputs such as interest rates.Thererates. There are no financial assets or liabilities that are being measured at fair value on a recurring basis at December 31, 20112013 or December 31, 2012.2014.
On a non-recurring basis, the Group teststested (tests) its long-lived assets and goodwill for impairment whenever events or changes in circumstances indicate the carrying amount of a long-lived asset may not be recoverable. The CompanyGroup 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 aappropriate discount rate calculated based on therates which consider costs of capital and risk profile of the online video industry.premia. During the years ended December 31, 2010, 20112012, 2013 and 2012,2014, the Group recognized impairment losses of nil, $1.4$21.0 million and nil for its intangible assets, respectively. respectively, and recognized a full impairment loss of $6.2 million for goodwill in 2013.
The Group has not presented tabular disclosures or further qualitative information regarding fair value for these levellong-lived Level 3-classified assets because the related assets have beenwere fully written off in 2011; accordingly,2013 and the related fair values are zero since then.zero. See NoteNotes 5 and 7 to the Consolidated Financial Statements for additional information, of the impairment provision relatingincluding rollforward information pertaining to the acquired intangible assets.
11. SHORT-TERM BORROWINGS
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. The interest rate was 6.89% per annum. The loan was pledged by a certificate of deposit of $3.6 million reflected as restricted cash. The Company repaid this short-term borrowing in 2012.
12.9. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consist of:
|
| December 31, 2011 |
| December 31, 2012 |
|
| December 31, 2013 |
| December 31, 2014 |
|
|
|
|
|
|
|
|
|
|
|
|
Accrued litigation provision |
| 2,683,968 |
| 2,077,753 |
|
| 2,079,671 |
| 1,653,032 |
|
Accrued payroll |
| 2,675,282 |
| 1,951,347 |
| |||||
Accrued professional service fees |
| 978,602 |
| 1,766,673 |
|
| 1,720,454 |
| 1,604,240 |
|
Accrued welfare benefits |
| 1,297,147 |
| 1,367,536 |
|
| 1,462,926 |
| 1,289,157 |
|
Accrued payroll |
| 659,870 |
| 452,583 |
| |||||
Indirect taxes payable |
| 400,602 |
| 297,293 |
| |||||
Advances from customers |
| 722,553 |
| 415,475 |
|
| 26,920 |
| 191,022 |
|
Business tax payable |
| 472,534 |
| 287,365 |
| |||||
Value-added tax payable |
| — |
| 158,292 |
| |||||
Other accrued expenses |
| 713,719 |
| 891,605 |
|
| 837,187 |
| 492,837 |
|
Other taxes payable |
| 472,845 |
| 437,438 |
| |||||
|
| 10,016,650 |
| 9,353,484 |
|
| 7,187,630 |
| 5,980,164 |
|
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
10. OTHER INCOME, NET
|
| Year ended |
| Year ended |
| Year ended |
|
|
| December 31, 2012 |
| December 31, 2013 |
| December 31, 2014 |
|
Sub-lease income |
| 249,123 |
| 317,915 |
| 276,895 |
|
Gain on derecognition of long-aged operating liabilities |
| — |
| 2,938,250 |
| 206,533 |
|
Government subsidies |
| 1,514,570 |
| 1,484,789 |
| 135,265 |
|
Reimbursement from depository bank related to ADR program |
| — |
| 240,470 |
| 92,144 |
|
Provision for Seed Music receivable (related party) |
| — |
| (980,000 | ) | — |
|
Other |
| (35,155 | ) | 99,615 |
| 35,121 |
|
Total |
| 1,728,538 |
| 4,101,039 |
| 745,958 |
|
For the year ended December 31, 2014, gains arising from derecognition of long-aged operating liabilities of $206,533 were recognized related to write-offs of sales rebate payables included in accounts payable in 2014. For the year ended December 31, 2013, a gain arising from derecognition of long-aged operating liabilities of $2,938,250 was recognized. These amounts included $1,077,242, $818,914 and $1,042,094 in write-offs of sales rebate payables (included in accounts payable), third-party commissions (included in accounts payable), and other accrued expenses payable. The write-offs in 2014 and 2013 all related to the Group’s previous (pre-2011) advertising sales business model. These amounts were significantly aged and have been monitored through time; based upon no or very little further claims activity, payment was judged to be remote based upon the Group’s policies and past experience.
In 2013, based upon changed facts and a revised assessment indicating unlikely collection of a $980,000 loan receivable originated to Seed Music (a former subsidiary of the Group sold to Shanda Interactive in 2010) for which collection was being sought from a shareholder of Seed Music unrelated to the Group, the Group fully provided for the impaired loan and reduced its net value to zero. In light of the character of the original loan (which represented a cash outflow reported in investing activities) and the lack of relation to the Group’s ongoing operations, as well as the fact that Seed Music is a related party not under common control, the Group recorded the corresponding charge as other expense within “other income, net”.
131. RELATED PARTY TRANSACTIONS AND BALANCES
Current Related Parties of Ku6 Media Co., Ltd. (both pre- and post-2010 Reorganization)
Entity |
| Relationship to Ku6 Media Co., Ltd. | |
Xu Xudong (“Mr. Xu”) | Largest shareholder | ||
Shanghai Qinhe Internet Technology Software Development Co., Ltd., (“Qinhe”) | Entity controlled by Mr. Xu | ||
Shanda Interactive Entertainment Limited (“Shanda”) |
|
| |
Shanda Computer (Shanghai) Co., Ltd. (“Shanda Computer”) |
| Wholly owned affiliate of Shanda | |
|
|
| |
Shanghai |
| ||
|
| Wholly owned affiliate of Shanda | |
Shanda Media Group Ltd. | Wholly owned affiliate of Shanda | ||
Shanda Capital Ltd. | Wholly owned affiliate of Shanda | ||
Shanghai |
| Wholly owned affiliate of Shanda | |
|
| Wholly owned affiliate of Shanda | |
|
|
| |
|
| ||
|
| ||
|
| ||
|
|
Post-2010 Reorganization Related Party Activities
FollowingIn the Reorganizationpast (prior to Shanda’s cessation of majority ownership in August 2010,April 2014 (Note 1)), the Group receivesreceived advertising revenues from, and payspaid promotional service fees to, companies under common control by Shanda. Accordingly, certain advertising revenues from the sale of advertising resources to sister entities, and related party costs of revenue are separately classified in the consolidated statement of operations and comprehensive loss. From time to time in the past, the Group also lendslent cash resources to (or borrowsborrowed cash resources from) other companies under common control byof Shanda based upon its U.S. or RMB-denominated cash resource positions and the related resources and needs of other companies under common control byof Shanda. These lending (borrowing) transactions are reflected as investing (financing) activities, respectively, in the consolidated statement of cash flows and are reflected in the consolidated balance sheet (and below in this Note) as other receivables due from, or other payables due to, related parties. A detailed discussion of related party activity pre-dating the 2010 Reorganization is not included herein as such activity relates to operations which have been divested (Note 4).
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
Former Related Parties
Due to certain sale transactions conducted by Shanda in 2014 resulting in Shanda’s disposal of certain of its affiliates to third parties, the following entities were no longer related parties of the Group as of the dates hereby noted.
Entity | Relationship to Ku6 Media Co., Ltd. | ||
Shanghai Shengyue Advertising Co., Ltd. (“Shengyue”) | Wholly owned affiliate of Shanda until April 2014 | ||
Shanghai Shulong Technology Co., Ltd. (“Shanghai Shulong”) | Consolidated affiliate of Shanda Games Limited | ||
Shanghai Shulong Computer Technology Co., Ltd. (“Shanghai Shulong Computer”) | Consolidated affiliate of Shanda Games Limited | ||
Hurray! Media Co., Ltd. | Wholly owned affiliate of Shanda until May 2014 | ||
Shanda Games Ltd. (“Shanda Games”) | Majority owned affiliate of Shanda until September 2014 | ||
Seed Music Group Limited | Significant influence exercised by Shanda until May 2014 |
Annual Related Party Activities
During the years ended December 31, 2010, 20112012, 2013 and 20122014 significant related party transactions occurring during the annual periods were as follows.
��
|
| Year ended |
| Year ended |
| Year ended |
|
Related party transactions in continuing operations: |
|
|
|
|
|
|
|
Advertising revenue received from companies under common control by Shanda |
| 701,732 |
| 8,076,155 |
| 12,481,927 |
|
Promotion service fee paid to companies under common control by Shanda |
| 376,302 |
| 379,465 |
| — |
|
Loan borrowing from Shanghai Shulong Computer Technology Co., Ltd. |
| — |
| 6,832,012 |
| — |
|
Loan borrowing from Shanghai Shulong Technology Co., Ltd. |
| 3,030,711 |
| 6,503,884 |
| — |
|
Loan borrowing from Shanda Computer (Shanghai) Co., Ltd. * |
| 1,565,290 |
| — |
| — |
|
Loan repayment from Shanda Games Limited |
| — |
| — |
| 13,900,000 |
|
Loan repayment to Shanghai Shulong Computer Technology Co., Ltd. |
| — |
| — |
| 6,769,544 |
|
Loan repayment to Shanghai Shulong Technology Co., Ltd. |
| — |
| 3,189,527 |
| 3,135,076 |
|
Loan to Shanda Games Limited |
| 3,200,000 |
| 14,000,000 |
| — |
|
Loan to Shanda Capital Limited |
| — |
| — |
| 470,000 |
|
Loan interest income from Shanda Games Limited |
| — |
| 108,019 |
| 246,178 |
|
Loan interest income from Shanda Capital Limited |
| — |
| — |
| 10,575 |
|
Convertible Bond issued to Shanda Media (Note 1) |
| — |
| 50,000,000 |
| — |
|
Convertible Bond redeemed from Shanda Media (Note 1) |
| — |
| 50,000,000 |
| — |
|
Interest expense for loan from companies under common control by Shanda |
| — |
| 688,952 |
| 448,011 |
|
Interest expense of Convertible Bond issued to Shanda Media (Note 1) |
| — |
| 375,000 |
| — |
|
*Borrowing is not reflected in “other payables due to related parties” as the liability was incurred by the Company’s formerly consolidated subsidiary Yisheng, which was deconsolidated in 2011 (Note 8). The loan was assumed by the acquiring parties of Yisheng and de-recognized upon deconsolidation.
The Company entered into a cooperative agreement with Shengyue, a wholly owned subsidiary of Shanda in 2011. Under this agreement, Shengyue was appointed as the Company’s primary agency to secure advertisement from various end advertisers. The Company provides advertising capacity/spots (i.e. headlines, banners, short video, etc) to Shengyue on its online video portal. This cooperative agreement coversed a period of 1 year and 9 months commencing April 1, 2011. During the testing period from April 1, 2011 to June 30, 2011, Shengyue did not guarantee a minimum revenue stream to the Company, nor was the Company obligated for any commission fee. Following the testing period, the “commission free period” started from July 1, 2011 and ended on December 31, 2011, and during the period Shengyue guaranteed minimum advertising revenue for each fiscal quarter to the Company; however, the commission fee was waived in this period. Commencing January 1, 2012, in addition to the guaranteed minimum revenue, the Company was obligated for commission fees based on certain percentages of the advertising revenue volume. There were no commission fees incurred for any historical periods, as the Group enjoyed the commission-free period in 2011 and earned minimum guaranteed revenues in 2012.
|
| Year ended |
| Year ended |
| Year ended |
|
Online advertising revenue received from Shengyue (Note A) |
| 12,481,927 |
| 12,404,031 |
| 2,703,492 |
|
Promotional advertising revenue received from Qinhe (Note A) |
| — |
| — |
| 1,613,606 |
|
Technical service fees in cost of revenues paid to Shanda Network (Note B) |
| — |
| 335,504 |
| 673,899 |
|
Technical service fees in cost of revenues payable but forgiven by Shanda Network (Notes B, C) |
| — |
| — |
| 235,876 |
|
Rental fee payable but forgiven by Shanda Network (Note C) |
| — |
| — |
| 170,086 |
|
Rental fee payable but forgiven by Shengjin (Note C) |
| — |
| — |
| 23,926 |
|
Interest expense payable but forgiven by Shanda Media Group Ltd. (Note C) |
| — |
| — |
| 375,000 |
|
Receivables due from Hurray! Media Co., Ltd. to the Company but forgiven as to repayment (Note C) |
| — |
| — |
| 1,246,641 |
|
Purchase of equipment from companies under control of Shanda |
| — |
| 188,334 |
| — |
|
Equity contribution from Shanda (Note C) |
| — |
| — |
| 5,847,070 |
|
Loan repayment from Shanda Capital Limited (Note D) |
| — |
| — |
| 470,000 |
|
Loan repayment from Shanda Games Limited |
| 13,900,000 |
| 3,300,000 |
| — |
|
Loan repayment to Shanghai Shulong Computer |
| 6,769,544 |
| — |
| — |
|
Loan repayment to Shanghai Shulong |
| 3,135,076 |
| 3,303,760 |
| — |
|
Loan to Shanda Capital Limited |
| 470,000 |
| 13,865 |
| — |
|
Interest income from Shanda Games Limited |
| 246,178 |
| 14,236 |
| — |
|
Interest income from Shanda Capital Limited (Note D) |
| 10,575 |
| 14,620 |
| 3,388 |
|
Interest expense for loans from Shanghai Shulong Computer and Shanghai Shulong |
| 448,011 |
| 16,365 |
| — |
|
In March 2012, the Company provided a $0.5 million unsecured loan to Shanda Capital Limited, a company controlled by Shanda Interactive, which carries an interest rate of 3% per year and was due on March 25, 2013; its terms are in the process of being extended.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
Note A. The Group entered into an original advertising agency agreement with Shengyue in 2011, when Shengyue was controlled by Shanda. Under this agreement, Shengyue was appointed as the Group’s primary agency to secure advertisements from various end advertisers. The Group provided advertising capacity/spots to Shengyue on its online video portal. The original agreement covered a period of 1 year and 9 months commencing April 1, 2011 and was extended thereafter through early 2014. In early 2014, following the disposition of Shengyue by Shanda to an independent third party, a new agreement was reached (Note 1). Amounts depicted in the foregoing table only relate to the period of time when Shengyue was a related party (under Shanda’s ownership).
During the second quarter of 2014, the Company entered into two agreements with related party Qinhe, a company controlled by Mr. Xu, stipulating the provision of promotional advertising services (Notes 1 and 2(16)). As the supplemental agreement (Note 1) related to marketing services expired on December 31, 2014, the Group will share the revenue with Qinhe under the original agreement (Note 1), without the benefit of the supplemental agreement, since the beginning of 2015. The actual revenue from Qinhe may decrease in 2015 given the cessation of the supplemental agreement.
Note B. In April 2013, the Group entered into a technical services agreement with Shanda Network, which continued in 2014. Pursuant to this agreement, Shanda Network provided technical support services including computer cabinet management, server maintainance, and other items. The service fees are settled on a monthly basis.
Note C. During April and May 2014, Shanda provided loans totaling $5.8 million (RMB 36.1 million) to the Group. The loan were interest-free and were immediately unconditionally forgiven as to repayment. Related thereto, certain existing related party payables, amounting to $0.8 million, and receivables, amounting to $1.2 million, involving certain companies controlled by Shanda were forgiven as to repayment. The net effect of the foregoing was a $5.4 million equity contribution reflected as an increase in the Group’s additional paid-in capital (Note 1).
Note D. In 2014, the Group’s remaining loan receivable from Shanda Capital Limited was repaid in full.
Year-End Related Party Balances
At December 31, 20112013 and December 31, 2012,2014, the amounts receivable from and payable to related parties included in the consolidated balance sheet mainly represent the outstanding amounts arising from the transactions described in the preceding section.
Receivables from Shengyue relate to the pre-existing advertising revenue arrangement described in the preceding subsection of this note. Accounts Receivablereceivable balances due from related parties are as follows:follows.
|
| December 31, 2011 |
| December 31, 2012 |
|
| December 31, 2013 |
| December 31, 2014 |
|
Accounts receivable due from related parties |
|
|
|
|
| |||||
Shanghai Shengyue Advertising Co., Ltd. |
| 6,313,489 |
| — |
| |||||
Other companies under control of Shanda |
| 208,495 |
| 972 |
| |||||
|
|
|
|
|
|
| 6,521,984 |
| 972 |
|
Shanghai Shengyue Advertising Co., Ltd. |
| 2,649,385 |
| 4,333,797 |
| |||||
Other companies under common control by Shanda |
| 90,794 |
| 65,240 |
| |||||
|
| 2,740,179 |
| 4,399,037 |
|
OtherAccounts payable balances with related parties are as follows:
|
| December 31, 2011 |
| December 31, 2012 |
|
Other receivables due from related parties |
|
|
|
|
|
Shanda Games Limited |
| 17,308,019 |
| 3,389,567 |
|
Hurray! Media Co., Ltd. |
| 1,246,641 |
| 1,246,641 |
|
Seed Music Group Limited |
| 980,000 |
| 980,000 |
|
Shanda Capital Limited |
| — |
| 480,575 |
|
Other companies under common control by Shanda |
| 4,609 |
| — |
|
|
| 19,539,269 |
| 6,096,783 |
|
All amounts due from related parties are non-interest bearing, unsecured and receivable on demand except for the receivables due from Shanda Games Limited and Shanda Capital Limited with an annual interest rate of 3% and from Seed Music Group Limited with an annual interest rate of 0.6%.
|
| December 31, 2011 |
| December 31, 2012 |
|
Other payables due to related parties |
|
|
|
|
|
Shanghai Shulong Technology Co. Ltd |
| 6,345,068 |
| 3,404,497 |
|
Shanghai Shulong Computer Technology Co., Ltd |
| 6,832,012 |
| — |
|
Other related party |
| 375,000 |
| 375,000 |
|
|
| 13,552,080 |
| 3,779,497 |
|
All amounts due to related parties are non-interest bearing, unsecured and payable on demand with annual interest rates ranging from 5.05%as follows.
|
| December 31, 2013 |
| December 31, 2014 |
|
Accounts payable due to related parties |
|
|
|
|
|
Shanghai Shanda Network Development Co., Ltd |
| 355,820 |
| 709,911 |
|
Shanghai Shengle Information Technology Co., Ltd. |
| 190,837 |
| — |
|
Other companies under control of Shanda |
| 11 |
| — |
|
|
| 546,668 |
| 709,911 |
|
Payables to 6.71%.Shanghai Shanda Network Development Co., Ltd. for technical service fees in 2014 were partially forgiven by Shanda Network as to repayment, as described under Note C above.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
Other balances with related parties are as follows.
|
| December 31, 2013 |
| December 31, 2014 |
|
Other receivables due from related parties |
|
|
|
|
|
Hurray! Media Co., Ltd. (Note 1) |
| 1,246,641 |
| — |
|
Seed Music Group Limited (Note 10) |
| — |
| — |
|
Shanda Capital Limited |
| 495,196 |
| — |
|
Other companies under control of Shanda |
| 45,668 |
| 2,924 |
|
|
| 1,787,505 |
| 2,924 |
|
All amounts due from related parties are non-interest bearing, unsecured and receivable on demand except for the receivable due from Shanda Capital Limited with an annual interest rate of 3%. In 2013, based upon changed facts and a revised assessment indicating unlikely collection of a $980,000 loan receivable originated to Seed Music (a former subsidiary of the Group sold to Shanda Interactive in 2010) for which collection was being sought from a shareholder of Seed Music unrelated to the Group, the Group fully provided for the impaired loan and reduced its net value to zero. In light of the character of the original loan (which represented an cash outflow reported in investing activities) and the lack of relation to the Group’s ongoing operations, as well as the fact that Seed Music is a related party not under common control, the Group recorded the corresponding charge as other expense within “other income, net”. In early 2014, the Group forgave as to repayment its receivable due from Hurray! Media Co., Ltd. in partial exchange for an RMB 20.0 million equity contribution (received in the form of a forgiven loan) from Shanda (Note 1).
December 31, 2013 | December 31, 2014 | ||||
Other payables due to related parties | |||||
Shanda Media Group Limited | 375,000 | — | |||
375,000 | — |
Interest payable to Shanda Media Group Limited amounting to $375,000 was fully forgiven as to repayment in 2014 as stated in Note C above.
142. INCOME TAXES
The Company is a tax exempted company incorporated in the Cayman Islands. The subsidiariesSubsidiaries or VIEs in the PRC are subject to PRC Enterprise Income Tax at a corporate income tax rate of 25%. There are no reduced tax rates afforded to the Group’s PRC entities.
Provision (benefit) for income taxes is comprised as follows for each annual period.
|
| Year ended |
| Year ended |
| Year ended |
|
|
|
|
|
|
|
|
|
Current income taxes from discontinued operations |
| 6,229 |
| — |
| — |
|
Deferred income taxes from discontinued operations |
| (31,813 | ) | — |
| — |
|
Current income taxes from continuing operations |
| — |
| — |
| — |
|
Deferred income taxes from continuing operations |
| (41,172 | ) | (99,479 | ) | — |
|
|
| (66,756 | ) | (99,479 | ) | — |
|
Year ended | Year ended | Year ended | |||||
Current income tax expense (benefit) | — | — | — | ||||
Deferred income tax expense (benefit) | — | (4,826,059 | ) | — | |||
— | (4,826,059 | ) | — |
During the year ended December 31, 2013, the deferred tax benefit recognized related to the derecognition of remaining deferred tax liabilities associated with the Group’s full impairment of remaining intangible assets (Note 5). The principal components of deferred tax assets and liabilities are as follows:
|
| December 31, 2011 |
| December 31, 2012 |
|
Current deferred tax assets (liabilities): |
|
|
|
|
|
Cost and expense accruals |
| 2,810,508 |
| 1,754,349 |
|
Revenue recognition |
| (173,502 | ) | 771,061 |
|
Less: valuation allowance |
| (2,637,006 | ) | (2,525,410 | ) |
Current deferred tax assets, net |
| — |
| — |
|
|
|
|
|
|
|
Non-current deferred tax assets (liabilities): |
|
|
|
|
|
Depreciation and amortization |
| 1,748,889 |
| 631,747 |
|
Net operating loss carry forwards |
| 18,450,814 |
| 21,146,362 |
|
Less: valuation allowance |
| (20,199,703 | ) | (21,778,109 | ) |
Non-current deferred tax assets, net |
| — |
| — |
|
|
|
|
|
|
|
Intangible assets |
| (4,826,059 | ) | (4,826,059 | ) |
Non-current deferred tax liabilities |
| (4,826,059 | ) | (4,826,059 | ) |
KU6 MEDIA CO., LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014
(all amounts in U.S. dollars (US$) unless otherwise stated)
|
| December 31, 2013 |
| December 31, 2014 |
|
Current deferred tax assets (liabilities): |
|
|
|
|
|
Cost and expense accruals |
| 847,197 |
| 1,352,773 |
|
Revenue recognition |
| 84,241 |
| 401,436 |
|
Less: valuation allowance |
| (931,438 | ) | (1,754,209 | ) |
Current deferred tax assets, net |
| — |
| — |
|
|
|
|
|
|
|
Non-current deferred tax assets (liabilities): |
|
|
|
|
|
Depreciation and amortization |
| 72,477 |
| 92,195 |
|
Net operating loss carry forwards |
| 25,247,628 |
| 22,017,057 |
|
Less: valuation allowance |
| (25,320,105 | ) | (22,109,252 | ) |
Non-current deferred tax assets, net |
| — |
| — |
|
|
|
|
|
|
|
Intangible assets |
| — |
| — |
|
Non-current deferred tax liabilities |
| — |
| — |
|
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 areis the adjustments to the valuation allowance for deferred tax assets that are, as assessed under ASC 740, likely to not be realized in the foreseeable future.
Table. The primary drivers of Contentsthe Company’s effective tax rate for 2013 are non-deductible impairment charges for intangible assets and goodwill (Notes 5 and 7), as well as the derecognition of deferred tax liabilities in relation thereto which is included in the preceding table containing the components of current and deferred tax expense (benefit).
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
|
| Year ended |
| Year ended |
| Year ended December |
|
| Year ended |
| Year ended |
| Year ended |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Statutory tax rate |
| 25.0 | % | 25.0 | % | 25.0 | % |
| 25.0 | % | 25.0 | % | 25.0 | % |
Differential statutory tax rates |
| (3.3 | )% | (7.9 | )% | (4.7 | )% |
| (4.7 | )% | (5.0 | )% | (1.4 | )% |
Non-deductible expenses |
| 0.4 | % | (7.9 | )% | (1.5 | )% |
| (1.5 | )% | (14.8 | )% | (1.1 | )% |
Change in deferred tax liabilities |
| — |
| 12.3 | % | — |
| |||||||
Change in valuation allowance |
| (22.0 | )% | (9.0 | )% | (18.8 | )% |
| (18.8 | )% | (5.2 | )% | (22.5 | )% |
Effective tax rate |
| 0.1 | % | 0.2 | % | 0.0 | % |
| 0.0 | % | 12.3 | % | 0.0 | % |
The movement of valuation allowances were as follows:
|
| Year ended |
| Year ended |
| Year ended |
|
| Year ended |
| Year ended |
| Year ended |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At beginning of year |
| (8,309,621 | ) | (19,122,901 | ) | (22,836,709 | ) |
| (22,836,709 | ) | (24,303,518 | ) | (26,251,543 | ) |
Acquisition of Ku6 |
| (6,123,900 | ) | — |
| — |
| |||||||
Current year additions |
| (14,292,925 | ) | (4,452,155 | ) | (1,415,765 | ) |
| (1,415,765 | ) | (1,239,840 | ) | (71,991 | ) |
Current year reversals |
| 1,404,205 |
| 1,591,018 |
| 180,965 |
|
| 180,965 |
| — |
| 1,879,698 |
|
Transferred out due to disposal of WVAS and recorded music businesses |
| 8,433,935 |
| — |
| — |
| |||||||
Effect of exchange rate changes |
| (234,595 | ) | (852,671 | ) | (232,009 | ) |
| (232,009 | ) | (708,185 | ) | 580,375 |
|
|
| (19,122,901 | ) | (22,836,709 | ) | (24,303,518 | ) |
| (24,303,518 | ) | (26,251,543 | ) | (23,863,461 | ) |
At December 31, 20112013 and 2012,2014, tax loss carry forwards (on a gross basis prior to measurement via the tax rate) amounted to approximately $73.8$101.0 million and $84.6$88.1 million, respectively, which will expire byin various years through 2017.2018. 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 within a tax jurisdiction. A valuation allowance of $22,836,709$26,251,543 and $24,303,518$23,863,461 has been established as of December 31, 20112013 and 2012,2014, respectively, in respect of all deferred tax assets as it is considered more likely than not that the relevant deferred tax assets will not be realized in the foreseeable future. At December 31, 2010, 20112013 and 2012,2014, all of the Company’s deferred tax assets were fully reserved through valuation allowances.
KU6 MEDIA CO., LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014
(all amounts in U.S. dollars (US$) unless otherwise stated)
As noted in Note 2(25)2(23), the Company accounts for the financial statement effects of uncertain tax positions under the provisions of ASC 740-10. At December 31, 20112013 and 2012,2014, there were no liabilities for unrecognized tax benefits as the Company did not have any significant uncertain tax positions requiring recognition and measurement under ASC 740-10.
In accordance with the PRC EIT Law, dividends which arise from profits of foreign invested enterprises (“FIEs”) earned after January 1, 2008, are subject to a 10% withholding income tax if and when remitted.
Since there are no undistributed earnings of the Company’sGroup’s subsidiaries located in the PRC that are available for distribution at December 31, 20112013 and 20122014 given the accumulated loss positions of the Company’sGroup’s subsidiaries, no provision has been made for withholding taxes. Further, the CompanyGroup 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.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
153. REPURCHASE OF SHARES
Pursuant to a share repurchase program announced December 30, 2011, the Company’s Board of Directors authorized the Company to repurchase up to US$3.2$3.2 million of its outstanding ADSs from time to time, based on market conditions. In 2012,2013, the Company repurchased and immediately retired a total of 99,585 ADS57,982 ADSs for aggregate consideration of $97,695$58,147 from unrelated third parties, at a weighted average price of $0.98$1.00 per ADS. The excess of the repurchase price above par value was charged to additional paid-in capital. In 2014, the Company did not repurchase any ADSs.
In a separate transaction distinct from the Company’saforementioned ongoing share repurchase program, as authorized by the Company’s Board of Directors, the Company repurchased and immediately retired in July 2012 a total of 269,409,276 ordinary shares and 79,717 ADSs (each ADS representing 100 ordinary shares) formerly held by several former senior members of management and an investment entity controlled by one of those individuals, at a price of $0.0291 per share (US$($2.91 per ADS) for a total of $8,071,786. The Board of Directors had approved this transaction, taking into consideration a number of factors, including but not limited to the following: (i) the nature and timing of such share repurchase, (ii) the repurchase price of those ordinary shares and ADSs, (iii) the possible impact of such share repurchase on the ADS price, (iv) the price movements and liquidity of the Company’s ADSs and the stock market environment, (v) the Company’s financial condition, and (vi) the Company’s plans and alternative uses of its capital resources. The Board of Directors had received a fairness opinion from an independent financial advisor and concluded that the repurchase price of those ordinary shares and ADSs was within a reasonable indicative range of fair value. Given the high volatility of the Company’s ADS price, which ranged from $0.90 per ADS to $3.30 per ADS during 2012 (based upon quoted closing prices), coupled with the thinly traded volume, it was not possible to rely solely upon past or current quoted market prices at the time to establish an appropriate indicative range of fair value. Therefore, the fairness opinion considered a range of valuation techniques, coupled with the Company’s historical and projected financial results, to establish a reasonable indicative range of fair value, which, based upon the facts and circumstances that existed at the time, supported the repurchase price as was approved by the Board of Directors. This repurchase was approved by shareholders at the annual general meeting of shareholders on July 12, 2012 and consummated on July 13, 2012. All the repurchased shares were cancelled upon repurchase.
The excess of the repurchase price above par value for all repurchase transactions was recorded as a charge to additional paid in capital.
16.14. EQUITY COMPENSATION PLANS
2004 Share Incentive Plan
Stock options
Ku6 Media’s 2004 Share Incentive Plan (“2004 Plan”) allows the Company to offer incentive awards to employees, directors, consultants or external service advisors of the Company. Under the terms of the Plan, options were generally granted at prices equal to or greater than the fair market value on the grant date, expire 10 years from the date of grant, and generally vest over 3-4 years.
Stock options under these plans were all granted prior to 2006 and as of January 1, 2006 all granted stock options were vested. There were 43,746,70015,720,000 and 34,669,3721,620,000 options outstanding as of December 31, 20112013 and 2012,2014, respectively. Pursuant to the resolution of the Company’s boardBoard on December 3, 2010, the 185,550,800 remaining ordinary shares available for future grants under the 2004 Plan were terminated and unavailable for future use. The remaining options as of December 31, 2014 expired in early 2015 unexercised.
The movements in stock options under the 2004 Share Incentive Plan as of and for the years ended December 31, 2010, 2011 and 2012 are set out below:
|
| Options |
| Weighted |
| Weighted |
| Aggregate |
|
|
|
|
| $ |
|
|
| $ |
|
Outstanding at January 1, 2010 |
| 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 |
| — |
| — |
|
Outstanding at December 31, 2011 |
| 43,746,700 |
| 0.079 |
| 1.62 |
| — |
|
Granted |
| — |
| — |
| — |
| — |
|
Exercised |
| — |
| — |
| — |
| — |
|
Forfeited |
| (9,077,328 | ) | 0.025 |
| — |
| — |
|
Outstanding at December 31, 2012 |
| 34,669,372 |
| 0.094 |
| 0.89 |
| — |
|
Vested and expected to vest at December 31, 2012 |
| 34,669,372 |
| 0.094 |
| 0.89 |
| — |
|
Vested and exercisable at December 31, 2012 |
| 34,669,372 |
| 0.094 |
| 0.89 |
| — |
|
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
|
| Options |
| Weighted |
| Weighted |
| Aggregate |
|
|
|
|
| $ |
|
|
| $ |
|
Outstanding at January 1, 2012 |
| 43,746,700 |
| 0.079 |
| 1.62 |
| — |
|
Granted |
| — |
| — |
| — |
| — |
|
Exercised |
| — |
| — |
| — |
| — |
|
Cancelled or Expired |
| (9,077,328 | ) | 0.025 |
| — |
| — |
|
Outstanding at December 31, 2012 |
| 34,669,372 |
| 0.094 |
| 0.89 |
| — |
|
Granted |
| — |
| — |
| — |
| — |
|
Exercised |
| — |
| — |
| — |
| — |
|
Forfeited |
| (18,949,372 | ) | 0.076 |
| — |
| — |
|
Outstanding at December 31, 2013 |
| 15,720,000 |
| 0.116 |
| 0.11 |
| — |
|
Granted |
| — |
| — |
| — |
| — |
|
Exercised |
| — |
| — |
| — |
| — |
|
Forfeited |
| (14,100,000 | ) | 0.117 |
| — |
| — |
|
Outstanding at December 31, 2014 |
| 1,620,000 |
| 0.103 |
| 0.00 |
| — |
|
Vested and expected to vest at December 31, 2014 |
| 1,620,000 |
| 0.103 |
| 0.00 |
| — |
|
Vested and exercisable at December 31, 2014 |
| 1,620,000 |
| 0.103 |
| 0.00 |
| — |
|
The aggregate intrinsic values are calculated as the differences between the market valuevalues of $0.0495, $0.0120$0.0106, $0.0282 and $0.0106$0.0100 of ordinary shares as of December 31, 2010, 20112012, 2013 and 2012,2014, respectively, and the exercise prices of the shares. The total intrinsic value of options exercised during the years ended December 31, 2010, 20112012, 2013 and 20122014 was approximately nil.
2010 Equity Compensation Plan
In December 2010, the Company authorized an equity compensation plan (“2010 Equity Compensation Plan”) that provides for issuance of options to purchase up to 698,381,300 ordinary shares of the Company. Under the 2010 Equity Compensation Plan, the directors may, at their discretion, grant any officers (including directors) and employees of the Company and/or its subsidiaries, and individual consultant or advisor (i) options to subscribe for ordinary shares, (ii) share appreciation rights to receive payment, in cash and/or the Company’ ordinary shares, equalsequal to the excess of the fair market value of the Company’ ordinary shares, or (iii) other types of compensation based on the performance 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 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.
On August 28, 2012, the Company granted stock options to purchase up to 28,500,000 ordinary shares under the 2010 Equity Compensation Plan at an exercise price of $0.0116 per share to its employees. The contract term of the options is six years.
TableOn May 7, 2013, the Company granted stock options to purchase up to 254,100,000 ordinary shares under the 2010 Equity Compensation Plan at an exercise price of Contents$0.0103 per share to its employees and senior management. Of all the stock options granted, 140,000,000 were granted to senior management of the Company, 50,600,000 were granted to employees of the Company, and 63,500,000 were granted to senior management and employees of Shanda. The contract term of the options is six years.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31,On June 3, 2013, the Company granted stock options to purchase up to 69,800,000 ordinary shares under the 2010 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)Equity Compensation Plan at an exercise price of $0.0113 per share to its senior management. The contract term of the options is six years.
There were no options granted in 2014. As of December 31, 2012, 393,125,3002014, 440,962,300 ordinary shares were available for future grants under the 2010 Equity Compensation Plan.
The options granted to directors and employees vest over a four year period, with 25% of the options to vest on each of the first, second, third and fourth anniversaries of the grant date as stipulated in the stock option agreements.
KU6 MEDIA CO., LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014
(all amounts in U.S. dollars (US$) unless otherwise stated)
Options which were granted to senior management prior to 2013 vest in 16 instalments. The first 2 of 16 instalments - options earned in the first two quarters after the grant date - shall vest and become exercisable at the first anniversary of the grant date. There are no performance conditions attached to the first 2 instalments. For each quarter during the four-year period after the grant date (the “Performance Period Start Date”), one 1/16th instalment of the total options have the opportunity to be earned for each quarter contingent on the achievement of positive quarterly operating income for the quarter, provided the aggregate number of options earned in the Performance Period shall not exceed 14 of the 16 instalments comprising the total options granted. On each of the first, fourth, eighth and twelfth quarter earnings release dates from the first quarter of the Performance Period, all of the earned options during the four quarters preceding such earnings release date shall vest and become exercisable, in each case, provided that the employment with the Company remains on such vesting date.
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, theThe options granted to senior management in 2013 vest over a four year period, with 25% of the options to vest on each of the first, second, third and fourth anniversaries of the grant date as stipulated in the stock option agreements.
Option Modification
On December 11, 2013, the Board of Directors approved option modifications to modify the vesting conditions of certain outstanding options (granted to senior management) that were granted by the Company under the 2010 Equity Compensation Plan. The modifications waived the performance conditions attributable to the periods from the third quarter of 2011 to the third quarter of 2013, resulting in 60% of the options attributable to that period immediately vesting. Simultaneously, the performance condition was eliminated from the fourth quarter of 2013 prospectively. Other terms of the option grants remain unchanged. All eligible option grantees affected by such directors, senior managements and employeeschanges entered into amendments to their original share option agreements. The effect of the modification on the estimated fair value of the options was computed under relevant U.S. GAAP; the modifications resulted in total incremental compensation cost of $0.37 million, of which $0.18 million was recorded during the year ended December 31, 2013 for options that were forfeited.fully vested. The remaining $0.19 million is being amortized over the remaining vesting periods of the respective options.
In accordance with ASC Topic 718, the Company recognizes share-based compensation expense for the options granted to directors and employees as well as the options to senior management vested only based on passage of time and continued employment with the Company, net of a forfeiture rate, using the straight-line method. For the options granted to senior management earned contingent on the achievement of quarterly performance target,targets, the Company recognized share-based compensation expensesexpense for the options earned in each quarter during the Performance Period using the graded-vesting attribution method when the Company concludesconcluded that it iswas probable that the performance targets willwould 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 $1,231,919$463,753, $1,023,871 and $463,753$600,995 for the yearyears ended December 31, 20112012, 2013 and 2012,2014, respectively. Share-based compensation expensecost related to the option awards granted by the Company to the directors, senior management and employees of Shanda under the 2010 Equity Compensation Plan amounted to $257,230$350,761, $52,888 and $350,761$15,475 for the yearyears ended December 31, 20112012, 2013 and 2012,2014, respectively, whichand was recognized as a dividenddividends distributed to Shanda.Shanda up to the time of the cessation of majority ownership by Shanda on April 3, 2014; thereafter, it was recognized as expense.
The movements in stock options under the 2010 Equity Compensation Plan as of and for the years ended December 31, 2010, 20112012, 2013 and 20122014 are set out below.
|
| Options |
| Weighted |
| Weighted |
| Aggregate |
|
|
|
|
| $ |
|
|
| $ |
|
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 |
| — |
| — |
|
Outstanding at December 31, 2011 |
| 402,826,000 |
| 0.0352 |
| 5.47 |
| — |
|
Granted |
| 28,500,000 |
| 0.0116 |
| — |
| — |
|
Exercised |
| — |
| — |
| — |
| — |
|
Forfeited |
| (126,070,000 | ) | 0.0367 |
| — |
| — |
|
Outstanding at December 31, 2012 |
| 305,256,000 |
| 0.0324 |
| 4.57 |
| — |
|
Vested and expected to vest at December 31, 2012 |
| 278,013,600 |
| 0.0314 |
| 4.61 |
| — |
|
Vested and exercisable at December 31, 2012 |
| 76,314,000 |
| 0.0324 |
| 4.57 |
| — |
|
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
|
| Options |
| Weighted |
| Weighted |
| Aggregate |
|
|
|
|
| $ |
|
|
| $ |
|
Outstanding at January 1, 2012 |
| 402,826,000 |
| 0.0352 |
| 5.47 |
| — |
|
Granted |
| 28,500,000 |
| 0.0116 |
| — |
| — |
|
Exercised |
| — |
| — |
| — |
| — |
|
Cancelled or expired |
| (126,070,000 | ) | 0.0367 |
| — |
| — |
|
Outstanding at December 31, 2012 |
| 305,256,000 |
| 0.0324 |
| 4.57 |
| — |
|
Granted |
| 323,900,000 |
| 0.0105 |
| — |
| — |
|
Exercised |
| (4,000,000 | ) | 0.0116 |
| — |
| 55,213 |
|
Forfeited |
| (113,862,000 | ) | 0.0317 |
| — |
| — |
|
Outstanding at December 31, 2013 |
| 511,294,000 |
| 0.0189 |
| 4.70 |
| 6,514,815 |
|
Granted |
| — |
| — |
| — |
| — |
|
Exercised |
| (32,712,500 | ) | 0.0103 |
| — |
| 138,955 |
|
Forfeited |
| (257,875,000 | ) | 0.0121 |
| — |
| — |
|
Outstanding at December 31, 2014 |
| 220,706,500 |
| 0.0280 |
| 2.97 |
| — |
|
Vested and expected to vest at December 31, 2014 |
| 200,348,900 |
| 0.0289 |
| 2.90 |
| — |
|
Vested and exercisable at December 31, 2014 |
| 119,243,125 |
| 0.0332 |
| 2.63 |
| — |
|
The intrinsic valuevalues as of December 31, 2010, 20112012, 2013 and 2012 is2014 are calculated as the differencedifferences between the market valuevalues of $$0.01060.0495, $0.0120, $0.0282 and $0.0106$0.0100 of ordinary shares as of December 31, 2010, 20112012, 2013 and 20122014 and the exercise prices of the options.
The weighted average grant-date fair value of options granted during the yearyears ended December 31, 2010, 20112012, 2013 and 20122014 were $0.0483, $0.0151$0.0076, $0.0071 and $0.0076,nil, respectively. Options vested during the years ended December 31, 20112013 and 20122014 were 27,142,50050,140,375 and 51,464,000,51,602,500, respectively.
As of December 31, 2012,2014, there was $1.87$0.35 million of unrecognized compensation cost, adjusted for estimated forfeitures, related to stock options granted by the Company to its employees, senior management and directors under the 2010 Equity Compensation Plan. This cost is expected to be recognized over a weighted average period of 2.51.55 years. Total compensation cost may be adjusted for future changes in estimated forfeitures and the probability of the achievement of performance conditions.forfeitures. As of December 31, 2012,2014, there was $0.92$0.6 million of unrecognized compensation cost, adjusted for estimated forfeitures, related to stock options granted by the Company to the employees of Shanda under the 2010 Equity Compensation Plan, which will be recognized as expense over a dividend distributed to Shanda upon the completionweighted average period of vesting.2.36 years.
The Black-Scholes option pricing model is used to determine the fair value of the stock options granted under the 2010 Equity Compensation Plan. The Black-Scholes model requires the input of highly subjective assumptions, including the expected stock price volatility and the sub-optimal early exercise factor. The risk-free rate for periods within the contractual lives of the options is based on the U.S. Treasury yield curve in effect at the time of grant. The fair values of stock options were estimated using the following weighted-average assumptions:
|
| Options Granted |
| Options Granted |
| Options Granted |
| Options Granted |
| Options Granted |
| Options Granted |
|
Fair value of ordinary shares ($) |
| 0.0800 |
| 0.0186~0.0367 |
| 0.0116 |
| 0.0116 |
| 0.0106~0.0131 |
| — |
|
Exercise price ($) |
| 0.0568 |
| 0.0188~0.0392 |
| 0.0116 |
| 0.0116 |
| 0.0103~0.0113 |
| — |
|
Expected volatility (%) |
| 60%~65% |
| 75%~82% |
| 100% |
| 100 | % | 94% |
| — |
|
Expected dividend yield (%) |
| 0% |
| 0% |
| 0% |
| 0 | % | 0% |
| — |
|
Expected term (years) |
| 4~5 |
| 3.5~5 |
| 3.5 |
| 3.5 |
| 3.5 |
| — |
|
Risk-free interest rate (per annum) (%) |
| 1.9407%~2.6565% |
| 1.2680%~1.9933% |
| 1.2425% |
| 1.2425 | % | 1.3445%~1.3843% |
| — |
|
(1) The risk-free interest rate for periods within the contractual life of the share option is based on the U.S. Treasury yield curve in effect at the time of grant for a term consistent with the expected term of the awards.
(2) The expected term of stock options granted is developed giving consideration to vesting period, contractual term and historical exercise pattern of options granted by the Company.
(3) The Company has no history or expectation of paying dividends on its common stock.
KU6 MEDIA CO., LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014
(all amounts in U.S. dollars (US$) unless otherwise stated)
(4) Expected volatility is estimated based on the historical volatility of comparable companies’ stocks and of the Company’s common stock for a period equal to the expected term preceding the grant date.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)1
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS5
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
17.. SEGMENT INFORMATION
The Company follows the provisions of ASC 280, which establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance.
Following the 2010 Reorganization (the disposal of the WVAS and recorded music businesses (Note 2(1)) in August 2010 presented in discontinued operations for all the periods presented herein), the Company The Group has only one operating segment made up of Ku6’s online advertising business (“Online Advertising”Advertising Services”), which is presented in the continuing operations section of our consolidated statement of operations. The Group has not disclosed segment information prior to the 2010 Reorganization for the former WVASoperations and Recorded Music segments due to the disposal thereof; such segment information has no relevance to the Group’s current and future results.comprehensive loss.
Geographic Information
The Company primarily operates in the PRC and derives all of its revenues (see Note 17 for revenue information) from the PRC; all of the Company’s long-lived assets are located in the PRC.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)1
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS6
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
18.. NET LOSS PER SHARE
The following table sets forth the computation of basic and diluted net loss per share (1 ADS = 100 Shares):
|
| Year ended |
| Year ended |
| Year ended |
|
|
|
|
|
|
|
|
|
Numerator: |
|
|
|
|
|
|
|
Net loss attributable to Ku6 Media Co., Ltd. ordinary shareholders from continuing operations |
| (52,858,278 | ) | (49,343,907 | ) | (9,491,138 | ) |
Net income attributable to Ku6 Media Co., Ltd. ordinary shareholders from discontinued operations |
| 1,348,014 |
| — |
| — |
|
Net loss attributable to Ku6 Media Co., Ltd. |
| (51,510,264 | ) | (49,343,907 | ) | (9,491,138 | ) |
Denominator: |
|
|
|
|
|
|
|
Weighted-average ordinary shares outstanding for basic calculation |
| 3,096,421,097 |
| 4,265,277,638 |
| 4,901,279,176 |
|
Dilutive effect of potential ordinary shares |
| — |
| — |
| — |
|
Weighted average ordinary shares outstanding for diluted calculation |
| 3,096,421,097 |
| 4,265,277,638 |
| 4,901,279,176 |
|
|
|
|
|
|
|
|
|
Weighted-average ADS used in per basic ADS calculations |
| 30,964,211 |
| 42,652,776 |
| 49,012,792 |
|
Dilutive effect of potential ordinary shares |
| — |
| — |
| — |
|
Weighted-average ADS used in per diluted ADS calculations |
| 30,964,211 |
| 42,652,776 |
| 49,012,792 |
|
|
|
|
|
|
|
|
|
Loss per share — basic and diluted |
|
|
|
|
|
|
|
Loss from continuing operations attributable to Ku6 Media Co., Ltd. ordinary shareholders per share — basic and diluted |
| (0.02 | ) | (0.01 | ) | (0.00 | ) |
Income from discontinued operations attributable to Ku6 Media Co., Ltd. ordinary shareholders per share — basic and diluted |
| 0.00 |
| — |
| — |
|
Loss attributable to Ku6 Media Co., Ltd. ordinary shareholders per share — basic and diluted |
| (0.02 | ) | (0.01 | ) | (0.00 | ) |
|
|
|
|
|
|
|
|
Loss per ADS — basic and diluted |
|
|
|
|
|
|
|
Loss from continuing operations attributable to Ku6 Media Co., Ltd. ordinary shareholders per ADS — basic and diluted |
| (1.71 | ) | (1.16 | ) | (0.19 | ) |
Income from discontinued operations attributable to Ku6 Media Co., Ltd. ordinary shareholders per ADS — basic and diluted |
| 0.04 |
| — |
| — |
|
Loss attributable to Ku6 Media Co., Ltd. ordinary shareholders per ADS — basic and diluted |
| (1.67 | ) | (1.16 | ) | (0.19 | ) |
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
|
| Year ended |
| Year ended |
| Year ended |
|
|
|
|
|
|
|
|
|
Numerator: |
|
|
|
|
|
|
|
Net loss |
| (9,491,138 | ) | (34,427,734 | ) | (10,727,642 | ) |
Denominator: |
|
|
|
|
|
|
|
Weighted-average ordinary shares outstanding for basic calculation |
| 4,901,279,176 |
| 4,728,185,434 |
| 4,746,324,022 |
|
Dilutive effect of potential ordinary shares |
| — |
| — |
| — |
|
Weighted average ordinary shares outstanding for diluted calculation |
| 4,901,279,176 |
| 4,728,185,434 |
| 4,746,324,022 |
|
|
|
|
|
|
|
|
|
Weighted-average ADS used in per basic ADS calculations |
| 49,012,792 |
| 47,281,854 |
| 47,463,240 |
|
Dilutive effect of potential ADS |
| — |
| — |
| — |
|
Weighted-average ADS used in per diluted ADS calculations |
| 49,012,792 |
| 47,281,854 |
| 47,463,240 |
|
|
|
|
|
|
|
|
|
Loss per share — basic and diluted |
|
|
|
|
|
|
|
Net loss per share — basic and diluted |
| (0.00 | ) | (0.01 | ) | (0.00 | ) |
|
|
|
|
|
|
|
|
Loss per ADS — basic and diluted |
|
|
|
|
|
|
|
Net loss per ADS — basic and diluted |
| (0.19 | ) | (0.73 | ) | (0.23 | ) |
Incremental ordinary shares with dilutive effect are calculated using the treasury stock method for stock options. Under the treasury stock method, the proceeds from the assumed conversion of options are used to repurchase outstanding ordinary shares using the average fair value for the period. For incremental ordinary shares associated with convertible debt, dilution is calculated (if necessary) using the if-converted method, which assumes conversion at the beginning of the annual period (or date of issuance of the related debt, if later).
KU6 MEDIA CO., LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014
(all amounts in U.S. dollars (US$) unless otherwise stated)
For all periods presented, all potentially dilutive securities associated with the Company’s convertible bond which was issued in Q2 2011 and extinguished in Q3 2011 (Note 1) and all stock options (Note 16)14) have not been reflected in the dilutive calculations pursuant to ASC 260, “Earnings Per Share,” due to the presence of a net loss in each period as the inclusion of such potential common shares would be anti-dilutive.
19.17. CONCENTRATIONS
(1) Dependence onRevenue concentrations, including related party revenuerevenues
The Company entered into a cooperative agreementIn 2012, 2013, and 2014, revenues of $14.1 million, $13.1 million, and $7.0 million were derived from online advertising services (Note 2(16)). In 2014, revenues of $1.6 million were derived from promotional advertising revenue services (Note 2(16)).
Under agreements with Shengyue a wholly owned subsidiary of Shanda in 2011. Under this agreement,(Note 1), Shengyue was previously appointed as the Company’sGroup’s primary agencyagent to secure advertisement sales from various end advertisers. In 20112012, 2013 and 2012, 38%2014, 88.4%, 94.4% and 88%31.5% of net revenues, respectively, were derived from Shengyue. If the relationship withRefer to Note 11 for discussion of receivables due from Shengyue is terminated or scaled-back, or if Shengyue alters theat December 31, 2013 and 2014 (there were no net amounts due at December 31, 2014 following collections and a full provision on remaining amounts).
Under a new advertising agency agreement inwith Huzhong consummated on August 29, 2014, Huzhong was appointed as the Group’s primary agent to secure advertisement sales from various end advertisers. In 2014, 32.4% of net revenues were derived from Huzhong.
In early 2014, the Group entered into certain marketing services agreements with Qinhe, a way that is adverse to the Company, the Company’s revenue would be adversely affected.related party (Note 1). In 2014, 18.8% of net revenues were derived from Qinhe.
(2) Credit risk
As of December 31, 2011 and 2012, accountsAccounts receivable of the online advertising business are typically unsecured and are derived from revenue earned from customers and agencies in China. The risk with respect to accounts receivables is mitigated by credit evaluations the Company performs on its customers and its ongoing monitoring process of outstanding balances.
|
| December 31, 2011 |
| December 31, 2012 |
|
| December 31, 2013 |
| December 31, 2014 |
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable |
| 5,194,099 |
| 2,240,058 |
|
| 544,754 |
| 532,355 |
|
Allowance for doubtful accounts |
| (4,416,706 | ) | (2,172,972 | ) |
| (480,076 | ) | (418,539 | ) |
Accounts receivable, net of allowance for doubtful accounts |
| 777,393 |
| 67,086 |
|
| 64,678 |
| 113,816 |
|
The Company generally does not require collateral for its accounts receivable. The movements of the allowance for doubtful accounts were as follows:
Movement of allowance for doubtful accounts
|
| Year ended |
| Year ended |
| Year ended |
|
| Year ended |
| Year ended |
| Year ended |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of the year |
| 4,015,145 |
| 2,437,179 |
| 4,416,706 |
|
| 4,416,706 |
| 2,172,972 |
| 480,076 |
|
Acquisition of Ku6 |
| 101,484 |
| — |
| — |
| |||||||
Provisions |
| 1,976,053 |
| 3,637,147 |
| — |
|
| — |
| — |
| 1,038,047 |
|
Reversed |
| (501,485 | ) | (177,321 | ) | (2,255,301 | ) |
| (2,255,301 | ) | (310,699 | ) | (49,912 | ) |
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 | ) | — |
| |||||||
Accounts written off |
| — |
| (1,435,204 | ) | (1,038,047 | ) | |||||||
Translation difference |
| — |
| — |
| 11,567 |
|
| 11,567 |
| 53,007 |
| (11,625 | ) |
Balance at the end of the year |
| 2,437,179 |
| 4,416,706 |
| 2,172,972 |
|
| 2,172,972 |
| 480,076 |
| 418,539 |
|
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
As part of the Company’s change in the business strategy (Note 1), the CompanyThe Group significantly reduced its sales force and appointed Shengyue as its primary advertisement agencyadvertising agent in 2011. As a result of this change, the relationships with some of the Group’s previous advertisement customers were terminated and the CompanyGroup provided additional allowance for doubtful accounts to reflect the expected uncollectibility in 2011. In 2012,2013 and 2014, based on continued collections efforts on the doubtful receivables, $2.3$0.3 million and $0.05 million of amounts previously written down were collected; accordingly, a reversal adjustment wasadjustments were recorded.
Account receivable from Shengyue (Note 13) are unsecured and subject to similar credit risks as accounts receivable related to the external advertising revenue. The Company has been closely evaluating the credit status and payment cycle of Shengyue. As of December 31, 2011 and 2012, no allowance for the accounts receivable from Shengyue was provided.
20.18. MAINLAND CHINA CONTRIBUTION PLAN
Full time employees of the Company in the PRC participate in a government-mandated multi-employer defined contribution plan pursuant to which certain pension benefits, medical care, unemployment insurance, employee housing fund and other welfare benefits are provided to employees. Chinese labor regulations require the Company to accrue for these benefits based on certain percentages of the employees’ salaries. The total amounts charged to the statements of operations and comprehensive loss for such employee benefits were $3,660,438, $2,554,561 and $1,609,711, $1,816,719 and $1,059,305 for the years ended December 31, 2010, 20112012, 2013 and 2012,2014, respectively.
21.19. COMMITMENTS AND CONTINGENCIES
Operating lease commitments
The Company entered into leasing arrangements relating to office area and internet bandwidth in 2010, 20112012, 2013 and 2012.2014. Leasing expenses for the years ended December 31, 2010, 20112012, 2013 and 20122014 were $11,785,743, $10,614,276 and $9,095,530, $9,175,500 and $8,367,927, respectively.
Future minimum lease payments under non-cancellable operating lease agreements are as follows:
Within 1 year |
|
|
|
Between 1 and 2 years |
|
|
|
Between 2 and 3 years |
|
|
|
Between 3 and 4 years |
| — |
|
Total |
|
|
|
Litigation
The CompanyGroup is subject to claims and litigation, which may arise in the normal course of business. The CompanyGroup is involved in a number of cases pending in various courts and arbitration as of December 31, 2012.2014. These cases are substantially related to alleged copyright infringement. Adverse results in these lawsuits may include awards of damages and may also result in, or even compel, a change in the Company’sGroup’s business practices, which could impact the Company’sGroup’s future financial results.
The CompanyGroup has recorded an accrual balance of $2,077,753$1,653,032 in “Accrued expenses and other liabilities” in the consolidated balance sheet as of December 31, 20122014 (Note 12)9). The accrual was based on judgments handed down by the courtcourts and out-of-court settlements as of or after December 31, 2012 butand related to alleged copyright infringement arising before December 31, 2012.2014. The accrual wasis based upon management’s best estimation according to the historical actual compensation amount per video of the CompanyGroup for the similar legal actions and the advice from PRC counsel. The CompanyGroup also considers the frequency and pattern of claims for infringement and the fact that claims are often submitted, and judgments rendered, long after the alleged underlying infringement activity occurred. Furthermore, while claims for alleged infringement may be term limited in certain cases, parties alleging infringement may be able to renew their claims by re-filing them upon expiry, leading to continuation of the claim resolution process. The Group is in the process of appealing certain judgments for which the loss has been accrued. During the year ended December 31, 2014, management of the Group re-evaluated the accrued litigation provision related to alleged copyright infringement and revised its estimates based upon favourable resolution experience and the pattern of incidence of new claims; this revision resulted in a de-recognition of a portion of $333,485 of amounts previously accrued, which was recorded as a reduction to general and administrative expenses.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
A rollforward of the Group’s accrued litigation provision related to alleged copyright infringement is as follows.
|
| Year ended |
| Year ended |
| Year ended |
|
|
|
|
|
|
|
|
|
At beginning of year |
| 2,683,968 |
| 2,077,753 |
| 2,079,671 |
|
Current year additions (reversals) |
| (113,611 | ) | 141,912 |
| (333,485 | ) |
Payments during the year |
| (492,604 | ) | (139,994 | ) | (93,154 | ) |
Balance at end of year |
| 2,077,753 |
| 2,079,671 |
| 1,653,032 |
|
There are no accruals for any additional losses related to unasserted claims or any other amounts.
Contingencies
The CompanyGroup accounts for loss contingencies in accordance with ASC 450, “Contingencies”, and other related guidance. Set forth below is a description of certain loss contingencies as well as the opinion of management as to the likelihood of loss.
Current PRC laws and regulations place certain restrictions on foreign ownership of companies that engage in Internet business, including the provision of online video and online advertising services. Specifically, foreign ownership in an Internet content provider or other value-added telecommunication service providers may not exceed 50%. Since the Company is incorporated in the Cayman Islands, neither the Company nor its PRC subsidiary is eligible to engage in Internet business. To comply with PRC laws and regulations, the Company conducts its operations in China through a series of contractual arrangements entered into among its wholly owned PRC subsidiaries, Beijing Technology, Tianjin Technology and Kusheng.Kusheng (collectively “wholly owned PRC“PRC subsidiaries”), and the consolidated affiliated entities in the PRC, namely Ku6 Beijing Information, Tianjin Information, Ku6 (Beijing) Cultural Media Co., Ltd. (“Ku6 Cultural”) and Ku6 Network (collectively “consolidated affiliated entities in the PRC”“VIEs”) and their respective shareholders.
Under the equity pledge agreements among ourthe PRC subsidiaries, certain of our consolidated affiliated entitiesthe VIEs and the shareholders of our consolidated affiliated entities,the VIEs, the shareholders of our consolidated affiliated entities have pledged all of their equity interests in these entities to our relevantthe PRC subsidiaries by recording the pledgepledges on the shareholdershareholders’ 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 completed thecommerce; such registration of equity pledge on November 13, 2008 and further on November 12, 2012 after an increasehas been accomplished for all of the registered capital. Tianjin Ku6 Network, Ku6 Cultural, and Tianjin information completed their registration of equity pledges on January 20, 2012, October 10, 2012, and February 20, 2013, respectively.Group’s VIEs.
Ku6 Beijing Information, Tianjin Information, Ku6 Cultural and Ku6 Network hold the licenses and permits necessary to conduct ourthe Group’s online video, online advertising and related businesses in China. In the opinion of management, (i) the ownership structure of the Company,Group, its wholly owned PRC subsidiaries and the consolidated affiliated entitiesVIEs in the PRC are in compliance with existing PRC laws and regulations; (ii) the contractual arrangements with the consolidated affiliated entitiesVIEs 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 and its contractual arrangements with the consolidated affiliated entities in the PRC were found to be in violation of any existing or future PRC laws and regulations, the Company may be required to restructure its ownership structure and operations in the PRC to comply with the changing and new PRC laws and regulations.
Under PRC Ministry of Commerce (“MOFCOM”) security review rules promulgated in September 2011, a national security review is required for certain mergers and acquisitions by foreign investors raising concerns regarding national defense and security. Foreign investors are prohibited from circumventing the national security review requirements by structuring transactions through proxies, trusts, indirect investment, leases, loans, control through contractual arrangements, or offshore transactions. Management has concluded there is no need to submit the existing contractual arrangements with the consolidated affiliated entities in the PRC and their shareholders to the MOFCOM for national security review based upon analysis of the rules. However, there are substantial uncertainties regarding the interpretation and application of the MOFCOM security review rules, and any new laws, rules, regulations or detailed implementation measures in any form relating to such rules. Therefore, the Company cannot be assured that the relevant PRC regulatory authorities, such as the MOFCOM, would not ultimately take a contrary view to the opinion of management and the Company’s PRC legal counsel. If the MOFCOM or other PRC regulatory authority determines that the Company needs to submit the existing contractual arrangements with the consolidated affiliated entities in the PRC and their shareholders for national security review, the Company may face sanctions by the MOFCOM or other PRC regulatory authority, which may include, among others, requiring the Company to restructure its ownership structure, discontinuation or restriction of operations in the PRC, or invalidation of the agreements that the wholly owned PRC subsidiaries have entered into with the consolidated affiliated entities in the PRC and their shareholders.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
MOFCOM published a discussion draft of a proposed Foreign Investment Law in January 2015 aiming to, upon its enactment, replace the trio of existing laws regulating foreign investment in China, namely, the Sino-foreign Equity Joint Venture Enterprise Law, the Sino-foreign Cooperative Joint Venture Enterprise Law and the Wholly Foreign-invested Enterprise Law. The draft Foreign Investment Law embodies an expected PRC regulatory trend to rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic investments. MOFCOM is currently soliciting comments on this draft and substantial uncertainties exist with respect to its enactment timetable, interpretation and implementation. The draft Foreign Investment Law, if enacted as proposed, may materially impact the viability of the Group’s current corporate structure, corporate governance and business operations in many aspects.
Among other things, the draft Foreign Investment Law expands the definition of foreign investment and introduces the principle of “actual control” in determining whether a company is considered a foreign-invested enterprise, or an FIE. The draft Foreign Investment Law specifically provides that entities established in China but “controlled” by foreign investors will be treated as FIEs, whereas an entity set up in a foreign jurisdiction would nonetheless be, upon market entry clearance by the Ministry of Commerce, treated as a PRC domestic investor provided that the entity is “controlled” by PRC entities and/or citizens. In this connection, “foreign investors” refers to the following subjects making investments within the PRC: (i) natural persons without PRC nationality; (ii) enterprises incorporated under the laws of countries or regions other than China; (iii) the governments of countries or regions other than the PRC and the departments or agencies thereunder; and (iv) international organizations. Domestic enterprises under the control of the subjects as mentioned in the preceding sentence are deemed foreign investors, and “control” is broadly defined in the draft law to cover the following summarized categories: (i) holding, directly or indirectly, not less than 50% of shares, equities, share of voting rights or other similar rights of the subject entity; (ii) holding, directly or indirectly, less than 50% of the voting rights of the subject entity but having the power to secure at least 50% of the seats on the board or other equivalent decision making bodies, or having the voting power to materially influence the board, the shareholders’ meetings, or other equivalent decision making bodies; or (iii) having the power to exert decisive influence, via contractual or trust arrangements, over the subject entity’s operations, financial matters or other key aspects of business operations. Once an entity is determined to be an FIE, it will be subject to the foreign investment restrictions or prohibitions set forth in a catalogue of “special administrative measures,” which is classified into the “catalogue of prohibitions” and “the catalogue of restrictions”, to be separately issued by the State Council later. Foreign investors are not allowed to invest in any sector set forth in the catalogue of prohibitions. However, unless the underlying business of the FIE falls within the catalogue of restrictions, which calls for market entry clearance by MOFCOM, prior approval from the government authorities as mandated by the existing foreign investment legal regime would no longer be required for establishment of the FIE.
The “variable interest entity” structure, or VIE structure, has been adopted by many PRC-based companies, including the Group, to obtain necessary licenses and permits in the industries that are currently subject to foreign investment restrictions in China. Under the draft Foreign Investment Law, variable interest entities that are controlled via contractual arrangements would also be deemed FIEs if they are ultimately “controlled” by foreign investors. Therefore, for any companies with a VIE structure in an industry category that is on the “catalogue of restrictions,” the VIE structure may be deemed a domestic investment only if the ultimate controlling person(s) is/are of PRC nationality (either PRC companies or PRC citizens). Conversely, if the actual controlling person(s) is/are of foreign nationalities, then the variable interest entities will be treated as FIEs and any operation in the industry category on the “catalogue of restrictions” without market entry clearance may be considered illegal.
KU6 MEDIA CO., LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2012, 2013 AND 2014
(all amounts in U.S. dollars (US$) unless otherwise stated)
The draft Foreign Investment Law has not taken a position on what actions shall be taken with respect to the existing companies with a VIE structure, whether or not these companies are controlled by Chinese parties, and MOFCOM is soliciting comments from the public on this point. Moreover, it is uncertain whether the industry in which our variable interest entities operate will be subject to the foreign investment restrictions or prohibitions set forth in the “catalogue of special administrative measures” to be issued. If the enacted version of the Foreign Investment Law and the final “catalogue of special administrative measures” mandate further actions, such case,as MOFCOM providing market entry clearance, to be completed by companies with an existing VIE structure like the CompanyGroup, the Group faces uncertainties as to whether such clearance can be timely obtained, or at all.
The draft Foreign Investment Law, if enacted as proposed, may also materially impact the Group’s corporate governance practices and increase compliance costs. For instance, the draft Foreign Investment Law imposes stringent ad hoc and periodic information reporting requirements on foreign investors and the applicable FIEs. Aside from an investment information report required at each investment, and investment amendment reports, which shall be submitted upon changes to investments, it is mandatory for entities established by foreign investors to submit an annual report, and large foreign investors meeting certain criteria are required to report on a quarterly basis. Any company found to be non-compliant with these reporting obligations may potentially be subject to fines and/or administrative or criminal liabilities, and the persons directly responsible may be subject to criminal liabilities.
With respect to the aforementioned security review rules and draft Foreign Investment Law, and any other matters creating uncertainty regarding VIEs, the Group may not be able to operate or control its business in the same manner as it currently does, and therefore, may not be able to consolidate the affiliated entities in the PRC. In addition, the relevant regulatory authorities would have broad discretion in dealing with such violations which may adversely impact the financial statements, operations and cash flows of the CompanyGroup (including restrictions on the Company to carrycarrying out business).
If the consolidated affiliated entitiesVIEs in the PRC and their shareholders fail to perform their respective obligations under the current contractual arrangements, the CompanyGroup 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 CompanyGroup 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.Group.
In the opinion of management, the likelihood of loss in respect of the Company’sGroup’s current ownership structure or the contractual arrangements with the consolidated affiliated entitiesVIEs in the PRC is remote.
220. SUBSEQUENT EVENTS
On February 2, 2015, the Group entered into a related party loan agreement with Mr. Xu, pursuant to which Mr. Xu agreed to provide a loan of RMB30.0 million ($4.8 million) to the Group within 20 business days from the date thereof. The term of the loan is one year, with a maturity date of February 2, 2016, with principal repayable at maturity, and the loan bears interest at a rate of 6.5% per annum (with interest payable at maturity). The Group received the loan principal from Mr. Xu on March 4, 2015. This amount will be reported as a related party loan payable in future periods.
21. RESTRICTED NET ASSETS
Relevant PRC laws and regulations permit PRC companies to pay dividends only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Additionally, the Company’s VIE subsidiaries can only distribute dividends upon approval of the shareholders after they have met the PRC requirements for appropriation to statutory reserves. The statutory general reserve fund requires annual appropriations of 10% of net after-tax income to be set aside prior to payment of any dividends. As a result of these and other restrictions under PRC laws and regulations, the PRC subsidiaries and affiliates are restricted in their ability to transfer a portion of their net assets to the Company either in the form of dividends, loans or advances, which restricted portion amounted to approximately $52.7$30.9 million, or 157.0%which was in excess of the Company’sGroup’s total consolidated net assets and shareholders’ deficit as of December 31, 2012.2014. Even though the Company currently does not require any such dividends, loans or advances from the PRC subsidiaries and affiliates for working capital and other funding purposes as all business is principally conducted inside the PRC, the Company may in the future require additional cash resources from ourits PRC subsidiaries and affiliates due to changes in business conditions, to fund future acquisitions and developments, or merelyto declare and pay dividends to or distributions to the Company’s ordinary shareholders. Accordingly, the Company has included Schedule I in accordance with Regulation S-X promulgated by the United States Securities and Exchange Commission.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 20112012, 2013 AND 20122014
(all amounts in U.S. dollars (US$) unless otherwise stated)
KU6 MEDIA CO., LTD. (FOMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)22
. ADDITIONAL INFORMATION — FINANCIAL STATEMENT SCHEDULE IBALANCE SHEET
|
| December 31, 2011 |
| December 31, 2012 |
|
|
| (in U.S. dollars, except number of shares) |
| ||
Assets |
|
|
|
|
|
Current assets: |
|
|
|
|
|
Cash and cash equivalents |
| 7,754,457 |
| 5,219,295 |
|
Prepaid expenses and other current assets |
| 434,230 |
| 312,174 |
|
Amount due from subsidiaries and variable interest entities |
| — |
| 3,003,202 |
|
Amount due from related parties |
| 19,534,641 |
| 6,096,800 |
|
Total current assets |
| 27,723,328 |
| 14,631,471 |
|
Investments in subsidiaries |
| 27,155,056 |
| 21,046,640 |
|
Total assets |
| 54,878,384 |
| 35,678,111 |
|
|
|
|
|
|
|
Liabilities and shareholders’ equity |
|
|
|
|
|
Accrued expenses and other current liabilities |
| 942,423 |
| 664,896 |
|
Amounts due to subsidiaries and variable interest entities |
| 2,707,933 |
| 1,071,669 |
|
Amount due to related parties |
| 375,000 |
| 375,000 |
|
Total current liabilities |
| 4,025,356 |
| 2,111,565 |
|
|
|
|
|
|
|
Shareholders’ equity: |
|
|
|
|
|
Ordinary shares ($0.00005 par value; 12,000,000,000 shares authorized; 5,019,786,036 and 4,732,446,560 shares issued and outstanding as of December 31, 2011 and 2012, respectively) |
| 250,939 |
| 236,575 |
|
Additional paid-in capital |
| 184,874,259 |
| 177,182,895 |
|
Accumulated deficit |
| (132,449,371 | ) | (141,940,509 | ) |
Accumulated other comprehensive loss |
| (1,822,799 | ) | (1,912,415 | ) |
Total shareholders’ equity |
| 50,853,028 |
| 33,566,546 |
|
Total liabilities and shareholders’ equity |
| 54,878,384 |
| 35,678,111 |
|
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED- CONDENSED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
KU6 MEDIA CO., LTD. (FOMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
ADDITIONAL INFORMATION — FINANCIAL STATEMENT SCHEDULE ISTATEMENT OF OPERATIONS
|
| Year ended |
| Year ended |
| Year ended |
|
|
| (in U.S. dollars, except number of shares) |
| ||||
Operating expenses: |
|
|
|
|
|
|
|
Product development |
| 150,584 |
| 603,879 |
| 278,168 |
|
Selling and marketing |
| 160,231 |
| (31,880 | ) | 30,773 |
|
General and administrative |
| 4,072,134 |
| 2,433,905 |
| 1,119,757 |
|
Total operating expenses |
| 4,382,949 |
| 3,005,904 |
| 1,428,698 |
|
Loss from operations |
| (4,382,949 | ) | (3,005,904 | ) | (1,428,698 | ) |
Interest income |
| 9,404 |
| 112,416 |
| 349,525 |
|
Interest expense |
| — |
| (375,000 | ) | — |
|
Other income |
| 205,043 |
| — |
| — |
|
Foreign exchange loss |
| (38,767 | ) | (9 | ) | (15,589 | ) |
Equity in losses of subsidiaries |
| (47,302,995 | ) | (46,075,410 | ) | (8,396,376 | ) |
Net loss |
| (51,510,264 | ) | (49,343,907 | ) | (9,491,138 | ) |
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
KU6 MEDIA CO., LTD. (FOMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
ADDITIONAL INFORMATION — FINANCIAL STATEMENT SCHEDULE ISTATEMENTS OF CASH FLOWS
|
| Year ended |
| Year ended |
| Year ended |
|
|
| (in U.S. dollars, except number of shares)) |
| ||||
Operating activities: |
|
|
|
|
|
|
|
Net loss |
| (51,510,264 | ) | (49,343,907 | ) | (9,491,138 | ) |
Adjustments to reconcile net loss to net cash used in operating activities: |
|
|
|
|
|
|
|
Share-based compensation |
| 1,891,931 |
| 1,231,919 |
| 463,753 |
|
Share-based compensation cost in relation to disposition of Yisheng |
| — |
| 522,251 |
| — |
|
Equity in losses of subsidiaries |
| 47,302,995 |
| 46,075,410 |
| 8,396,376 |
|
Prepaid expenses and other current assets |
| (106,581 | ) | (193,214 | ) | 122,056 |
|
Amounts due from subsidiaries and variable interest entities |
| — |
| — |
| (1,645 | ) |
Amount due from related parties |
| (942,919 | ) | (1,692,875 | ) | (92,159 | ) |
Other payables and accruals |
| 4,738 |
| (323,956 | ) | (277,527 | ) |
Amounts due to subsidiaries and variable interest entities |
| 2,381 |
| (77,833 | ) | (4,013,840 | ) |
Amounts due to related parties |
| — |
| 375,000 |
| — |
|
Net cash used in operating activities |
| (3,357,719 | ) | (3,427,205 | ) | (4,894,124 | ) |
|
|
|
|
|
|
|
|
Investing activities: |
|
|
|
|
|
|
|
Decrease of short-term investments |
| 10,000,000 |
| — |
| — |
|
Proceeds from disposal of subsidiary |
| 37,243,901 |
| — |
| — |
|
Loan to subsidiaries |
| (53,418,876 | ) | (5,762,569 | ) | (3,001,557 | ) |
Loan to related parties |
| (3,200,000 | ) | (14,108,019 | ) | (470,000 | ) |
Repayment of loans to related parties under common control of Shanda |
| — |
| — |
| 14,000,000 |
|
Investment in subsidiary |
| — |
| (30,000,000 | ) | — |
|
Net cash provided by (used in) investing activities |
| (9,374,975 | ) | (49,870,588 | ) | 10,528,443 |
|
|
|
|
|
|
|
|
|
Financing activities: |
|
|
|
|
|
|
|
Proceeds from exercise of options |
| 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 | ) | — |
|
Repuchase of ordinary shares |
| — |
| — |
| (8,169,481 | ) |
Net cash provided by (used in) financing activities |
| 20,350 |
| 50,003,750 |
| (8,169,481 | ) |
Effect of exchange rate changes on cash and cash equivalents |
| — |
| — |
| — |
|
Net decrease in cash and cash equivalents |
| (12,712,344 | ) | (3,294,043 | ) | (2,535,162 | ) |
Cash and cash equivalents, beginning of year |
| 23,760,844 |
| 11,048,500 |
| 7,754,457 |
|
Cash and cash equivalents, end of year |
| 11,048,500 |
| 7,754,457 |
| 5,219,295 |
|
Note
Basis for Preparation
The following condensed financial statements of the Company have been prepared in accordance with SEC Regulation S-X RuleRules 5-04 and Rule 12-04.
KU6 MEDIA CO., LTD. (FORMERLY KNOWN AS HURRAY! HOLDING CO., LTD.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2011 AND 2012
(all amounts in U.S. dollars (US$) unless otherwise stated)
The Financial Informationfinancial information of the Parentparent company, Ku6 Media Company Limited, has been prepared using the same accounting policies as set out in the Company’spreceding footnotes to the consolidated financial statements except that the Company records its investment in subsidiaries under the equity method of accounting. Such investment and long-term loans to subsidiaries are presented on the balance sheet as “Investment in subsidiaries” and the profit of the subsidiaries is presented as “Equity in losses of subsidiaries” on the statement of operations.
These statements should be read in conjunction with the preceding notes to the consolidated financial statements of the Group. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted.
F-53As of December 31, 2013 and 2014, there were no material contingencies, significant provisions for long-term obligations, or guarantees of the Company, except for those which have been separately disclosed in the consolidated financial statements of the Group, if any.
FINANCIAL INFORMATION OF KU6 MEDIA CO., LTD.
CONDENSED BALANCE SHEETS
|
| December 31, 2013 |
| December 31, 2014 |
|
|
| (in U.S. dollars, except number of shares) |
| ||
Assets |
|
|
|
|
|
Current assets: |
|
|
|
|
|
Cash and cash equivalents |
| 56,999 |
| 341,320 |
|
Prepaid expenses and other current assets |
| 250,091 |
| 195,049 |
|
Amount due from subsidiaries and variable interest entities |
| 15,709,401 |
| — |
|
Amount due from related parties |
| 1,741,836 |
| 627 |
|
Total current assets |
| 17,758,327 |
| 536,996 |
|
Investments in subsidiaries |
| 8,082,866 |
| 19,690,895 |
|
Total assets |
| 25,841,193 |
| 20,227,891 |
|
|
|
|
|
|
|
Liabilities and shareholders’ equity (deficit) |
|
|
|
|
|
Accrued expenses and other current liabilities |
| 701,375 |
| 541,961 |
|
Amounts due to subsidiaries and variable interest entities |
| 24,711,656 |
| 23,821,671 |
|
Amounts due to related parties |
| 375,000 |
| — |
|
Total current liabilities |
| 25,788,031 |
| 24,363,632 |
|
|
|
|
|
|
|
Shareholders’ equity (deficit): |
|
|
|
|
|
Ordinary shares ($0.00005 par value; 12,000,000,000 shares authorized; 4,730,648,360 and 4,763,360,860 shares issued and outstanding as of December 31, 2013 and 2014, respectively) |
| 236,485 |
| 238,120 |
|
Additional paid-in capital |
| 178,195,109 |
| 184,538,349 |
|
Accumulated deficit |
| (176,368,243 | ) | (187,095,885 | ) |
Accumulated other comprehensive loss |
| (2,010,189 | ) | (1,816,325 | ) |
Total shareholders’ equity (deficit) |
| 53,162 |
| (4,135,741 | ) |
Total liabilities and shareholders’ equity (deficit) |
| 25,841,193 |
| 20,227,891 |
|
FINANCIAL INFORMATION OF KU6 MEDIA CO., LTD.
CONDENSED STATEMENTS OF OPERATIONS
|
| Year ended |
| Year ended |
| Year ended |
|
|
| (in U.S. dollars, except number of shares) |
| ||||
Operating expenses: |
|
|
|
|
|
|
|
Product development |
| 278,168 |
| 269,876 |
| 208,656 |
|
Selling and marketing |
| 30,773 |
| 54,503 |
| 3,802 |
|
General and administrative |
| 1,119,757 |
| 1,403,657 |
| 928,506 |
|
Total operating expenses |
| 1,428,698 |
| 1,728,036 |
| 1,140,964 |
|
Loss from operations |
| (1,428,698 | ) | (1,728,036 | ) | (1,140,964 | ) |
Interest income |
| 349,525 |
| 30,483 |
| 3,463 |
|
Interest expense |
| — |
| — |
| — |
|
Other (expense) / income |
| — |
| (739,530 | ) | 92,144 |
|
Foreign exchange (loss) / gain |
| (15,589 | ) | 355,337 |
| (76 | ) |
Equity in losses of subsidiaries |
| (8,396,376 | ) | (32,345,988 | ) | (9,682,209 | ) |
Net loss |
| (9,491,138 | ) | (34,427,734 | ) | (10,727,642 | ) |
FINANCIAL INFORMATION OF KU6 MEDIA CO., LTD.
CONDENSED STATEMENTS OF CASH FLOWS
|
| Year ended |
| Year ended |
| Year ended |
|
|
| (in U.S. dollars, except number of shares) |
| ||||
Operating activities: |
|
|
|
|
|
|
|
Net loss |
| (9,491,138 | ) | (34,427,734 | ) | (10,727,642 | ) |
Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |
|
|
|
|
|
|
|
Share-based compensation |
| 463,753 |
| 1,023,871 |
| 600,995 |
|
Provision for Seed Music receivable (related party) |
| — |
| 980,000 |
| — |
|
Exchange gains |
| — |
| (355,337 | ) | — |
|
Equity in losses of subsidiaries |
| 8,396,376 |
| 32,345,988 |
| 9,682,209 |
|
Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
Prepaid expenses and other current assets |
| 122,056 |
| 62,083 |
| 55,042 |
|
Amounts due from subsidiaries and variable interest entities |
| (1,645 | ) | — |
| — |
|
Amount due from related parties |
| (92,159 | ) | 74,964 |
| (4,015 | ) |
Accrued expenses and other current liabilities |
| (277,527 | ) | 36,479 |
| (159,414 | ) |
Amounts due to subsidiaries and variable interest entities |
| (4,013,840 | ) | 4,160,000 |
| — |
|
Net cash provided by (used in) operating activities |
| (4,894,124 | ) | 3,900,314 |
| (552,825 | ) |
|
|
|
|
|
|
|
|
Investing activities: |
|
|
|
|
|
|
|
Loan to subsidiaries |
| (3,001,557 | ) | (12,350,863 | ) | — |
|
Loan to Shanda Capital Limited |
| (470,000 | ) | — |
| — |
|
Repayment of loans from related parties under control of Shanda |
| 14,000,000 |
| 3,300,000 |
| 498,583 |
|
Net cash provided by (used in) investing activities |
| 10,528,443 |
| (9,050,863 | ) | 498,583 |
|
|
|
|
|
|
|
|
|
Financing activities: |
|
|
|
|
|
|
|
Proceeds from exercise of options |
| — |
| 46,400 |
| 338,563 |
|
Repurchase of ordinary shares |
| (8,169,481 | ) | (58,147 | ) | — |
|
Net cash provided by (used in) financing activities |
| (8,169,481 | ) | (11,747 | ) | 338,563 |
|
Effect of exchange rate changes on cash and cash equivalents |
| — |
| — |
| — |
|
Net increase (decrease) in cash and cash equivalents |
| (2,535,162 | ) | (5,162,296 | ) | 284,321 |
|
Cash and cash equivalents, beginning of year |
| 7,754,457 |
| 5,219,295 |
| 56,999 |
|
Cash and cash equivalents, end of year |
| 5,219,295 |
| 56,999 |
| 341,320 |
|