RISK FACTORS
An investment in our securities s involves significant risks. You should carefully consider all the information in this
prospectus supplement, the accompanying prospectus and the documents incorporated by reference herein and therein, including the risks and uncertainties described below, before making an investment in
our securities. Any of the following risks could materially and adversely affect our business, financial condition and results of operations. In any such case, the market price of the ADSs could
decline, and you may lose all or part of your investment.
Risks Related to Our Business
We had net loss and negative cash flows from operating activities in the past, and we may not achieve or
sustain profitability.
We had a net loss of US$36.8 million and negative cash flows from operations of US$15.7 million in 2019. We recorded a net loss of
US$28.6 million and positive cash flows from operations of US$6.0 million for the nine months ended September 30, 2020. We cannot assure you that we will be able to generate net
profit or positive cash flows from operating activities in the future. Our future revenue growth and profitability will depend on a variety of factors, many of which are beyond our control. These
factors include market acceptance of our products, effectiveness of our monetization strategy, our ability to control cost and expenses and to manage our growth effectively, market competition,
macroeconomic and regulatory environment. We also expect our cost and expenses to increase in the future as we continue to expand our operations and to increase our investments in research and
development, which will place significant demands on our management and our operational and financial resources. Continuous expansion may increase the complexity of our business, and we may encounter
various difficulties. We may fail to develop and improve our operational, financial and managerial controls, enhance our financial reporting systems and procedures, recruit, train and retain skilled
professional personnel, or maintain customer satisfaction to effectively support and manage our growth. If we invest substantial time and resources to expand our operations but fail to manage the
growth of our business and capitalize on our growth opportunities effectively, we may not be able to achieve profitability, and our business, financial condition, results of operations and prospects
would be materially and adversely affected.
We are out of compliance with certain financial covenants in our credit facility agreements. If we fail to
receive any required waiver, we may be in default, which could impose operating and financial restrictions on us.
We entered into two credit facility agreements with a commercial bank, both of which were further renewed in June 2020, under which we can
borrow up to a total of US$15.0 million collateralized by our accounts receivable by June 2021. In the nine months ended September 30, 2020, we had in the aggregate drawn down
US$15.1 million and repaid US$9.5 million under these two credit facilities. The total outstanding balance of our short-term bank borrowings as of September 30, 2020 was
US$14.8 million. These credit facility agreements contain financial covenants which require us to maintain a minimum net profit of US$1.00 on a consolidated basis in the three months ended
September 30, 2020. We failed to meet such financial covenants as of September 30, 2020 and are
negotiating a waiver of such financial covenants with the counterparty, which, if granted, will waive the financial covenants for such period.
We
cannot assure you that we would be able to obtain such waivers in a timely manner, on acceptable terms or at all. If we were not able to obtain such waiver under any one or more of
these credit facilities, we would be in default of such agreements, and the relevant counterparty could elect to declare the loans, together with accrued and unpaid interest and other fees, if any,
immediately due and payable and proceed against any collateral securing such loans. If the loans under certain of our
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credit
facility agreements that we entered into were to be accelerated, even though we believe that our assets would be sufficient to repay our loans in full, our business and liquidity could
nevertheless be subject to adverse effects. In addition, such waiver, even if granted, may lead to increased costs, increased interest rates, additional restrictive covenants and other available
counterparty protections that would be applicable to us under these credit facilities, including the granting of additional security our interests in collateral, which could adversely affect our
business, financial condition, results of operations and our ability to acquire additional capital resources.
Our
ability to comply with financial or other restrictive covenants under our credit facility agreements may be affected by factors beyond our control, including prevailing economic,
financial and industry conditions, and our ability to issue additional equity. We may continue to fall out of compliance with such or other covenants in the future, which could materially and
adversely affect our business, financial condition and results of operations.
If we fail to implement and maintain an effective system of internal control, we may be unable to accurately
report our operating results, meet our reporting obligations or prevent fraud.
In preparing our consolidated financial statements for the fiscal years ended December 31, 2019, we and our independent registered public
accounting firm identified one material weakness and one significant deficiency in our internal control over financial reporting as well as other control deficiencies as of December 31, 2019,
in accordance with the standards established by the Public Company Accounting Oversight Board of the United States. The material weakness identified related to the lack of accounting policies and
procedures relating to financial reporting in accordance with U.S. GAAP and SEC financial reporting requirements. We have implemented and are continuing to implement a number of measures to
address the material weaknesses identified. However, the implementation of these measures may not fully address the material weakness and deficiencies in our internal control over financial reporting,
and we cannot conclude that they have been fully remedied.
As a result of the material weakness and significant deficiency identified, our management has concluded that, as included in our annual report on Form 20-F for the fiscal year ended
December 31, 2019, our disclosure controls and procedures were ineffective as of December 31, 2019 in ensuring that the information required to be disclosed by us in such annual report
is recorded, processed, summarized and reported to them for assessment, and that the required disclosure is made within the time period specified in the rules and forms of the SEC. We cannot assure
you that we will be able to implement an effective system of internal control, or that we will not identify additional material weaknesses or significant deficiencies in the future.
We
are a public company in the United States subject to the Sarbanes-Oxley Act of 2002. The SEC adopted rules pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 requiring
every public company to include a management report on such company's internal control over financial reporting in its annual report, which contains management's assessment of the effectiveness of our
internal control over financial reporting. In addition, once we cease to be an "emerging growth company" as such term is defined under the JOBS Act, our independent registered public accounting firm
must attest to and report on the effectiveness of our internal control over financial reporting. Our management may conclude that our internal control over financial reporting is not effective.
Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm, after conducting its own independent
testing, may issue a report that is qualified if it is not satisfied with our internal controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets
the relevant requirements differently from us. In addition, as we have become a public company, our reporting obligations may place a significant strain on our management, operational and financial
resources and systems for the foreseeable future. We may be unable to timely complete our evaluation testing and any required remediation.
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During
the course of documenting and testing our internal control procedures, in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, we may
identify other weaknesses and deficiencies in our internal control over financial reporting. In addition, if we fail to maintain the adequacy of our internal control over financial reporting, as these
standards are modified, supplemented or amended from time to time, we may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance
with Section 404 of the Sarbanes-Oxley Act of 2002. Generally, if we fail to achieve and maintain an effective internal control environment, we could suffer material misstatements in our
financial statements and fail to meet our reporting obligations, which would likely cause investors to lose confidence in our reported financial information. This could in turn limit our access to
capital markets, harm our results of operations, and lead to a decline in the trading price of our ADSs. Additionally, ineffective internal control over financial reporting could expose us to
increased risk of fraud or misuse of corporate assets and subject us to potential delisting from the stock exchange on which we list, regulatory investigations and civil or criminal sanctions.
If we fail to maintain or expand our user base, our business, financial condition and operating results may
be materially and adversely affected.
The size of our active user base with our products are critical to our success. Our portfolio products had an average of 27.7 million
DAUs in September 2020, which grew from an average of 24.7 million DAUs in December 2019. Our financial performance has been and will continue to be significantly affected by our ability to
grow and engage our active user base. As the size of our user base increases and our business enters a more mature stage of development over time, the growth rate of our user base may decline or
become flat as a result of market saturation. In addition, we may fail to maintain or increase our user base or our users' engagement if, among other things:
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we fail to innovate or develop new products and services that provide relevant content and satisfactory experience to, or are favorably
received by, our users;
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we fail to respond to or adopt evolving technologies for product development on a timely and cost-effective basis;
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we fail to successfully market and monetize our existing and new mobile applications throughout their life cycles;
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we fail to develop products that are compatible with existing or new mobile devices, mobile operating systems or their respective upgrades;
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we fail to maintain or improve our technology infrastructure and security measures designed to protect our users' personal privacy and data
security;
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we lose users to competing products and services or due to concerns related to personal privacy and data security or other reasons;
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we fail to successfully implement our strategies related to the continued expansion of our global user base; or
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we are required by existing or new laws, regulations or government policies to implement changes to our products or services that are adverse
to our business.
If
we are unable to maintain or increase our user base, our advertising services may become less attractive to our advertising customers, which may have a material and adverse impact on
our business, financial condition and operating results.
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We generate substantially all of our revenues from advertising. Our failure to attract or retain advertising
customers, or a reduction in their spending with us, could seriously harm our business, operating results and growth prospects.
We generated 98.4% and 99.4% of our revenues from mobile advertising services in 2019 and the nine months ended September 30, 2020,
respectively. Advertisers purchase advertising services either directly from us or through third-party advertising exchanges and advertising agencies. Our advertising customers, including advertisers
and advertising exchanges and agencies, typically do not have long-term contractual arrangements with us. They may be dissatisfied with our advertising services or perceive our advertising services as
ineffective. In addition, new advertising formats emerge from time to time and customer preferences can change. We may not be able to adapt our products and services to future advertising formats or
changing customer preferences on a timely and cost-effective basis.
We
compete for advertising customers not only with other providers of digital advertising spaces, but also with other types of platforms and advertising service providers such as
newspapers, magazines, billboards, television and radio stations. Some of our competitors have access to considerably greater financial and other resources for expanding their product offerings and
present considerable challenges to gaining and maintaining additional market share.
If
we fail to deliver advertising services in an effective manner, or if our advertising customers believe that placing advertisements through our products and services does not generate
a competitive return when compared to placing advertisements through our competitors' products, they may not continue to do business with us or they may only be willing to advertise with us at reduced
prices. If our existing advertising customers reduce or discontinue their advertising spending with us, or if we fail to attract new advertising customers, our business, financial condition and
results of operations could be materially and adversely affected.
We depend on certain third-party advertising exchanges and agencies for a large portion of our mobile
advertising revenues.
We generate a large portion of our mobile advertising revenues from a limited number of third-party advertising exchanges and advertising
agencies. Our top two advertising customers in 2019, which are advertising exchanges, accounted for approximately 44.65% of our total revenues for the same year. Our top advertising customers in the
nine months ended September 30, 2020 accounted for approximately 26.99% of our total revenues for the same period. Our dependence on a limited number of advertising exchange customers increases
their bargaining power and the need for us to maintain good relationships with them. The major advertising customers we work with typically offer standard terms and conditions that govern their
contractual relationships with us. In addition, our agreements with such customers generally provide for a fixed term and are not automatically renewable. For example, the ad network distribution
agreements we entered into with our top advertising customer, an advertising exchange in China, in the nine months ended September 30, 2020 for the cooperation in placing advertisements on our
mobile apps will expire on December 31, 2021. If any of these advertising customers we work with ceases to do business with us for any reason or alters its standard terms and conditions to our
disadvantage, or if we fail to collect any significant amount of account receivables from these advertising customers timely, or at all, our business, financial conditions and operating results may be
materially and adversely affected.
We
provide sales rebates to certain PRC domestic advertising agencies in order to maintain good relationships with them and to incentivize them to maximize the volume of advertising
business that they bring to us. In order to maintain the appropriate level of incentives for those advertising agencies, we may continue to incur expenses from providing such sales rebates, which
could have an adverse effect on our financial conditions and operating results.
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We rely on our business collaborations with third parties, including major digital distribution platforms and
mobile device manufacturers, to maintain and expand our user base. Our failure to maintain good relationships with these business partners may materially and adversely affect our business and
operating results.
We collaborate with various business partners to promote our products and enlarge our user base. We use third-party digital distribution
platforms such as Apple App Store, Tencent YingYongBao App Store and Google Play to distribute our mobile applications to users. We also advertise on third-party platforms, such as TikTok and
Kuaishou, to acquire users. The promotion and distribution of our mobile applications are subject to such digital distribution platforms' standard terms and policies for application developers, which
are subject to the interpretation of, and frequent changes by, these platforms. In addition, our applications may be suspended by or removed from such platforms as a result of allegations or claims by
third parties regardless of their merits. For instance, in July 2019, some of our global portfolio apps were disabled by Google from Google Play Store and Google Admob, and our access to Google Play
Store and Google Admob was disabled too. See "We have been and may continue to be subject to notices or complaints alleging, among other things, our infringement of copyrights and
delivery of illegal or inappropriate content through our products, which could lead to suspension or removal of such products from digital distribution platforms, a decrease of our user base, and a
significantly adverse impact on our financial results and our reputation." We collaborate with mobile device manufacturers for the pre-installation of TouchPal Smart Input on new mobile devices as one
way to distribute our product and to acquire users. Due to intense competition, these mobile device manufacturers may raise prices to a point where it becomes cost prohibitive for us to rely on them
for user acquisition. There can be no guarantee that they will continue to pre-install TouchPal Smart Input or will agree to pre-install any of our other mobile applications on their devices.
If
we are unable to maintain good relationships with our business partners or the business of our business partners declines, the reach of our products and services may be adversely
affected and our ability to maintain and expand our user base may decrease. Most of the agreements with our business partners, including mobile device manufacturers and digital distribution platforms,
do not prohibit them from working with our competitors or from offering competing services. If our partner distribution platforms change their standard terms and conditions in a manner that is
detrimental to our business, or if our business partners decide not to continue working with us or choose to devote more resources to supporting our competitors or their own competing products, we may
not be able to find a substitute on commercially favorable terms, or at all, and our competitive advantages may be diminished.
We have been and may continue to be subject to notices or complaints alleging, among other things, our
infringement of copyrights and delivery of illegal or inappropriate content through our products, which could lead to suspension or removal of such products from digital distribution platforms, a
decrease of our user base, and a significantly adverse impact on our financial results and our reputation.
We use third-party digital distribution platforms such as Apple App Store, Tencent YingYongBao App Store and Google Play to distribute our
mobile applications to users. In the ordinary course of our business, we and digital distribution platforms have received, and may from time to time in the future receive, notices or complaints from
third parties alleging that certain of our products infringe copyrights, deliver illegal, fraudulent, pornographic, violent, bullying or other inappropriate content, or otherwise fail to comply with
applicable policies, rules and regulations. Upon receipt of such notices or complaints, those digital distribution platforms may suspend or remove such products from such platforms. The processes for
appealing such suspensions and removals with those platforms could be time-consuming, and we cannot guarantee that our appeals will always prevail or that any such suspended or removed application
will be made available again. Such suspensions and removals of our products could lead to a decrease of our user base and, if they occur frequently and/or in a large scale, could significantly
adversely affect our reputation, business operation and financial performance.
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For
instance, in July 2019, some of our global portfolio apps were disabled by Google from the Google Play Store and Google Admob. These disabled apps were discontinued but users can
still use the relevant apps already downloaded. The suspensions and removals of our global portfolio apps could lead to the difficulty in growing or sustaining our user base and could significantly
adversely affect our reputation, business operation and financial performance in a certain period. Primarily as a result of the suspension, the DAUs of our portfolio products decreased from
27.6 million in June 2019 to 23.9 million in September 2019, and our net revenues decreased from US$37.6 million in the second quarter of 2019 to US$31.3 million in the
third quarter of 2019. In addition, our access and developer account to Google Play Store and Google Admob was disabled in the same period. Consequently, we cannot use Google push notification to
reach and activate our users, and the DAU/MAU ratio of our portfolio products decreased from 42.4% in June 2019 to 35.4% in September 2019, and further to 33.1% in December 2019. Although we have
implemented several measures to mitigate the impact, for example, by distributing our products on other digital distribution platforms, such as Tencent YingYongBao App Store, and broadening our user
acquisition channels, such as collaborating with third-party platforms in China, we cannot guarantee that these measures will be effective. In addition, these digital distribution platforms and third
party platforms may also receive, from time to time, notices or complaints from third parties alleging that certain of our products infringe copyrights, deliver illegal, fraudulent, pornographic,
violent, bullying or other inappropriate content, or otherwise fail to comply with applicable policies, rules and regulations, consequently those digital distribution platforms may suspend or remove
such products from their platforms and those third party platforms may terminate their collaboration with us.
We have significant international operations and plan to continue expanding our operations globally. We may
face challenges and risks presented by our growing global operations, which may have a material and adverse impact on our business and operating results.
We are headquartered in China and provide our products and services to a global user base. We intend to continue the international expansion of
our business operations and grow our user base globally. In September 2020, the user base of our portfolio products reached an average of 27.7 million DAUs and our users of TouchPal Smart Input
reached an average of 130.0 million DAUs, spanning more than 240 countries and regions. The headquarters of our major advertising customers are located in China and the U.S., and, therefore,
substantially all of our advertising revenues in 2019 and the nine months ended September 30, 2020 were derived from China and the U.S.
We
believe the sustainable growth of our business depends on our ability to increase the penetration of our products in both developed and emerging markets. Our continued international
operations and global expansion may expose us to a number of challenges and risks, including:
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challenges in developing successful products and implementing effective marketing strategies that respectively target mobile internet users and
advertising customers from various countries and with a diverse range of preferences and demands;
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difficulties in managing and overseeing global operations and in affording increased costs associated with doing business in multiple
international locations;
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local competition;
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difficulties in integrating and managing potential foreign acquisitions or investments;
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compliance with applicable laws and regulations in various countries worldwide, including but not limited to internet content requirements,
data security and data privacy requirements, intellectual property protection rules, exchange controls, and cash repatriation restrictions;
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fluctuations in currency exchange rates;
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political, social or economic instability in markets or regions in which we operate; and
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compliance with statutory equity requirements and management of tax consequences.
Our
business, financial condition and results of operations may be materially and adversely affected by these challenges and risks associated with our global operations.
Our product development and monetization strategies are highly dependent on our technology capabilities and
infrastructure. If the amount of user data generated on our products declines, or if we fail to enhance or upgrade our technologies at a competitive pace, the effectiveness of our business model may
be harmed, and our operating results may be materially and severely affected.
We depend on our technological capabilities and infrastructure to analyze our users' preferences and needs and to generate valuable user
insights. Active users of our products
generate a large amount of data across our applications and in a variety of use cases on a daily basis. The data generated by our users lays the foundation for us to build our user profiles. By
analyzing such user data with our big data analytics and other relevant technologies, we aim to understand our users' interests and needs for content in order to develop products that deliver relevant
content catering to their interests and needs. Therefore, the effectiveness of our product development and monetization strategies is dependent on our ability to obtain and process data and to refine
the algorithms used in processing such data. If we fail to maintain and expand the user base of our products to continually generate large amounts of user data, or if we fail to keep up with the rapid
development and upgrade of big data analytics and other relevant technologies on a timely and cost-effective basis, we may not be able to effectively grow and monetize our products, and our business
and operating results may be materially and adversely affected.
We may not be able to sustain our historical growth and maintain the effectiveness of our monetization.
We have grown significantly over a relatively short period. We have experienced rapid growth of the number of DAU and MAU of our portfolio
products. At the same time, our net revenues grew rapidly from US$37.3 million in 2017 to US$134.1 million in 2018, and further to US$177.9 million in 2019. Our net revenues
increased from US$108.9 million in the nine months ended September 30, 2019 to US$339.1 million in the nine months ended September 30, 2020. Our advertising revenue
increased from US$35.0 million in 2017 to US$131.3 million in 2018, and further increased to US$175.0 million in 2019. Our advertising revenue increased from
US$106.6 million in the nine months ended September 30, 2019 to US$337.0 million in the nine months ended September 30, 2020. We may not be able to sustain a rate of growth
in future periods similar to what we experienced in the past.
In
addition, growing our revenue in the future depends on successfully building our global products besides TouchPal Smart Input. We monetize our user base primarily through mobile
advertising. Advertising revenue derived from our portfolio products have accounted for approximately 20%, 63%, 85%, 77% and 99% of our total advertising revenue in 2017, 2018, 2019 and the nine
months ended September 30, 2019 and 2020, respectively. Most of the advertising revenues were generated from our portfolio products in 2019 and the nine months ended September 30, 2020
attributable to the rapid growth of our portfolio products. We launched our in-house developed advertising platform, CooTek Ads, to provide high-quality and tailored advertising services in 2019. If
we are unable to build new products which are attractive to users, our ability to effectively monetize our advertising services and grow our revenues may be materially impacted.
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If we fail to correctly anticipate user preferences and develop and commercialize new products and services,
we may fail to attract or retain existing users, the lifecycles of our mobile applications may end prematurely, and our operating results may be materially and adversely affected.
Our success depends on our ability to maintain, grow and monetize our user base, which in turn depends on our ability to continually develop and
commercialize new mobile applications, introduce new features or functions to our existing mobile applications and provide users with high-quality content and an enjoyable user experience. This is
particularly important since the mobile internet industry is characterized by fast and frequent changes, including rapid technological evolution, shifting user demands, frequent introductions of new
products and services, and constantly evolving industry standards, operating systems and practices. We launched our first mobile application, TouchPal Smart Input, in 2008, and have launched over 40
content-rich portfolio products as of September 30, 2020. In September 2020, the user base of our portfolio products reached an average of 27.7 million DAUs, and we intend to continue
developing new products and services to attract more users who match our targeted profiles in the future. Our ability to roll out new or enhanced products and services depends on a number of factors,
including timely and successful research and development efforts by us as well as correctly analyzing and predicting users' interests and demands for content using our big data analytical
capabilities. If we fail to correctly analyze and predict users' interests and demands for content, fail to cater to the anticipated needs and preferences of users, or fail to provide a superior user
experience, our existing and new mobile applications may suffer from reduced user traffic or be unsuccessful in the market and our user base may decrease which in turn may impact our ability to earn
advertising revenue. There can be no assurance that our new products and services will generate revenues or profits and we may not be able to recoup the investments and expenditures involved in such
development. Our interim results may also experience significant fluctuations as we continue to invest in the development of new products and services.
In
addition, as a result of rapidly evolving user preferences, our existing mobile applications may reach the end of their lifecycles prematurely. There can be no assurance that we will
be able to correctly predict the lifecycles of our new mobile applications, our estimates regarding the lifecycles of our existing mobile applications may turn out to be incorrect, and our business,
financial condition and results of operations may be materially and adversely affected.
Non-compliance on the part of third parties with whom we conduct business could disrupt our business and
adversely affect our financial conditions and operating results.
We may be implicated by the non-compliant or improper activities of our users, advertising customers and business partners. For example, we may
be involved in litigation related to user-generated content uploaded to our mobile applications. See also "We may be held liable for information or content displayed on, distributed by,
retrieved from or linked to the mobile applications integrated into our products, which may adversely impact our brand image and materially and adversely affect our business and operating results."
Similarly, we may also be subject to disputes related to advertisements displayed on our mobile applications. Although we have adopted a
comprehensive internal control and screening procedure over the content of advertisements, a third party may find advertisements displaying on our mobile applications improper or illegal, and may take
actions against us over such advertisements. As of December 31, 2020, our bank accounts with a total balance of US$21.6 million were frozen by a local authority in connection with an
ongoing investigation of alleged illegal advertisements posted by certain third-party advertisers on our platform. To facilitate the investigation, bank accounts through which our transactions with
such advertisers took place were frozen by the local authority. In addition, we incurred costs of US$1.6 million to compensate victims of the alleged illegal advertisements for our failure to
supervise advertising contents displayed on our platform in compliance with relevant PRC laws and regulations.
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In
addition, we may be impacted by lawsuits against our business partners, such as mobile devices manufacturers that have contractual arrangements with us. Although we have no control
over the design, system, network or standard of the manufacturing of smartphones by these business partners, any lawsuits against them claiming infringement of intellectual property and any cessation
of handset production resulting from such lawsuits may interrupt our collaborative operations and result in the reduction of our delivery of products and services to potential users.
Our advertising services may display advertisements when our products are in use, or insert promoted
marketing messages into users' feeds, which may negatively affect user experience and may lead to a decline in user engagement and, in turn, a reduction in revenues generated from our advertising
services.
We primarily generate revenues by distributing advertisements to targeted audience through our products. Advertisements are displayed in various
formats when users launch or exit our products, in our theme stores or in-app stores, and in customized news feeds, among others. It is important for us to balance the frequency, prominence, size and
content of advertisements that we display against ensuring a favorable user experience of our products. If our users find the advertisements displayed irrelevant, disturbing or negatively affecting
their user experience of our products, they may become less engaged or stop using our products altogether. Furthermore, if advertisements contain controversial, false or misleading content, or the
marketing messages we display or the products or services we advertise result in negative emotions or associations in our users, the user experience of our products could be diminished, our financial
results could suffer and our reputation could be damaged. If we are unable to deliver advertisements in a way that is acceptable or favorable to our users, our users may not maintain the current level
of engagement, and our advertising customers may perceive our advertising services as ineffective in generating a competitive return for them. As a result, our revenues may decline and our business,
financial conditions and operating results may be materially and adversely affected.
Data privacy concerns relating to our products and current practices may, particularly in light of increased
regulatory scrutiny of and user expectations regarding the processing, collection, use, storage, dissemination, transfer and disposal of user data, require changes to our business practices and may
result in declines in user growth or engagement, increased costs of operations and threats of lawsuits, enforcement actions and related liabilities, including financial penalties.
Recently, companies' practices regarding collection, use, retention, transfer, disclosure and security of user data have been, and continue to
be, the subject of enhanced regulations and increased public scrutiny. The regulatory frameworks regarding privacy issues in many jurisdictions are constantly evolving and can be subject to
significant changes from time to time, and therefore we may not be able to comprehensively assess the scope and extent of our compliance responsibility at a global level. Moreover, certain of our
users, particularly those in the United States and Europe, may have strong expectations for the level of privacy afforded to their personal data and the content of their communications. Further, the
developing requirements around clear and prominent privacy notices (including in the context of obtaining informed and specific consent to the collection and processing of personal data, if
applicable) can potentially deter users from consenting to certain uses of their personal information. In general, negative publicity of us or our industry regarding actual or perceived violations of
our users' privacy-related rights may also impair users' trust in our privacy practices and make them reluctant to give their consent to share their data with us.
Many
jurisdictions, including China and the U.S., continue to consider the need for greater regulation or reform to the existing regulatory framework. In the U.S., all 50 states have now
passed laws to regulate the actions that a business must take in the event of a data breach, such as prompt disclosure and notification to affected users and regulatory authorities. In addition to the
data breach notification laws, some states have also enacted statutes and rules requiring businesses to reasonably
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protect
certain types of personal information they hold or to otherwise comply with certain specified data security requirements for personal information. Additionally, the U.S. federal and state
governments will likely continue to consider the need for greater regulation aimed at restricting certain uses of personal data for targeted advertising. California recently enacted the California
Consumer Privacy Act, or CCPA, which creates new individual privacy rights for consumers (as that word is broadly defined in the law) and places increased privacy and security obligations on entities
handling personal data of consumers or households. The CCPA, which went into effect on January 1, 2020, requires covered companies to provide new disclosures to California consumers, and
provides such consumers new ways to opt-out of certain sales of personal information. The CCPA provides for civil penalties for violations, as well as a private right of action for data breaches that
is expected to increase data breach litigation. The CCPA may increase our compliance costs and potential liability. Some observers have noted that the CCPA could mark the beginning of a trend toward
more stringent privacy legislation in the U.S., which could increase our potential liability and adversely affect our business.
In
the European Union, or EU, the General Data Protection Regulation, or GDPR, which came into effect on May 25, 2018, increased our burden of regulatory compliance and requires
us to change certain of our privacy and data security practices in order to achieve compliance. The GDPR applies to any company established in the EU as well as any company outside the EU that
processes personal data in connection with the offering of goods or services to individuals in the EU or the monitoring of their behavior. The GDPR implements more stringent operational requirements
for processors and controllers of personal data, including, for example, requiring expanded disclosures about how personal information is to be used, limitations on retention of information, mandatory
data breach notification requirements, and higher standards for data controllers to demonstrate that they have obtained either valid consent or have another legal basis in place to justify their data
processing activities. The GDPR further provides that EU member states may make their own additional laws and regulations in relation to certain data processing activities, which could further limit
our ability to use and share personal data and could require localized changes to our operating model. Under the GDPR, fines of up to 20 million euros or up to 4% of the total worldwide annual
turnover of the preceding financial year, whichever is higher, may be assessed for noncompliance, which significantly increases our potential financial exposure for non-compliance. However, with
limited precedence on the interpretation and application of GDPR and limited guidance from EU regulators, the application of GDPR to the provision of internet services remains unsettled. We have
adopted policies and procedures in compliance with the GDPR, however, such policies and procedures may need to be updated when additional information concerning the best practices is made available
through guidance from regulators or published enforcement decisions.
Finally,
in China, the PRC Cybersecurity Law, which became effective in June 2017, leaves substantial uncertainty as to the circumstances and standard under which the law would apply and
violations would be found.
Outside
of the U.S. and the EU, many jurisdictions have adopted or are adopting new data privacy and data protection laws that may impose further onerous compliance requirements, such as
data localization, which prohibits companies from storing data relating to resident individuals in data centers outside the jurisdiction. The proliferation of such laws within jurisdictions and
countries in which we operate may result in conflicting and contradictory requirements.
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In order for us to maintain or become compliant with applicable laws as they come into effect, it may require substantial expenditures on resources to continually
evaluate our policies and processes and adapt to new requirements that are or become applicable to us. Complying with any additional or new regulatory requirements on a jurisdiction-by-jurisdiction
basis would impose significant burdens and costs on our operations or may require us to alter our business practices. While we strive to protect our users' privacy and data security and to comply with
material data protection laws and regulations applicable to us, it is possible that our practices are, and will continue to be, inconsistent with certain regulatory requirements. Our international
business expansion could be adversely affected if these laws and regulations are interpreted or implemented in a manner that is inconsistent with our current business practices or that requires
changes to these practices. In particular, the large amount of user data generated on and collected from our products has been, and will continue to be, critical for our business model, including to
enable us to understand our users' interests and demands for content, improve their user experience with our products and services and deliver targeted advertising. Therefore, if these laws and
regulations materially limit our ability to collect and use our users' data, our ability to continue our current operations without modification, develop new services or features of the products and
expand our user base will be impaired. Any failure or perceived failure by us to comply with applicable data privacy laws and regulations, including in relation to the collection of necessary end-user
consents and providing end-users with sufficient information with respect to our use of their personal data may result in fines and penalties imposed by regulators, governmental enforcement actions
(including enforcement orders requiring us to cease collecting or processing data in a certain way), litigation and/or adverse publicity. Proceedings against us, regulatory, civil or
otherwise, could force us to spend money and devote resources in the defense or settlement of, and remediation related to, such proceedings. Furthermore, any of the foregoing consequences could damage
our reputation and discourage current and potential users from using our mobile applications. In addition, as users' expectations and regulatory attitudes with respect to personal privacy and data
security continue to evolve, future regulations on the extent to which personal information and user-generated data can be used by us or shared with third parties may adversely affect our ability to
leverage and derive economic value from the data that our users generate and share with us, which may limit our ability to carry out targeted advertising and thereby result in a decline in the mobile
advertising revenues upon which our revenues are dependent.
If we fail to obtain or maintain the requisite licenses and approvals, or otherwise fail to comply with the
rules and regulations applicable to our business operations in and outside China, or if we are required to apply for new licenses and approvals which are time-consuming or costly to obtain, our
business and operating results may be materially and adversely affected.
We are incorporated in the Cayman Islands and our corporate affairs are governed by our memorandum and articles of association, the Companies
Act (As Revised) of the Cayman Islands and the common law of the Cayman Islands. We primarily conduct our business through our subsidiaries and consolidated affiliated entities incorporated in
mainland China and Hong Kong. However, because our products and services are used worldwide, one or more other jurisdictions may claim that we are required to comply with their laws based on the
location of our offices and staff, commercial operations, equipment or our users.
The
internet industry, including the mobile internet industry, is highly regulated in China. Our VIEs are required to obtain and maintain applicable licenses and approvals from different
regulatory authorities in order to provide their current services to our users. In addition to PRC laws and regulations, we face additional regulatory risks and costs outside of China as a portion of
our active users and revenues are from markets outside of China. We are subject to a variety of laws and regulations in China and foreign jurisdictions that involve matters central to our business,
including but not limited to privacy and data protection, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion,
national security, electronic contracts
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and
other communications, competition, consumer protection, telecommunications, taxation, and economic or other trade prohibitions or sanctions. The introduction of new products, services or expansion
of our business in certain jurisdictions may subject us to additional laws and regulations. Furthermore, PRC and foreign laws and regulations are constantly evolving and can be subject to significant
change from time to time. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving mobile
internet industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. There can be no assurance
that we will not be found in violation of any future laws and regulations or violation of any of the laws and regulations currently in effect due to changes in the relevant authorities' implementation
or interpretation of such laws and regulations.
Under
the current PRC regulatory scheme, a number of regulatory agencies, including but not limited to the State Administration of Radio and Television (previously known as the State
Administration of Press, Publication, Radio, Film and Television, or the SAPPRFT), or the SART, the Propaganda Department of the Central Committee of the Communist Party of China, or the NAPP, the
Ministry of Culture and Tourism (previously known as the Ministry of Culture, or the MOC), or the MCT, the Ministry of Industry and Information Technology, or the MIIT, the State Council Information
Office, or the SCIO, and the Cyberspace Administration of China, or the CAC, jointly regulate all major aspects of the internet industry, including mobile internet businesses. Operators in this
industry must obtain various government approvals and licenses for relevant internet or mobile business.
If
we fail to obtain or maintain any of the required licenses or approvals, make any necessary filings, or otherwise fail to comply with the applicable laws and regulations, we may be
subject to various penalties, such as confiscation of revenues that were generated through the unlicensed internet or mobile activities, the imposition of fines and the discontinuation or restriction
of our operations. Any such penalties may disrupt our business operations and materially and adversely affect our business, financial condition and operating results.
The
operation of our TouchPal Phonebook in China may require additional licenses and failure to obtain such licenses could subject us to severe penalties. We have obtained the
value-added telecommunications service business operation license, or VAT License, with a service scope of information services, domestic multiparty communication services and domestic call center
business. According to the PRC Telecommunications Regulations and other relevant laws and regulations, we may be required to obtain a basic telecommunications business service business operating
license for our services to facilitate calls between users of the application and other mobile phone devices through internet and telecommunication network. Although we terminated the operation of our
international VoIP product in March 2019, according to the Administrative penalty Law of the People's Republic of China, an administrative penalty could be imposed within two years from the date the
illegal act is terminated. Our TouchPal Phonebook also delivers personalized content to users, including news and videos. According to the Administrative Provisions for the Internet Audio-Video
Program Service jointly issued by the SAPPRFT and the MIIT in 2007 and amended in August 2015, we may be required to obtain the internet audio-video program transmission license for displaying videos
in TouchPal Phonebook. According to the Administrative Regulations for Internet News Information Services promulgated by the CAC in 2017, we may be required to obtain the internet news information
service license for dissemination of political and other news.
The
operations of our online literature mobile apps and casual game mobile apps may require us to apply for additional license and permits or to update our existing licenses and permits.
According to the Provisional Regulations for the Administration of Online Culture issued by the MCT in 2011 and as amended in 2017, we may be required to amend our current Online Culture Operating
Permit for
the provision of e-books and online games. Under regulations issued by the SAPPRFT, the publication of each online game requires approval from the SAPPRFT. As of the date of this prospectus
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supplement,
we have not obtained approvals from the SAPPRFT or its successor for those domestic online games operated by us. After the re-organization of SAPPRFT, we will apply with the NAPP for the
approvals for publishing our games in the future. The NAPP at the national level had suspended the approval of game registration and issuance of publication codes for online games starting from March
2018. Although the NAPP later resumed game registration and issued game publication codes for the first batch of games with an effective date of December 19, 2018, the issuance of publication
is still difficult to be obtained. Any delay in game registration with NAPP or obtaining game publication codes could negatively affect the operation results of our games. Pursuant to the Notice to
Adjust the Scope of Online Culture Operation License Approval and to Further Regulate the Approval Work released in May 2019, the MCT no longer assumes the responsibility to regulate online game
industry, and the provincial counterparts of MCT would no longer grant Online Culture Operation License covering the business scope of using the information network to operate online games. However,
the licenses granted by the MCT before this notice will remain valid until the expiration dates of these licenses. On July 23, 2019, the MCT announced the abolishment of the Interim Measures on
Administration of Online Games, which regulated the issuance of Online Culture Operation Licenses relating to online games. As of the date of this prospectus supplement, the governmental authorities
have not issued laws or regulations to replace the Interim Measures on Administration of Online Games, or to clarify the new regulatory body of online games. If we are unable to comply with the new
renewal procedures relating to our Online Culture Operating License, our ability to introduce, launch and operate new games may be adversely affected, and our financial condition and operating results
could be adversely affected. In addition, we cannot assure you that we can obtain the NAPP's approvals or complete the filings with the MCT for all games operated by us in a timely manner or at all,
which could adversely and materially impact our ability to introduce new games, the timetable to launch new games and our business growth.
Moreover,
the provisions of online games and online literature are deemed to be internet publication activities. According to the Administrative Measures for Internet Publication
Services jointly issued by the SAPPRFT and the MIIT in 2016, we may be required to obtain an internet publication service license for the provisions of online games and online literature. According to
the Notice on Administration of Mobile Game Publishing Services issued by the SAPPRFT in 2016, we may be required to obtain publishing and authorization codes for the online games. As of the date of
this prospectus supplement, we have not obtained the approval for our internet publication service license and publication codes for those domestic online games operated by us. In the event of failure
to obtain these licenses and approvals, an operator may face heavy penalties, such as being ordered by the regulatory authority to shut down services and delete all relevant internet publications. The
regulatory authority may also confiscate all of such operator's illegal income as well as major equipment and specialized tools used in illegal publishing activities. If the illegal income exceeds
RMB10,000, such operator may face a fine of five to ten times of such illegal income; and if the illegal income is less than RMB10,000, such operator may face a fine of less than RMB50,000. Such
operator may also bear civil liability if its operation has infringed on other persons' legal rights and interests.
Furthermore,
in August 2018, the National Office of Anti-Pornography and Illegal Publication, the MIIT, the Ministry of Public Security, the MCT, the SART and the CAC jointly issued the
Notice on Strengthen the Management of Live Streaming Service, which required a real-name registration system for users to be put in place by live streaming service providers. On October 25,
2019, the NAPP issued the Notice on Preventing Minor's Addiction to Online Games, which requires all online gamers to register accounts with their valid identity information and all game companies to
stop providing game services to users who fail to do so. We plan to implement several measures to comply with the current real-name registration system. However, the PRC government may further tighten
the real-name registration requirements or require us to implement a more thorough compulsory real-name registration system for all users on our platform in the future, in which case we will need to
upgrade our system or purchase relevant services from third party service providers and incur additional costs in
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relation
thereto. If we were required to implement a more rigid real-name registration system for users on our platform, potential users may be deterred from registering with our platform, which may
in turn negatively affect the growth of our user base and business prospects.
Our
international VoIP product may be subject to laws, regulations and policies related to internet communications of multiple jurisdictions. These laws, regulations and policies may not
specifically address the issues related to internet and its related technologies, and their interpretation and application remain largely uncertain. The laws, regulations and policies in certain
countries may restrict the use of VoIP products, block access to such products or impose extensive regulatory requirements on operations of such products. We cannot be certain that we are in
compliance with regulatory or legal requirements in the numerous countries in which such product is available for download and use. Regulators may disagree with our interpretations of existing laws or
regulations or the applicability of such laws or regulations to our business, or they may alter their view of the products and services we provide, due to a change in laws or regulations or a change
in the interpretation of existing laws or regulations or otherwise. Our failure to comply with existing or future regulatory requirements could materially and adversely affect our business, financial
condition and operating results. We terminated the operation of our international VoIP product since March 2019.
If we fail to prevent security breaches, cyber-attacks or other unauthorized access to our systems or our
users' data, we may be exposed to significant consequences, including legal and financial exposure and loss of users, and our reputation, business and operating results may be materially and adversely
affected.
We collect, store, transmit and process a large volume of personal and other sensitive data generated by our users through their interactions
with our products. Although we have taken various security measures and adopted robust internal policies to protect our users' personal
privacy and data security, we may nevertheless be exposed to risks of security breaches or unauthorized access to or cyber-attacks on our systems or the data we store. Given the size of our user base,
and the types and volume of personal data on our systems, we believe that we may be a particularly attractive target for security breaches and cyber-attacks. Our efforts to protect our data may be
unsuccessful due to software "bugs", system errors or other technical deficiencies, mistakes or malfeasance of our employees or contractors, vulnerabilities of our vendors and service providers, or
other cybersecurity-related vulnerabilities. Any failure to prevent or mitigate security breaches, cyber-attacks or other unauthorized access to our systems or disclosure of our users' data, including
personal information, could result in loss or misuse of such data, interruptions to the services we provide, diminished user experience, loss of user confidence and trust in our products, impairment
of our network and technological infrastructure, and harm to our reputation and business, significant legal and financial exposure and potential lawsuits brought by private individuals or regulators.
We have invested and will continue to devote resources to maintain strong security protections that shield our systems and our users' data against bugs, theft, misuse or security vulnerabilities or
breaches. Although we have developed systems and processes that are designed to prevent and detect security breaches and protect our users' data, we cannot guarantee that such measures will be
sufficient defenses against the evolving techniques used to obtain unauthorized access, disable or degrade services or sabotage systems. In addition, as our data centers and servers are dispersed
around the world, we may incur significant costs in protecting them against, or remediating, security breaches and cyber-attacks.
Our products and internal systems rely on software that is highly technical, and if it contains undetected
errors or vulnerabilities, our business could be adversely affected.
Our products and internal systems rely on numerous proprietary and licensed software that is highly technical and complex. In addition, our
products and internal systems depend on the ability of certain software to encrypt, store, retrieve, process, and manage large amounts of data. The software on which we rely now or in the future may
contain undetected errors, bugs, or vulnerabilities that may
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not
be discovered until after the relevant source code is released and examined. Errors, vulnerabilities, or other design defects within the software on which we rely may result in a negative
experience for users of our products, delay product introductions or enhancements, compromise our ability to protect the data of our users and/or our intellectual property or lead to reductions in our
ability to provide some or all of our services. In addition, any errors, bugs, vulnerabilities, or defects discovered in the software on which we rely, and any associated degradations or interruptions
of service, could result in damage to our reputation, loss of users, loss of revenue, or liability for damages, any of which could materially and adversely affect our business and operating results.
The industry in which our business operates is highly competitive. If we fail to compete effectively, our
business will suffer.
We face intense competition in every aspect of our business, including competition for users, usage time, advertising customers, technology, and
highly-skilled employees. Our portfolio products compete with applications of the same or a similar kind. Our TouchPal Smart Input competes primarily with default mobile device input methods,
including Gboard, Samsung mobile keyboard and Apple's default mobile device input method, as well as other alternative input method products for mobile devices that offer similar language prediction
capabilities and other smart features, such as Microsoft/SwiftKey. In addition, we compete with all major internet companies for user attention and advertising spend.
We
compete with other developers of mobile applications for users, usage time and advertising customers on the basis of quality, features, availability and ease of use of products and
services, and the number and quality of advertising distribution channels. We also compete with other developers for talented employees with technological expertise that is crucial for the sustained
development of successful products and services. Our competitors may operate with more efficient business models and cost structures. They may prove more adaptable to new technological and other
market developments than we are. Many of our competitors are larger and more established companies and may have significantly more financial, technological, marketing and other resources than we do
and may be able to devote greater resources to the development, promotion, sales and support of their products and services. They may allow our competitors to respond to new or emerging technologies
and changes in market requirements better than we can. Our competitors may also develop products, features, or services that are similar to ours or that achieve greater market acceptance. These
products, features, and services may undertake more far-reaching and successful product development efforts or marketing campaigns. As a result, our competitors may acquire and engage users at the
expense of our user growth or engagement, which may seriously harm our business. If we cannot effectively compete, our user engagement may decrease, which could make us less attractive to users,
advertisers and seriously harm our business and have a material and adverse impact on our business, operating results and growth potential.
Our mobile applications are mainly designed for Android operating systems. A decrease in the popularity of
Android operating systems may materially and adversely affect our business and operating results.
Our business is dependent on the compatibility of our products with popular mobile operating systems that we do not control, including Android
and iOS operating systems. Most of our mobile applications are designed to operate on the Android operating system. Any significant decline in the overall popularity of the Android ecosystem or
Android devices could materially and adversely affect the demand for, and revenues generated from, our mobile applications. There can be no assurance that the Android ecosystem will grow in the future
and at what growth rate. Another operating system for mobile devices may replace Android and decrease its popularity, especially considering the constantly evolving nature of the mobile internet
industry. To the extent that our
mobile applications continue to mainly support Android devices, our mobile business could be vulnerable to any decline in popularity of the Android operating system or Android devices. In addition,
any changes, bugs, or technical issues
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in
Android operating system may degrade our products' functionality and limit our ability to deliver, target, or measure the effectiveness of ads, or to charge fees related to our delivery of ads,
which may have an adverse impact on our business and operating results.
User growth and engagement depend upon effective interoperation of our products with mobile devices,
operating systems and standards that we do not control.
Our products and services are available across a variety of mobile devices and mobile operating systems. In order to deliver high quality
products and services to a broad spectrum of mobile internet users, it is important for our products and services to work well with a range of mobile devices, operating systems, networks and standards
that we do not control, including Android and iOS operating systems. Any changes in such devices or operating systems that degrade the functionality of our products and services would affect our
users' experience with our products. If we fail to develop relationships with the key participants in the mobile internet industry and mobile advertising industry, or if we fail to maintain the
effective interoperation of our products and services with these mobile devices, operating systems, networks and standards, our user growth and user engagement could be harmed, and our business and
operating results could be adversely affected.
We may be held liable for information or content displayed on, distributed by, retrieved from or linked to
the mobile applications integrated into our products, which may adversely impact our brand image and materially and adversely affect our business and operating results.
We may display third-party content, such as videos, pictures, books, articles and other works, on our mobile applications without the explicit
consent from such third party, and we may further explore market opportunities in the content-related business. Our users may misuse our products to disseminate content that contains inappropriate,
fraudulent or illegal information or that infringes the intellectual property rights of third parties. We have implemented control measures and procedures to detect and block inappropriate, fraudulent
or illegal content uploaded to or disseminated through our products, particularly those that violate our user agreements or applicable laws and regulations. However, such procedures may not be
sufficient to block all such content due to the large
volume of third-party content. Despite the procedures and measures we have taken, if the content displayed on our products are found to be fraudulent, illegal or inappropriate, we may suffer a loss of
users and damage to our reputation. In response to any allegations of fraudulent, illegal or inappropriate activities conducted through our mobile applications or any negative media coverage about us,
government authorities may intervene and hold us liable for non-compliance with laws and regulations concerning the dissemination of information on the internet and subject us to administrative
penalties or other sanctions, such as requiring us to restrict or discontinue certain features and services provided by our mobile applications or to temporarily or permanently disable such mobile
applications. If any of such events occurs, our reputation and business may suffer and our operating results may be materially and adversely affected.
We may not be able to prevent unauthorized use of our intellectual property, which could harm our business
and competitive position.
We regard our patents, copyrights, trademarks, trade secrets, and other intellectual property as critical to our business. Unauthorized use of
our intellectual property by third parties may adversely affect our business and reputation. We rely on a combination of intellectual property laws and contractual arrangements to protect our
proprietary rights. It is often difficult to register, maintain, and enforce intellectual property rights in countries with less developed regulatory regimes or inconsistent and unreliable enforcement
mechanisms. Sometimes laws and regulations are subject to interpretation and enforcement and may not be applied consistently due to the lack of clear guidance on statutory interpretation. In addition,
our contractual agreements may be breached by our counterparties, and there may not be adequate remedies available to us for any such breach. Accordingly, we may not be
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able
to effectively protect our intellectual property rights or to enforce our contractual rights in China and other jurisdictions in which we operate. Detecting and preventing any unauthorized use of
our intellectual property is difficult and costly and the steps we have taken may be inadequate to prevent infringement or misappropriation of our intellectual property. In the event that we resort to
litigation to enforce or protect our intellectual property rights, such litigation could result in substantial costs and a diversion of our managerial and financial resources. We can provide no
assurance that we will prevail in such litigation. In addition, our trade secrets may be leaked or otherwise become available to, or be independently discovered by, our competitors.
We may be subject to intellectual property infringement lawsuits which could be expensive to defend and may
result in our payment of substantial damages or licensing fees, disruption to our product and service offerings, and reputational harm.
The success of our business relies on the quality of our products, which in turn depends on the underlying software and related technology, such
as big data analytics. The protection of such software and related technologies primarily relies on intellectual property rights including patents and trade secrets. Meanwhile, for the purpose of our
business expansion, we may from time to time display third-party content, such as videos, pictures, books, articles and other works, on our mobile applications without acquiring the explicit consent
from such third party. Third parties, including our competitors, may assert claims against us for alleged infringements of their patents, copyrights, trademarks, trade secrets and internet content.
For
instance, in June 2019, a third-party company in China brought a lawsuit against Shanghai Chubao in Shanghai Intellectual Property Court for patent infringement. The plaintiff
alleged that TouchPal Phonebook infringed its patent of IP telephone system and communication method, and claimed for stopping the usage of this involved patent and acts of using, offering to sell and
selling the involved product according to the involved patent, disabling the involved product from app stores, and compensation of RMB3,000,000. The lawsuit was voluntarily withdrawn by the plaintiff.
In addition, in May 2019, a third-party company in China brought a lawsuit against Shanghai Chubao and Shanghai Chule in Shanghai Intellectual Property Court for design patent infringement. The
plaintiff alleged that TouchPal Smart Input infringed its design patent of an input method, and claimed for stopping the infringement and compensation of RMB1,000,000. We recorded a one-time
litigation reserve of RMB500,000 in the third quarter of 2019. The plaintiff's claim has not been litigated. While we believe that the claims against us in these litigations are without merit and
intend to defend the action vigorously, we cannot assure you that these lawsuits will be ultimately resolved in our favor.
The
lengthy application procedures of software-related patents may lead to uncertainty on our intellectual property rights to our self-developed software because it increases the
likelihood that there are pending patent applications whose priority dates pre-date the development of our own software that is identical or substantially similar to the software subject of the
pending patent application. We have been subject to patent disputes, and expect that we may increasingly be subject to patent infringement claims as our products and monetization model expand in
market share, scope and complexity. Claims have been threatened and brought against us for alleged copyright or trademark infringements based on the nature and content of information that is generated
by us or by third parties, including our users, and posted in our products. In addition, we may in the future be subject to domestic or international actions alleging that certain content we have
generated or third-party content that we have made available within our products and services violates the applicable laws in China or other jurisdictions.
Intellectual
property claims against us, whether meritorious or not, are time consuming and costly to resolve, could divert management attention away from our daily business, could
require changes of the way we do business or develop our products, could require us to enter into costly royalty or licensing agreements or to make substantial payments to settle claims or satisfy
judgments, and could
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require
us to cease conducting certain operations or offering certain products in certain areas or generally. We do not conduct comprehensive patent searches to determine whether the technologies used
in our products infringe upon patents held by others. In addition, product development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent
applications pending, many of which are confidential when filed, with regard to similar technologies. While we believe that our products do not infringe in any material respect upon any intellectual
property rights of third parties, we cannot be certain that this is the case.
In
addition, in any potential dispute involving our patents or other intellectual property, our advertising customers and business partners could also become the target of litigation. We
have certain contractual obligations to indemnify our advertising customers and the mobile device manufacturers that pre-install our products on their devices for liability that they may incur based
on third-party claims of intellectual property infringement for the use of our products or technology. Many of our collaboration contracts with mobile device manufacturers provide for a cap on our
indemnity obligations. In addition, in the event of any such claims, our advertising customers or business partners may decide not to use our products in the future, which could harm our financial
condition and operating results. For example, one mobile device manufacturer that pre-installs input methods on its mobile devices, including our TouchPal Smart Input under a license agreement with
us, was sued by a multinational company in the United States in 2015. The plaintiff alleged that, among others, certain features of the input methods installed on the mobile devices produced and sold
by the defendant infringed on the plaintiff's input-related patent. In late 2016, a third party requested that the Patent Trial and Appeal Board of the United States Patent and Trademark Office, or
PTAB, to initiate inter parties review (IPR) proceedings against the input-related patent claim of the plaintiff and to invalidate such patent. The IPR request has been granted by the PTAB in 2016 and
another third party joined the IPR proceedings as a petitioner in 2017. On September 26, 2018, the PTAB issued the final written decision affirming the patentability of all challenged claims of
this patent. The third party then appealed on January 6, 2020, and the Court of Appeals for the Federal Circuit made an opinion, concluding that the plaintiff's claims of the related patents
are not patentable and the PTAB's decision is reversed. The plaintiff and the defendant have executed a final, binding settlement agreement thereafter. As of the date of this prospectus supplement, we
have not received the request to indemnify this mobile device manufacturer in relation to this proceeding.
Finally,
we may also face infringement claims from the employees, consultants, agents and outside organizations we have engaged to develop our technology. While we have sought to protect
ourselves against such claims through contractual means, there can be no assurance that such contractual provisions are adequate, and any of these parties might claim full or partial ownership of the
intellectual property in the technology that they were engaged to develop for us.
Pending or future litigation could have a material and adverse impact on our financial condition and
operating results.
We have been, and may continue to be, subject to lawsuits brought by our competitors, individuals, or other entities against us. For example, in
June 2020, a mobile device manufacturer sued us for unfair competition, alleging that one of our mobile applications has interfered with the normal use of their devices by ways of pop-up
advertisements, and claimed for stopping the act and compensation of RMB4,900,000. No conclusive judicial decision has been made with respect to the lawsuit. We may also in the future be involved in
legal proceedings between us and the mobile device manufactures who had contractual arrangements with us with respect to the pre-installation of our products on their mobile devices. In addition, we
have been involved in lawsuits brought by our competitors alleging the infringement of intellectual property from time to time. See "We may be subject to intellectual property
infringement lawsuits which could be expensive to defend and may result in our payment of
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substantial
damages or licensing fees, disruption to our product and service offerings, and reputational harm."
Where
we can make a reasonable estimate of the liability relating to pending litigation against us and can determine that an adverse liability resulting from such litigation is probable,
we record a related contingent liability. As additional information becomes available, we assess the potential liability and revise estimates as appropriate. However, due to the inherent uncertainties
relating to litigation, the amount of our estimates may be inaccurate, in which case our financial condition and results of operation may be adversely affected. In addition, the outcomes of actions we
institute may not be successful or favorable to us. Lawsuits against us may also generate negative publicity that significantly harms our reputation, which in turn may adversely affect our user base
and adverting customer base. In addition to the related cost, managing and defending litigation and related indemnity obligations can significantly divert our management's attention from operating our
daily business. We may also need to pay damages or settle lawsuits with substantial amounts of cash, which may adversely affect our cash flow and financial conditions. While we do not believe that any
currently pending proceedings are likely to have a material adverse effect on our business, financial condition, results of operations, and cash flows, if there were adverse determinations in legal
proceedings against us, we could be required to pay substantial monetary damages or to materially alter our business practices, which could have an adverse effect on our financial condition and
results of operations, and cash flows.
Some of our mobile applications contain open source software, which may pose risks to our proprietary
software.
We use open source software in our products and services and expect to continue to use open source software in the future. The terms of many
open source licenses to which we are subject have not been interpreted by U.S. or foreign courts, and there is a risk that such licenses could be construed in a manner that imposes unanticipated
conditions or restrictions on our ability to sell or distribute our mobile applications. Additionally, we may from time to time face threats or claims from third parties claiming ownership of, or
demanding release of, the alleged open source software or derivative works we developed using such software, which could include our proprietary source code, or otherwise seeking to enforce the terms
of the applicable open source license. These threats or claims could result in litigation and could require us to make our source code freely available, purchase a costly license or cease offering the
implicated mobile applications unless and until we can re-engineer them to avoid infringement. Such a re-engineering process could require significant additional research and development resources,
and we may not be able to complete it successfully. In addition to risks related to license requirements, our use of certain open source software may lead to greater risks than use of third-party
commercial software, as open source licensors generally do not provide warranties or controls on the origin of the software. Additionally, because any software source code we contribute to open source
projects is publicly available, our ability to protect our intellectual property rights with respect to such software source code may be limited or lost entirely, and we are unable to prevent our
competitors or others from using such contributed software source code. Any of these risks could be difficult to eliminate or manage and, if not addressed, could adversely affect our business,
financial condition and operating results.
Any financial or economic crisis, or perceived threat of such a crisis may materially and adversely affect
our business, financial condition and results of operations.
The global financial markets experienced significant disruptions in 2008, and the United States, European and other economies went into
recession. The recovery from the lows of 2008 and 2009 was uneven and the global financial markets are facing new challenges, including the escalation of the European sovereign debt crisis since 2011,
the hostilities in the Ukraine, the end of quantitative easing by the U.S. Federal Reserve, the economic slowdown in the Eurozone in 2014 and the volatility in
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markets across the world due to the recent outbreak of coronavirus, later renamed COVID-19. It is unclear whether these challenges will be contained and what effects they each may have.
There is considerable uncertainty over the long-term effects of the expansionary monetary and
fiscal policies that have been adopted by the central banks and financial authorities of some of the world's leading economies, including China's. Recently there have been signs that the rate of
China's and global economic growth is declining. Any prolonged slowdown in global economic development might lead to tighter credit markets, increased market volatility, sudden drops in business and
market confidence and dramatic changes in business and consumer behaviors.
A severe or prolonged downturn in the Chinese or global economy could materially and adversely affect our
business and financial condition.
The global macroeconomic environment is facing numerous challenges. The growth rate of the Chinese economy has gradually slowed in recent years,
and the trend may continue especially in light of the challenges the global economy is facing due to the COVID-19 global pandemic. There is considerable uncertainty over the long-term effects of the
expansionary monetary and fiscal policies adopted by the central banks and financial authorities of some of the world's leading economies, including the United States and China. Unrest, terrorist
threats and the potential for war in the Middle East and elsewhere may increase market volatility across the globe. There have also been concerns about the relationship between China and other
countries, including the surrounding Asian countries, which may potentially have economic effects. In particular, there is significant uncertainty about the future relationship between the United
States and China with respect to trade policies, treaties, government regulations and tariffs. Economic conditions in China are sensitive to global economic conditions, as well as changes in domestic
economic and political policies and the expected or perceived overall economic growth rate in China. Any severe or prolonged slowdown in the global or Chinese economy may materially and adversely
affect our business, results of operations and financial condition.
Changes in international trade policies and international barriers to trade, or the escalation of trade
tensions, may have an adverse effect on our business.
International trade disputes could result in tariffs and other protectionist measures that could adversely affect our business. Tariffs could
increase our operating costs as well as the cost of the goods and products which could affect our customer's discretionary spending level. In addition, any escalation in existing trade tensions or the
advent of a trade war, or news and rumors of the escalation of a potential trade war, could affect consumer confidence and have a material adverse effect on our business, results of operations and,
ultimately, the trading price of our ADSs.
Political
tensions between the United States and China have escalated due to, among other things, the COVID-19 outbreak, the PRC National People's Congress' passage of Hong Kong national
security legislation, sanctions imposed by the U.S. Department of Treasury on certain officials of the Hong Kong Special Administrative Region and the central government of the PRC, and the executive
orders issued by U.S. President in August 2020 that prohibit certain transactions with ByteDance Ltd., Tencent
Holdings Ltd. and the respective subsidiaries of such companies. In addition, on December 31, 2020, the New York Stock Exchange commenced proceedings to delist securities of three major
telecommunications service providers in China in light of an executive order prohibiting any transaction in publicly traded securities of certain China-based companies by any U.S. person. There
remains uncertainty as to whether the New York Stock Exchange or relevant regulatory authorities will finally determine the executive order or additional regulatory rules or orders to be applicable
and proceed with the delisting proceedings against these companies or any other China-based issuers listed in the United States. Rising political tensions could reduce levels of trades, investments,
technological exchanges and other economic activities between the two major economies, which would have a material adverse effect on global economic conditions and the stability of global financial
markets. Any
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of
these factors could have a material adverse effect on our business, prospects, financial condition and results of operations. Furthermore, there have been media reports on deliberations within the
U.S. government regarding potentially limiting or restricting China-based companies from accessing U.S. capital markets. If any such deliberations were to materialize, the resulting legislation may
have a material and adverse impact on the stock performance of China-based issuers listed in the United States. It is currently unclear whether the proposed or additional legislations would be enacted
that would have the effect of potentially limiting or restricting China-based companies from accessing U.S. capital markets.
If relations between China and the United States deteriorate, our business, results of operations and
financial condition could be adversely affected.
At various times during recent years, the United States and China have had significant disagreements over monetary, economic, political and
social issues, including currently in relation to the COVID-19 pandemic, and future relations between these two countries may deteriorate. Changes in political conditions and changes in the state of
China-U.S. relations are difficult to predict and could adversely affect our business, results of operations and financial condition. In addition, because of our extensive operations in the Chinese
market, any deterioration in political or trade relations might cause a public perception in the United States or elsewhere that might cause our products to become less attractive. We cannot predict
what effect any changes in China-U.S. relations may have on our ability to access capital or effectively do business in China or the United States. Moreover, any political or trade controversies
between the United States and China, whether or not directly related to our business, could cause investors to be unwilling to hold or buy our ADSs and consequently cause the trading price of our ADSs
to decline.
Our business could be adversely affected by trade tariffs or other trade barriers.
The U.S. government has made statements and taken certain actions that may lead to potential changes to U.S. and international trade policies
towards China. In January 2020, the "Phase One" agreement was signed between the United States and China on trade matters. However, it remains unclear what additional actions, if any, will be taken by
the U.S. or other governments with respect to international trade agreements, the imposition of tariffs on goods imported into the U.S., tax policy related to international commerce, or other trade
matters. Although we do not currently export any products to the United States, it is not yet clear what impact these tariffs may have or what actions other governments, including the Chinese
government may take in retaliation. Although we only provide services, tariffs could potentially impact the business of our suppliers and business partners which may in turn affect our business. In
addition, these developments could have a material adverse effect on global economic conditions and the stability of global financial markets. Any of these factors could have a material adverse effect
on our business, financial condition and results of operations.
Our business depends on a number of key employees, including our executive officers and other employees with
key technical skills and knowledge. If we fail to hire, retain, or motivate our key employees, our business and operating results may be materially and adversely affected.
We depend on the continued contributions of our executive officers and other key employees, including those with key technological expertise,
many of whom are difficult to replace. Any loss of the services of any of our senior management or other key employees could harm our business. Competition for qualified employees in and outside China
is intense. Some of the companies with which we compete for experienced employees may have greater resources than we do and may be able to offer more attractive terms of employment. Our future success
is dependent on our ability to attract a significant number of qualified employees and retain our existing key employees. If our key employees cease to work for us, our business may be materially and
adversely affected and we may incur additional expenses to recruit, train and retain qualified personnel to replace them.
Although
we have entered into confidentiality and non-compete agreements with our key employees, our key employees may join our competitors or form a competing business. If any
dispute arises between our current or former officers and us, we may have to incur substantial costs and expenses in order to enforce such agreements in China or we may be unable to enforce them at
all. We commit significant time and other resources to training our employees, which increases their value to competitors if they subsequently leave us for our competitors.
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Our failure to effectively manage our growth or implement our business strategies may harm our business and
operating results.
We have experienced rapid growth in the number of active users, and we plan to continue to expand our product offerings in the global market.
Managing our growth requires allocation of valuable management time and resources, and significant expenditures. As part of our strategy, we intend to continue making investments to expand our user
base, strengthen our research and development efforts, and enhance our ability to deliver highly-targeted content. To execute our business plan and growth strategy, we need to continuously improve our
operational and financial systems, procedures and controls, and hire, train, manage and maintain good relations with our employees. Continued growth could also strain our ability to maintain reliable
service levels for our users, advertising customers and business partners. We have limited operational experience in managing the business at the current scale and we cannot assure you we will be able
to maintain the current level of growth rate in the future.
From time to time we may conduct strategic investments and acquisitions, which may require significant
management attention, disrupt our business and adversely affect our financial conditions.
We may take advantage of opportunities to invest in or acquire additional businesses, services, assets or technologies. However, we may fail to
select appropriate investment or acquisition targets, or we may not be able to negotiate optimal arrangements, including arrangements to finance any acquisitions. Acquisitions and the subsequent
integration of new assets and businesses into our own could require significant management attention and could result in a diversion of resources away from our existing business. Investments and
acquisitions could result in the use of substantial amounts of cash, increased leverage, potentially dilutive issuances of equity securities, goodwill impairment charges, amortization expenses for
other intangible assets and exposure to potential liabilities of the acquired business. In addition, the invested or acquired assets or businesses may not generate the financial results we expect.
Moreover, the costs of identifying and consummating these transactions may be significant. In addition to obtaining the necessary corporate governance approvals, we may also need to obtain approvals
and licenses from relevant government authorities for the acquisitions and investments to comply with applicable laws and regulations, which could result in increased costs and delays.
We rely on our assumptions and estimates to calculate certain key operating metrics. Any real or perceived
inaccuracies in our calculations may harm our reputation and negatively affect our business.
The numbers of daily and monthly active users of our products are calculated using our internal data that has not been independently verified.
While these numbers are based on what we believe to be reasonable calculations for the applicable periods of measurement, there are inherent challenges in accurately measuring usage and user
engagement across our large user base. For example, we treat each mobile device or each application on a mobile device as a separate user for purposes of calculating our DAU and MAU, and we may not be
able to distinguish individual users who use multiple applications from us or have multiple mobile devices. Accordingly, the calculations of our active users may not accurately reflect the actual
number of people using our products.
We
regularly review and may adjust our processes for calculating our internal metrics to improve their accuracy. Our measures of user growth and user engagement may differ from estimates
published by third parties or from similarly titled metrics used by our competitors due to differences in methodology. If our advertising customers, business partners or investors do not perceive our
user metrics to be accurate representations of our user base or user engagement, or if we discover material inaccuracies in our user metrics, our reputation may be harmed and our advertising customers
and business partners may be less willing to allocate their spending or resources to our products, which could negatively affect our business and operating results.
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Our operating results are subject to seasonal fluctuations due to a number of factors, any of which could
adversely affect our business and operating results.
We are subject to seasonality and other fluctuations in our business. Revenues from our mobile advertising services, which constituted a
substantial part of our total revenues, are affected by seasonality in advertising spending in both international and China markets. We believe that such seasonality in advertising spending affects
our quarterly results, resulting in the significant growth in our mobile advertising revenues between the third and the fourth quarters but a decline from the fourth quarter to the next quarter. Thus,
our operating results for one or more future quarters or years may fluctuate substantially or fall below the expectations of securities analysts and investors. In such event, the trading price of the
ADSs may fluctuate significantly.
The successful operation of our business depends upon the performance and reliability of the internet
infrastructure in China and in other countries as well as the safety of our network and infrastructure.
Our growth and expansion will depend in part on the reliability of state-owned telecommunications services providers in China and similar
providers in other countries in maintaining and expanding internet and telecommunications infrastructure, standards, protocols, and complementary products and services.
Almost
all access to the internet in China is offered through China Mobile, China Unicom and China Telecom, which are under the administrative control and regulatory supervision of the
MIIT. We rely on the internet infrastructure of China Mobile, China Unicom, and China Telecom to provide bandwidth and transmit data. Although the Chinese government has announced plans to develop
China's national information infrastructure, this infrastructure may not be developed in time or at all, and the existing internet infrastructure in China may not be able to support the continued
growth of internet usage. In addition, it is unlikely that we will have access to alternative networks and services on a timely basis, if at all, in the event of any infrastructure disruption or
failure.
Users of our mobile applications may employ existing or new technologies to block advertisements placed by
us, which may limit our ability to generate revenues from our advertising services.
Existing or new technologies that can disable the display of our advertisements may impair the growth of our mobile advertising business. Most
of our revenues are derived from fees paid to us by advertising exchange customers based on the effective price per impression, which is impacted by the number of our users' valid clicks, conversions,
impressions delivered or other measurable results. If technologies capable of blocking advertisements on our products are adopted by a significant number of our users, we may not be able to continue
delivering such advertisements to our users and our revenues may decrease. In addition, advertisers may choose not to advertise on or through our products in light of the perceived use by our users of
advertisement-blocking measures, which may adversely affect our business and growth prospects.
If we fail to detect click-through fraud, we could lose the confidence of our advertisers and our revenues
may decline as a result.
Our business is exposed to the risk of click-through fraud on our mobile applications. Click-through fraud occurs when a person clicks an
advertisement displayed by us for a reason other than to view the underlying content of such advertisement. If we fail to detect significant fraudulent click-throughs or otherwise are unable to
prevent significant fraudulent activity, the affected advertisers may experience a reduced return on their investment in our mobile advertising services and may lose confidence in the integrity of our
systems. As a result, we may have to issue refunds to our advertisers and we may be unable to retain existing advertising customers and attract new advertising customers for our advertising services,
and our mobile advertising revenues may decline. In addition, affected
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advertisers
may commence legal action against us for claims related to click-through fraud. Any such claims or similar claims, regardless of their merit, could be time-consuming and costly for us to
defend against and could also adversely affect our brand and operating results.
Our business emphasizes rapid innovation and prioritizes the growth in user base and cultivation of content
ecosystem of content-rich portfolio products. That strategy may produce results that do not align with investors' expectation and our stock price may be negatively affected as a result.
Our growth depends on our ability to actively develop and launch new and innovative products and services. We intend to quickly adapt our
products to changes in market trends and user needs, but we have no control over whether these adaptions will be well received by our users, advertising customers or business partners, and may result
in unintended outcomes or consequences. We prioritize the growth in user base and cultivation of content ecosystem of content-rich portfolio products. For example, we monitor how our delivery of
advertisements on our products affects our users' experience with the products and we may decide to decrease the number of advertisements placed on our products to ensure our users' satisfaction with
our products. This could result in a loss of advertising customers and negatively impact our mobile advertising revenue. Our decisions may not be consistent with the short-term expectations of
investors and may not produce the long-term benefits that we expect, in which case the maintenance and growth of our user base, our relationships with advertising customers, and our business and
operating results could be adversely and materially harmed.
We have granted, and may continue to grant, options, restricted shares units and other types of share-based
incentive awards, which may result in increased share-based compensation expenses.
We adopted a stock incentive plan in 2012 and a share incentive plan in 2018, as amended from time to time, for the purpose of granting
share-based compensation awards to our directors, officers, employees and advisors to incentivize their performance and align their interests with ours. Expenses associated with share-based
compensation have affected our net income and may reduce our net income in the future, and any additional securities issued pursuant to share-based incentive awards will dilute the ownership interests
of our shareholders, including holders of the ADSs. On November 6, 2018, our Board of Directors approved an option modification to reduce the exercise price of certain options granted under our
2012 Plan to employees. Other terms of the share options granted remain unchanged. The modification resulted in incremental compensation costs of US$ 0.3 million, which is amortized over
the remaining vesting period of the modified options, ranging from 2018 to 2021. We believe the granting of share-based incentive awards is of significant importance to our ability to attract and
retain key employees, and we plan to grant share-based incentive awards in the future. As a result, our share-based compensation expenses may increase, which may have an adverse effect on our results
of operations.
If we fail to build, maintain and enhance our brands, or if we incur a disproportionate amount of expenses
pursuing this effort, our business, operating results and prospects may be materially and adversely affected.
We believe that maintaining and enhancing our brand is critical to expanding our user base and number of advertising customers. We also believe
that maintaining and enhancing our brand will depend largely on our ability to continue to provide useful, reliable, trustworthy, and innovative products, which we may not be able to do successfully
in the future. We will also continue to experience media, legislative, or regulatory scrutiny of our decisions regarding user privacy, content, advertising, and other issues, which may adversely
affect our reputation and brands. We also may fail to respond expeditiously to the sharing and uploading of objectionable content on our products and services or objectionable practices by advertising
customers, or may fail to otherwise address user concerns, which could erode confidence in our brands. In addition, maintaining and enhancing our brands may require us to make substantial investments
and these investments may not be successful.
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We
promote our brand and products through online advertising networks and platforms, which primarily include TikTok, Tencent and Kuaishou. These branding and marketing efforts may not result in
increased user traffic in a cost-effective way. If we fail to successfully promote and maintain our brands or if we incur excessive expenses in this effort, our business and financial results may be
adversely affected. In addition, any negative publicity in relation to our mobile applications, regardless of its veracity, could harm our brands and reputation and, in turn, our business and
financial results.
We are a "controlled company" within the meaning of the NYSE Listed Company Manual and, as a result, we may
rely on exemptions from certain corporate governance requirements that provide protection to shareholders of other companies.
We are a "controlled company" as defined under the NYSE Listed Company Manual because Mr. Karl Kan Zhang owns more than 50% of our total
voting power. For so long as we remain a controlled company under that definition, we are permitted to elect to rely, and may rely, on certain exemptions from corporate governance rules, including an
exemption from the rule that a majority of our board of directors must be independent directors or that we have to establish a nominating committee and a compensation committee composed entirely of
independent directors. As a result, you will not have the same protection afforded to shareholders of companies that are subject to these corporate governance requirements.
We lease premises and may not be able to fully control the rental costs, quality, maintenance and our
leasehold interest in these premises, nor can we guarantee that we will be able to successfully renew or find suitable premises to replace our existing premises upon expiration of the existing leases.
We lease all premises used in our operations from third parties and we require the landlords' cooperation to effectively manage the condition of
such premises, buildings and facilities. In the event that the condition of the office premises, buildings and facilities deteriorates, or if any or all of our landlords fail to properly maintain and
renovate such premises, buildings or facilities in a timely manner or at all, the operation of our offices could be materially and adversely affected. In addition, with respect to our leased premises,
at the end of each lease term, we may need to negotiate an extension of the lease when the lease expires. If we are unable to successfully extend or renew our leases upon expiration of the current
term on commercially reasonable terms or at all, we may be forced to relocate our offices, or the rental costs may increase significantly.
Moreover,
certain lessors have not provided us with valid ownership certificates or authorizations of sublease for our leased properties. Under relevant PRC laws and regulations, if the
lessors are unable to obtain certificate of title because such real estates were built illegally or failed to pass the inspection, such lease contracts may be recognized as void. In addition, if our
lessors are not the owners of the properties and they have not obtained consents from the owners or their lessors or permits from the relevant government authorities, our leases could be invalidated.
If this occurs, we may have to renegotiate the leases with owners or parties who have the right to lease the properties, and the terms of the new leases may be less favorable to us.
As
of the date of this prospectus supplement, we are not aware of any material claims or actions being contemplated or initiated by government authorities, property owners or any other
third parties with respect to our leasehold interests in or use of such properties. However, we cannot assure you that our use of such leased properties will not be challenged. In the event that our
use of properties is successfully challenged, we may be subject to fines and forced to relocate the affected operations. In addition, we may become involved in disputes with the property owners or
third parties who otherwise have rights to or interests in our leased properties. We can provide no assurance that we will be able to find suitable replacement sites on terms acceptable to us on a
timely basis, or at all, or that we will not be subject to liabilities resulting from third parties' challenges on our use of such properties. As a
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result,
our business operations may be interrupted, and our financial condition and results of operations may be adversely affected.
We have limited business insurance coverage. Any interruption of our business may result in substantial costs
to us and the diversion of our resources, which could have an adverse effect on our financial condition and operating results.
Insurance products available in China currently are not as extensive as those offered in more developed economies. Consistent with customary
industry practice in China, our business insurance is limited and we do not carry business liability or disruption insurance to cover our operations. We have determined that the costs of insuring for
related risks and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to obtain or maintain such insurance. Any uninsured damage to
our systems or disruption of our business operations could require us to incur substantial costs and divert our resources, which could have an adverse effect on our financial condition and results of
operations.
The recent global COVID-19 outbreak could adversely affect our business.
The recent outbreak of COVID-19 could lead to a potential global economic downturn, which may cause our advertising and marketing customers to
reduce their advertising budgets, and result in other adverse effects that could harm our operating results and financial performance generally. Our advertising and marketing customers may reduce
their advertising budgets due to the COVID-19 outbreak. This outbreak of communicable diseases has caused, and may continue to cause, companies including us, our customers and certain of our business
partners, to implement temporary adjustment of work schemes allowing employees to work from home and adopt remote collaboration, which may lead to lower work efficiency and productivity. This outbreak
has also caused and may continue to cause the restrictions on our employees', our customers' and other service providers' ability to travel. As a result of any of the above developments, our business,
financial condition and results of operations could be adversely affected by the COVID-19 outbreak. The extent to which this outbreak impacts our results will depend on future developments, which are
uncertain and cannot be predicted, including new information which may emerge concerning the severity of this outbreak and future actions we take, if any, to contain this outbreak or treat its impact,
among others.
We face risks related to natural disasters, health epidemics and other outbreaks, which could significantly
disrupt our business operations.
Our business could be adversely affected by the effects of epidemics. In recent years, there have been breakouts of epidemics in and outside
China. Our business operations could be disrupted if any of our employees is suspected of having COVID-19, H1N1 flu, avian flu or another epidemic, since it could require our employees to be
quarantined and/or our offices to be disinfected. In addition, our results of operations could be adversely affected to the extent that the outbreak harms
the Chinese or global economy or our business environment in particular. We are also vulnerable to natural disasters and other calamities, which may give rise to server interruptions, breakdowns,
system failures, technology platform failures or internet failures, and may adversely affect our ability to provide advertising services through our products.
Changes in the method for determining the London Interbank Offered Rate and the potential replacement of
LIBOR may affect our cost of capital and net investment income.
We entered into a credit facility agreement with a commercial bank in July 2018, as renewed in October 2019 and further renewed in June 2020,
under which agreement we can borrow up to US$4.0 million collateralized by our accounts receivable by June 2021. The interest rate for this credit facility is London Interbank Offered Rate, or
the LIBOR, plus an applicable margin. In 2019, we had
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in
aggregate drawn down the credit facility of US$6.4 million and repaid US$3.2 million. In the nine months ended September 30, 2020, we had in aggregate drawn down the credit
facility of US$4.0 million and repaid US$3.2 million. The LIBOR benchmark has been subject to national, international, and other regulatory guidance and proposals for reform. In July
2017, the U.K. Financial Conduct Authority announced that it intends to stop persuading or compelling banks to submit rates for calculation of LIBOR after 2021. These reforms may cause LIBOR to
perform differently than in the past and LIBOR may ultimately cease to exist after 2021 or be unsuitable to use as a benchmark. The consequences of any potential cessation, modification or other
reform of LIBOR cannot be predicted at this time. Any new benchmark rate will likely not replicate LIBOR exactly, which could impact new credit facilities and derivative transaction entered into after
2021. We may need to negotiate with the commercial bank to determine an alternative reference rate for our credit facility agreement, which may perform differently than LIBOR. Any changes to benchmark
rates could have an impact on our cost of funds and our access to the capital markets, which could impact our results of operations and cash flows. Uncertainty as to the nature of such potential
changes may also adversely affect the trading market for our securities.
Risks Related to Our Corporate Structure
If the PRC government finds that the agreements that establish the structure for operating our businesses in
China do not comply with PRC regulations on foreign investment in internet and other related businesses, or if these regulations or their interpretation change in the future, we could be subject to
severe penalties or be forced to relinquish our interests in those operations.
Current PRC laws and regulations impose certain restrictions or prohibitions on foreign ownership of companies that engage in internet and other
related businesses, including the provision of internet information services. Specifically, foreign ownership of an internet information services provider may not exceed 50%. We are a company
incorporated in the Cayman Islands and Shanghai Chule (CooTek) Information Technology Co., Ltd., which we refer to as Shanghai Chule or the WFOE, is our wholly-owned PRC subsidiary and
therefore is considered as a foreign-invested enterprise. To comply with PRC laws and regulations, we conduct our business in China through our consolidated affiliated entities, including Shanghai
Chubao (CooTek) Information Technology Co., Ltd., or Shanghai Chubao, and three other PRC domestic entities, based on a series of contractual arrangements by and among Shanghai Chule,
our consolidated affiliated entities and their respective shareholders. As a result of these contractual arrangements, we exert control over our consolidated affiliated entities and consolidate or
combine their operating results in our financial statements under U.S. GAAP. Our consolidated affiliated entities hold the licenses, approvals and certain key assets that are essential for our
business operations.
In
the opinion of our PRC counsel, Junhe LLP, based on its understanding of the relevant PRC laws and regulations, the contractual arrangements among our PRC subsidiary, our
consolidated affiliated entities and their respective shareholders are valid, binding and enforceable under the existing PRC laws and regulations. There are, however, substantial uncertainties
regarding the interpretation and application of current or future PRC laws and regulations. Thus, we cannot assure you that the PRC government will not ultimately take a view contrary to the opinion
of our PRC counsel. If we are found in violation of any PRC laws or regulations or if the contractual arrangements among Shanghai Chule, our consolidated affiliated entities and their respective
shareholders are determined as illegal or invalid by the PRC court, arbitral tribunal or regulatory authorities, the relevant governmental authorities would have broad discretion in dealing with such
violation, including, without limitation:
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revoke our business and operating licenses;
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levy fines on us;
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confiscate any of our income that they deem to be obtained through illegal operations;
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require us to discontinue or restrict operations;
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restrict our right to collect revenues;
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block our mobile applications;
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require us to restructure the operations in such a way as to compel us to establish a new enterprise, re-apply for the necessary licenses or
relocate our businesses, staff and assets;
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impose additional conditions or requirements with which we may not be able to comply; or
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take other regulatory or enforcement actions against our group that could be harmful to our group's business.
The
imposition of any of these penalties may result in a material and adverse effect on our ability to conduct the business. In addition, if the imposition of any of these penalties
causes us to lose the rights to direct the activities of our consolidated affiliated entities or the right to receive their economic benefits, we would no longer be able to consolidate our
consolidated affiliated entities. We do not believe that any penalties imposed or actions taken by the PRC government would result in the liquidation of our company, Shanghai Chule, or our
consolidated affiliated entities.
We rely on contractual arrangements with our consolidated affiliated entities and their respective
shareholders for our operations in China, which may not be as effective in providing operational control as direct ownership.
Due to the PRC restrictions or prohibitions on foreign ownership of internet and other related businesses in China, we operate our business in
China through our consolidated affiliated entities, in which we have no ownership interest. We rely on a series of contractual arrangements with our consolidated affiliated entities and their
respective shareholders, including the powers of attorney, to control and operate their business.
Our
ability to control the consolidated affiliated entities depends on the powers of attorney, pursuant to which Shanghai Chule can vote on all matters requiring shareholder approval in
our consolidated affiliated entities. We believe these powers of attorney are legally enforceable but may not be as effective as direct equity ownership. These contractual arrangements are intended to
provide us with effective control over our consolidated affiliated entities and allow us to obtain economic benefits from them.
Although
we have been advised by our PRC counsel, Junhe LLP, that the contractual arrangements among our PRC subsidiary, our consolidated affiliated entities and their respective
shareholders are valid, binding and enforceable under existing PRC laws and regulations, these contractual arrangements may not be as effective in providing control over our consolidated affiliated
entities as direct ownership. If our consolidated affiliated entities or their shareholders fail to perform their respective obligations under the contractual arrangements, we may incur substantial
costs and expend substantial resources to enforce our rights. All of these contractual arrangements are governed by and interpreted in accordance with PRC laws, and disputes arising from these
contractual arrangements will be resolved through arbitration in China. Such disputes do not include claims arising under the United States federal securities laws and therefore these arbitration
provisions do not prevent you from pursuing claims arising under the United States federal securities laws. However, the legal system in China, particularly as it relates to arbitration proceedings,
is not as developed as in other jurisdictions, such as the United States. See "Risks Related to Doing Business in ChinaUncertainties in the interpretation and enforcement of
PRC laws and regulations could limit the legal protections available to you and us." There are very few precedents and little official guidance as to how contractual arrangements in the context of a
variable interest entity should be interpreted or enforced under PRC law. There remain significant uncertainties regarding the ultimate outcome of arbitration should legal
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action
become necessary. These uncertainties could limit our ability to enforce these contractual arrangements. In addition, arbitration awards are final and can only be enforced in PRC courts through
arbitration award recognition proceedings, which could cause additional expenses and delays. In the event we are unable to enforce these contractual arrangements or we experience significant delays or
other obstacles in the process of enforcing these contractual arrangements, we may not be able to exert effective control over our affiliated entities and may lose control over the assets owned by our
consolidated affiliated entities. As a result, we may be unable to consolidate our consolidated affiliated entities in our consolidated financial statements, our ability to conduct our business may be
negatively affected, and our business operations could be severely disrupted, which could materially and adversely affect our results of operations and financial condition.
We may lose the ability to use and maintain the benefit of assets held by our consolidated affiliated
entities that are important to the operation of our business if our consolidated affiliated entities declare bankruptcy or become subject to a dissolution or liquidation proceeding.
Our consolidated affiliated entities hold certain assets that are important to our business operations, including the VAT License concerning
information services, domestic multiparty communication services and domestic call center services and the Online Culture Operating Permit. Under our contractual arrangements, the shareholders of our
consolidated affiliated entities may not voluntarily liquidate our consolidated affiliated entities or approve them to sell, transfer, mortgage or dispose of their assets or legal or beneficial
interests exceeding certain threshold in the business in any manner without our prior consent. However, in the event that the shareholders breach this obligation and voluntarily liquidate our
consolidated affiliated entities, or our consolidated affiliated entities declare bankruptcy, or all or part of their assets become subject to liens or rights of third-party creditors, we may be
unable to continue some or all of our business operations, which could materially and adversely affect our business, financial condition and results of operations. Furthermore, if our consolidated
affiliated entities undergo a voluntary or involuntary liquidation proceeding, their shareholders or unrelated third-party creditors may claim rights to some or all of their assets, thereby hindering
our ability to operate our business, which could materially and adversely affect our business, financial condition and results of operations.
Contractual arrangements we have entered into with our consolidated affiliated entities and their respective
shareholders may be subject to scrutiny by the PRC tax authorities. A finding that we owe additional taxes could significantly reduce our consolidated net income and the value of your investment.
Pursuant to applicable PRC laws and regulations, arrangements and transactions among related parties may be subject to audit or challenge by the
PRC tax authorities. We may be subject to adverse tax consequences if the PRC tax authorities determine that the contractual arrangements among our PRC subsidiary, our consolidated affiliated entities
and their shareholders are not on an arm's length basis and therefore constitute favorable transfer pricing. As a result, the PRC tax authorities could require that our consolidated affiliated
entities adjust its taxable income upward for PRC tax purposes. Such an adjustment could adversely affect us by increasing our consolidated affiliated entities' tax expenses without reducing the tax
expenses of our PRC subsidiary, subjecting our consolidated affiliated entities to late payment fees and other penalties for under-payment of taxes, and resulting in our PRC subsidiary's loss of its
preferential tax treatment. Our consolidated results of operations may be adversely affected if our consolidated affiliated entities' tax liabilities increase or if it is subject to late payment fees
or other penalties.
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If the chops of our PRC subsidiary, our consolidated affiliated entities, are not kept safely, are stolen or
are used by unauthorized persons or for unauthorized purposes, the corporate governance of these entities could be severely and adversely compromised.
In China, a company chop or seal serves as the legal representation of the company towards third parties even when unaccompanied by a signature.
Each legally registered company in China is required to maintain a company chop, which must be registered with the local Public Security Bureau. In addition to this mandatory company chop, companies
may have several other chops which can be used for specific purposes. The chops of our PRC subsidiary, our consolidated affiliated entities are generally held securely by personnel designated or
approved by us in accordance with our internal control procedures. To the extent those chops are not kept safe, are stolen or are used by unauthorized persons or for unauthorized purposes, the
corporate governance of these entities could be severely and adversely compromised and those corporate entities may be bound to abide by the terms of any documents so chopped, even if they were
chopped by an individual who lacked the requisite power and authority to do so.
The shareholders of our consolidated affiliated entities may have potential conflicts of interest with us,
which may materially and adversely affect our business.
The shareholders of our major consolidated affiliated entities include Karl Kan Zhang, Susan Qiaoling Li, Michael Jialiang Wang, Jim Jian Wang
and Haiyan Zhu. Karl Kan Zhang, Susan Qiaoling Li, Michael Jialiang Wang and Jim Jian Wang are our co-founders, directors and executive officers. Haiyan Zhu is one of our early investors. In addition
to these five individuals, Qiming Century (HK) Limited, Orange Capital Management and Qualcomm International, Inc are also the shareholders of Shanghai Hanxiang (CooTek) Information
Technology Co., Ltd., one of our consolidated affiliated entities which has ceased business operations. Conflicts of interest may arise between the roles of these persons as
shareholders, directors or officers of our company and as shareholders of our consolidated affiliated entities. We rely on these individuals to abide by the laws of the Cayman Islands, which provide
that our directors and officers owe a fiduciary duty to our company to act in good faith and in the best interest of our company and not to use their positions for personal gain. The shareholders of
our consolidated affiliated entities have executed powers of attorney to appoint Shanghai Chule, our PRC subsidiary, or a person designated by Shanghai Chule to vote on their behalf and exercise
voting rights as shareholders of our consolidated affiliated entities. We cannot assure you that when conflicts arise, shareholders of our consolidated affiliated entities 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 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 may rely on dividends paid by our PRC subsidiary to fund cash and financing requirements. Any limitation
on the ability of our PRC subsidiary to pay dividends to us could have a material adverse effect on our ability to conduct our business and to pay dividends to holders of the ADSs and our ordinary
shares.
We are a holding company, and we may rely on dividends to be paid by our PRC subsidiary for our cash and financing requirements, including the
funds necessary to pay dividends and other cash distributions to the holders of the ADSs and our ordinary shares and service any debt we may incur. If our PRC subsidiary incur debt on their own behalf
in the future, the instruments governing the debt may restrict their ability to pay dividends or make other distributions to us.
Under
PRC laws and regulations, our wholly-owned subsidiary in the PRC, Shanghai Chule, may pay dividends only out of its accumulated profits as determined in accordance with PRC
accounting standards and regulations. In addition, a wholly foreign-owned enterprise is required to set aside at least 10% of its after-tax profits each year, after making up previous years'
accumulated losses, if any,
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to
fund certain statutory reserve funds, until the aggregate amount of such a fund reaches 50% of its registered capital. The PRC company could distribute the remaining after-tax profits after making
up losses and funding reserve funds in accordance with the provisions of the PRC Company Law. Any limitation on the ability of our wholly-owned PRC subsidiary 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.
Substantial uncertainties exist with respect to the interpretation and implementation of the newly enacted
PRC Foreign Investment Law and how it may impact the viability of our current corporate structure and business operations.
The National People's Congress approved the Foreign Investment Law, or the FIL, on March 15, 2019 and the State Council approved the
Regulation on Implementing the Foreign Investment Law, or the Implementation Regulations, on December 12, 2019, effective from January 1, 2020, which replaced 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, together with their implementation rules and ancillary regulations. The Supreme People's Court of China issued a judicial interpretation on the Foreign Investment Law on
December 26, 2019, effective from January 1, 2020, to ensure fair and efficient implementation of the Foreign Investment Law. According to this judicial interpretation, courts in China
shall not, among other things, support contracted parties to claim foreign investment contracts in sectors not on the Special Administrative Measures for Access to Foreign Investment (Negative List)
(2019), or the 2019 Negative List, as void because the contracts have not been approved or registered by administrative authorities. The Foreign Investment Law grants national treatment to foreign
invested enterprises, except for those operating in "restricted" or "prohibited" industries in the "negative list", where if a foreign invested enterprise proposes to conduct business in an industry
subject to foreign investment "restrictions" in the "negative list," the foreign invested enterprise must go through a MOFCOM pre-approval process. The internet content service, internet audio-visual
program services and online culture activities that we conduct through our consolidated affiliated entities, which are our VIEs, are subject to foreign investment restrictions set forth in the 2019
Negative List. The Foreign Investment Law and Implementation Regulations embody 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.
However,
since these rules are relatively new, uncertainties still exist in relation to their interpretation. For instance, under the Foreign Investment Law, "foreign investment" refers
to the investment activities directly or indirectly conducted by foreign individuals, enterprises or other entities in China. Though it does not explicitly classify contractual arrangements as a form
of foreign investment, there is no assurance that foreign investment via contractual arrangement would not be interpreted as a type of
indirect foreign investment activities under the definition in the future. In addition, the definition contains a catch-all provision which includes investments made by foreign investors through means
stipulated in laws or administrative regulations or other methods prescribed by the State Council. Therefore, it still leaves leeway for future laws, administrative regulations or provisions
promulgated by the State Council to provide for contractual arrangements as a form of foreign investment. In any of these cases, it will be uncertain whether our contractual arrangements will be
deemed to be in violation of the market access requirements for foreign investment under the PRC laws and regulations. Furthermore, if future laws, administrative regulations or provisions prescribed
by the State Council mandate further actions to be taken by companies with respect to existing contractual arrangements, we may face substantial uncertainties as to whether we can complete such
actions in a timely manner, or at all. Failure to take timely and appropriate measures to cope with any of these or
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similar
regulatory compliance challenges could materially and adversely affect our current corporate structure, corporate governance and business operations.
Risks Related to Doing Business in China
Adverse changes in China's economic, political or social conditions or government policies could have a
material and adverse effect on overall economic growth in China, which could materially and adversely affect our business.
Our principal offices are based in China. Accordingly, our operating results, financial condition and prospects are influenced by economic,
political and legal developments in China. Economic reforms begun in the late 1970s have resulted in significant economic growth. However, any economic reform policies or measures in China may from
time to time be modified or revised. China's economy differs from the economies of most developed countries in many respects, including with respect to the amount of government involvement, level of
development, growth rate, control of foreign exchange and allocation of resources. While the PRC economy has experienced significant growth in the past 30 years, growth has been uneven across
different regions and among different economic sectors. In addition, the rate of growth has been slowing since 2012, and the impact of COVID-19 on the Chinese and global economies in 2020 and 2021 is
likely to be severe. In particular, the National Bureau of Statistics of China reported a 6.8% drop and a 3.2% growth in GDP for the first and second quarters of 2020, respectively, compared with the
respective periods of 2019.
The
PRC government exercises significant control over China's economic growth through strategically allocating resources, controlling the payment of foreign currency-denominated
obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Although the Chinese economy has grown significantly in the past decade, that growth
may not continue, as evidenced by the slowing of the growth of the Chinese economy in recent years. Any adverse changes in economic conditions in China, in the policies of the Chinese government or in
the laws and regulations in China could have a material adverse effect on the overall economic growth of China. Such developments could adversely affect our business and operating results, lead to
reduction in demand for our services and adversely affect our competitive position.
Uncertainties in the interpretation and enforcement of PRC laws and regulations could limit the legal
protections available to you and us.
The PRC legal system is based on written statutes and court decisions have limited precedential value. The PRC legal system evolves rapidly, and
the interpretations of many laws, regulations and rules may contain inconsistencies and enforcement of these laws, regulations and rules involves uncertainties.
From
time to time, we may have to resort to administrative and court proceedings to enforce our legal rights. However, since PRC judicial and administrative authorities have significant
discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to predict the outcome of a judicial or administrative proceeding than in more developed legal
systems. Furthermore, the PRC legal system is based, in part, on government policies and internal rules, some of which are not published in a timely manner, or at all, but which may have retroactive
effect. As a result, we may not always be aware of any potential violation of these policies and rules. Such unpredictability towards our contractual, property (including intellectual property) and
procedural rights could adversely affect our business and impede our ability to continue our operations.
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Content posted or displayed on our platform may be found objectionable by PRC regulatory authorities and may
subject us to penalties and other severe consequences.
The PRC government has adopted regulations governing internet and wireless access and the distribution of information over the internet and
wireless telecommunication networks. Under these regulations, internet content providers and internet publishers are prohibited from posting or displaying over the internet or wireless networks
content that, among other things, violates PRC laws and regulations, impairs the national dignity of China or the public interest, or is obscene, superstitious, fraudulent or defamatory. Furthermore,
internet content providers are also prohibited from displaying content that may be deemed by relevant government authorities as "socially destabilizing" or leaking "state secrets" of the PRC. Failure
to comply with these requirements may result in the revocation of licenses to provide internet content or other licenses, the closure of the concerned platforms and reputational harm. The operator may
also be held liable for any censored information displayed on or linked to their platform.
We
operate a number of portfolio products in China, including TouchPal Phonebook. We have implemented procedures to monitor the content displayed on our products in order to comply with
relevant laws and regulations. However, it may not be possible to determine in all cases the types of content that could result in our liability as a distributor of such content and, if any of the
content posted or displayed on our products is deemed by the PRC government to violate any content restrictions, we would not be able to continue to display such content and could become subject to
penalties, including confiscation of income, fines, suspension of business and revocation of required licenses, which could materially and adversely affect our business, financial condition and
results of operations.
We
may also be subject to potential liability for any unlawful actions by our users on our products. It may be difficult to determine the type of content or actions that may result in
liability to us and, if we are found to be liable, we may be prevented from operating our business in China. Moreover, the costs of compliance with these regulations may continue to increase as a
result of more content being made available by an increasing number of users of our platform, which may adversely affect our results of operations. Although we have adopted internal procedures to
monitor content and to remove offending content once we become aware of any potential or alleged violation, we may not be able to identify all the content that may violate relevant laws and
regulations or third-party intellectual property rights. Even if we manage to identify and remove offensive content, we may still be held liable. As of the date of this prospectus supplement, we have
not received government sanctions in connection with content posted on our platform. However, we cannot assure you that our business and operations will be immune from government actions or sanctions
in the future. To the extent that PRC regulatory authorities find any content displayed on our platform objectionable, they may require us to limit or eliminate the dissemination of such content on
our platform in the form of take-down orders or otherwise. In addition, these laws and regulations are subject to interpretation by the relevant authorities, and it may not be possible to determine in
all cases the types of content that could result in our liability as a platform operator.
Advertisements shown on our platform may subject us to penalties and other administrative actions.
Under PRC advertising laws and regulations, we are obligated to monitor the advertising content shown on our platform to ensure that such
content is true and accurate and in full compliance with applicable laws and regulations. Advertisements shall not hinder public order, violate social morality or contain illegal contents, including
but not limited to obscenity, pornography, gambling, superstition, terror and violence contents. Otherwise, the administration of market regulation may (1) order to stop publishing of the
advertisement and; (2) confiscate the advertising fees; (3) impose a penalty ranging from RMB200,000 to RMB1,000,000; or (4) in serious cases, cancel the business license and
cancel the registration certificate for publishing advertisements. In addition, where a special government review is
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required
for specific types of advertisements prior to internet 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. 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 by
us, PRC governmental authorities may force us to terminate our advertising operations or revoke our licenses.
While
we have made significant efforts to ensure that the advertisements shown on our platform are in full compliance with applicable PRC laws and regulations, we cannot assure you that
all the content contained in such advertisements or offers is true and accurate as required by the advertising laws and regulations or otherwise in full compliance with applicable PRC laws and
regulations, especially given the uncertainty in the interpretation of these PRC laws and regulations. If we are found to be in violation of applicable PRC advertising laws and regulations, we may be
subject to penalties and our reputation may be harmed, which may negatively affect our business, financial condition, and results of operations and prospects. Although the advertisements displayed on
our platform may not directly contain sensitive or illegal contents, including but not limited to gambling and pyramid selling, the advertisers may use inducing words to indirectly attract
advertisement viewers to participate in gambling, pyramid selling, or other illegal activities. If we receive a complaint that any superficially compliant advertisement is linked to one or more
webpages that feature non-compliant advertising content, we will remove the related advertisement. Although our agreements with the advertising agencies provide that the advertisements provided by the
advertisers shall comply with the requirements of relevant laws and regulations, we cannot control or supervise advertising contents and the linked webpages all the time. Therefore, we cannot
guarantee you that all of the advertisements displayed on our platform will comply with relevant laws and regulations.
In
April 2015, the Standing Committee of the National People's Congress promulgated the PRC Advertising Law, effective on September 1, 2015 and amended on October 26, 2018.
According to the Advertising Law, advertisements shall not have any false or misleading content, or defraud or mislead consumers. Furthermore, an advertisement will be deemed as a "false
advertisement" if any of the following situations exist: (1) the advertised product or service does not exist; (2) there is any inconsistency that has a material impact on the decision
to purchase in what is included in the advertisement with the actual circumstances with respect to the product's performance, function, place of production, usage, quality, specification, ingredient,
price, producer, term of validity, sales condition and honors received, among others, or the service's content, provider, form, quality, price, sales condition, and honors received, among others, or
any commitments, among others, made on the product or service; (3) using fabricated, forged or unverifiable scientific research results, statistical data, investigation results, excerpts,
quotations or other information as supporting material; (4) effect or results of using the good or receiving the service are fabricated; or (5) other circumstances where consumers are
defrauded or misled by any false or misleading content.
The
laws and regulations of advertising are relatively new and evolving and there is substantial uncertainty as to the interpretation of "false advertisement" by the State Administration
for Market
Regulation (formerly known as the State Administration for Industry and Commerce), or the SAMR. We have published certain relatively aggressive advertisements on some of our portfolio products to
acquire and retain users. For example, we publish advertisements for our lucky draw events on Fengdu Novel, a mobile online reading application operated, in part, by Shanghai Dengyong Information
Technology Co., Ltd., a significant subsidiary, and some users have filed complaints with the SAMR because, among other reasons, the possibilities of winning these lucky draws are
overstated in the advertisements. If any of the advertisements, such as those for the lucky draw events, that we publish is deemed to be a "false advertisement" by the SAMR or its local branch, we
could be subject to various penalties, such as discontinuation of publishing the relevant advertisement, imposition of fines and
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obligations
to eliminate any adverse effects incurred by such false advertisement, revocation of our business license and other approvals, rejection of our other advertisement examination application,
or even criminal liabilities under circumstances of serious violations. Any resulting penalties may disrupt our business and materially adversely affect our results of operations and financial
conditions.
The audit report incorporated by reference to this prospectus supplement is prepared by an auditor who is not
inspected by the Public Company Accounting Oversight Board and, as such, you are deprived of the benefits of such inspection. In addition, the adoption of any rules, legislations or other efforts to
increase U.S. regulatory access to audit information could cause uncertainty, and we could be delisted if we were unable to meet any PCAOB inspection requirement in time.
The independent registered public accounting firm that issued the audit report incorporated by reference to this prospectus supplement, as
auditors of companies that are traded publicly in the United States and a firm registered with the Public Company Accounting Oversight Board (United States), or PCAOB, is required by the laws of the
United States to undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards. According to Article 177 of the PRC Securities
Law which became effective in March 2020, no overseas securities regulator is allowed to directly conduct investigation or evidence collection activities within the territory of the PRC. Accordingly,
without the consent of the competent PRC securities regulators and relevant authorities, no organization or individual may provide the documents and materials relating to securities business
activities to overseas parties. Because our auditors are located in the PRC, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities,
our auditors are not currently inspected by the PCAOB. On May 24, 2013, PCAOB announced that it had entered into a Memorandum of Understanding on Enforcement Cooperation with the China
Securities Regulatory Commission, or the CSRC, and the Ministry of Finance which establishes a cooperative framework between the parties for the production an exchange of audit documents relevant to
investigations in the U.S. and China. PCAOB continues to be in discussions with the CSRC and the Ministry of Finance to permit joint inspections in the PRC of audit firms that are registered with
PCAOB and audit Chinese companies that trade on U.S. exchanges.
On
December 7, 2018, the SEC and the PCAOB issued a joint statement highlighting continued challenges faced by the U.S. regulators in their oversight of financial statement audits
of U.S.-listed companies with significant operations in China. The joint statement reflects a heightened interest in this issue. However, it remains unclear what further actions the SEC and PCAOB will
take and its impact on Chinese companies listed in the U.S. On April 21, 2020, the Chairman of the SEC, Chairman of the PCAOB and certain other SEC divisional heads jointly issued a public
statement, reminding the investors that with respect to investments in companies that are based in or have substantial operations in many emerging markets, including China, there is substantially
greater risk of incomplete or misleading disclosures and, in the event of investor harm, substantially less recourse, in comparison to U.S. domestic companies. The joint statement reinforced past
statements of the SEC and the PCAOB on matters including the difficulty to inspect audit work papers in China and its potential harm to investors. On June 4, 2020, the U.S. President issued a
memorandum ordering the President's Working Group on Financial Markets, or the PWG, to submit a report to the President within 60 days of the memorandum that includes recommendations for
actions that can be taken by the executive branch and by the SEC or PCAOB on Chinese companies listed on U.S. stock exchanges and their audit firms, in an effort to protect investors in the United
States. On August 6, 2020, the PWG released a report recommending that the SEC take steps to implement the five recommendations outlined in the report. In particular, to address companies from
jurisdictions that do not provide the PCAOB with sufficient access to fulfill its statutory mandate, or NCJs, the PWG recommended enhanced listing standards on U.S. stock exchanges. This would
require, as a condition to initial and continued exchange listing, PCAOB access to work papers of the principal audit firm for the audit of the listed company. Companies unable to satisfy this
standard as a result of governmental restrictions
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access to audit work papers and practices in NCJs may satisfy this standard by providing a co-audit from an audit firm with comparable resources and experience where the PCAOB determines it has
sufficient access to audit work papers and practices to conduct an appropriate inspection of the co-audit firm. The report permits the new listing standards to provide for a transition period until
January 1, 2022 for listed companies, but would apply immediately to new listings once the necessary rulemakings and/or standard-setting are effective. There can be no assurance that any of the
recommendations as described above would be officially adopted or become operative in their current form or that more stringent listing standards would not otherwise become effective. If we fail to
meet the proposed new listing standards in their current form before the deadline specified thereunder due to factors beyond our control, we could face possible de-listing from the New York Stock
Exchange, deregistration from the SEC and/or other risks, which may materially and adversely affect, or effectively terminate, our ADS trading in the United States.
Inspections
of other firms that the PCAOB has conducted outside the PRC have identified deficiencies in those firms' audit procedures and quality control procedures, which may be
addressed as part of the inspection process to improve future audit quality. This lack of PCAOB inspections in the PRC prevents the PCAOB from regularly evaluating our auditor's audits and its quality
control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections. The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to
evaluate the effectiveness of our auditor's audit procedures or quality control procedures as compared to auditors
outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.
As
part of a continued regulatory focus in the United States on access to audit and other information currently protected by national law, in particular China's, in June 2019, a
bipartisan group of lawmakers introduced bills in both houses of the U.S. Congress, which if passed, would require the SEC to maintain a list of issuers for which PCAOB is not able to inspect or
investigate an auditor report issued by a foreign public accounting firm. The proposed Ensuring Quality Information and Transparency for Abroad-Based Listings on our Exchanges (EQUITABLE) Act
prescribes increased disclosure requirements for these issuers and, beginning in 2025, the delisting from U.S. national securities exchanges of issuers included on the SEC's list for three consecutive
years. On May 20, 2020, the U.S. Senate passed the Holding Foreign Companies Accountable Act, or the HFCAA, which includes requirements similar to those in the EQUITABLE Act requiring the SEC
to identify issuers whose audit reports are prepared by auditors that the PCAOB is unable to inspect or investigate because of restrictions imposed by non-U.S. authorities. The HFCAA would also
require public companies on the SEC's list to certify that they are not owned or controlled by a foreign government and make certain additional disclosures on foreign ownership and control of such
issuers in their SEC filings. The HFCAA was approved by the U.S. House of Representatives on December 2, 2020 and was signed into law by the U.S. President on December 18, 2020. The
HFCAA would amend the Sarbanes-Oxley Act of 2002 to require the SEC to prohibit securities of any U.S.-listed companies from being listed on any of the U.S. securities exchanges, such as the New York
Stock Exchange, or traded "over-the-counter," if the registrant's financial statements have been audited by an accounting firm branch or office that is not subject to PCAOB inspection for a period of
three consecutive years after the HFCAA becomes effective. Enactment of the HFCAA or any other similar legislations or other efforts to increase U.S. regulatory access to audit information could cause
investor uncertainty for affected issuers, including us, and the market price of our ADSs could be adversely affected. In addition, enactment of these legislations may result in prohibitions on the
trading of our ADSs on the New York Stock Exchange, if our auditors fail to meet the PCAOB inspection requirement in time. Furthermore, there has been media reports on deliberations within the U.S.
government regarding potentially limiting or restricting China-based companies from accessing U.S. capital markets. If any such deliberations were to materialize, the resulting legislation may have
material and adverse impact on the stock performance of China-based issuers listed in the United States.
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It may be difficult for overseas regulators to conduct investigation or collect evidence within China.
Shareholder claims or regulatory investigation that are common in the United States generally are difficult to pursue as a matter of law or
practicality in China. For example, in China, there are significant legal and other obstacles to providing information needed for regulatory investigations or litigations initiated outside China.
Although the authorities in China may establish a
regulatory cooperation mechanism with the securities regulatory authorities of another country or region to implement cross-border supervision and administration, such cooperation with the securities
regulatory authorities in the Unities States may not be efficient in the absence of mutual and practical cooperation mechanism. Furthermore, according to Article 177 of the PRC Securities Law,
which became effective in March 2020, no overseas securities regulator is allowed to directly conduct investigation or evidence collection activities within the PRC territory. While detailed
interpretation of or implementation rules under Article 177 have yet to be promulgated, the inability for an overseas securities regulator to directly conduct investigation or evidence
collection activities within China may further increase the difficulties you face in protecting your interests. See also "Risks Related to Our ADSsYou may face difficulties
in protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are incorporated under Cayman Islands law."
The custodians or authorized users of our controlling non-tangible assets, including chops and seals, may
fail to fulfill their responsibilities, or misappropriate or misuse these assets.
Under the PRC law, legal documents for corporate transactions, including agreements and contracts are executed using the chop or seal of the
signing entity or with the signature of a legal representative whose designation is registered and filed with relevant PRC market regulation administrative authorities.
In
order to secure the use of our chops and seals, we have established internal control procedures and rules for using these chops and seals. In any event that the chops and seals are
intended to be used, the responsible personnel will submit a formal application, which will be verified and approved by authorized employees in accordance with our internal control procedures and
rules. In addition, in order to maintain the physical security of our chops, we generally have them stored in secured locations accessible only to authorized employees. Although we monitor such
authorized employees, the procedures may not be sufficient to prevent all instances of abuse or negligence. There is a risk that our employees could abuse their authority, for example, by entering
into a contract not approved by us or seeking to gain control of one of our subsidiaries or our affiliated entities or their subsidiaries. If any employee obtains, misuses or misappropriates our chops
and seals or other controlling non-tangible assets for whatever reason, we could experience disruption to our normal business operations. We may have to take corporate or legal action, which could
involve significant time and resources to resolve and divert management from our operations, and we may not be able to recover our loss due to such misuse or misappropriation if the third party relies
on the apparent authority of such employees and acts in good faith.
Under the PRC Enterprise Income Tax Law, we may be classified as a PRC "resident enterprise," which could
result in unfavorable tax consequences to us and our shareholders and have a material adverse effect on our results of operations and the value of your investment.
Under the PRC Enterprise Income Tax Law, or the EIT Law, which became effective in January 2008 and most recently amended in December 2018, an
enterprise established outside the PRC with "de facto management bodies" within the PRC is considered a "resident enterprise" for PRC enterprise income
tax purposes and is generally subject to a uniform 25% enterprise income tax rate on its worldwide income. In 2009, the State Administration of Taxation, or the SAT, issued the Notice Regarding the
Determination of Chinese-Controlled Overseas Incorporated Enterprises as PRC Tax Resident Enterprise on the Basis of De Facto Management Bodies, or SAT Circular 82, which provides
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certain
specific criteria for determining whether the "de facto management body" of a PRC-controlled enterprise that is incorporated offshore is located
in China. Further to SAT Circular 82, in 2011, the SAT issued the Administrative Measures for Enterprise Income Tax of Chinese-Controlled Offshore Incorporated Resident Enterprises (Trial), or SAT
Bulletin 45, amended in 2018, to provide more guidance on the implementation of SAT Circular 82. SAT Bulletin 45 clarified certain issues in the areas of resident status determination,
post-determination administration and competent tax authorities' procedures.
According
to SAT Circular 82, an offshore incorporated enterprise controlled by a PRC enterprise or a PRC enterprise group will be considered as a PRC tax resident enterprise by virtue
of having its "de facto management body" in China and will be subject to PRC enterprise income tax on its worldwide income only if all of the following
conditions are met: (1) the senior management and core management departments in charge of its daily operations function have their presence mainly in the PRC; (2) its financial and
human resources decisions are subject to determination or approval by persons or bodies in the PRC; (3) its major assets, accounting books, company seals, and minutes and files of its board and
shareholders' meetings are located or kept in the PRC; and (4) more than half of the enterprise's directors or senior management with voting rights habitually reside in the PRC. SAT Bulletin 45
specifies that when provided with a copy of Chinese tax resident determination certificate from a resident Chinese controlled offshore incorporated enterprise, the payer should not withhold 10% income
tax when paying the Chinese-sourced dividends, interest, royalties, etc. to the Chinese controlled offshore incorporated enterprise.
Although
SAT Circular 82 and SAT Bulletin 45 only apply to offshore incorporated enterprises controlled by PRC enterprises or PRC enterprise groups and not those controlled by PRC
individuals or foreigners, the determination criteria set forth therein may reflect the SAT's general position on how
the term "de facto management body" could be applied in determining the tax resident status of offshore enterprises, regardless of whether they are
controlled by PRC enterprises, individuals or foreigners.
In
addition, the SAT issued the Announcement of the State Administration of Taxation on Issues concerning the Determination of Resident Enterprises Based on the Standards of Actual
Management Institutions in January 2014 to provide more guidance on the implementation of SAT Circular 82. This bulletin further provides that, among other things, an entity that is classified as a
"resident enterprise" in accordance with the circular shall file the application for classifying its status of residential enterprise with the local tax authorities where its main domestic investors
are registered. From the year in which the entity is determined to be a "resident enterprise," any dividend, profit and other equity investment gain shall be taxed in accordance with the enterprise
income tax law and its implementing rules.
Although
our offshore holding entity is not controlled by PRC enterprises or a PRC enterprise group and our revenues are primarily generated from business operations conducted outside of
China, we cannot rule out the possibility that the PRC tax authorities determine that we or any of our non-PRC subsidiaries is a PRC resident enterprise for PRC enterprise income tax purposes, which
could subject our company or any of our non-PRC subsidiaries to PRC tax at a rate of 25% on its world-wide income, which could materially reduce our net income. In addition, we may also be subject to
PRC enterprise income tax reporting obligations.
If
the PRC tax authorities determine that our company is a PRC resident enterprise for PRC enterprise income tax purposes, gains realized on the sale or other disposition of ADSs or
ordinary shares may be subject to PRC tax, at a rate of 10% in the case of non-PRC enterprises or 20% in the case of non-PRC individuals (in each case, subject to the provisions of any applicable tax
treaty), if such gains are deemed to be from PRC sources. Any such tax may reduce the returns on your investment in the ADSs.
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There are significant uncertainties under the EIT Law relating to the withholding tax liabilities of our PRC
subsidiary, and dividends payable by our PRC subsidiary to our offshore subsidiaries may not qualify to enjoy certain treaty benefits.
Under the EIT Law and its implementation rules, the profits of a foreign-invested enterprise generated through operations, which are distributed
to its immediate holding company outside China, will be subject to a withholding tax rate of 10.0%. Pursuant to a special arrangement
between Hong Kong and China, such rate may be reduced to 5.0% if a Hong Kong resident enterprise owns more than 25.0% of the equity interest in the PRC company. Our current PRC subsidiary is wholly
owned by our Hong Kong subsidiary, CooTek HongKong Limited, or CooTek HK. Accordingly, CooTek HK may qualify for a 5.0% tax rate in respect of distributions from its PRC subsidiary. Under the Notice
of the State Administration of Taxation on Issues regarding the Administration of the Dividend Provision in Tax Treaties promulgated on February 20, 2009, the taxpayer needs to satisfy certain
conditions to enjoy the benefits under a tax treaty. These conditions include: (1) the taxpayer must be the beneficial owner of the relevant dividends, and (2) the corporate shareholder
to receive dividends from the PRC subsidiary must have continuously met the direct ownership thresholds during the 12 consecutive months preceding the receipt of the dividends. Further, the SAT
promulgated the Notice on How to Understand and Recognize the "Beneficial Owner" in Tax Treaties in 2009, most recently amended on February 3, 2018 and effective from April 1, 2018,
which sets forth several non-rebuttable presumptions to be a "beneficial owner", and certain detailed factors in determining the "beneficial owner" status.
Entitlement
to a lower tax rate on dividends according to tax treaties or arrangements between the PRC central government and governments of other countries or regions is subject to
Administrative Measures on Entitlement of Non-residents to Treatment under Tax Treaties , or SAT Circular 60, replaced by SAT Circular 35 in 2019, which provides that non-resident enterprises are not
required to obtain pre-approval from the relevant tax authority in order to enjoy the reduced withholding tax. Instead, non-resident enterprises and their withholding agents may, by self-assessment
and on confirmation that the prescribed criteria to enjoy the tax treaty benefits are met, directly apply the reduced withholding tax rate, and file necessary forms and supporting documents when
performing tax filings, which will be subject to post-tax filing examinations by the relevant tax authorities. As a result, we cannot assure you that we will be entitled to any preferential
withholding tax rate under tax treaties for dividends received from our PRC subsidiary.
We face uncertainty with respect to indirect transfer of equity interests in PRC resident enterprises by
their non-PRC holding companies.
We face uncertainties regarding the reporting on and consequences of previous private equity financing transactions involving the transfer and
exchange of shares in our company by non-resident investors.
In
February 2015, the SAT issued the Bulletin on Issues of Enterprise Income Tax on Indirect Transfers of Assets by Non-PRC Resident Enterprises, or SAT Bulletin 7, as amended in 2017,
which replaced certain clauses of the Notice of the State Administration of Taxation on Strengthening the Administration of Enterprise Income Tax on Non-resident Enterprises' Equity Transfer Income
issued by the SAT in December 2009. Pursuant to this bulletin, an "indirect transfer" of assets, including equity interests in a PRC resident enterprise, by non-PRC resident enterprises may be
re-characterized and treated as a direct transfer of PRC taxable assets, if such arrangement does not have a reasonable commercial purpose and was established for the purpose of avoiding payment of
PRC enterprise income tax. As a result, gains derived from such indirect transfer may be subject to PRC enterprise income tax. According to SAT Bulletin 7, "PRC taxable assets" include assets
attributed to an
establishment in China, immovable properties located in China, and equity investments in PRC resident enterprises, in respect of which gains from their transfer by a direct holder, being a non-PRC
resident enterprise, would be subject to PRC enterprise income taxes. When determining whether there is a
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"reasonable
commercial purpose" of the transaction arrangement, features to be taken into consideration include: whether the main value of the equity interest of the relevant offshore enterprise
derives from PRC taxable assets; whether the assets of the relevant offshore enterprise mainly consist of direct or indirect investment in China or if its income mainly derives from China; whether the
offshore enterprise and its subsidiaries directly or indirectly holding PRC taxable assets have real commercial nature which is evidenced by their actual function and risk exposure; the duration of
existence of the business model and organizational structure; the replicability of the transaction by direct transfer of PRC taxable assets; and the tax situation of such indirect transfer and
applicable tax treaties or similar arrangements. In respect of an indirect offshore transfer of assets of a PRC establishment, the resulting gain is to be included with the enterprise income tax
filing of the PRC establishment or place of business being transferred, and would consequently be subject to PRC enterprise income tax at a rate of 25%. Where the underlying transfer relates to the
immovable properties located in China or to equity investments in a PRC resident enterprise, which is not related to a PRC establishment or place of business of a non-resident enterprise, a PRC
enterprise income tax of 10% would apply, subject to available preferential tax treatment under applicable tax treaties or similar arrangements, and the party who is obligated to make the transfer
payments has the withholding obligation. Where the payor fails to withhold any or sufficient tax, the transferor is required to declare and pay such tax to the tax authority by itself within the
statutory time limit. Late payment of applicable tax will subject the transferor to default interest. SAT Bulletin 7 does not apply to transactions of sale of shares by investors through a public
stock exchange where such shares were acquired from a transaction through a public stock exchange.
There
is uncertainty as to the application of SAT Bulletin 7. We face uncertainties as to the reporting and other implications of certain past and future transactions where PRC taxable
assets are involved, such as offshore restructuring, sale of the shares in our offshore subsidiaries or investments. Our company may be subject to filing obligations or taxed if our company is
transferor in such transactions, and may be subject to withholding obligations if our company is transferee in such transactions under SAT Bulletin 7. In 2014, we repurchased certain number of
ordinary shares in CooTek (Cayman) Inc. from an existing shareholder for the consideration of US$9.3 million. The existing shareholder undertook to make the necessary tax filings in
relation to this repurchase by herself and to indemnify us against any losses arising from the failure to make such tax filings. However, we cannot assure you that, if the existing shareholder fails
to make necessary tax filings, the tax authority would not require us to make such tax filings and even subject us to fines. As of the date of this prospectus supplement, we have neither received any
notice of warning nor been subject to any penalties or other disciplinary action from the relevant government authorities regarding such tax filing. For transfer of shares in our company by investors
that are non-PRC resident enterprises, our PRC subsidiary may be requested to assist in the filing under SAT Bulletin 7. As a result, we may be required to expend valuable resources to comply with SAT
Bulletin 7 or to request the relevant transferors from whom we purchase taxable assets to comply with these circulars, or to establish that our company should not be taxed under these circulars.
China's M&A Rules and certain other PRC regulations establish complex procedures for some acquisitions of
Chinese companies by foreign investors, which could make it more difficult for us to pursue growth through acquisitions in China.
The Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rules, and other recently adopted
regulations and rules concerning mergers and acquisitions established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time consuming
and complex. For example, the M&A Rules require that MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise, if
(1) any important industry is concerned, (2) such transaction involves factors that impact or may impact national economic security, or (3) such transaction will lead
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to
a change in control of a domestic enterprise which holds a famous trademark or PRC time-honored brand. Moreover, the Anti-Monopoly Law promulgated by the Standing Committee of the National People's
Congress in August 2007 and effective in August 2008 requires that transactions which are deemed concentrations and involve parties with specified turnover thresholds (i.e., during the previous
fiscal year, (1) the total global turnover of all operators participating in the transaction exceeds RMB10 billion and at least two of these operators each had a turnover of more than
RMB400 million within China, or (2) the total turnover within China of all the operators participating in the concentration exceeded RMB2 billion, and at least two of these
operators each had a turnover of more than RMB400 million within China) must be cleared by MOFCOM before they can be completed. In addition, in February 2011, the General Office of the State
Council promulgated a Notice on Establishing the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the Circular 6, which officially established a
security review system for mergers and acquisitions of domestic enterprises by foreign investors. Further, in August 2011, MOFCOM promulgated the Regulations on Implementation of Security Review
System for the Merger and Acquisition of Domestic Enterprises by Foreign Investors, or the MOFCOM Security Review Regulations, to implement the Circular 6. Under Circular 6, a security review is
required for mergers and acquisitions by foreign investors having "national defense and security" concerns and mergers and acquisitions by which foreign investors may acquire the
"de facto control" of domestic enterprises with "national security" concerns. Under the MOFCOM Security Review Regulations, MOFCOM will focus on the
substance and actual impact of the transaction when deciding whether a specific merger or acquisition is subject to security review. If MOFCOM decides that a specific merger or acquisition is subject
to security review, it will submit it to the Inter-Ministerial Panel, an authority established under the Circular 6 led by the National Development and Reform Commission, or NDRC, and MOFCOM under the
leadership of the State Council, to carry out security review. The regulations prohibit foreign investors from bypassing the security review by structuring transactions through trusts, indirect
investments, leases, loans, control through contractual arrangements or offshore transactions. There is no explicit provision or official interpretation stating that the merging or acquisition of a
company
engaged in the internet information services, online games, online audio-visual program services and related businesses requires security review, and there is no requirement that acquisitions
completed prior to the promulgation of the Security Review Circular are subject to MOFCOM review.
In
the future, we may grow our business by acquiring complementary businesses. Complying with the requirements of the above-mentioned regulations and other relevant rules to complete
such transactions could be time consuming, and any required approval processes, including obtaining approval from the MOFCOM or its local counterparts may delay or inhibit our ability to complete such
transactions. It is unclear whether our business would be deemed to be in an industry that raises "national defense and security" or "national security" concerns. However, MOFCOM or other government
agencies may publish explanations in the future determining that our business is in an industry subject to the security review, in which case our future acquisitions in the PRC, including those by way
of entering into contractual control arrangements with target entities, may be closely scrutinized or prohibited.
PRC regulations relating to offshore investment activities by PRC residents may limit our PRC subsidiary's
ability to increase their registered capital or distribute profits to us or otherwise expose us to liability and penalties under PRC law.
In July 2014, the SAFE promulgated the Circular on Relevant Issues Relating to Domestic Resident's Investment and Financing and Roundtrip
Investment through Special Purpose Vehicles, or SAFE Circular 37, which replaced the Relevant Issues Concerning Foreign Exchange Control on Domestic Residents' Corporate Financing and Roundtrip
Investment through Offshore Special Purpose Vehicles, or Circular 75. Circular 37 requires PRC residents or entities to register with SAFE or its local branch in connection with their establishment or
control of an offshore entity established for the
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purpose
of overseas investment or financing. In addition, such PRC residents or entities must update their SAFE registrations when the offshore special purpose vehicle undergoes material events
relating to any change of basic information (including change of such PRC citizens or residents, name and operation term), increases or decreases in investment amount, transfers or exchanges of
shares, or mergers or divisions. According to the Notice on Further Simplifying and Improving Policies for the Foreign Exchange Administration of Direct Investment released on February 13, 2015
by the SAFE, as amended in 2019, local banks will examine and handle foreign exchange registration for overseas direct investment, including the initial foreign exchange registration and amendment
registration, under SAFE Circular 37 from June 1, 2015.
If
our shareholders who are PRC residents or entities do not complete their registration with the local SAFE branches, our PRC subsidiary may be prohibited from distributing their
profits and proceeds from any reduction in capital, share transfer or liquidation to us, and we may be restricted in our ability to contribute additional capital to our PRC subsidiary. Moreover,
failure to comply with the SAFE registration described above could result in liability under PRC laws for evasion of applicable foreign exchange restrictions.
Karl
Kan Zhang, Susan Qiaoling Li, Michael Jialing Wang, Jim Jian Wang and Haiyan Zhu, who directly or indirectly hold shares in CooTek (Cayman) Inc. and who are PRC residents,
have completed the SAFE registration in connection with our financings and have committed to update their registration filings with SAFE under SAFE Circular 75 or Circular 37 when any changes should
be registered under SAFE Circular 75 or Circular 37. However, we may not at all times be fully aware or informed of the identities of all our shareholders or beneficial owners that are required to
make such registrations, and we cannot compel our beneficial owners to comply with SAFE registration requirements. As a result, we cannot assure you that all of our shareholders or beneficial owners
who are PRC residents or entities have complied with, and will in the future make or obtain any applicable registrations or approvals required by, SAFE regulations. Failure by such shareholders or
beneficial owners to comply with SAFE regulations, or failure by us to amend the foreign exchange registrations of our PRC subsidiary, could subject us to fines or legal sanctions, restrict our
overseas or cross-border investment activities, limit our subsidiary's ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and
prospects.
Failure to comply with PRC regulations regarding the registration requirements for employee stock ownership
plans or share option plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.
Pursuant to SAFE Circular 37, PRC residents who participate in share incentive plans in overseas non-publicly-listed companies due to their
position as director, senior management or employees of the PRC subsidiaries of the overseas companies may submit applications to SAFE or its local branches for the foreign exchange registration with
respect to offshore special purpose companies. Our directors, executive officers and other employees who are PRC residents and who have been granted options may follow SAFE Circular 37 to apply for
the foreign exchange registration before our company becomes an overseas listed company. In February 2012, SAFE promulgated the Notices on Issues Concerning the Foreign Exchange Administration for
Domestic Individuals Participating in Stock Incentive Plans of Overseas Publicly-Listed Companies, or the Stock Option Rules. Under the Stock Option Rules and other relevant rules and regulations, PRC
residents who participate in stock incentive plan in an overseas publicly-listed company are required to register with SAFE or its local branches and complete certain other procedures. Participants of
a stock incentive plan who are PRC residents must retain a qualified PRC agent, which could be a PRC subsidiary of such overseas publicly listed company or another qualified institution selected by
such PRC subsidiary, to conduct the SAFE registration and other procedures with respect to the stock incentive plan on behalf of its participants. Such participants must also retain an overseas
entrusted institution to handle matters in connection with their exercise of
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stock
options, the purchase and sale of corresponding stocks or interests and fund transfers. In addition, the PRC agent is required to amend the SAFE registration with respect to the stock incentive
plan if there is any material change to the stock incentive plan, the PRC agent or the overseas entrusted institution or other material changes. We and our PRC employees who have been granted stock
options are subject to these regulations. We have completed such SAFE registrations for our PRC stock option holder employees in March 2019. However, we cannot assure you that we will be able to
complete the relevant registration for new employees who participate in such stock incentive plan in the future in a timely manner or at all. Failure of our PRC stock option holders to complete their
SAFE registrations may subject these PRC residents to fines and legal sanctions and may also limit our ability to contribute additional capital into our PRC subsidiary, limit our PRC subsidiary's
ability to distribute dividends to us, or otherwise materially adversely affect our business.
PRC regulation of loans to, and direct investment in, PRC entities by offshore holding companies and
governmental control of currency conversion may restrict or prevent us from using the proceeds of our initial public offering to make loans to our PRC subsidiary and consolidated affiliated entities,
or to make additional capital contributions to our PRC subsidiary.
We are an offshore holding company conducting our operations in China through our PRC subsidiary and consolidated affiliated entities. We may
make loans to our PRC subsidiary and consolidated affiliated entities, or we may make additional capital contributions to our PRC subsidiary, or we may establish new PRC subsidiary and make capital
contributions to these new PRC subsidiaries, or we may acquire offshore entities with business operations in China in an offshore transaction.
Most
of these ways are subject to PRC regulations and approvals. For example, loans by us to our wholly owned PRC subsidiary to finance its activities cannot exceed statutory limits and
must be registered with the local counterpart of SAFE. If we decide to finance our wholly owned PRC subsidiary by means of capital contributions, these capital contributions are subject to the
requirement of making necessary filings with the MOFCOM and registration with other governmental authorities in China. Due to the restrictions imposed on loans in foreign currencies extended to any
PRC domestic companies, we are not likely to make such loans to our consolidated affiliated entities, which are PRC domestic company. Further, we are not likely to finance the activities of our
consolidated affiliated entities by means of capital contributions due to regulatory restrictions relating to foreign investment in PRC domestic enterprises engaged in internet information services,
online games, online audio-visual program services and related businesses.
The
SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming the Administration of Foreign Exchange Settlement of Capital of Foreign-invested Enterprises,
or SAFE
Circular 19, effective in June 2015. According to SAFE Circular 19, the flow and use of the RMB capital converted from foreign currency-denominated registered capital of a foreign-invested company is
regulated such that RMB capital may not be used for the issuance of RMB entrusted loans, the repayment of inter-enterprise loans or the repayment of banks loans that have been transferred to a third
party. Although SAFE Circular 19 allows RMB capital converted from foreign currency-denominated registered capital of a foreign-invested enterprise to be used for equity investments within the PRC, it
also reiterates the principle that RMB converted from the foreign currency-denominated capital of a foreign-invested company may not be directly or indirectly used for purposes beyond its business
scope. SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming and Standardizing the Foreign Exchange Settlement Management Policy of Capital Account, or SAFE Circular
16, effective in June 2016, which reiterates some of the rules set forth in SAFE Circular 19, but changes the prohibition against using RMB capital converted from foreign currency-denominated
registered capital of a foreign-invested company to issue RMB entrusted loans to a prohibition against using such capital to issue loans to non-associated enterprises. SAFE Circular 19 and SAFE
Circular 16 may significantly limit our ability to transfer any foreign currency we hold,
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including
the net proceeds from our initial public offering, to our PRC subsidiary, which may adversely affect our liquidity and our ability to fund and expand our business in the PRC. On
October 23, 2019, SAFE issued Notice of the State Administration of Foreign Exchange on Further Promoting the Facilitation of Cross-border Trade and Investment, or the Circular 28. Circular 28
allows non-investment foreign-invested enterprises to use their capital funds to make equity investments in China, provided that such investments do not violate the Negative List and the target
investment projects are genuine and in compliance with PRC laws. Since Circular 28 was issued only recently, its interpretation and implementation in practice are still subject to substantial
uncertainties.
In
light of the various requirements imposed by PRC regulations on loans to and direct investment in PRC entities by offshore holding companies, we cannot assure you that we will be able
to complete the necessary government registrations or obtain the necessary government approvals on a timely basis, if at all, with respect to future loans by us to our PRC subsidiary or with respect
to future capital contributions by us to our PRC subsidiary. If we fail to complete such registrations or obtain such approvals, our ability to use the proceeds we received from our initial public
offering and to capitalize or otherwise fund our PRC operations may be negatively affected, which could materially and adversely affect our liquidity and our ability to fund and expand our business.
Fluctuation in the value of the RMB may have a material adverse effect on the value of your investment.
The conversion of Renminbi into foreign currencies, including U.S. dollars, is based on rates set by the People's Bank of China. The Renminbi
has fluctuated against the U.S. dollar, at times significantly and unpredictably. The value of Renminbi against the U.S. dollar and other currencies is affected by changes in China's political and
economic conditions and by China's foreign exchange policies, among other things. We cannot assure you that Renminbi will not appreciate or depreciate significantly in value against the U.S. dollar in
the future. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between Renminbi and the U.S. dollar in the future.
A
certain percentage of our costs, expenses and revenues are denominated in RMB. Any significant depreciation of the RMB may materially adversely affect the value of, and any dividends
payable on, our ADSs in U.S. Dollars. To the extent that we need to convert U.S. Dollars we received from our initial public offering into RMB for our operations, appreciation of the RMB against the
U.S. Dollar would have an adverse effect on the RMB amount we would receive from the conversion. Conversely, if we decide to convert our RMB into U.S. Dollars for the purpose of paying dividends on
our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. Dollar against the RMB would have an adverse effect on the U.S. Dollar amount available to us.
Very
limited hedging options are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to
reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedges may be limited and we
may not be able to adequately hedge our exposure or at all. In addition, our currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert Renminbi
into foreign currency. As a result, fluctuations in exchange rates may have a material adverse effect on your investment.
If additional remedial measures are imposed on major PRC-based accounting firms, including our independent
registered public accounting firm, our financial statements could be determined not to be in compliance with the SEC requirements.
Beginning in 2011, the Chinese affiliates of the "big four" accounting firms (including our independent registered public accounting firm) were
affected by a conflict between the U.S. and Chinese law. Specifically, for certain U.S. listed companies operating and audited in the PRC, the SEC and the PCAOB sought to obtain access to the audit
work papers and related documents of the
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Chinese
affiliates of the "big four" accounting firms. The accounting firms were, however, advised and directed that, under Chinese law, they could not respond directly to the requests of the SEC and
the PCAOB and that such requests, and similar requests by foreign regulators for access to such papers in the PRC, had to be channeled through the China Securities Regulatory Commission, or the CSRC.
In
late 2012, this impasse led the SEC to commence administrative proceedings under Rule 102(e) of its Rules of Practice and also under the Sarbanes-Oxley Act of 2002 against the
"big four" accounting firms (including our independent registered public accounting firm). A first instance trial of these proceedings in July 2013 in the SEC's internal administrative court resulted
in an adverse judgment against the firms. The administrative law judge proposed penalties on the firms, including a temporary suspension of their right to practice before the SEC. Implementation of
the latter penalty was postponed pending review by the SEC Commissioners. On February 6, 2015, before a review by the SEC Commissioners had taken place, the firms reached a settlement with the
SEC. Under the settlement, the SEC accepts that future requests by the SEC for the production of documents will normally be made to the CSRC. The firms will receive matching Section 106
requests, and are required to abide by a detailed set of procedures with respect to such requests, which in substance require them to facilitate production via the CSRC. If the firms fail to follow
these procedures and meet certain other specified criteria, the SEC retains the authority to impose a variety of additional remedial measures, including, as appropriate, an automatic six-month bar on
a firm's ability to perform certain audit work, commencement of new proceedings against a firm or, in extreme cases, the resumption of the current administrative proceeding against all four firms.
In
the event that the SEC restarts administrative proceedings, depending upon the final outcome, listed companies in the U.S. with major PRC operations may find it difficult or
impossible to retain auditors in respect of their operations in the PRC, which could result in their financial statements being determined to not be in compliance with the requirements of the
Securities Exchange Act of 1934, as amended, or the Exchange Act, including possible delisting. Moreover, any negative news about any such future proceedings against the firms may cause investor
uncertainty regarding PRC-based, U.S.-listed companies and the market price of their shares may be adversely affected.
If
our independent registered public accounting firm was denied, even temporarily, the ability to practice before the SEC and we were unable to timely find another registered public
accounting firm to audit and issue an opinion on our financial statements, our financial statements could be determined not to be in compliance with the requirements of the Exchange Act. Such a
determination could ultimately lead to the delisting of our shares from the New York Stock Exchange or deregistration from the SEC, or both, which would substantially reduce or effectively terminate
the trading of our shares in the U.S.
We face uncertainties with respect to the enactment, interpretation and implementation of draft Anti-Monopoly
Guidelines for the Internet Platform Economy Sector.
In early November 2020, the State Administration for Market Regulation further published a draft Anti-Monopoly Guidelines for the Internet
Platform Economy Sector that aims at specifying some of the circumstances under which an activity of Internet platform may be identified as monopolistic act as well as setting out merger controlling
filing procedures involving variable interest entities. These draft guidelines are now open for public comment and are pending finalization and enactment, and we cannot assure you that there will not
be any material changes in the final form of these draft guidelines. Due to the uncertainties associated with the evolving legislative activities and varied local implementation practices of
anti-monopoly and competition laws and regulations in the PRC, it may be costly to adjust some of our business practice in order to comply with these laws, regulations, rules, guidelines and
implementations, and any incompliance or associated inquiries, investigations and other governmental actions may divert significant management time and attention and our financial resources, bring
negative publicity, subject us to liabilities or administrative penalties, and/or materially and adversely affect our financial conditions, operations and business prospects.
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Risks Related to This Offering
There is no public market for the Note.
There is no established public trading market for the Note, and we do not expect a market to develop. In addition, we do not intend to apply to
list the Note on any national securities exchange or other nationally recognized trading system, including the New York Stock Exchange. Without an active market, the liquidity of the Note will be
limited.
The Note issued in this offering are speculative in nature.
The Note issued in this offering do not confer any rights of ADSs ownership on their holders, but rather merely represent the right to acquire
ADSs at a conversion price. However, noteholder will be subject to all changes affecting our ADSs to the extent the market price of the Note depends on the market price of our ADSs and to the extent
they receive ADSs upon conversion of the Note. Following this offering, the market value of the Note, if any, is uncertain and there can be no assurance that the market value of the Note will equal or
exceed their conversion price.
The issuance and sale of shares issuable upon the conversion of the Note may depress our stock price.
If the Investor elects to convert the Note, it will have a dilutive effect on our existing shareholders. The securities issued to it pursuant to
the conversion of the Note and such sales could cause the market price of our ADSs to decline.
Holders of the Note will not have rights of holders of our ADSs until such Note is converted.
Until holders of Note acquire ADSs upon conversion of the Note, holders of Note will have no rights with respect to the ADSs.
The trading price of our ADSs is likely to be volatile, which could result in substantial losses to
investors.
During the fiscal year ended December 31, 2020, the trading price of our ADSs has ranged from US$2.61 to US$ 7.45 per ADS. On
March 18, 2021, the closing price of the ADSs on the New York Stock Exchange was US$3.10 per ADS. The trading price of our ADSs is likely to be volatile and could fluctuate widely due to
factors beyond our control. This may happen because of broad market and industry factors, including the performance and fluctuation of the market prices of other mobile internet companies based in
China that have listed their securities in the United States. In addition to market and industry factors, the price and trading volume for our ADSs may be highly volatile for factors specific to our
own operations, including the following:
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variations in our revenues, earnings, cash flow and data related to our operating metrics;
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announcements of new investments, acquisitions, strategic partnerships or joint ventures by us or our competitors;
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announcements of new product and service offerings, solutions and expansions by us or our competitors;
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changes in financial estimates by securities analysts;
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financial projections that may be provided by us and changes to these projections;
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detrimental adverse publicity about us, our products and services or our industry;
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additions or departures of key personnel;
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release of lock-up or other transfer restrictions on our outstanding equity securities or sales of additional equity securities; and
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potential litigation or regulatory investigations.
Any
of these factors may result in large and sudden changes in the volume and price at which our ADSs will trade.
In
the past, shareholders of public companies have often brought securities class action suits against those companies following periods of instability in the market price of their
securities. If we were involved in a class action suit, it could divert a significant amount of our management's attention and other resources from our business and operations and require us to incur
significant expenses to defend the suit, which could harm our operating results. Any such class action suit, whether or not successful, could harm our reputation and restrict our ability to raise
capital in the future. In addition, if a claim is successfully made against us, we may be required to pay significant damages, which could have a material adverse effect on our financial condition and
results of operations.
Techniques employed by short sellers may drive down the market price of our ADSs.
Short selling is the practice of selling securities that the seller does not own but rather has borrowed from a third party with the intention
of buying identical securities back at a later date to return to the lender. The short seller hopes to profit from a decline in the value of the securities between the sale of the borrowed securities
and the purchase of the replacement shares, as the short seller expects to pay less in that purchase than it received in the sale. As it is in the short seller's interest for the price of the security
to decline, many short sellers publish, or arrange for the publication of, negative opinions regarding the relevant issuer and its business prospects in order to create negative market momentum and
generate profits for themselves after selling a security short. These short attacks have, in the past, led to selling of shares in the market.
Public
companies listed in the United States that have a substantial majority of their operations in China have been the subject of short selling. Much of the scrutiny and negative
publicity has centered on allegations of a lack of effective internal control over financial reporting resulting in financial and accounting irregularities and mistakes, inadequate corporate
governance policies or a lack of adherence
thereto and, in many cases, allegations of fraud. As a result, many of these companies are now conducting internal and external investigations into the allegations and, in the interim, are subject to
shareholder lawsuits and/or SEC enforcement actions.
We
may be the subject of unfavorable allegations made by short sellers in the future. Any such allegations may be followed by periods of instability in the market price of our common
shares and ADSs and negative publicity. If and when we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we could have to expend a
significant amount of resources to investigate such allegations and/or defend ourselves. While we would strongly defend against any such short seller attacks, we may be constrained in the manner in
which we can proceed against the relevant short seller by principles of freedom of speech, applicable federal or state law or issues of commercial confidentiality. Such a situation could be costly and
time-consuming and could distract our management from growing our business. Even if such allegations are ultimately proven to be groundless, allegations against us could severely impact our business
operations and shareholders' equity, and the value of any investment in our ADSs could be greatly reduced or rendered worthless.
Our dual-class share structure with different voting rights will limit your ability to influence corporate
matters and could discourage others from pursuing any change of control transactions that holders of our Class A ordinary shares and ADSs may view as beneficial.
We have created a dual-class share structure such that our ordinary shares shall consist of Class A ordinary shares and Class B
ordinary shares. In respect of matters requiring the votes of shareholders, holders of Class A ordinary shares are entitled to one vote per share, while holders of Class B ordinary
shares are entitled to twenty-five (25) votes per share on all matters subject to vote at general meetings
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our company based on our dual-class share structure. Each Class B ordinary share is convertible into one Class A ordinary share at any time at the option of the holder thereof, while
Class A ordinary shares are not convertible into Class B ordinary shares under any circumstances. Upon any sale, transfer, assignment or disposition of any Class B ordinary shares
by a holder thereof to any person or entity other than holders of Class B ordinary shares or their affiliates, or upon a change of ultimate beneficial ownership of any Class B ordinary
shares to any person who is not an affiliate of the holder thereof, such Class B ordinary shares shall be automatically and immediately converted into the equivalent number of Class A
ordinary shares.
As
of December 31, 2020, our chairman of the board of directors and chief technology officer, Karl Kan Zhang, beneficially owns all of our issued Class B ordinary shares.
These Class B ordinary shares constitutes approximately 8.1% of our total issued and outstanding share capital and 68.7% of the aggregate voting power of our total issued and outstanding share
capital as of December 31, 2020, due to the disparate voting powers associated with our dual-class share structure. As a result of the dual-class share structure and the concentration of
ownership, holders of Class B ordinary shares have considerable influence over matters such as decisions regarding mergers, consolidations and the sale of all or substantially all of our
assets, election of directors and other significant corporate actions. Such holders may take actions that are not in the best interest of us or our other shareholders. This concentration of ownership
may discourage, delay or prevent a change in control of our company, which could have the effect of depriving our other shareholders of the opportunity to receive a premium for their shares as part of
a sale of our company and may reduce the price of our ADSs. This concentrated control will limit your ability to influence corporate matters and could discourage others from pursuing any potential
merger, takeover or other change of control transactions that holders of Class A ordinary shares and ADSs may view as beneficial.
The dual-class structure of our ordinary shares may adversely affect the trading market for our ADSs.
S&P Dow Jones and FTSE Russell have recently announced changes to their eligibility criteria for inclusion of shares of public companies on
certain indices, including the S&P 500, to exclude companies with multiple classes of shares and companies whose public shareholders hold no more than 5% of total voting power from being added
to such indices. In addition, several shareholder advisory firms have announced their opposition to the use of multiple class structures. As a result, the dual-class structure of our ordinary shares
may prevent the inclusion of our ADSs representing Class A ordinary shares in such indices and may cause shareholder advisory firms to publish negative commentary about our corporate governance
practices or otherwise seek to cause us to change our capital structure. Any such exclusion from indices could result in a less active trading market for our ADSs. Any actions or publications by
shareholder advisory firms critical of our corporate governance practices or capital structure could also adversely affect the value of our ADSs.
If securities or industry analysts do not publish research about our business, or if they adversely change
their recommendations regarding our ADSs, the market price for our ADSs and trading volume could decline.
The trading market for our ADSs will be influenced by research or reports that industry or securities analysts publish about our business. If
one or more analysts who cover us downgrade our ADSs, the market price for our ADSs would likely decline. If one or more of these analysts cease to cover us, or fail to regularly publish reports on
us, we could lose visibility in the financial markets, which in turn could cause the market price or trading volume for our ADSs to decline.
Substantial future sale or the perception of a potential sale of substantial amounts of our ADSs could
adversely affect our ADRs' market price.
Sales of substantial amounts of our ADSs in the public market, or the perception that these sales could occur, could adversely affect the market
price of our ADSs and could materially impair our
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to raise capital through equity offerings in the future. We cannot predict what effect, if any, market sales of securities held by our significant shareholders or any other shareholder or the
availability of these securities for future sale will have on the market price of our ADSs.
Because we do not expect to pay dividends in the foreseeable future, you must rely on price appreciation of
our ADSs for return on your investment.
We currently intend to retain most, if not all, of our available funds and any future earnings to fund the development and growth of our
business. As a result, we do not expect to pay any cash dividends in the foreseeable future. Therefore, you should not rely on an investment in our ADSs as a source for any future dividend income.
Pursuant
to our seventh amended and restated memorandum and articles of association, our board of directors has complete discretion as to whether to distribute dividends, subject to
certain requirements of Cayman Islands law. In addition, our shareholders may by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended by our board of directors.
Under Cayman Islands law, a Cayman Islands company may pay a dividend either out of profits or share premium account, provided that in no circumstances may a dividend be paid if this would result in
the company being unable to pay its debts as they fall due in the ordinary course of business. Even if our board of directors decides to declare and pay dividends, the timing, amount and form of
future dividends, if any, will depend on, among other things, our future results of operations and cash flow, our capital requirements and surplus, the amount of distributions, if any, received by us
from our subsidiaries, our financial condition, contractual restrictions and other factors deemed relevant by our board of directors. Accordingly, the return on your investment in our ADSs will likely
depend entirely upon any future price appreciation of our ADSs. There is no guarantee that our ADSs will appreciate in value or even maintain the price at which you purchased the ADSs. You may not
realize a return on your investment in our ADSs and you may even lose your entire investment in our ADSs.
You may be subject to PRC income tax on dividends from us or on any gain realized on the transfer of our
ADSs.
Under the EIT Law and its implementation rules, subject to any applicable tax treaty or similar arrangement between the PRC and your
jurisdiction of residence that provides for a different income tax arrangement, PRC withholding tax at the rate of 10% is normally applicable to dividends from PRC sources payable to investors that
are non-PRC resident enterprises, which do not have an establishment or place of business in the PRC, or which have such establishment or place of business if the relevant income is not effectively
connected with the establishment or place of business. Any gain realized on the transfer of ADSs or ordinary shares by such non-PRC resident enterprise investors is also subject to 10% PRC income tax
if such gain is regarded as income derived from sources within the PRC, unless a tax treaty or similar arrangement provides otherwise. Under the PRC Individual Income Tax Law and its implementation
rules, dividends from sources within the PRC paid to foreign individual investors who are not PRC residents are generally subject to a PRC withholding tax at a rate of 20% and gains from PRC sources
realized by such investors on the transfer of ADSs or ordinary shares are generally subject to 20% PRC income tax, in each case, subject to any reduction or exemption set forth in applicable tax
treaties and similar arrangements and PRC laws. Although substantially all of our daily operations are in China, it is unclear whether dividends we pay with respect to our ADSs, or the gain realized
from the transfer of our ADSs, would be treated as income derived from sources within the PRC and as a result be subject to PRC income tax if we were considered a PRC resident enterprise, as described
above. If PRC income tax were imposed on gains realized through the transfer of our ADSs or on dividends paid to our non-PRC resident investors, the value of your investment in our ADSs may be
materially and adversely affected. Furthermore, our ADS holders whose jurisdictions of residence
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have
tax treaties or similar arrangements with China may not qualify for benefits under such tax treaties or arrangements.
There can be no assurance that we will not be a passive foreign investment company, or PFIC, for U.S. federal
income tax purposes for any taxable year, which could result in adverse U.S. federal income tax consequences to U.S. holders of our ADSs or ordinary shares.
A non-U.S. corporation will be a passive foreign investment company, or PFIC, for any taxable year if either (1) at least 75% of its
gross income for such year consists of certain types of "passive" income; or (2) at least 50% of the value of its assets (generally determined on the basis of
a quarterly average) during such year is attributable to assets that produce passive income or are held for the production of passive income, or the asset test. Based on our historical, current and
expected value of our assets and the composition of our income and assets (taking into account our historical and current market capitalization and expected cash proceeds from this offering), we do
not believe that we were a PFIC for our taxable year ended December 31, 2020 and we do not expect to be a PFIC for the current taxable year or the foreseeable future. However, no assurance can
be given in this regard because the determination of whether we are or will become a PFIC is a fact-intensive inquiry made on an annual basis that depends, in part, upon the composition of our income
and assets. Fluctuations in the market price of our ADSs may cause us to become a PFIC for the current or subsequent taxable years because the value of our assets for the purpose of the asset test may
be determined by reference to the market price of our ADSs (which may be volatile). The composition of our income and assets may also be affected by how, and how quickly, we use our liquid assets.
If
we were to be or become a PFIC for any taxable year during which a U.S. Holder holds our ADSs or ordinary shares, certain adverse U.S. federal income tax consequences could apply to
such U.S. Holder. See "TaxationMaterial United States Federal Income Tax ConsiderationsPassive Foreign Investment Company Rules."
Our memorandum and articles of association contain anti-takeover provisions that could have a material
adverse effect on the rights of holders of our Class A ordinary shares and ADSs.
Our seventh memorandum and articles of association contain provisions to limit the ability of others to acquire control of our company or cause
us to engage in change-of-control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices
by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. Our dual-class voting structure gives disproportionate voting power to holders of
the Class B ordinary shares. In addition, our board of directors has the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix their
designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations or restrictions, including dividend rights, conversion rights,
voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our Class A ordinary shares, in the form of ADS or otherwise.
Preferred shares could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to
issue preferred shares, the price of our ADSs may fall and the voting and other rights of the holders of our Class A ordinary shares and ADSs may be materially and adversely affected.
You may face difficulties in protecting your interests, and your ability to protect your rights through U.S.
courts may be limited, because we are incorporated under Cayman Islands law.
We are an exempted company limited by shares incorporated under the laws of the Cayman Islands. Our corporate affairs are governed by our
memorandum and articles of association, the Companies Act (As Revised) of the Cayman Islands and the common law of the Cayman Islands. The
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rights
of shareholders to take action against the directors, actions by minority shareholders, and the fiduciary duties owed to us by our directors under Cayman Islands law are to a large extent
governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from the common
law of England, the decisions of whose courts are of persuasive authority, but are not binding, on a court in the Cayman Islands. The rights of our shareholders and the fiduciary duties owed to us by
our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the United States. In particular, the Cayman
Islands has a less developed body of securities laws than the United States. Some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the
Cayman Islands. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States.
Shareholders
of Cayman Islands exempted companies like us have no general rights under Cayman Islands law to inspect corporate records (save for our memorandum and articles of
association) or to obtain copies of lists of shareholders of these companies. Our directors have discretion under our memorandum and articles of association to determine whether or not, and under what
conditions, our corporate records may be inspected by our shareholders, but are not obliged to make them available to our shareholders. This may make it more difficult for our shareholders to obtain
the information needed to establish any facts necessary for them to motion or to solicit proxies from other shareholders in connection with a proxy contest.
As
a result of all of the above, our public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of the board of
directors or controlling shareholders than they would as public shareholders of a company incorporated in the United States.
ADS holders may not be entitled to a jury trial with respect to claims arising under the deposit agreement,
which could result in less favorable outcomes to the plaintiff(s) in any such action.
The deposit agreement governing the ADSs representing our ordinary shares provides that, subject to the depositary's right to require a claim to
be submitted to arbitration, the federal or state courts in the City of New York have exclusive jurisdiction to hear and determine claims arising under the deposit agreement and in that regard, to the
fullest extent permitted by law, ADS holders waive the right to a jury trial of any claim they may have against us or the depositary arising out of or relating to our shares, the ADSs or the deposit
agreement, including any claim under the U.S. federal securities laws.
If
we or the depositary opposed a jury trial demand based on the waiver, the court would determine whether the waiver was enforceable based on the facts and circumstances of that case in
accordance with the applicable U.S. state and federal law. To our knowledge, the enforceability of a contractual pre-dispute jury trial waiver in connection with claims arising under the U.S. federal
securities laws has not been finally adjudicated by the United States Supreme Court. However, we believe that a contractual pre-dispute jury trial waiver provision is generally enforceable, including
under the laws of the State of New York, which govern the deposit agreement. In determining whether to enforce a contractual pre-dispute jury trial waiver provision, courts will generally consider
whether a party knowingly, intelligently and voluntarily waived the right to a jury trial. We believe that this is the case with respect to the deposit agreement and the ADSs. It is advisable that you
consult legal counsel regarding the jury waiver provision before investing in the ADSs.
If
you or any other holders or beneficial owners of ADSs bring a claim against us or the depositary in connection with matters arising under the deposit agreement or the ADSs, including
claims under U.S. federal securities laws, you or such other holder or beneficial owner may not be entitled to a jury trial with respect to such claims, which may have the effect of limiting and
discouraging lawsuits against us and/or the depositary. If a lawsuit is brought against us and/or the depositary under the deposit
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agreement,
it may be heard only by a judge or justice of the applicable trial court, which would be conducted according to different civil procedures and may result in different outcomes than a trial
by jury would have had, including results that could be less favorable to the plaintiff(s) in any such action.
Nevertheless,
if this jury trial waiver provision is not enforced, to the extent a court action proceeds, it would proceed under the terms of the deposit agreement with a jury trial. No
condition, stipulation or provision of the deposit agreement or ADSs serves as a waiver by any holder or beneficial owner of
ADSs or by us or the depositary of compliance with any substantive provision of the U.S. federal securities laws and the rules and regulations promulgated thereunder.
Certain judgments obtained against us by our shareholders may not be enforceable.
We are a Cayman Islands exempted company and substantially all of our assets are located outside of the United States. Substantially all of our
daily operations are conducted in China. In addition, substantially all of our current directors and officers are nationals and residents of countries other than the United States, and substantially
all of the assets of these persons are located outside the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the
United States in the event that you believe that your rights have been infringed under the U.S. federal securities laws or otherwise. Even if you are successful in bringing an action of this kind, the
laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers.
We are an emerging growth company within the meaning of the Securities Act and may take advantage of certain
reduced reporting requirements.
We are an "emerging growth company," as defined in the JOBS Act, and we may take advantage of certain exemptions from requirements applicable to
other public companies that are not emerging growth companies including, most significantly, not being required to comply with the auditor attestation requirements of Section 404 for so long as
we remain an emerging growth company until the fifth anniversary from the date of our initial listing. As a result, if we elect not to comply with such auditor attestation requirements, our investors
may not have access to certain information they may deem important. In addition, pursuant to the JOBS Act, we have elected to take advantage of the extended transition period for complying with new or
revised accounting standards until those standards would otherwise apply to private companies. As a result, our operating results and financial statements may not be comparable to the operating
results and financial statements of other companies who have adopted the new or revised accounting standards. If we cease to be an emerging growth company, we will no longer be able to take advantage
of these exemptions or the extended transition period for complying with new or revised accounting standards.
We
cannot predict if investors will find our ADSs less attractive or our company less comparable to certain other public companies because we will rely on these exemptions and election.
If some investors find our ADSs less attractive as a result, there may be a less active trading market for our ADSs and our ADS price may be more volatile.
We will incur increased costs as a result of being a public company, particularly after we cease to qualify
as an "emerging growth company."
We are a public company and expect to incur significant legal, accounting and other expenses that we did not incur as a private company. The
Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC and the New York Stock Exchange, impose various requirements on the corporate governance practices of public companies.
As a company with less than US$1.07 billion in revenues for our last fiscal year, we qualify as an "emerging growth company" pursuant to the JOBS Act. An emerging growth company may take
advantage of specified reduced reporting and other
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requirements
that are otherwise applicable generally to public companies. These provisions include exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act
of 2002, or Section 404, in the assessment of the emerging growth company's internal control over financial reporting. The JOBS Act also permits an emerging growth company to delay adopting new
or revised accounting standards until such time as those standards apply to private companies. We have elected to take advantage of such extended transition period for complying with new or revised
accounting standards as required when they are adopted for public companies.
We
expect these rules and regulations to increase our legal and financial compliance costs and to make some corporate activities more time-consuming and costly. After we are no longer an
"emerging growth company," we expect to incur significant expenses and devote substantial management effort toward ensuring compliance with the requirements of Section 404 of the Sarbanes-Oxley
Act of 2002 and the other rules and regulations of the SEC. For example, as a result of becoming a public company, we will need to increase the number of independent directors and adopt policies
regarding internal controls and disclosure controls and procedures. We also expect that operating as a public company may make it more difficult and more expensive for us to obtain director and
officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. In addition, we may incur
additional costs associated with our public company reporting requirements. It may also be more difficult for us to find qualified persons to serve on our board of directors or as executive officers.
We are currently evaluating and monitoring developments with respect to these rules and regulations, and we cannot predict or estimate with any degree of certainty the amount of additional costs we
may incur or the timing of such costs.
As a company incorporated in the Cayman Islands, we are permitted to adopt certain home country practices in
relation to corporate governance matters that differ significantly from the NYSE corporate governance listing standards; these practices may afford less protection to shareholders than they would
enjoy if we complied fully with the NYSE corporate governance listing standards.
As a Cayman Islands exempted company listed on the New York Stock Exchange, we are subject to the NYSE corporate governance listing standards.
However, NYSE rules permit a foreign private issuer like us to follow the corporate governance practices of its home country. Certain corporate governance practices in the Cayman Islands, which is our
home country, may differ significantly from the NYSE corporate governance listing standards. We have chosen, and may from time to time choose, to follow home country exemptions with respect to certain
corporate matters. For example, beginning on September 2, 2019, we choose to follow home country practice in lieu of the requirements of NYSE Listed Company Manual Section 303A.01 to
have a majority of independent directors and Section 303A.07 to have an audit committee with at least three members. As a result, our shareholders may be afforded less protection than they
would otherwise enjoy under the NYSE governance listing standards applicable to U.S. domestic issuers.
We are a foreign private issuer within the meaning of the rules under the Exchange Act, and as such we are
exempt from certain provisions applicable to United States domestic public companies.
Because we are a foreign private issuer under the Exchange Act, we are exempt from certain provisions of the securities rules and regulations in
the United States that are applicable to U.S. domestic issuers, including:
-
-
the rules under the Exchange Act requiring the filing of quarterly reports on Form 10-Q or current reports on Form 8-K with the
SEC;
-
-
the sections of the Exchange Act regulating the solicitation of proxies, consents, or authorizations in respect of a security registered under
the Exchange Act;
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the sections of the Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and liability for
insiders who profit from trades made in a short period of time; and
-
-
the selective disclosure rules by issuers of material nonpublic information under Regulation FD.
We
are required to file an annual report within four months of the end of each fiscal year. In addition, we voluntarily publish our results on a quarterly basis through press releases,
distributed pursuant to the rules and regulations of the New York Stock Exchange. Press releases relating to financial results and material events are furnished to the SEC on Form 6-K. However,
the information we are required to file with or furnish to the SEC are less extensive and less timely compared to that required to be filed with the SEC by U.S. domestic issuers. As a result, you may
not be afforded the same protections or information, which would be made available to you, were you investing in a U.S. domestic issuer.
The voting rights of holders of ADSs are limited by the terms of the deposit agreement.
Holders of ADSs do not have the same rights as our registered shareholders. As a holder of our ADSs, you do not have any direct right to attend
general meetings of our shareholders or to cast any votes at such meetings. You will only be able to exercise the voting rights which are carried by the underlying Class A ordinary shares
represented by your ADSs indirectly by giving voting instructions to the depositary in accordance with the provisions of the deposit agreement. Under the deposit agreement, you may vote by giving
voting instructions to the depositary. Upon receipt of your voting instructions, the depositary will try, as far as is practicable, to vote the underlying Class A ordinary shares represented by
your ADSs in accordance with your instructions. If we ask for your instructions, then upon receipt of your voting instructions, the depositary will try to vote the underlying Class A ordinary
shares in accordance with these instructions. If we do not instruct the depositary to ask for your instructions, the depositary may still vote in accordance with instructions you give, but it is not
required to do so. You are not able to directly exercise your right to vote with respect to the underlying Class A ordinary shares represented by your ADSs unless you withdraw such shares, and
become the
registered holder of such shares prior to the record date for the general meeting. When a general meeting is convened, you may not receive sufficient advance notice of the meeting to withdraw the
underlying Class A ordinary shares represented by your ADSs and become the registered holder of such shares to allow you to attend the general meeting and to vote directly with respect to any
specific matter or resolution to be considered and voted upon at the general meeting. In addition, under our seventh amended and restated articles of association, for the purposes of determining those
shareholders who are entitled to attend and vote at any general meeting, our directors may close our register of members and/or fix in advance a record date for such meeting, and such closure of our
register of members or the setting of such a record date may prevent you from withdrawing the underlying Class A ordinary shares represented by your ADSs and becoming the registered holder of
such shares prior to the record date, so that you would not be able to attend the general meeting or to vote directly. If we ask for your instructions, the depositary will notify you of the upcoming
vote and will arrange to deliver our voting materials to you. We cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote the
underlying Class A ordinary shares represented by your ADSs. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for their manner of
carrying out your voting instructions. This means that you may not be able to exercise your right to direct how the underlying Class A ordinary shares represented by your ADSs are voted and you
may have no legal remedy if the underlying Class A ordinary shares represented by your ADSs are not voted as you requested.
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You may experience dilution of your holdings due to inability to participate in rights offerings.
We may, from time to time, distribute rights to our shareholders, including rights to acquire securities. Under the deposit agreement, the
depositary will not distribute rights to holders of ADSs unless the distribution and sale of rights and the securities to which these rights relate are either exempt from registration under the
Securities Act with respect to all holders of ADSs, or are registered under the provisions of the Securities Act. The depositary may, but is not required to, attempt to sell these undistributed rights
to third parties, and may allow the rights to lapse. We may be unable to establish an exemption from registration under the Securities Act, and we are under no obligation to file a registration
statement with respect to these rights or underlying securities or to endeavor to have a registration statement declared effective. Accordingly, holders of ADSs may be unable to participate in our
rights offerings and may experience dilution of their holdings as a result.
You may be subject to limitations on 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 from time to time for a number of reasons, including in connection with corporate events such as a
rights offering, during which time the depositary needs to maintain an exact number of ADS holders on its books for a specified period. The depositary may also close its books in emergencies, and on
weekends and public holidays. The depositary may refuse to deliver, transfer or register transfers of our ADSs generally when our share register or the books of the depositary are closed, or at any
time if we or the depositary thinks it is advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any
other reason.
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