DRS/A
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As confidentially submitted to the Securities and Exchange Commission on May 23, 2018

Registration No. 333-            

 

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form F-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Qtech Ltd.

(Exact name of Registrant as specified in its charter)

 

 

 

Cayman Islands   7370   Not Applicable
(State or Other Jurisdiction of
Incorporation or Organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification Number)

11/F, Block 3, XingChuang Technology Center

Shen Jiang Road 5005,

Pudong New Area, Shanghai, 200120

People’s Republic of China

+86-21-6858-3790

(Address and Telephone Number of Registrant’s Principal Executive Offices)

 

 

Law Debenture Corporate Services Inc.

801 2nd Avenue, Suite 403

New York, NY 10017, United States

+1-212-750-6474

(Name, address and telephone number of agent for service)

 

 

Copies to:

 

Chris K.H. Lin, Esq.

Daniel Fertig, Esq.
Simpson Thacher & Bartlett LLP
35th Floor, ICBC Tower
3 Garden Road
Central, Hong Kong
+852-2514-7600

 

Dan Ouyang, Esq.

Wilson Sonsini Goodrich & Rosati

Suite 1509, 15F, Jardine House

1 Connaught Place, Central

Hong Kong

+852-3972-4955

 

Jie Zhu, Esq.

Wilson Sonsini Goodrich & Rosati

Professional Corporation

Unit 03-04, 38F, Jin Mao Tower

88 Century Boulevard

Pudong New Area, Shanghai 200121

People’s Republic of China

+86-21-6165-1700

 

 

Approximate date of commencement of proposed sale to the public:

As soon as practicable after the effective date of this registration statement.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ☐

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933.

Emerging growth company  ☒

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 7(a)(2)(B) of the Securities Act.  ☒

† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered(1)

 

Proposed

Maximum
Aggregate

Offering Price(2)(3)

  Amount of
Registration Fee

Ordinary shares, par value US$0.0001 per share

  US$               US$            

 

 

(1) American depositary shares, or ADSs, issuable upon deposit of the ordinary shares registered hereby will be registered under a separate registration statement on Form F-6 (Registration No. 333-            ). Each ADS represents              ordinary shares.
(2) Includes (a)              ordinary shares represented by              ADSs that may be purchased by the underwriters pursuant to their over-allotment option and (b) all ordinary shares represented by ADSs initially offered and sold outside the United States that may be resold from time to time in the United States either as part of the distribution or within 40 days after the later of the effective date of this registration statement and the date the securities are first bona fide offered to the public.
(3) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.

The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to such Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the United States Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion. Dated             , 2018.

American Depositary Shares

 

LOGO

Qtech Ltd.

Representing              Ordinary Shares

This is an initial public offering of shares of American depositary shares, or ADSs, representing ordinary shares of Qtech Ltd.

We are offering              ADSs to be sold in this offering. Each ADS represents              ordinary shares, US$0.0001 par value per share. We anticipate the initial public offering price per ADS will be between US$             and US$            .

Prior to this offering, there has been no public market for the ADSs or our shares. We will apply to list the ADSs on the [NYSE]/[NASDAQ], under the symbol “QT.”

We are an “emerging growth company” under applicable United States federal securities laws and are eligible for reduced public company reporting requirements.

See “Risk Factors” on page 13 to read about factors you should consider before buying the ADSs.

Neither the United States Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

     Per ADS      Total  

Initial public offering price

   US$                   US$               

Underwriting discounts and commissions(1)

   US$                   US$               

Proceeds, before expenses, to us

   US$                   US$               

 

(1) For additional information on underwriting compensation, see “Underwriting.”

To the extent that the underwriters sell more than             ADSs in this offering, the underwriters have a 30-day option to purchase up to an aggregate of             additional ADSs from us at the initial public offering price less the underwriting discounts and commissions.

We will be a “controlled company” as defined under the [NYSE Listed Company Manual/ Nasdaq Stock Market Rules] because Mr. Eric Siliang Tan, our co-founder and executive chairman, holds a majority of the aggregate voting power of our company and is expected to remain as our controlling shareholder upon the completion of this offering.

The underwriters expect to deliver the ADSs against payment in New York, New York on             , 2018.

 

Citigroup   Deutsche Bank Securities

(in alphabetical order)

Prospectus dated             , 2018


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TABLE OF CONTENTS

 

Prospectus Summary

     1  

Summary Consolidated Financial and Operating Data

     10  

Risk Factors

     13  

Special Note Regarding Forward-Looking Statements and Industry Data

     59  

Use of Proceeds

     60  

Dividend Policy

     61  

Capitalization

     62  

Dilution

     63  

Exchange Rate Information

     65  

Enforcement of Civil Liabilities

     66  

Our History and Corporate Structure

     68  

Selected Consolidated Financial and Operating Data

     72  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     75  

Industry Overview

     96  

Business

     101  

Regulations

     113  

Management

     127  

Principal Shareholders

     138  

Related Party Transactions

     141  

Description of Share Capital

     142  

Description of American Depositary Shares

     152  

Shares Eligible for Future Sale

     161  

Taxation

     163  

Underwriting

     170  

Expenses Related to this Offering

     181  

Legal Matters

     182  

Experts

     183  

Where You Can Find More Information

     184  

Index to Consolidated Financial Statements

     F-1  

No dealer, salesperson or other person is authorized to give any information or to represent as to anything not contained in this prospectus or in any free writing prospectus we may authorize to be delivered or made available to you. You must not rely on any unauthorized information or representations. This prospectus is an offer to sell, and we are seeking offers to buy, only the ADSs offered hereby, and only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date, regardless of the time of delivery of this prospectus or any sale of the ADSs.

 

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Neither we nor the underwriters have done anything that would permit this offering or the possession or distribution of this prospectus or any filed free writing prospectus in any jurisdiction where other action for that purpose is required, other than in the United States. Persons outside the United States who come into possession of this prospectus or any free writing prospectus filed with the United States Securities and Exchange Commission, or SEC, must inform themselves about, and observe any restrictions relating to, the offering of the ADSs and the distribution of this prospectus or any filed free writing prospectus outside of the United States.

Until             , 2018 (the 25th day after the date of this prospectus), all dealers that buy, sell or trade ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

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PROSPECTUS SUMMARY

This summary highlights selected information contained in greater detail elsewhere in this prospectus. This summary may not contain all of the information that you should consider before investing in our ADSs. You should carefully read the entire prospectus, including “Risk Factors” and the financial statements, before making an investment decision. This prospectus contains information from an industry report commissioned by us and prepared by Analysys International, an independent market research firm, to provide information regarding our industry and our market position in China. We refer to this report, which is dated as of March 9, 2018, as the Analysys Report.

Overview

We deliver fun and personalized content to mobile users in China.

Our flagship mobile application, Qutoutiao, meaning “fun headlines” in Chinese, aggregates articles and short videos uploaded onto our platform and presents customized feeds to users based on each user’s profile, behavior and social relationships. These feeds are optimized in real time through our proprietary machine learning algorithm as we gain new insights into each user. Covering a broad range of interests, Qutoutiao is focused on humor, stories and other light entertainment content that delight and inspire. In addition to articles and short videos, we plan to diversify our content offerings into literatures, games, live streaming, animations and comics, creating a comprehensive light entertainment content ecosystem.

Qutoutiao has rapidly gained popularity since its launch in June 2016. Qutoutiao had approximately 24.2 million average MAUs and 9.5 million average DAUs in the three months ended December 31, 2017. Qutoutiao ranks third among all mobile content aggregators in China in terms of both monthly penetration rate and daily penetration rate in December 2017, according to the Analysys Report.

We strategically target users from tier-3 and below cities in China because of the enormous opportunities in this underserved market. More than half of China’s mobile Internet users live in tier-3 and below cities but mobile Internet penetration rate in these cities is still relatively low, according to the Analysys Report. Such users are typically faced with lower financial pressures and generally have a slower pace of life. Moreover, they have fast increasing disposable income and high propensity to spend on mobile Internet entertainment. These factors contribute to a significant need for entertainment content while also create strong monetization potential. Users from tier-3 and below cities also tend to have different interests and preferences than users from tier-1 and tier-2 cities. We believe our experience with these users has enabled us to gain a significant understanding of their entertainment needs. Qutoutiao’s light entertainment-oriented and easily digestible content is designed to resonate with such users and provides us with a significant advantage to capture this underserved market.

Our rapid growth since the launch of Qutoutiao was also in large part due to our innovative user account system and gamified user loyalty programs. We believe we are a pioneer in the mobile content feed industry in applying such loyalty programs. Registered users can earn rewards by referring new users to register on Qutoutiao or by viewing content or engaging in other activities on Qutoutiao. Although rewards only translate into trivial monetary amounts, we believe they nurture users’ competitive psyche and emotional connection to Qutoutiao. The loyalty programs create a strong viral effect, which we believe enables us to enjoy lower user acquisition cost compared to acquiring users through online advertising. Users on Qutoutiao also remain highly engaged through our differentiated and extensive content capable of capturing their various niche interests coupled with gamified experience. In addition, almost all users remain logged on to their accounts while accessing Qutoutiao, enabling us to better understand their behaviors.



 

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We strive to provide quality and relevant content to our users by focusing on content sourcing and delivery. As of December 31, 2017, there were more than 126,000 content providers on Qutoutiao comprised of freelancers and professional media outlets. In December 2017, there were approximately 2.5 million content uploaded to Qutoutiao, out of which approximately 1.4 million were videos. We introduced a separate mobile application in May 2017 that allows users to produce and submit videos. Such user generated videos represented approximately 61.7% of all videos uploaded to Qutoutiao in December 2017 as compared to approximately 35.3% in June 2017.

We currently generate revenue primarily by providing advertising services. We plan to explore additional monetization opportunities as we grow our user base and introduce additional content formats, such as literatures, games and live streaming.

Our net revenues have increased rapidly from RMB58.0 million (US$8.9 million) in 2016 to RMB517.1 million (US$79.5 million) in 2017. As we focused on growing our user base and enhancing our services, we have incurred net losses of RMB10.9 million (US$1.7 million) in 2016 and RMB94.8 million (US$14.6 million) in 2017.

Our Strengths

We believe our success to date is largely attributable to the following key competitive strengths:

 

    leading mobile content aggregator;

 

    effective user acquisition supported by social-based user loyalty programs;

 

    powerful account system driving high user engagement;

 

    differentiated and extensive content offerings;

 

    intelligent content delivery supported by data capabilities; and

 

    visionary and experienced management team.

Our Strategies

We aim to create a leading comprehensive light entertainment content ecosystem in China. To achieve this goal, we plan to pursue the following growth strategies:

 

    expand our user base;

 

    strengthen social features and promote user generated content;

 

    enrich our content offerings;

 

    enhance monetization capabilities;

 

    invest in technology; and

 

    selectively pursue acquisition and investment opportunities.

Our Challenges

Our business and successful execution of our strategies are subject to certain challenges, risks and uncertainties including:

 

    our limited operating history;


 

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    our ability to acquire users, retain existing users and maintain high user engagement;

 

    our ability to increase the strength of our brand;

 

    the attractiveness of our mobile applications to users, including any new content formats and other products and services that we may introduce in the future;

 

    our ability to compete effectively in the industry we operate;

 

    our ability to continue to monetize, including through our advertising solutions and other products and services that we will introduce in the future;

 

    the fact that we have not completed the registration for “Qutoutiao,” the name of our flagship mobile application, due to an objection filed by one of our competitors on the purported ground that “Qutoutiao” is similar to a trademark registered by such competitor; and

 

    whether content providers continue to contribute content to our platform.

In addition, we face risks and uncertainties related to our corporate structure and regulatory environment in China, including:

 

    regulatory risks related to the mobile content feed industry in China;

 

    risks associated with our control over our consolidated variable interest entity, or consolidated VIE, in China, which is based on contractual arrangements rather than equity ownership; and

 

    changes in the political and economic policies of the PRC government.

We also face other risks and uncertainties that may materially affect our business, financial conditions, results of operations and prospects. You should consider the risks discussed in “Risk Factors” and elsewhere in this prospectus before investing in our ADSs.

Our History and Corporate Structure

We launched our flagship mobile application, Qutoutiao, in June 2016. We primarily operate our business through our consolidated VIE, Shanghai Jifen, and its subsidiaries. To facilitate financing offshores, we incorporated Qtech Ltd. in July 2017. Through a series of transactions, Qtech Ltd. then became our ultimate holding company.



 

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The following diagram illustrates our corporate structure as of the date of this prospectus. Except as otherwise specified, equity interests depicted in this diagram are held as to 100%. The relationships between Shanghai Quyun Internet Technology Co., Ltd., or Shanghai Quyun, Shanghai Jifen Culture Communications Co., Ltd., or Shanghai Jifen, and its shareholders as illustrated in this diagram are governed by contractual arrangements and do not constitute equity ownership.

 

LOGO

 

(1) Mr. Eric Siliang Tan, Mr. Lei Li, Tianjin Shanshi Technology L.P. and Shanghai Xihu Cultural Transmission Co., Ltd. held 45%, 15%, 20% and 20% equity interest in Shanghai Jifen, respectively.

Both Tianjin Shanshi Technology L.P. and Shanghai Xihu Cultural Transmission Co., Ltd. are controlled by Mr. Eric Siliang Tan.

 

(2) We acquired Shanghai Dianguan in February 2018.

 

(3) Include Anhui Zhangduan Internet Technology Co., Ltd., Beijing Qukandian Internet Technology Co., Ltd., Shanghai Xike Information Technology Service Co., Ltd. and Shanghai Tuile Information Technology Service Co., Ltd.

Our Corporate Information

Our principal executive offices are located at 11/F, Block 3, XingChuang Technology Center, Shen Jiang Road 5005, Pudong New Area, Shanghai, 200120, People’s Republic of China. Our telephone number at this address is +86-21-6858-3790. Our registered office in the Cayman Islands is located at the offices of Vistra (Cayman) Limited, P.O. Box 31119 Grand Pavilion, Hibiscus Way, 802 West Bay Road, Grand Cayman, KY1-1205, Cayman Islands. Investors should submit any inquiries to the address and telephone number of our principal executive offices set forth above.

Our main website is www.qutoutiao.net, and the information contained on this website is not a part of this prospectus. Our agent for service of process in the United States is Law Debenture Corporate Service Inc., located at 801 2nd Avenue, Suite 403, New York, NY 10017.



 

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Implications of Being an Emerging Growth Company

As a company with less than US$1.07 billion in revenue for the last fiscal year, we qualify as an “emerging growth company” pursuant to the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other 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, related to the assessment of the effectiveness of the emerging growth company’s internal control over financial reporting. The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards. However, we have elected to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted for public companies. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.

We will remain an emerging growth company until the earliest of (a) the last day of our fiscal year during which we have total annual gross revenues of at least US$1.07 billion; (b) the last day of our fiscal year following the fifth anniversary of the completion of this offering; (c) the date on which we have, during the previous three year period, issued more than US$1.0 billion in non-convertible debt; or (d) the date on which we are deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended, or the Exchange Act, which would occur if the market value of our ADSs that are held by non-affiliates exceeds US$700 million as of the last business day of our most recently completed second fiscal quarter. Once we cease to be an emerging growth company, we will not be entitled to the exemptions provided in the JOBS Act discussed above.

Conventions That Apply to This Prospectus

Unless we indicate otherwise, references in this prospectus to:

 

    “ADSs” are to our American depositary shares, each of which represents             ordinary shares, and “ADRs” are to the American depositary receipts that evidence our ADSs;

 

    “CAGR” are to compound annual growth rate;

 

    “CPC” are to cost-per-click as basis for charging our advertising services;

 

    “CPM” are to cost-per-thousand-impressions as basis for charging our advertising services;

 

    “China” and the “PRC” are to the People’s Republic of China, excluding, for the purposes of this prospectus only, Taiwan, the Hong Kong Special Administrative Region and the Macao Special Administrative Region;

 

    “DAUs” are to the number of unique mobile devices that accessed our relevant mobile application on a given day. “Average DAUs” for a particular period is the average of the DAUs on each day during that period;

 

    “MAUs” are to the number of unique mobile devices that accessed our relevant mobile application in a given month;

 

    “PVs” are to page views, which are the number of content posts in the relevant mobile application viewed by all users during a period;

 

    “registered users” are to, as of a given day, the aggregate number of registered user accounts since the launch of the relevant mobile application through such day;


 

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    “RMB” or “Renminbi” are to the legal currency of China;

 

    “tier-3 and below cities” are to cities in China that are not tier-1 and tier-2 cities;

 

    “tier-1 and tier-2 cities” refer to (i) tier-1 cities in China, which are Beijing, Shanghai, Guangzhou and Shenzhen and (ii) tier-2 cities in China, which are Hangzhou, Nanjing, Jinan, Chongqing, Qingdao, Dalian, Ningbo, Xiamen, Tianjin, Chengdu, Wuhan, Harbin, Shenyang, Xi’an, Changchun, Changsha, Fuzhou, Zhengzhou, Shijiazhuang, Suzhou, Foshan, Dongguan, Wuxi, Yantai, Taiyuan, Hefei, Kunming, Nanchang, Nanning, Tangshan, Wenzhou and Zibo;

 

    “US$,” “U.S. dollars,” or “dollars” are to the legal currency of the United States; and

 

    “we,” “us,” “our company” and “our” are to Qtech Ltd., its consolidated VIE and their respective subsidiaries, as the context requires.

Unless specifically indicated otherwise or unless the context otherwise requires, all references to our ordinary shares exclude (i) ordinary shares issuable upon the exercise of outstanding options with respect to our ordinary shares under our share incentive plan and (ii) assumes that the underwriters will not exercise their over-allotment option to purchase additional ADSs.

This prospectus contains translations between Renminbi and U.S. dollars solely for the convenience of the reader. The translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this prospectus were made at a rate of RMB6.5063 to US$1.00, the exchange rate set forth in the H.10 statistical release of the Federal Reserve Board on December 29, 2017. We make no representation that the Renminbi or U.S. dollar amounts referred to in this prospectus could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. On April 13, 2018, the noon buying rate for Renminbi was RMB6.2725 to US$1.00.

Unless the context indicates otherwise, all share and per share data in this prospectus have given effect to a share split in September 2017 in which each one of the previously issued ordinary shares were split into 10,000 ordinary shares.



 

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The Offering

 

Offering Price per ADS

We currently estimate that the initial public offering price will be between US$             and US$             per ADS.

 

ADSs Offered by Us

             ADSs (or              ADSs if the underwriters exercise in full the over-allotment option).

 

ADSs Outstanding Immediately After This Offering

             ADSs (or              ADSs if the underwriters exercise in full the over-allotment option).

 

Ordinary Shares Outstanding Immediately After This Offering

             ordinary shares (or              ordinary shares if the underwriters exercise in full the over-allotment option), excluding ordinary shares issuable upon the exercise of options outstanding under our share incentive plan as of the date of this prospectus.

 

The ADSs

Each ADS represents              ordinary shares, par value US$0.0001 per share.

 

  The depositary will be the holder of the ordinary shares underlying the ADSs and you will have the rights of an ADR holder as provided in the deposit agreement among us, the depositary and holders and beneficial owners of ADSs from time to time.

 

  You may surrender your ADSs to the depositary to withdraw the ordinary shares underlying your ADSs. The depositary will charge you a fee for any such exchange.

 

  We may amend or terminate the deposit agreement for any reason without your consent. Any amendment that imposes or increases fees or charges or which materially prejudices any substantial existing right you have as an ADS holder will not become effective as to outstanding ADSs until 30 days after notice of the amendment is given to ADS holders. If you continue to hold your ADSs, you will be bound by the deposit agreement as amended.

 

  To better understand the terms of the ADSs, you should carefully read the section in this prospectus entitled “Description of American Depositary Shares.” You should also read the deposit agreement, which is an exhibit to the registration statement that includes this prospectus.

 

Over-Allotment Option

We have granted to the underwriters an option, exercisable within 30 days from the date of this prospectus, to purchase up to an aggregate of              additional ADSs at the initial public offering price, less underwriting discounts and commissions.

 

Use of Proceeds

We estimate that we will receive net proceeds of approximately US$             million from this offering, assuming an initial public



 

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offering price of US$     per ADS, the mid-point of the estimated range of the initial public offering price, after deducting estimated underwriter discounts, commissions and estimated offering expenses payable by us, and assuming no exercise of the underwriters’ over-allotment option.

We anticipate using the net proceeds of this offering for (i) expanding and enhancing our content offerings, (ii) product development and technology infrastructure, (iii) marketing and promotion of our products and branding and (iv) general corporate purposes, including potential acquisitions and investments (although we are not currently negotiating any such acquisitions or investments).

 

  See “Use of Proceeds” for more information.

 

Lock-up

[We, our officers and directors, our existing shareholders and certain option and warrant holders have agreed with the underwriters not to sell, transfer or dispose of any ADSs, ordinary shares or similar securities for a period of 180 days after the date of this prospectus, subject to certain exceptions]. See “Shares Eligible for Future Sale” and “Underwriting.”

 

Risk Factors

See “Risk Factors” and other information included in this prospectus for a discussion of the risks relating to investing in our ADSs. You should carefully consider these risks before deciding to invest in our ADSs.

 

[Directed Share Program]

[At our request, the underwriters have reserved up to     % of the ADSs being offered by this prospectus for sale at the initial public offering price to certain of our directors, executive officers, employees, business associates and members of their families. The sales will be made by             , an underwriter of this offering, through a directed share program. We do not know if these persons will choose to purchase all or any portion of these reserved ADSs, but any purchases they do make will reduce the number of ADSs available to the general public. Any reserved ADSs not so purchased will be offered by the underwriters to the general public on the same terms as the other ADSs. Certain participants may be subject to the lock-up agreements as described in “Underwriting — Directed Share Program” elsewhere in this prospectus.]

 

Listing

We will apply to list our ADSs on the [NYSE/NASDAQ]. Our ordinary shares will not be listed on any exchange or quoted for trading on any over-the-counter trading system.

 

Proposed [NYSE/NASDAQ] Trading Symbol

QT

 

Payment and settlement

The underwriters expect to deliver the ADSs against payment on             , 2018, through the facilities of the Depositary Trust Company, or DTC.

Depositary



 

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The total number of ordinary shares that will be outstanding immediately after this offering is based upon (i) 50,000,000 ordinary shares issued and outstanding as of the date of this prospectus (including (1) 10,000,000 ordinary shares held by a nominee of our equity incentive trust, of which 2,516,899 are underlying shares of vested options as of the date hereof and (2) 15,937,500 ordinary shares which are restricted shares beneficially owned by our co-founders and are expected to be fully vested upon the completion of this offering); (ii) conversion of all outstanding convertible redeemable preferred shares (including series A, series A1, series B1 and series B2 convertible redeemable preferred shares) into 15,422,829 ordinary shares; and (iii)              ordinary shares issued in connection with this offering (assuming the underwriters do not exercise their option to purchase additional ADSs), but excludes:

 

    2,004,725 ordinary shares issuable upon the exercise of outstanding share options under our 2018 equity incentive plan;

 

    959,416 ordinary shares reserved for future issuance under our 2018 equity incentive plan; and

 

    211,724 series B2 convertible redeemable preferred shares to be issued pursuant to a warrant that has been exercised by an investor.


 

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SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA

The following summary consolidated statements of comprehensive loss data and summary consolidated statements of cash flows data for the years ended December 31, 2016 and 2017 and summary consolidated balance sheets data as of December 31, 2016 and 2017 have been derived from our audited consolidated financial statements included elsewhere in this prospectus.

Our consolidated financial statements are prepared and presented in accordance with the generally accepted accounting principles in the United States, or the U.S. GAAP. Our historical results are not necessarily indicative of results to be expected for any future period. The following summary consolidated financial data for the periods and as of the dates indicated are qualified by reference to, and should be read in conjunction with, our consolidated financial statements and related notes and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” both of which are included elsewhere in this prospectus.

Summary Consolidated Statements of Comprehensive Loss Data

 

     Year Ended December 31,  
     2016     2017  
     RMB     US$     RMB     US$  
     (in thousands, except for percentages, share and per share data)  

Revenues:

        

Advertising revenue

     57,880       8,896       512,883       78,829  

Other revenue

     74       11       4,170       641  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net revenues

     57,954       8,907       517,053       79,470  
  

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenues(1)

     7,178       1,103       76,481       11,755  

Gross profit

     50,776       7,804       440,572       67,715  

Operating expenses(1):

        

Research and development

     2,627       404       15,317       2,354  

Sales and marketing

     54,633       8,397       494,724       76,038  

General and administrative

     4,427       680       25,947       3,988  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     61,687       9,481       535,988       82,380  
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations(2)

     (10,911     (1,677     (95,416     (14,665
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest income

     51       8       673       104  

Others, net

     (2     (0     (17     (3
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income tax expenses

     (10,862     (1,670     (94,760     (14,564

Income tax expenses

     —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (10,862     (1,670     (94,760     (14,564
  

 

 

   

 

 

   

 

 

   

 

 

 

Accretion to convertible redeemable preferred shares redemption value

     —         —         (6,012     (924

Net loss attributable to Qtech Ltd.’s ordinary shareholders

     (10,862     (1,670     (100,772     (15,488
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

        

Foreign currency translation adjustment, net of nil tax

     —         —         24       3  
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss attributable to Qtech Ltd.

     (10,862     (1,670     (100,748     (15,485
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share attributable to Qtech Ltd.

        

– Basic and diluted

     (0.45     (0.07     (4.19     (0.64


 

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     Year Ended December 31,  
     2016      2017  
     RMB      US$      RMB      US$  
     (in thousands, except for percentages, share and per share data)  

Weighted average number of ordinary shares used in per share calculation:

           

– Basic and diluted

     24,062,500     

 

24,062,500

 

     24,062,500        24,062,500  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Cost of revenues and operating expenses from transactions with related parties are set forth below for the periods indicated:

 

     Year Ended December 31,  
     2016      2017  
     RMB      US$      RMB      US$  
     (in thousands)  

Cost of revenues

     120        18        484        74  

Research and development

     166        26        220        34  

Sales and marketing

     74        11        950        146  

General and administrative

     2,664        409        15,134        2,326  

 

(2) We recognized share-based compensation expenses of RMB0.4 million (US$0.1 million) and RMB3.4 million (US$0.5 million) in 2016 and 2017, respectively.

Summary Consolidated Balance Sheets Data

 

     As of December 31,  
     2016      2017  
     RMB      US$      RMB      US$  
     (in thousands)  

Cash and cash equivalents

     269        41        278,458        42,798  

Short-term investments

     12,370        1,901        129,770        19,945  

Total current assets

     29,758        4,574        466,208        71,655  

Total assets

     29,896        4,594        476,581        73,249  

Registered users’ loyalty payable

     1,023        157        20,977        3,224  

Accrued liabilities related to user loyalty programs

     24,509        3,767        187,003        28,742  

Total liabilities

     41,087        6,315        311,246        47,837  

Mezzanine equity

     —          —          273,895        42,097  

Total shareholders’ deficits

     (11,191      (1,720      (108,560      (16,685


 

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Summary Consolidated Statements of Cash Flows Data

 

     Year Ended December 31,  
     2016      2017  
     RMB      US$      RMB      US$  
     (in thousands)  

Selected Consolidated Cash Flows Data:

           

Net cash provided by operating activities

     12,719        1,955        132,226        20,323  

Net cash used in investing activities

     (12,523      (1,925      (121,919      (18,738

Net cash provided by financing activities

     —          —          272,121        41,824  

Net increase in cash and cash equivalents

     196        30        282,428        43,409  

Effect of exchange rate changes on cash and cash equivalents

     —          —          (4,239      (652

Cash and cash equivalents at beginning of the year

     73        11        269        41  

Cash and cash equivalents at the end of the year

     269        41        278,458        42,798  

Key Operating Metrics

We regularly review a number of key operating metrics to evaluate our business and measure our performance. The table below sets forth key operating metrics relating to the Qutoutiao mobile application.

 

    For the Three Months Ended  
    September 30     December 31     March 31     June 30     September 30     December 30  
    2016     2017  
    (in millions, except for percentages and per user data)  

Registered users as of the end of the period

    4.6       11.3       17.8       28.0       46.8       72.8  

Average MAUs during the period

    1.7       3.9       5.7       8.8       16.0       24.2  

Average DAUs during the period

    0.5       1.5       2.5       3.9       6.4       9.5  

Average daily PVs during the period

    8.4       26.3       47.9       82.5       135.0       225.5  

Video PVs as a percentage of total PVs during the period (%)

    2.4       5.7       4.2       6.9       11.1       28.4  

Average daily time spent per DAU during the period (minutes)

    27.2       29.0       31.3       33.7       34.0       32.3  


 

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RISK FACTORS

An investment in our ADSs involves significant risks. You should carefully consider all the information in this prospectus, including the risks and uncertainties described below, before making an investment in our ADSs. 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 our ADSs could decline, and you may lose all or part of your investment.

Risks Relating to Our Industry and Business

We have a limited operating history, which makes it difficult to evaluate our business.

We launched Qutoutiao in June 2016. We have experienced rapid growth since the launch of Qutoutiao in terms of registered users, MAUs, DAUs and revenues. However, our historical growth may not be indicative of our future performance, and we cannot assure you that this level of significant growth will be sustainable or achievable at all in the future. Our growth prospects should be considered in light of the risks and uncertainties that fast-growing companies with limited operating history in our industry may encounter, including, among others, risks and uncertainties regarding our ability to:

 

    retain existing users on, and attract new users to, our platform;

 

    present real-time customized feeds to users based on their profiles, behaviors and social relationships;

 

    maintain the effectiveness of our user loyalty programs;

 

    maintain stable relationships with our content providers;

 

    develop and implement successful monetization measures;

 

    convince advertising customers of the benefits of our advertising services compared to alternative forms of marketing;

 

    increase brand awareness through marketing and promotional activities;

 

    upgrade existing technology and infrastructure and develop new technologies to support increasing user traffic, improve user experience, expand functionality and ensure system stability;

 

    successfully compete with other companies that are currently in, or may in the future enter, our industry;

 

    attract, retain and motivate talented employees;

 

    adapt to the evolving regulatory environment; and

 

    defend ourselves against litigation, regulatory, intellectual property, privacy or other claims.

All of these endeavors involve risks and will require significant capital expenditures and allocation of valuable management and employee resources. We cannot assure you that we will be able to effectively manage our growth or implement our business strategies effectively. If the market for our platform does not develop as we expect or if we fail to address the needs of this dynamic market, our business, results of operations and financial condition will be materially and adversely affected.

If we fail to acquire new users or retain existing users, or if user engagement on our platform declines, our business, results of operations and financial condition may be materially and adversely affected.

The growth of our user base and the level of user engagement are critical to our success. Our Qutoutiao mobile application had approximately 24.2 million average MAUs and 9.5 million average DAUs in the three months ended December 31, 2017. Our business has been and will continue to be significantly affected by our

 

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success in growing the number of active users and increasing their overall level of engagement on our platform. We anticipate that our user growth rate will slow over time as the size of our user base increases. To the extent our user growth rate slows, our success will become increasingly dependent on our ability to increase user engagement with our platform. We have implemented user account systems and loyalty programs to, among other things, help us cost effectively acquire new users and develop an engaged user base. However, although such user account systems and loyalty programs have contributed significantly to the growth in our registered users and high user engagement in the past, there can be no assurance that such systems and programs will continue to function effectively. Additionally, our acquisition cost per user may increase as we implement new marketing initiatives, such as placing advertisements in app stores. Our user engagement efforts, including by increasing the number of content providers, expanding the breadth and quality of content, including video and user generated content, on our platform, diversifying into new content formats and strengthening our content recommendation capabilities, may also not achieve expected results. Users may no longer perceive content and other products and services on our platform to be entertaining and relevant, and we may not be able to attract users or increase their usage frequency of our platform. If we fail to execute any such new initiatives successfully or in a cost-effective manner, our business, results of operations and financial condition would be materially and adversely affected. If we are unable to grow our user base or the level of user engagement, or if the number of users or their level of engagement declines, this could result in our platform being less attractive to potential new users and thus advertising customers, which would have a material and adverse impact on our business, results of operations and financial condition.

If we do not continue to increase the strength of our brand, we may not be able to maintain current or attract new users and customers for our products and services.

Our operational and financial performance is highly dependent on the strength of our brand. We believe we enjoy lower user acquisition cost compared to acquiring users through online advertising. Our platform’s innovative user account systems and gamified loyalty programs enable us to focus our resources on directly connecting with new users. In order to further expand our user base, we may need to substantially increase our marketing expenditures to enhance brand awareness.

In addition, negative coverage in the media of our company could threaten the perception of our brand, and we cannot assure you that we will be able to defuse negative press coverage about our company to the satisfaction of our investors, users, advertising customers and content providers. If we are unable to defuse negative press coverage about our company, our brand may suffer in the marketplace, our operational and financial performance may be negatively impacted and the price of our ADSs may decline.

Furthermore, we have not completed the trademark registration for “Qutoutiao,” the name of our flagship mobile application. After we submitted our application material with the relevant authorities, one of our competitors filed an objection on the ground that “Qutoutiao” is similar to a trademark registered by such competitor. We believe such objection is meritless and we have contested the objection and submitted the written defense to the Trademark Office in February 2018. However, there can be no assurance that we will be able to prevail and register “Qutoutiao” as a trademark. If we fail to do so, we will not be able to protect our brand name. In addition, if our competitor initiate lawsuit against on for infringing its trademark, we may be forced to adopt a new brand name for our flagship mobile application. As a result, we may incur additional marketing cost to raise awareness of such new brand name. We may also be ordered to pay a significant amount of damages, and our business, results of operations and financial condition could be materially and adversely affected.

Our lack of an Internet news license may expose us to administrative sanctions, including an order to cease our Internet information services that provide news or to cease the Internet access services provided by third parties to us.

The PRC government regulates the Internet industry extensively, including foreign ownership of, and the licensing requirements pertaining to, companies in the Internet industry. A number of regulatory agencies,

 

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including the Ministry of Culture, or the MOC, the Ministry of Industry and Information Technology, or MIIT, the Cyberspace Administration of China, or CAOC, the General Administration of Press and Publication, Radio, Film and Television, or GAPPRFT, the State Council Information Office, or the SCIO, and other governmental authorities, jointly regulate all major aspects of the Internet industry. Operators are required to obtain various government approvals and licenses prior to providing the relevant Internet information services.

Our platform primarily focuses on light entertainment content. Nonetheless, certain content related to current affairs, finance, society and economy provided on our Qutoutiao mobile application may be deemed to be news content. According to the Provisions for the Administration of Internet News Information Services issued by the national CAOC on May 2, 2017 that became effective on June 1, 2017, an Internet news license shall be obtained for a provider of Internet news information services to the public in a variety of ways, including through the offering of platforms for the dissemination of Internet news. As such, we may be required to obtain an Internet news license from CAOC for the dissemination of news through our mobile application. See “Regulation — Regulation on Internet News Dissemination.” As a result of our lack of an Internet news license, the CAOC or its applicable office at the provincial level may order us to cease disseminating news and impose a fine on us of not less than RMB10,000 but not more than RMB30,000. In the event we were ordered to cease disseminating news, our business, results of operations and financial condition could be materially and adversely affected.

We are in the process of preparing an application for an Internet news license, and we have communicated with CAOC as to our plan to submit such application. However, there can be no assurance that our application will be accepted or approved by the regulatory authorities.

Our lack of an Internet audio-visual program transmission license may expose us to administrative sanctions, which would materially and adversely affect our business, results of operations and financial condition.

Pursuant to the Administrative Provisions on Internet Audio-visual Program Service, or the Audio-visual Program Provisions, which was issued by the State Administration of Radio, Film and Television (the predecessor of GAPPRFT), or SARFT, and MIIT on December 20, 2007 and came into effect on January 31, 2008 and was amended on August 28, 2015, online transmission of audio and video programs requires an Internet audio-visual program transmission license and online audio-visual service providers must be either wholly state-owned or state-controlled. In a press conference jointly held by SARFT and MIIT to answer questions with respect to the Audio-visual Program Provisions in February 2008, SARFT and MIIT clarified that online audio-visual service providers that had already been operating lawfully prior to the issuance of the Audio-visual Program Provisions may re-register and continue to operate without becoming state-owned or controlled, provided that such providers have not engaged in any unlawful activities. This exemption will not be granted to online audio/video service providers established after the Audio-visual Program Provisions was issued. See “Regulation — Regulation on Online Transmission of Audio-visual Programs.”

We currently do not possess an Internet audio-visual program transmission license. As a result, the relevant regulatory authorities may find our operations to be in violation of the applicable laws and regulations. We may receive a warning and be ordered to pay a fine of not more than RMB30,000. In the case of severe contravention, we may be ordered to cease transmission of audio and video programs, be subject to a penalty equal to one to two times our total investment in the affected business and the devices we used for such operation may be confiscated. Furthermore, according to the Audio-visual Program Provisions, the telecommunications administrative authorities may, based on written opinions of GAPPRFT, and in accordance with the relevant laws and regulations on supervision of telecommunications and Internet, close our platform, revoke the license for the provision of Internet information services, or the ICP license, and order the relevant network operation entity which provides us signal access services to stop such provision of services. Such penalties would materially and adversely affect our business, results of operations and financial condition.

 

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New content formats and other products and services and changes to existing content formats and products and services could fail to attract users or generate revenues.

Our ability to increase the size and engagement level of our user base, attract advertising customers and generate revenues will depend in part on our ability to create and offer successful new content formats and other products and services. Such new content formats and other products and services may involve new distribution capabilities or technologies with which we have little or no prior development or operating experience, such as literatures, games and live streaming. We may also continuously refine our existing content formats and other products and services as part of our efforts to further enhance user engagement. However, if such efforts or our efforts in launching new content formats and other products and services fail to engage users, we may fail to attract or retain users or to generate sufficient revenues to justify our investments, and our business, results of operations and financial condition could be adversely affected.

If we are unable to compete effectively in the industry we operate, our business, results of operations and financial condition may be materially and adversely affected.

Competition for user traffic and user engagement, as well as advertising and marketing spending, is intense and we face strong competition in our business. Our primary competitors include content aggregators such as Jinritoutiao, Tiantiankuaibao (operated by Tencent) and Yidianzixun (an affiliate of Phoenix News). To a lesser extent, we also compete with mobile news portals such as Tencent News, SINA News, Sohu News, NetEase News and Phoenix News. Many of our competitors have more resources and longer operating history than us. As we plan to enhance our video content, we also compete with a number of “pure play” short video platforms, including Kuaishou, Huoshan, Xigua and Douyin. New players may emerge and seek to imitate our business strategies, thereby directly competing with us for users. Furthermore, we may face potential competition from global online content delivery platforms that seek to enter the China market, whether independently or through the formation of strategic alliances with, or acquisition of, PRC Internet companies. If we are not able to effectively compete with our competitors, our overall user base and level of user engagement may decrease. We may be required to spend additional resources to further enhance our brand recognition and promote our products and services, and such additional spending could adversely affect our profitability. Furthermore, if we are involved in disputes with any of our competitors that result in negative publicity to us, such disputes, regardless of their veracity or outcome, may harm our reputation or brand image and in turn lead to reduced number of users and advertising customers. Our competitors may unilaterally decide to adopt a wide range of measures targeted at us, including possibly designing their products to negatively impact our operations. Any legal proceedings or measures we take in response to competition and disputes with our competitors may be expensive, time-consuming and disruptive to our operations and divert our management’s attention.

In addition, our users face a vast array of entertainment choices. Other forms of entertainment, including other Internet-based activities such as social networking, online video or games, live streaming, as well as offline games and activities such as television, movies and sports, are much larger and more well-established markets and may be perceived by our users to offer greater variety, affordability, interactivity and enjoyment. Our platform competes against these other forms of entertainment for the discretionary time and spending of our users. If we are unable to sustain sufficient interest in our platform in comparison to other forms of entertainment, including new forms of entertainment that may emerge in the future, our business model may no longer be viable.

The Chinese government may prevent us from distributing content that it believes is inappropriate and we may be subject to penalties for such content or we may have to interrupt or stop the operation of our platform.

China has enacted regulations governing Internet access and the distribution of news and other information. In the past, the Chinese government has stopped the distribution of information over the Internet or through mobile Internet devices that it believes violates Chinese law, including content that it believes is obscene or defamatory, incites violence, endangers the national security, or contravenes the national interest. In addition,

 

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certain news items, such as news relating to national security, may not be published without permission from the Chinese government. If the Chinese government were to take any action to limit or prohibit the distribution of information through our mobile applications, or to limit or regulate any current or future content or services available to users on our platform, our business could be significantly harmed. Although we have adopted internal procedures to monitor the content displayed on our platform, due to the significant amount of content, including UGC, we may not be able to identify all the content that may violate relevant laws and regulations. Failure to identify and prevent inappropriate or illegal content from being displayed on our platform may subject us to penalties, including suspension of operations.

Moreover, because the definition and interpretation of prohibited content is in many cases vague and subjective, it is not always possible to determine or predict what content might be prohibited under existing restrictions, or what restrictions might be imposed in the future. For example, in 2005, SARFT issued a notice prohibiting commercials for wireless value-added services related to “fortune-telling” from airing on radio and television stations effective in February 2005. GAPPRFT or other Chinese government authorities may prohibit the marketing of other types of wireless value-added services through mobile applications, which could materially and adversely affect our business, results of operations and financial condition.

We generate a substantial majority of our revenues from advertising. A decline in our advertising revenue could harm our business.

We generated almost all of our revenues from advertising services in 2016 and 2017. When we first commenced our business, we collaborated with various third-party advertising platforms to place advertisements on our mobile applications. To enhance our platform’s monetization capabilities, we acquired an advertising agent in February 2018 that operate an programmatic advertising system. This system will serve to power our advertising solutions while reducing the use of third-party advertising platforms. In 2017, 26.2% of our total net revenues were generated through this advertising agent. We have limited experience in operating the programmatic advertising system and in acquiring our own advertising agents and advertising customers. We may not be able to establish our own sales personnel to effectively and efficiently acquire and retain advertising agents and advertising customers. The effectiveness of our programmatic advertising system may not perform as expected and achieve widespread acceptance by advertising customers.

Our advertising customers for our programmatic advertising system are comprised of advertising agents and end advertisers. There can be no assurance that these advertising agents will continue to attract advertising customers to our platform. Furthermore, as is common in the industry, we do not enter into long-term agreements with advertising agents or advertising customers. Advertising agents and advertising customers are not obligated to use our advertising solutions on an exclusive basis and they generally use multiple channels to manage their advertising need. Accordingly, we or advertising agents must convince advertising customers to use our programmatic advertising system, increase their usage and spend a larger share of their online advertising budgets with us, and to do so on an on-going basis. Advertising customers may not continue to utilize our platform or may only be willing to advertise with us at reduced prices if we do not deliver advertising services in an effective manner, including persuading our advertising customers as to the relevancy of our user base for their products or services, or if they do not believe that their investment in advertising with us will generate a competitive return relative to alternative advertising platforms. If we fail to retain existing advertising customers or ensure that their advertising spend with us remains at similar or increased levels or attract new advertising customers to advertise on our platform, our business, results of operations and financial condition may be materially and adversely affected.

Our efforts to expand the monetization of our products and services in addition to advertising may not be successful.

In order to sustain our revenue growth, we must effectively monetize our user base and expand the monetization of our products and services in addition to advertising. We plan to leverage our user account

 

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systems and loyalty programs to induce users not only to spend the cash credits in their accounts from using our platform but also to supplement their spending on our platform with additional funds. These measures include introducing paid content such as literatures, games, animation and comics, as well as content-driven e-commerce and live streaming products. There can be no assurance that we can successfully capture such monetization opportunities. For example, users may prefer to purchase merchandise from “pure play” e-commerce platforms, which tend to offer wider selections and may provide better services due to their deeper industry experience. In addition, we have primarily offered free content to users, and our paid content may not gain significant user acceptance. If we were unable to successfully execute our monetization strategies, our business, results of operations and financial condition would be materially and adversely affected.

If we fail to continue to anticipate user preferences and interests, we may not be able to generate sufficient user traffic to remain competitive.

Our success depends on our ability to intelligently deliver personalized light entertainment content to users. Through an automated process, we develop interest and social graphs for each user based on such person’s profile, behavior and social relationships. The user’s behavior also provides us with a granular view of the topics and content characteristics that likely are of interest to the user. In addition, the interest and social graphs take into account the user’s social relationships with other users and such other users’ interests, including their behaviors. Our content recommendation engine analyzes content and the interest and social graphs of each user to identify content that is most likely to interest such person. Such recommendation is based on analysis we have made as to user preferences and interests, and any errors in such analysis may lead our system to recommend content that fail to attract users. Furthermore, our future success will depend on our ability to anticipate and adapt new technologies. If we fail to continuously improve user experience through better recommendation results, we may not be able to compete effectively with our competitors, and our business, results of operations and financial condition may be materially and adversely affected.

If content providers on our platform do not continue to contribute content, decrease the amount of content contributed or the quality of their contributions declines, we may experience a decrease in the number of users and level of user engagement.

Our success depends on our ability to generate sufficient user traffic through the intelligent delivery of personalized light entertainment content, which in turn depends on the content contributed by our content providers. We believe that access to light entertainment-oriented and easily digestible content is one of the main reasons users visit Qutoutiao. We encourage our content providers to actively contribute quality content that will resonate with our users by implementing a system in which fees paid to them are related to the amount of views associated with content they contribute. We also seek to foster a broader and more engaged user base by encouraging social interactions and production of user generated content. If our content providers do not continue to contribute content, including user generated content, to our mobile applications due to their dissatisfaction with our fee arrangements with them, their entry into exclusive arrangements with other platforms or any other reasons, or the attractiveness of their content declines, and we are unable to provide users with entertaining and relevant content, our user base and user engagement may decline. If we were required to share a higher proportion of advertising revenue with content providers in order to enhance the quality of content delivered by us or increase the amount of content provided to us, our profitability could be materially and adversely affected. If we experience a decline in the number of users or the level of user engagement, advertising customers may not view our platform as attractive for their advertising expenditures and may reduce their spending with us, which would harm our business, results of operations and financial condition.

We have incurred net losses in the past, and we may not be able to achieve or subsequently maintain profitability.

Since our inception, we have incurred net losses. In 2016 and 2017, we recorded net losses of RMB10.9 million (US$1.7 million) and RMB94.8 million (US$14.6 million), respectively. We believe that our

 

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future revenue growth will depend on, among other factors, our ability to attract new users, increase user stickiness and level of engagement, establish effective monetization strategies, compete effectively and successfully, and develop new products and services. Accordingly, you should not rely on the revenues of any prior quarterly or annual period as an indication of our future performance. We also expect our costs to increase in future periods as we continue to expand our business and operations. In addition, we expect to incur substantial costs and expenses as a result of being a public company. If we are unable to generate adequate revenues and to manage our expenses, we may continue to incur significant losses in the future and may not be able to achieve or subsequently maintain profitability.

Our current dependence on a limited number of customers may cause significant fluctuations or declines in our revenues.

We currently generate a significant portion of our net revenues from a limited number of third-party advertising platforms. Baidu, which is our largest customer and operates a third-party advertising platform, contributed 69.6% and 43.5% of our net revenues in 2016 and 2017, respectively. Baidu also accounted for 90.3% and 59.8% of our accounts receivable as of December 31, 2016 and 2017, respectively. We supply traffic to the customer’s platform through advertisements placed on our mobile applications. Baidu has the right to terminate its agreement with us at any time. Such concentration of customers was primarily the result of our limited operating history and the fact that when we first commenced our business, we only collaborated with a limited number of third-party advertising platforms to place advertisements on our platform. Although we are reducing our collaboration with third-party advertising platforms, certain of these platforms may continue to contribute a large portion of our net revenues in the near future. Any adverse change in our relationship with these advertising platforms, including our arrangements with them, or a decrease in the amount or quality of the advertisement placed by these platforms on our mobile applications may materially and adversely affect our results of operations.

Our user metrics and other estimates are subject to inherent challenges in measuring our operating performance, which may harm our reputation.

We regularly review MAUs, DAUs, number of page views and other operating metrics to evaluate growth trends, measure our performance, and make strategic decisions. These metrics are calculated using internal company data, have not been validated by an independent third party, and may not be indicative of our future financial results. While these numbers are based on what we believe to be reasonable estimates for the applicable period of measurement, there are inherent challenges in measuring how our platform is used across a large population in China. For example, we may not be able to distinguish individual users who have multiple registered accounts.

Errors or inaccuracies in our metrics or data could result in incorrect business decisions and inefficiencies. For instance, if a significant understatement or overstatement of active users were to occur, we might expend resources to implement unnecessary business measures or fail to take required actions to remedy an unfavorable trend. If advertising customers or investors do not perceive our user or other operating metrics to accurately represent our user base, or if we discover inaccuracies in our user or other operating metrics, our reputation may be harmed.

If we fail to effectively manage our growth, our business, results of operations and financial condition could be harmed.

We expect we will continue to experience rapid growth in our business and operations, which will place significant demands on our management, operational and financial resources. We may encounter difficulties as we establish and expand our operations, product development, sales and marketing, and general and administrative capabilities. We face significant competition for talented employees from other high-growth companies, which include both publicly traded and privately held companies, and we may not be able to hire new employees quickly enough to meet our needs. To attract highly skilled personnel, we have had to offer, and believe we will need to continue to offer, competitive compensation packages. As we continue to grow, we are

 

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subject to the risks of over-hiring, over-compensating our employees and over-expanding our operating infrastructure, and to the challenges of integrating, developing and motivating a growing employee base. In addition, we may not be able to innovate or execute as quickly as a smaller and more efficient organization. If we fail to effectively manage our hiring needs and successfully integrate our new hires, our efficiency and ability to meet our forecasts and our employee morale, productivity and retention could suffer, and our business, results of operations and financial condition could be adversely affected.

Providing products and services to users may be costly and we expect our expenses to continue to increase in the future as we broaden our user base and increase user engagement, and develop and implement new content formats, features, products and services that require more infrastructure, such as literatures, games and live streaming. In addition, our costs and expenses, such as our labor-related expenses, product development expenses and sales and marketing expenses have grown rapidly as we have expanded our business. In particular, we have focused considerable resources on user acquisition through our loyalty programs. Our sales and marketing expenses consist primarily of cost of users’ rewards associated with our user loyalty programs, which increased from RMB50.9 million (US$7.8 million) in 2016 to RMB419.6 million (US$64.5 million) in 2017, representing 87.8% and 81.2% of our net revenues in 2016 and 2017, respectively. Historically, our costs have increased due to these factors and we expect to continue to incur increasing costs to support our anticipated future growth. We expect to continue to invest in our infrastructure to enable us to provide our products and services rapidly and reliably to users. Continued growth could also strain our ability to maintain reliable service levels for our users, content providers and advertising customers, develop and improve our operational, financial, legal and management controls, and enhance our reporting systems and procedures. Our expenses may grow faster than our revenues, and our expenses may be greater than we anticipate. Managing our growth will require significant expenditures and allocation of valuable management resources. If we fail to achieve the necessary level of efficiency in our organization as it grows, our business, results of operations and financial condition could be harmed.

Advertisements on our mobile applications 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 mobile applications to ensure that such content is true, accurate and in full compliance with applicable laws and regulations. In addition, where a special government review is required for specific types of advertisements prior to mobile application posting, such as advertisements relating to medical treatment, pharmaceuticals, medical instruments, agrochemicals, veterinary pharmaceuticals and health food, we are obligated to confirm that such review has been performed and approval has been obtained from relevant governmental authorities, which include the local branch of the State Administration for Industry & Commerce, or the SAIC, the local branch of the State Food and Drug Administration, the local branch of the Ministry of Health and the local branch of the State Administration of Traditional Chinese Medicine. On April 24, 2015, the Standing Committee of the National People’s Congress issued the Advertisement Law, which took effect on September 1, 2015, to further strengthen the supervision and management of advertisement services. In addition, on July 4, 2016, SAIC issued the Interim Measures for the Administration of Internet Advertising, or the New Interim Measures, to further regulate Internet advertising activities. Pursuant to these laws and regulations, any advertisement that contains false or misleading information to deceive or mislead consumers shall be deemed false advertising. Furthermore, the Advertisement Law explicitly stipulates detailed requirements for the content of several different kinds of advertisement, including advertisements for medical treatment, pharmaceuticals, medical instruments, health food, alcoholic drinks, education or training, products or services having an expected return on investment, real estate, pesticides, feed and feed additives, and some other agriculture-related advertisement. Also, according to the New Interim Measures, no advertisement of such special products or services which are subject to examination by an advertising examination authority shall be published unless it has passed such examination. In addition, an Internet advertisement shall be identifiable and clearly identified as an “advertisement” so that consumers will know that it is an advertisement. Paid search advertisements shall be clearly distinguished from natural search results. 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

 

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eliminate the effect of illegal advertisement. PRC governmental authorities may even force us to terminate our advertising operation or revoke our licenses in circumstances involving serious violations. We include clauses in most of our advertising contracts requiring that all advertising content provided by advertising customers must comply with relevant laws and regulations. Pursuant to the contracts between us and the relevant advertising agents or advertising customers, they are liable for all damages to us caused by their breach of such representations. However, there can be no assurance that we will be able to successfully enforce our contractual rights.

We cannot assure you that all of the content contained in such advertisements is true and accurate as required by the advertising laws and regulations. For example, the Advertisement Law provides that an advertisement operator who posts false or fraudulent advertisements related to the life and health of the consumers, or who knows or should have known other kind of posted advertisement is false or fraudulent will be subject to joint and several liabilities. Under the Detailed Implementation Rules on the Administrative Regulations for Advertisement, a mobile application must not post any advertisements that are untrue or lacking the requisite governmental approval if such type of advertisements are subject to special governmental review. The New Interim Measures provides that Internet advertisement publishers shall verify related supporting documents, check the content of the advertisement and be prohibited from publishing any advertisement with nonconforming content or without all the necessary certification documents. However, for the determination of the truth and accuracy of the advertisements, there are no implementing rules or official interpretations, and such a determination is at the sole discretion of the relevant local branch of the SAIC, which results in uncertainty in the application of these laws and regulations. If we are found to be in violation of applicable PRC advertising laws and regulations in the future, we may be subject to penalties and our reputation may be harmed, which may have a material and adverse effect on our business, results of operations and financial condition.

If we fail to detect click-through fraud of our platform, we could lose the confidence of advertising customers and our revenues could decline.

We are exposed to the risk of click-through fraud on our advertising services. Click-through fraud occurs when a person, automated script or computer program imitates a legitimate user clicking on an advertisement, for the purpose of generating a charge per click without having actual interest in the target of the advertisement’s link. If we fail to detect fraudulent clicks or otherwise are unable to prevent such fraudulent activity, the affected advertising customers may experience a reduced return on their investment in our mobile advertising services and lose confidence in the integrity of our services. If this happens, our reputation may be damaged and we may be unable to retain existing advertising customers and attract new advertising customers for our advertising services and our advertising revenue could decline.

If we fail to detect user misconduct on our platform, our business, results of operations and financial condition may be materially and adversely affected.

Our platform enables users to upload content, post comments, interact with others and engage in various other online activities. As the gatekeeper for our platform, our content management system is designed to ensure both the quality and appropriateness of information presented to users, which include content and comment postings. We undertake an efficient and thorough screening process that involves both algorithm-based screening and manual review. We have also implemented a complaint procedure that enables us to identify bad content with our users’ help. However, such procedures may not prevent all illegal or impropriate content or comments from being posted. In response to allegations of illegal or inappropriate activities conducted through our platform or any negative media coverage about us, PRC government authorities may intervene and hold us liable and subject us to administrative penalties or other sanctions, such as requiring us to restrict or discontinue some of the features and services provided on our mobile application. As a result, our business may suffer and our user base, revenues and profitability may be materially and adversely affected, and the price of our ADSs may decline.

 

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Additionally, we may be subject to fines or other disciplinary actions, including suspension or revocation of the licenses necessary to operate our platform, if we are deemed to have facilitated the appearance of inappropriate content placed by third parties on our platform. Furthermore, we may face claims for defamation, libel, negligence, copyright, patent or trademark infringement, other unlawful activities or other claims based on the nature and content of the information delivered on or otherwise accessed through our platform. Defending such actions could be costly and involve significant time and attention of our management and other resources, which would materially and adversely affect our our business, results of operations and financial conditions.

Our ability to prevent the misuse of our user loyalty programs while ensure their efficacy in user acquisition and engagement will have a material effect as to our business, results of operations and financial condition.

To incentivize word-of-mouth viral referrals and improve user engagement, we have gamified our platform by giving users rewards and cash credits in certain cases for taking specific actions. Such actions primarily include making referrals of our Qutoutiao mobile application to new users or for user engagement such as through the viewing or sharing of content, providing valuable comments and encourage inactive users to continue to use Qutoutiao. Rewards are automatically exchanged into cash credits at the end of each day based on an exchange rate determined by us. A user can then withdraw cash credits, which reflects the same amount of cash value, from the user’s account after the balance exceed a minimum amount as determined by us from time to time. A user can also currently redeem cash credits by purchasing merchandise through the marketplace on our Qutoutiao mobile application. Our user loyalty programs also cover our Quduopai mobile application. Our user loyalty programs have contributed significantly to the growth in our registered users and high user engagement. Such user loyalty programs are designed to balance between their efficacy in user acquisition and engagement while preventing users from using our mobile applications merely for the rewards. Our inability to achieve such balance may make our user loyalty programs no longer becoming enticing to users, which may materially and adversely affect user growth and user engagement. Moreover, we cannot assure you that there will not be users who are only attracted to our mobile applications because of our user loyalty programs. We have mechanisms in place to prevent potential abuse of our user loyalty programs. For example, for each article, the content page initially only shows the first few paragraphs and images, and the user must click an additional icon to see the rest. Our system takes into account how fast the user scrolls down the page to determine whether the viewer has actually viewed the article. However, our system may not be able to detect all instances of abuse. Furthermore, although our loyalty programs are designed so that only a small amount of reward is provided for taking any specific action with the aim to entice user referral and engagement, we cannot ensure you that there will not be users who will be able to hack our user loyalty programs to make earning rewards a highly lucrative endeavor. We have also focused on developing fraud detection technologies to combat fraudulent users and activities targeting our user loyalty programs and we cannot assure you that such system will be effective in identifying fraud. If we allow users to improperly earn rewards, our business, results of operations and financial condition may be materially and adversely affected. As clearly stated in our user agreement, we have the sole discretion in determining user misuse of our user loyalty programs, and we may freeze a user’s account if we find such user misused our user loyalty programs. Certain users that have their accounts frozen have complained online. Such complaints could undermine the public perception and credibility of our platform, and our business, results of operations and financial condition could be materially and adversely affected.

Our results of operations may fluctuate from quarter to quarter, which makes them difficult to predict.

Our quarterly results of operations have fluctuated in the past and will continue to fluctuate in the future. As a result, our past quarterly results of operations are not necessarily indicators of future performance. Our results of operations in any given quarter can be influenced by numerous factors, many of which we are unable to predict or are outside of our control, including:

 

    our ability to grow our user base and user engagement;

 

    fluctuations in spending by our advertising customers, including as a result of seasonality or other factors;

 

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    our ability to attract and retain advertising customers;

 

    the occurrence of planned or unplanned significant events, including events that may cause substantial share-based compensation or other charges;

 

    the development and introduction of new content formats, products or services or changes in features of existing content formats, products or services;

 

    the impact of competitors or competitive products and services;

 

    increases in our costs and expenses that we may incur to grow and expand our operations and to remain competitive;

 

    changes in the legal or regulatory environment or proceedings, including with respect to security, privacy or enforcement by government regulators, including fines, orders or consent decrees; and

 

    changes in Chinese or global business or macroeconomic conditions.

Given our limited operating history and the rapidly evolving market in which we compete, our historical results of operations may not be useful to you in predicting our future results of operations. Our short operating history and our rapid growth make it difficult for us to identify recurring seasonal trends in our business. The advertising industry in China experiences seasonality. Historically, advertising spending and user activities on our platform tend to be the lowest in the first quarter of each calendar year due to long holidays around the Lunar New Year, and we believe this seasonality affects our quarterly results.

We may be adversely affected by the complexity, uncertainties and changes in PRC regulation of Internet businesses and companies, including limitations on our ability to own key assets such as our mobile applications.

The Chinese government heavily regulates the Internet industry, including foreign investment in the Chinese Internet industry, content on the Internet and license and permit requirements for service providers in the Internet industry. Since some of the laws, regulations and legal requirements with respect to the Internet are relatively new and evolving, their interpretation and enforcement involve significant uncertainties. In addition, the Chinese legal system is based on written statutes, such that prior court decisions can only be cited for reference and have little precedential value. As a result, in many cases it is difficult to determine what actions or omissions may result in liabilities. Issues, risks and uncertainties relating to China’s government regulation of the Chinese Internet sector include the following:

 

    We operate our mobile applications in China through businesses controlled via contractual arrangements versus direct ownership due to restrictions on foreign investment in businesses providing value-added telecommunication services, including substantially all of our paid services and advertising services.

 

   

Uncertainties relating to the regulation of the Internet business in China, including evolving licensing practices, give rise to the risk that some of our permits, licenses or operations may be subject to challenge, which may be disruptive to our business, subject us to sanctions or require us to increase capital, compromise the enforceability of relevant contractual arrangements, or have other adverse effects on us. The numerous and often vague restrictions on acceptable content in China subject us to potential civil and criminal liability, temporary blockage of our mobile applications or complete shut-down of our mobile applications. For example, the State Secrecy Bureau, which is directly responsible for the protection of state secrets of all Chinese government and Chinese Communist Party organizations, is authorized to block any website or mobile applications it deems to be leaking state secrets or failing to meet the relevant regulations relating to the protection of state secrets in the distribution of online information. In addition, the newly amended Law on Preservation of State Secrets which became effective on October 1, 2010 provides that whenever an Internet service provider detects any leakage of state secrets in the distribution of online information, it should stop the

 

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distribution of such information and report to the authorities of state security and public security. As per request of the authorities of state security, public security or state secrecy, the Internet service provider should delete any content on its website that may lead to disclosure of state secrets. Failure to do so on a timely and adequate basis may subject the service provider to liability and certain penalties imposed by the State Security Bureau, Ministry of Public Security and/or MIIT or their respective local counterparts.

 

    On September 28, 2009, the General Administration of Press and Publication (the predecessor of GAPPRFT), or the GAPP, and the National Office of Combating Pornography and Illegal Publications jointly published a circular expressly prohibiting foreign investors from participating in Internet game operating business via wholly owned, equity joint venture or cooperative joint venture investments in China, and from controlling and participating in such businesses directly or indirectly through contractual or technical support arrangements. On February 4, 2016, the GAPPRFT and the MIIT jointly issued the Rules for the Administration for Internet Publishing Services, or the Internet Publishing Rules, which took effect in March 10, 2016 and prohibit wholly foreign-owned enterprises, Sino-foreign equity joint ventures and Sino-foreign cooperative enterprises from engaging in the provision of web publishing services. Under such rules, an Internet publishing license is required for a provider of online publications. Uncertainty remains regarding the interpretation of relevant concepts, including “online publications”. Although we have not been required by the GAPPRFT or other relevant authorities to obtain an Internet publishing license so far, we may face further scrutiny by such authorities, which may require us to apply for such license and/or subject us to penalties. In addition, project cooperation between an Internet publishing service provider and a wholly foreign-owned enterprise, Sino-foreign equity joint venture, or Sino-foreign cooperative enterprise within China or an overseas organization or individual involving Internet publishing services shall be subject to examination and approval by the GAPPRFT in advance.

Due to the increasing popularity and use of the Internet and other online services, it is possible that a number of laws and regulations may be adopted with respect to the Internet or other online services covering issues such as user privacy, pricing, content, copyrights, distribution, antitrust and characteristics and quality of products and services. The adoption of additional laws or regulations may impede the growth of the Internet or other online services, which could, in turn, decrease the demand for our products and services and increase our cost of doing business. Moreover, the applicability to the Internet and other online services of existing laws in various jurisdictions governing issues such as property ownership, sales and other taxes, libel and personal privacy is uncertain and may take years to resolve. Any new legislation or regulation, the application of laws and regulations from jurisdictions whose laws do not currently apply to our business, or the application of existing laws and regulations to the Internet and other online services could significantly disrupt our operations or subject us to penalties.

The interpretation and application of existing PRC laws, regulations and policies, the stated positions of relevant PRC government authorities and possible new laws, regulations or policies have created substantial uncertainties regarding the legality of existing and future foreign investments in, and the businesses and activities of, Internet businesses in China, including our business.

Non-compliance with law on the part of third parties with which we conduct business could disrupt our business and adversely affect results of our operation and financial condition.

Third parties with which we conduct business, such as content providers, advertising agents, advertising customers and merchandise suppliers, may be subject to regulatory penalties or punishments because of their regulatory compliance failures or may be infringing upon other parties’ legal rights, which may, directly or indirectly, disrupt our business. Although we conduct review of legal formalities and certifications before entering into contractual relationships with third parties, and take measures to reduce the risks that we may be exposed to in case of any non-compliance by third parties, we cannot be certain whether such third party has

 

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violated any regulatory requirements or infringed or will infringe any other parties’ legal rights. For example, content providers may submit copyrighted content that they have no right to distribute. While our content management system screens content for potential copyright infringements, we may not be able to identify all instances of copyright infringement. In the event we deliver content that violates copyrights of a third party, we may be required to pay damages to compensate such third party. Even though we have the contractual right to seek indemnification from the relevant content provider for such payment, there can be no assurance that we will be able to enforce such right. As a result, our business, results of operations and financial condition could be materially and adversely affected. Similarly, advertising content of advertising customers may also not be in full compliance with applicable laws and regulations that may have an adverse effect as to our business, results of operations and financial condition. See “— Advertisements on our mobile applications may subject us to penalties and other administrative actions.”

We cannot rule out the possibility of incurring liabilities or suffering losses due to any non-compliance by third parties. We cannot assure you that we will be able to identify irregularities or non-compliance in the business practices of third parties we conduct business with, or that such irregularities or non-compliance will be corrected in a prompt and proper manner. Any legal liabilities and regulatory actions affecting third parties involved in our business may affect our business activities and reputation, and may in turn affect our business, results of operations and financial condition.

Privacy concerns relating to our products and services and the use of user information could damage our reputation, deter current and potential users and customers from using our mobile applications and negatively impact our business.

We collect personal data from our users in order to better understand our users and their needs and to help advertising customers target specific demographic groups. Through an automated process, we develop a social graph for each user based on such person’s profile, behavior and social relationships. Concerns about the collection, use, disclosure or security of personal information or other privacy-related matters, even if unfounded, could damage our reputation, cause us to lose users and customers and adversely affect our business, results of operations and financial condition. While we strive to comply with applicable data protection laws and regulations, as well as our own posted privacy policies and other obligations we may have with respect to privacy and data protection, the failure or perceived failure to comply may result, and in some cases has resulted, in inquiries and other proceedings or actions against us by government agencies or others, as well as negative publicity and damage to our reputation and brand, each of which could cause us to lose users and customers, which could have an adverse effect on our business.

Any systems failure or compromise of our security that results in the unauthorized access to or release of our users’ or customers’ data could significantly limit the adoption of our products and services, as well as harm our reputation and brand and, therefore, our business. We expect to continue to expend significant resources to protect against security breaches. The risk that these types of events could seriously harm our business is likely to increase as we expand the number of products and services we offer and expand our user base.

New laws or regulations concerning data protection, or the interpretation and application of existing consumer and data protection laws or regulations, which is often uncertain and in flux, may be inconsistent with our practices. Complying with new laws and regulations could cause us to incur substantial costs or require us to change our business practices in a manner materially adverse to our business. For example, if privacy concerns or regulatory restrictions prevent us from selling demographically targeted advertising, we may become less attractive to advertising customers.

If we are unable to keep pace with rapid technological changes in the mobile Internet industries, our business may suffer.

The mobile feed industry, and the Internet industry in general, are characterized by constant changes, including rapid technological evolution, continual shifts in customer demands, frequent introductions of new

 

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products and services and constant emergence of new industry standards and practices. Thus, our success will depend, in part, on our ability to respond to these changes in a cost-effective and timely manner. If we are unable to keep up with big data analysis, artificial intelligence and other technological developments, users may no longer be attracted to our platform. A decrease in the number of active users may reduce our monetization opportunities and have a material and adverse effect on our business, results of operations and financial condition.

Our technological capabilities and infrastructure underlying our platform are critical to our success. The industry we operate in is subject to rapid technological changes and is evolving quickly in terms of technology innovation. We need to anticipate the emergence of new technologies and assess their market acceptance. We also need to invest significant resources, including financial resources, in research and development to keep pace with technological advances in order to make our products and services competitive in the market. However, development activities are inherently uncertain, and we might encounter practical difficulties in commercializing our development results. Our significant expenditures on research and development may not generate corresponding benefits. Given the fast pace with which the technology has been and will continue to be developed, we may not be able to timely upgrade our technologies in an efficient and cost-effective manner, or at all. New technologies in programming or operations could render our technologies, our platform or products or services that we are developing or expect to develop in the future obsolete or unattractive, thereby limiting our ability to recover related product development costs, outsourcing costs and licensing fees, which could result in a decline in our revenues and market share.

If our security measures are breached, or if our products and services are subject to attacks that degrade or deny the ability of users to access our products and services, our products and services may be perceived as not being secure, users may curtail or stop using our products and services and our business, results of operations and financial condition may be harmed.

Our products and services involve the storage and transmission of users’ information, and security breaches expose us to a risk of loss of this information, litigation and potential liability. We may experience cyber-attacks of varying degrees, including attempts to hack into our user accounts or redirect our user traffic to other websites. Functions that facilitate interactivity with other mobile applications, such as WeChat, which among other things allows users to log into our platform using their WeChat identities, could increase the scope of access of hackers to user accounts. Our security measures may also be breached due to employee error, malfeasance or otherwise. Additionally, outside parties may attempt to fraudulently induce employees or users to disclose sensitive information in order to gain access to our data or our users’ data or accounts, or may otherwise obtain access to such data or accounts. Any such breach or unauthorized access could result in significant legal and financial exposure, damage to our reputation and a loss of confidence in the security of our products and services that could have an adverse effect on our business, results of operations and financial condition. Because the techniques used to obtain unauthorized access, disable or degrade service or sabotage systems change frequently and often are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. If an actual or perceived breach of our security occurs, the market perception of the effectiveness of our security measures could be harmed, we could lose users and we may be exposed to significant legal and financial risks, including legal claims and regulatory fines and penalties. Any of these actions could have a material and adverse effect on our business, results of operations and financial condition.

Negative publicity about us, our services, operations and our management may adversely affect our reputation and business.

We have from time to time received negative publicity, including negative Internet and blog postings about our company, our business, our management or our services. Certain of such negative publicity may be the result of malicious harassment or unfair competition acts by third parties. We may even be subject to government or regulatory investigation as a result of such third-party conduct and may be required to spend significant time and

 

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incur substantial costs to defend ourselves against such third-party conduct, and we may not be able to conclusively refute each of the allegations within a reasonable period of time, or at all. Our reputation may be materially and adversely affected as a result of any negative publicity, which in turn may cause us to lose market share, users, advertising customers and other third parties we conduct business with. We have implemented user loyalty programs to gamify user experience and tap into the competitive reward psyche of users. However, some users have misunderstand the purpose of the system and expect it to function as a source of significant monetary compensation. Such users have complained about the inadequacy of rewards through Internet blog postings. Such postings could have a material and adverse effect on our ability to acquire new customers.

We may incur liability for merchandise sold on our platform that are without or have yet to receive proper authorization, infringe on other parties’ intellectual property rights, or fail to comply with related permits or filing requirements.

Our Qutoutiao mobile application includes an online marketplace which users can access and purchase merchandise offered by third-party merchandise suppliers, which allows us to both enhance user stickiness and capture valuable monetization opportunities. We may incur liability for merchandise sold by third-party merchandise suppliers that are without or have yet to receive proper authorization, infringe on other parties’ intellectual property rights, or fail to comply with related permits or filing requirements. If any material claim occurs in the future, irrespective of the validity of such claims, we may incur significant costs and efforts in either defending against or settling such claims. If there is a successful claim against us, we might be required to pay substantial damages or refrain from further sale of the relevant merchandise. Moreover, such claims could result in negative publicity and our reputation could be severely damaged. Any of these events could have a material and adverse effect on our business, results of operations or financial condition.

The security of operations of third-party online payment platforms may have material and adverse effects on our business.

Our users withdraw cash credits from their accounts on Qutoutiao through third-party online payment systems. Our users also can use third-party online payment systems to supplement their spending on Qutoutiao with additional funds. In such online payment transactions, secured transmission of confidential information such as customers’ personal information over public networks is essential to maintain consumer confidence.

We do not have control over the security measures of our third-party online payment platforms, and security breaches of the online payment systems that we use could expose us to litigation and possible liability for failing to secure confidential customer information and could, among other things, damage our reputation and the perceived security of all of the online payment systems that we use. If a well-publicized Internet or mobile network security breach were to occur, users concerned about the security of their online financial transactions may become reluctant to purchase our virtual items even if the publicized breach did not involve payment systems or methods used by us. In addition, there may be billing software errors that would damage customer confidence in these online payment systems. If any of the above were to occur and damage our reputation or the perceived security of the online payment systems we use, we lose active users, which may have an adverse effect on our business.

Furthermore, if any of the payment platforms we use decide to significantly increase the percentage they charge us for using their payment systems, our business, results of operations and financial condition may be materially and adversely affected.

Our business and growth could suffer if we are unable to hire and retain key personnel.

We depend on the continued contributions of our senior management and other key employees, many of whom are difficult to replace. The loss of the services of any of our executive officers or other key employees could harm our business. Competition for qualified talent in China is intense. Our future success is dependent on

 

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our ability to attract a significant number of qualified employees and retain existing key employees. If we are unable to do so, our business and growth may be materially and adversely affected and the trading price of our ADSs could suffer. Our need to significantly increase the number of our qualified employees and retain key employees may cause us to materially increase compensation-related costs, including share-based compensation.

We are also dependent on the services of Mr. Eric Siliang Tan, our co-founder and executive chairman. Although Mr. Tan spends significant time with us and is active in the management of our business, he does not devote his full time and attention to us. If Mr. Tan reduces his time with us in the future and become less involved with the management of our business, we may no longer benefit from his extensive industry experience and our business and growth may suffer.

Our co-founder and executive chairman Mr. Eric Siliang Tan has control over us and our corporate matters.

Our co-founder and executive chairman, Mr. Eric Siliang Tan, has control over us and our corporate matters. Innotech Group Holdings Ltd., a British Virgin Islands limited liability company which is ultimately controlled by Mr. Tan, holds 27,123,442 of our ordinary shares. In addition, pursuant to power of attorney by several shareholders, Innotech Group Holdings Ltd. has the right to exercise the voting power associated with 1,669,496 ordinary shares held by such shareholders. As a result, Innotech Group Holdings Ltd. has the voting power over 28,792,938 ordinary shares, or 52.0% of the aggregate voting power of our issued and outstanding share capital as of the date of this prospectus.

Mr. Tan is expected to remain as controlling shareholder upon the completion of this offering. After this offering, Mr. Tan will continue to have control over matters requiring shareholder approval, such as electing directors and approving material mergers, acquisitions or other business combination transactions. This concentrated control will limit your ability to influence corporate matters and could also discourage others from pursuing any potential merger, takeover or other change of control transactions, which could have the effect of depriving the holders of our ordinary shares and our ADSs of the opportunity to sell their shares at a premium over the prevailing market price.

We are a “controlled company” under the rules of [NYSE/NASDAQ] and, as a result, will 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/ Nasdaq Stock Market Rules] because Mr. Eric Siliang Tan holds more than 50% of the aggregate voting power of our company. For so long as we remain a controlled company under that definition, we are permitted to elect to rely, and will 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. As a result, you will not have the same protection afforded to shareholders of companies that are subject to these corporate governance requirements.

We have incurred and may continue to incur substantial share-based compensation expenses.

We have adopted a 2017 equity incentive plan that permits the grant of share options, and a 2018 equity incentive plan that permits the grant of share options, restricted shares, restricted share units, dividend equivalents, share appreciation rights and share payments as equity-based awards, to our directors, officers, employees and consultants. The maximum aggregate number of ordinary shares that may be issued pursuant to all share options and other awards under our equity incentive plans is 12,964,141, of which 10,000,000 ordinary shares are held by a nominee of our equity incentive trust. As of the date of this prospectus, options to purchase 12,004,725 ordinary shares have been granted and are outstanding under our equity incentive plans. We are required to account for options granted to our employees, directors and consultants. We are required to classify options granted to our employees, directors and consultants as equity awards and recognize share-based compensation expense based on the fair value of such share options, with the share-based compensation expense recognized over the period in which the recipient is required to provide service in exchange for the share option

 

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or other equity award. For 2017, we recorded RMB3.4 million (US$0.5 million) of share-based compensation expenses.

On January 3, 2018, entities respectively controlled by our co-founders Mr. Eric Siliang Tan and Mr. Lei Li entered into share restriction deeds with us, pursuant to which a total of 15,937,500 ordinary shares beneficially owned by such co-founders became restricted shares. 12,187,500 of such restricted shares are beneficially owned by Mr. Eric Siliang Tan and will be vested in a period over 34 months. 3,750,000 of such restricted shares are beneficially owned by Mr. Lei Li and will be vested in a period over 24 months. These share restriction deeds will be terminated, and any remaining restricted shares will be vested, upon the completion of this offering. For accounting purposes, this transaction has been reflected retrospectively similar to a reverse stock split, with a grant of 15,937,500 restricted shares to be recognized in January 2018 at their then fair value of approximately US$128.4 million and recognized as compensation expense over the vesting periods. For further information, see “Management — Equity Incentive Plans — Share Restriction Deeds.”

We believe the granting of share-based compensation is of significant importance to our ability to attract, retain and motivate our management team and talented employees, and we will continue to grant share-based compensation to employees in the future. As a result, our expenses associated with share-based compensation may increase significantly, which may have an adverse effect on our results of operations and financial condition. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies, Judgments and Estimates — Share-based Compensation and Valuation of Our Ordinary Shares”.

Future investments in and acquisitions of complementary assets, technologies and businesses may fail and may result in equity or earnings dilution.

We may invest in or acquire assets, technologies and businesses that are complementary to our existing business. Our investments or acquisitions may not yield the results we expect. In addition, investments and acquisitions could result in the use of substantial amounts of cash, potentially dilutive issuances of equity securities, significant amortization expenses related to goodwill or intangible assets and exposure to potential unknown liabilities of the acquired business. Furthermore, if such goodwill or intangible assets become impaired, we may be required to record a significant charge to our results of operations. Such investments and acquisitions may also require our management team to devote a significant amount of attention. Moreover, the cost of identifying and consummating investments and acquisitions, and integrating the acquired businesses into ours, may be significant, and the integration of acquired businesses may be disruptive to our existing business operations. In addition, we may have to obtain approval from the relevant PRC governmental authorities for the investments and acquisitions and comply with any applicable PRC rules and regulations, which may be costly. In the event our investments and acquisitions are not successful, our results of operations and financial condition may be materially and adversely affected.

We may not be able to adequately protect our intellectual property, which could cause us to be less competitive.

We regard our intellectual property as critical to our success. Such intellectual property includes trademarks, domain names, copyrights, know-how and proprietary technologies. We currently rely on trademarks, copyrights, trade secret law and confidentiality, invention assignment and non-compete agreements with our employees and others to protect our proprietary rights. See “Business — Intellectual Property” and “Regulations — Regulations Related to Intellectual Property Rights.” However, we cannot assure you that any of our intellectual property rights would not be challenged, invalidated or circumvented, or such intellectual property will be sufficient to provide us with competitive advantages. We have not completed the trademark registration for “Qutoutiao,” the name of our flagship mobile application. After we submitted our application material with the relevant authorities, one of our competitors filed an objection on the purported ground that “Qutoutiao” is similar to a trademark registered by such competitor. We believe such objection is meritless and we have contested the

 

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objection and submitted the written defense to the Trademark Office in February 2018. However, there can be no assurance that we will be able to prevail and register “Qutoutiao” as a trademark. See “— If we do not continue to increase the strength of our brand, we may not be able to maintain current or attract new users and customers for our products and services.” In addition, other parties may misappropriate our intellectual property rights, which would cause us to suffer economic or reputational damages. Because of the rapid pace of technological change, nor can we assure you that all of our proprietary technologies and similar intellectual property can be patented in a timely or cost-effective manner, or at all. Furthermore, parts of our business rely on technologies developed or licensed by other parties, or co-developed with other parties, and we may not be able to obtain or continue to obtain licenses and technologies from these other parties on reasonable terms, or at all.

It is often difficult to register, maintain and enforce intellectual property rights in China. Statutory laws and regulations are subject to judicial interpretation and enforcement and may not be applied consistently due to the lack of clear guidance on statutory interpretation. Confidentiality, invention assignment and non-compete agreements may be breached by counterparties, and there may not be adequate remedies available to us for any such breach. Accordingly, we may not be able to effectively protect our intellectual property rights or to enforce our contractual rights in China. Preventing any unauthorized use of our intellectual property is difficult and costly and the steps we take may be inadequate to prevent the misappropriation of our intellectual property. In the event that we resort to litigation to enforce 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. To the extent that our employees or consultants use intellectual property owned by others in their work for us, disputes may arise as to the rights in related know-how and inventions. Any failure in protecting or enforcing our intellectual property rights could materially and adversely affect our business, results of operations and financial condition.

We may be subject to intellectual property infringement claims or other allegations by third parties for information or content displayed on, retrieved from or linked to our platform, or delivered to our users, which may materially and adversely affect our business, financial condition and prospects.

We may be subject to intellectual property infringement claims or other allegations by third parties for products or services on our platform, which may materially and adversely affect our business, financial condition and prospects.

Companies in the Internet, technology and media industries are frequently involved in litigation based on allegations of infringement of intellectual property rights, unfair competition, invasion of privacy, defamation and other violations of other parties’ rights. The validity, enforceability and scope of protection of intellectual property rights in Internet-related industries, particularly in China, are uncertain and still evolving. As we face increasing competition and as litigation becomes more common in China in resolving commercial disputes, we face a higher risk of being the subject of intellectual property infringement claims.

We allow content providers to upload texts, images and videos on our platform. We have procedures designed to reduce the likelihood that content might be used without proper licenses or third-party consents. However, these procedures may not be effective in preventing the unauthorized posting of copyrighted content. We may face liability for copyright or trademark infringement, defamation, unfair competition, libel, negligence, and other claims based on the nature and content of the materials that are delivered, shared or otherwise accessed through our platform.

Defending intellectual property litigation is costly and can impose a significant burden on our management and employees, and there can be no assurances that favorable final outcomes will be obtained in all cases. Such claims, even if they do not result in liability, may harm our reputation. Any resulting liability or expenses, or changes required to our platform to reduce the risk of future liability, may materially and adversely affect our business, financial condition and prospects.

 

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If we fail to implement and maintain an effective system of internal control, we may be unable to accurately or timely report our results of operations or prevent fraud, and investor confidence and the market price of the ADSs may be materially and adversely affected.

We will be subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act and the rules and regulations of the [NYSE/NADSAQ] after the completion of this offering. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. Commencing with our fiscal year ending December 31, 2019, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting in our Form 20-F filing for that year, as required by Section 404 of the Sarbanes-Oxley Act. In addition, once we cease to be an “emerging growth company” as the term is defined in 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 not reach the same conclusion. Prior to this offering, we were a private company with limited accounting personnel and other resources with which to address our internal control and procedures, and we were never required to evaluate our internal control over financial reporting within a specified period, and, as a result, we may experience difficulty in meeting these reporting requirements in a timely manner. Our management has not completed an assessment of the effectiveness of our internal control over financial reporting and our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting.

In the course of preparing and auditing our consolidated financial statements for the years ended December 31, 2016 and 2017, we and our independent registered public accounting firm identified one material weakness in our internal control over financial reporting as of December 31, 2017. In accordance with U.S. GAAP and financial reporting requirements set forth by the SEC, a “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our company’s annual or interim consolidated financial statements will not be prevented or detected on a timely basis. The material weakness identified relates to the lack of sufficient financial reporting and accounting personnel with appropriate knowledge of U.S. GAAP and SEC reporting requirements to formalize key controls over financial reporting and to prepare consolidated financial statements and related disclosures. Neither we nor our independent registered public accounting firm undertook a comprehensive assessment of our internal control under the Sarbanes-Oxley Act for purposes of identifying and reporting any weakness in our internal control over financial reporting. We and they are required to do so only after we become a public company. Had we performed a formal assessment of our internal control over financial reporting or had our independent registered public accounting firm performed an audit of our internal control over financial reporting, additional control weaknesses may have been identified. To remedy our identified material weakness subsequent to December 31, 2017, we plan to undertake steps to strengthen our internal control over financial reporting, including: (i) hiring more qualified resources including financial controller, equipped with relevant U.S. GAAP and SEC reporting experience and qualifications to strengthen the financial reporting function and to set up a financial and system control framework, (ii) implementing regular and continuous U.S. GAAP accounting and financial reporting training programs for our accounting and financial reporting personnel, (iii) establishing effective oversight and clarifying reporting requirements for non-recurring and complex transactions to ensure consolidated financial statements and related disclosures are accurate, complete and in compliance with U.S. GAAP and SEC reporting requirements, and (iv) enhancing an internal audit function as well as engaging an external consulting firm to help us assess our compliance readiness under rule 13a-15 of the Exchange Act and improve overall internal control. However, we cannot assure you that we will remediate our material weakness in a timely manner.

Our internal control over financial reporting will not prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the

 

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control system’s objectives will be met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud will be detected.

If we are not able to comply with the requirements of Section 404 of the Sarbanes-Oxley Act in a timely manner, or if we are unable to maintain proper and effective internal control, we may not be able to produce timely and accurate financial statements. If that were to happen, the market price of our ADSs could decline and we could be subject to sanctions or investigations by the [NYSE/NADSAQ], SEC or other regulatory authorities.

The discontinuation of any of the preferential tax treatments available to us in China could materially and adversely affect our results of operations and financial condition.

Under PRC tax laws and regulations, our consolidated VIE, Shanghai Jifen enjoyed, or is qualified to enjoy, certain preferential income tax benefits. The modified Enterprise Income Tax Law, effective on February 24, 2017, or the EIT Law, and its implementation rules generally impose a uniform income tax rate of 25% on all enterprises, but grant preferential treatment to “high and new technology enterprises strongly supported by the state”, or HNTEs, to enjoy a reduced enterprise tax rate of 15%. According to the relevant administrative measures, to qualify as a “HNTE”, Shanghai Jifen must meet certain financial and non-financial criteria and complete verification procedures with the administrative authorities. Continued qualification as a “HNTE” is subject to a three-year review by the relevant government authorities in China, and in practice certain local tax authorities also require annual evaluation of the qualification. In the event the preferential tax treatment for Shanghai Jifen is discontinued or is not verified by the local tax authorities, and the affected entity fails to obtain preferential income tax treatment based on other qualifications such as Advanced Technology Service Enterprise, it will become subject to the standard PRC enterprise income tax rate of 25%. We cannot assure you that the tax authorities will not, in the future, discontinue any of our preferential tax treatments, potentially with retroactive effect.

User growth and engagement depend upon effective interoperation with operating systems, networks, devices and major mobile application distribution channels that we do not control.

We make our products and services available across a variety of mobile operating systems and through major mobile application distribution channels, namely app stores. We are dependent on the interoperability of our products and services with popular devices and mobile operating systems that we do not control, such as Android and iOS. In addition, any changes in such operating systems, devices or mobile application distribution channels that degrade the functionality of our products and services or give preferential treatment to competitive products or services could adversely affect usage of our products and services. Further, if the number of platforms for which we develop our products increases, it will result in an increase in our costs and expenses. In order to deliver high quality products and services, it is important that our products and services work well with a range of mobile operating systems and devices which we do not control. We may not be successful in developing relationships with key participants in the mobile Internet industry or in developing products or services that operate effectively with these mobile operating systems, devices and mobile application distribution channels. In the event it is difficult for our users to access and use our products and services on their mobile devices, our user growth and user engagement could be harmed, and our business, results of operations and financial condition could be adversely affected.

Our operations depend on the performance of the Internet infrastructure and fixed telecommunications networks in China.

Almost all access to the Internet in China is maintained through state-owned telecommunication operators under the administrative control and regulatory supervision of the Ministry of Industry and Information Technology, or the MIIT. Moreover, we primarily rely on a limited number of telecommunication service providers to provide us with data communications capacity through local telecommunications lines and Internet

 

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data centers to host our servers. We have limited access to alternative networks or services in the event of disruptions, failures or other problems with China’s Internet infrastructure or the fixed telecommunications networks provided by telecommunication service providers. Internet traffic in China has experienced significant growth during the past few years. Effective bandwidth and server storage at Internet data centers in large cities such as Shanghai are scarce. With the expansion of our business, we may be required to upgrade our technology and infrastructure to keep up with the increasing traffic on our platform. We cannot assure you that the Internet infrastructure and the fixed telecommunications networks in China will be able to support the demands associated with the continued growth in Internet usage. If we are unable to increase our online content and service delivering capacity accordingly, we may not be able to continuously grow our traffic, and the adoption of our products and services may be hindered, which could adversely impact our business and our share price.

In addition, we have no control over the costs of the services provided by telecommunication service providers. If the prices we pay for telecommunications and Internet services rise significantly, our business, results of operations and financial condition may be materially and adversely affected. Furthermore, if mobile Internet access fees or other charges to mobile Internet users increase, some users may be prevented from accessing the mobile Internet and thus cause the growth of mobile Internet users to decelerate. Such deceleration may adversely affect our ability to continue to expand our user base and increase our attractiveness to online customers.

Our business, results of operations and financial condition may be harmed by service disruptions, or by our failure to timely and effectively scale and adapt our existing technology and infrastructure.

We may experience service disruptions, outages and other performance problems due to a variety of factors, including infrastructure changes, human or software errors, hardware failure, capacity constraints due to an overwhelming number of people accessing our products and services simultaneously, computer viruses and denial of service, fraud and security attacks. Any disruption or failure in our infrastructure could hinder our ability to handle existing or increased traffic on our platform or cause us to lose content stored on our platform, which could significantly harm our business and our ability to retain existing users and attract new users.

As the number of our users increases and our users generate increasing volumes of user generated videos on our platform, and as we continue to diversify into new content formats, we may be required to expand and adapt our technology and infrastructure to continue to reliably store, analyze and deliver content. It may become increasingly difficult to maintain and improve the performance of our products and services, especially during peak usage times, as our products and services become more complex and our user traffic increases. In addition, because we lease our data center facilities, we cannot be assured that we will be able to expand our data center infrastructure to meet users’ demand in a timely manner, or on favorable economic terms. If our users are unable to access Qutoutiao or we are not able to make information available rapidly on Qutoutiao, or at all, users may become frustrated and seek other channels for their light entertainment needs, and may not return to Qutoutiao or use Qutoutiao as often in the future, or at all. This would negatively impact our ability to attract users and maintain high level of user engagement as well as our ability to attract advertising customers.

Legal or administrative proceedings or allegations of impropriety against us or our management could have a material adverse impact on our reputation, results of operation and financial condition.

We and members of our management may be subject to allegations or lawsuits brought by our competitors, individuals, government and regulatory authorities or other persons in the future. Any such lawsuit or allegation, with or without merit, or any perceived unfair, unethical, fraudulent or inappropriate business practice by us or perceived wrong-doing by any key member of our management team could harm our reputation and cause our user base to decline and distract our management from day-to-day operations of our company. We cannot assure you that we or key members of our management team will not be subject to lawsuits or allegations of a similar nature in the future. Where we can make a reasonable estimate of the liability relating to pending litigation and determine that an adverse liability resulting from such litigation is probable, we will record a related contingent

 

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liability. As additional information becomes available, we will assess the potential liability and revise estimates as appropriate. In 2016 and 2017, we did not record any contingent liabilities relating to pending litigation. However, when we record or revise our estimates of contingent liabilities in the future, the amount of our estimates may be inaccurate due to the inherent uncertainties relating to litigation. In addition, the outcomes of actions we institute against third parties may not be successful or favorable to us. Litigation and allegations against us or any of our management members, irrespective of their veracity, may also generate negative publicity that significantly harms our reputation, which may materially and adversely affect our user base and our ability to attract content providers and advertising customers. In addition to the related cost, managing and defending litigation and related indemnity obligations can significantly divert our management and the board of directors’ attention from operating our business. We may also need to pay damages or settle the litigation with a substantial amount of cash. All of these could have a material adverse impact on our reputation, results of operation and financial condition.

We may not have fully paid certain fees and surcharges in the past. As such, we may be subject to further scrutiny by the PRC tax authorities that may result in a finding which may subject us to additional taxes, fees and surcharges and fines or other penalties.

According to the Circular on Issues Relating to Cultural Undertaking Development Fee Policies and Administration of Levying and Collection Relating to Levying VAT in place of Business Tax, which was issued by the Ministry of Finance and the State Administration of Taxation, or the SAT, on March 28, 2016, or Circular 25, the provision of advertising services by advertising media agencies and outdoor advertisement business operators (including entities engaging in distribution, screening, promotion and exhibition of outdoor advertisements and other advertisements, as well as entities engaging in advertisement agency services) in China is subject to a cultural development fee at an applicable rate of 3% of the net advertising revenue. The net advertising revenue refers to, as specified in Circular 25, the balance after deducting advertisement distribution fee paid to other advertising company or advertisement distributor, from the total tax inclusive price and out of pocket expenses obtained from provision of advertising services.

We recorded cultural development fee and surcharges of RMB2.0 million (US$0.3 million) and RMB17.0 million (US$2.6 million) in 2016 and 2017 respectively, in our costs of revenues. As we did not consider all of our advertising revenue as revenue from advertising services subject to Circular 25, we have not historically paid all such cultural development fee and surcharges recorded to the relevant tax authorities. Although we have not been challenged by the tax authorities so far, we may face further scrutiny by the PRC tax authorities that may result in a conclusion that subjects us to additional taxes, fees and surcharges and substantially increases our taxes owed, thereby materially and adversely affecting our results of operations. As a result of not making adequate contributions, we may also be subject to fines or other penalties imposed by the relevant authorities pursuant to applicable laws and regulations.

A severe or prolonged downturn in the Chinese or global economy could materially and adversely affect our business, results of operations and financial condition.

Any prolonged slowdown in the Chinese or global economy may have a negative impact on our business, results of operations and financial condition. In particular, general economic factors and conditions in China or worldwide, including the general interest rate environment and unemployment rates, may affect advertising customers’ willingness to advertise or consumers’ willingness to spend on entertainment. Economic conditions in China are sensitive to global economic conditions. The global financial markets have experienced significant disruptions since 2008 and the United States, Europe and other economies have experienced periods of recession. The recovery from the lows of 2008 and 2009 has been uneven and is facing new challenges, including the escalation of the European sovereign debt crisis from 2011 and the slowdown of the Chinese economy since 2012. 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. There have been concerns over unrest in North Korea, Ukraine, the

 

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Middle East and Africa, which have resulted in volatility in financial and other markets. There have also been concerns over the expected withdrawal of the United Kingdom from the European Union as well as concerns about the economic effect of the tensions in the relationship between the United States, China and neighboring Asian countries. If present Chinese and global economic uncertainties persist, we may have difficulty in attracting advertising customers or spending by consumers on entertainment. Additionally, continued turbulence in the international markets may adversely affect our ability to access the capital markets to meet liquidity needs.

We have limited business insurance coverage.

Insurance companies in China currently do not offer as extensive an array of insurance products as are offered by insurance companies in more developed economies. We do not have any business liability or disruption insurance coverage for our operations. Any uninsured business disruptions may result in our incurring substantial costs and diversion of resources, which could have an adverse effect on our results of operations and financial condition.

Any catastrophe, including natural catastrophes and outbreaks of health pandemics and other extraordinary events, could disrupt our business operation.

We are vulnerable to natural disasters and other calamities. Fire, floods, typhoons, earthquakes, power loss, telecommunications failures, break-ins, war, riots, terrorist attacks or similar events may give rise to server interruptions, breakdowns, system failures or Internet failures, which could cause the loss or corruption of data or malfunctions of software or hardware as well as adversely affect our ability to provide our products or services.

Our business could also be adversely affected by the effects of Ebola virus disease, H1N1 flu, H7N9 flu, avian flu, Severe Acute Respiratory Syndrome, or SARS, or other epidemics. Our business operations could be disrupted if any of our employees is suspected of having Ebola virus disease, H1N1 flu, H7N9 flu, avian flu, SARS or another contagious disease or condition, since it could require our employees to be quarantined and/or our offices to be disinfected. In addition, our business, results of operations and financial condition could be adversely affected to the extent that any of these epidemics harms the Chinese economy in general.

Risks Relating to Our Corporate Structure

We rely on contractual arrangements with our consolidated VIE and its shareholders to operate our business, which may not be as effective as direct ownership in providing operational control and otherwise materially and adversely affect our business.

We rely on contractual arrangements with our consolidated VIE and its shareholders to operate our business. For a description of these contractual arrangements, see “Our History and Corporate Structure — Contractual Arrangements among Shanghai Quyuan, Shanghai Jifen and Its Shareholders.” All of our revenue is attributed to our consolidated VIE and its subsidiaries. These contractual arrangements may not be as effective as direct ownership in providing us with control over our consolidated VIE. If our consolidated VIE or its shareholders fail to perform their respective obligations under these contractual arrangements, our recourse to the assets held by our consolidated VIE is indirect and we may have to incur substantial costs and expend significant resources to enforce such arrangements in reliance on legal remedies under PRC law. These remedies may not always be effective, particularly in light of uncertainties in the PRC legal system. Furthermore, in connection with litigation, arbitration or other judicial or dispute resolution proceedings, assets under the name of any of record holder of equity interest in our consolidated VIE, including such equity interest, may be put under court custody. As a consequence, we cannot be certain that the equity interest will be disposed pursuant to the contractual arrangement or ownership by the record holder of the equity interest.

All of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC laws

 

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and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the U.S. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements. In the event that we are unable to enforce these contractual arrangements, or if we suffer significant time delays or other obstacles in the process of enforcing these contractual arrangements, it would be very difficult to exert effective control over our consolidated VIE, and our ability to conduct our business and our results of operations and financial condition may be materially and adversely affected. See “— Risks Relating to Doing Business in China — There are uncertainties regarding the interpretation and enforcement of PRC laws, rules and regulations.”

The arbitration provisions under these contractual arrangements have no effect on the rights of our shareholders to pursue claims against us under United States federal securities laws.

Any failure by our consolidated VIE or its shareholders to perform their obligations under our contractual arrangements with them would materially and adversely affect our business.

We, through one of our subsidiaries and a wholly foreign-owned enterprise in the PRC, have entered into a series of contractual arrangements with our consolidated VIE and its shareholders. For a description of these contractual arrangements, see “Our History and Corporate Structure — Contractual Arrangements among Shanghai Quyuan, Shanghai Jifen and Its Shareholders.” If our consolidated VIE or its shareholders fail to perform their respective obligations under these contractual arrangements, we may incur substantial costs and expend additional resources to enforce such arrangements. We may also have to rely on legal remedies under PRC laws, including seeking specific performance or injunctive relief, and claiming damages, which we cannot assure you will be effective under PRC laws. For example, if the shareholders of our consolidated VIE were to refuse to transfer their equity interests in the consolidated VIE to us or our designee when we exercise the purchase option pursuant to these contractual arrangements, or if they were otherwise to act in bad faith toward us, then we may have to take legal actions to compel them to perform their contractual obligations.

All the agreements under our contractual arrangements are governed by PRC laws and provide for the resolution of disputes through arbitration in China. Accordingly, these contracts would be interpreted in accordance with PRC laws and any disputes would be resolved in accordance with PRC legal procedures. The legal system in the PRC is not as developed as in some other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements. Meanwhile, there are very few precedents and little formal guidance as to how contractual arrangements in the context of a VIE should be interpreted or enforced under PRC laws. There remain significant uncertainties regarding the ultimate outcome of such arbitration should legal action become necessary. In addition, under PRC laws, rulings by arbitrators are final and parties cannot appeal arbitration results in court unless such rulings are revoked or determined unenforceable by a competent court. If the losing parties fail to carry out the arbitration awards within a prescribed time limit, the prevailing parties may only enforce the arbitration awards in PRC courts through arbitration award recognition proceedings, which would require additional expenses and delay. In the event that we are unable to enforce these contractual arrangements, or if we suffer significant delay or other obstacles in the process of enforcing these contractual arrangements, we may not be able to exert effective control over our consolidated VIE and relevant rights and licenses held by it which we require in order to operate our business, and our ability to conduct our business may be negatively affected. See “— Risks Related to Doing Business in China — There are uncertainties regarding the interpretation and enforcement of PRC laws, rules and regulations.”

The shareholders of our consolidated VIE may have potential conflicts of interest with us, which may materially and adversely affect our business, results of operations and financial condition.

The interests of the shareholders of our consolidated VIE in their capacities as such shareholders may differ from the interests of our company as a whole, as what is in the best interests of our consolidated VIE, including matters such as whether to distribute dividends or to make other distributions to fund our offshore requirement, may not be in the best interests of our company. There can be no assurance that when conflicts of interest arise, any or all of these shareholders will act in the best interests of our company or those conflicts of interest will be

 

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resolved in our favor. In addition, these shareholders may breach or cause our consolidated VIE and their subsidiaries to breach or refuse to renew the existing contractual arrangements with us.

Currently, we do not have arrangements to address potential conflicts of interest the shareholders of our consolidated VIE may encounter, on one hand, and as a beneficial owner of our company, on the other hand. We, however, could, at all times, exercise our option under the exclusive option agreement to cause them to transfer all of their equity ownership in our consolidated VIE to a PRC entity or individual designated by us as permitted by the then applicable PRC laws. In addition, if such conflicts of interest arise, we could also, in the capacity of attorney-in-fact of the then existing shareholders of our consolidated VIE as provided under the power of attorney agreements, directly appoint new directors of our consolidated VIE. We rely on the shareholders of our consolidated VIE to comply with PRC laws and regulations, which protect contracts and provide that directors and executive officers owe a duty of loyalty to our company and require them to avoid conflicts of interest and not to take advantage of their positions for personal gains, and the laws of the Cayman Islands, which provide that directors have a duty of care and a duty of loyalty to act honestly in good faith with a view to our best interests. However, the legal frameworks of China and the Cayman Islands do not provide guidance on resolving conflicts in the event of a conflict with another corporate governance regime. If we cannot resolve any conflicts of interest or disputes between us and the shareholders of our consolidated VIE, we would have to rely on legal proceedings, which could result in disruption of our business and subject us to substantial uncertainty as to the outcome of any such legal proceedings.

If the PRC government deems that the contractual arrangements in relation to our consolidated VIE do not comply with PRC regulatory restrictions on foreign investment in the relevant industries, or if these regulations or the interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations.

The PRC government regulates telecommunications-related businesses through strict business licensing requirements and other government regulations. These laws and regulations also include limitations on foreign ownership of PRC companies that engage in telecommunications-related businesses. Specifically, foreign investors are not allowed to own more than a 50% equity interest in any PRC company engaging in value-added telecommunications businesses. The primary foreign investor must also have experience and a good track record in providing value-added telecommunications services, or VATS, overseas.

Because we are an exempted company incorporated in the Cayman Islands, we are classified as a foreign enterprise under PRC laws and regulations, and our wholly foreign-owned enterprise in the PRC is a foreign-invested enterprise, or FIE. Accordingly, none of these subsidiaries are eligible to operate VATS business in China. We conduct our business in China through our consolidated VIE and its affiliates. Our PRC subsidiary, Shanghai Quyuan, has entered into a series of contractual arrangements with our consolidated VIE and its shareholders, which enable us to (i) exercise effective control over the consolidated VIE, (ii) receive substantially all of the economic benefits of the consolidated VIE, and (iii) have an exclusive option to purchase all or part of the equity interests and assets in the consolidated VIE when and to the extent permitted by PRC law. As a result of these contractual arrangements, we have control over and are the primary beneficiary of the consolidated VIE and hence consolidate its financial results as our consolidated VIE under U.S. GAAP. For a description of these contractual arrangements, see “Our History and Corporate Structure — Contractual Arrangements among Shanghai Quyuan, Shanghai Jifen and Its Shareholders.”

We believe that our corporate structure and contractual arrangements comply with the current applicable PRC laws and regulations. Our PRC legal counsel, King & Wood Mallesons, based on its understanding of the relevant laws and regulations, is of the opinion that each of the contracts among our wholly-owned PRC subsidiary, Shanghai Quyun, our consolidated VIE and its shareholders is valid, binding and enforceable in accordance with its terms. However, as there are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rules, and the Telecommunications Regulations and the relevant regulatory measures concerning the telecommunications industry, there can be no assurance that the PRC government authorities, such as the MOFCOM or the MIIT, or other authorities that regulate Internet content providers and other participants in the telecommunications industry, would agree that our corporate structure or

 

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any of the above contractual arrangements comply with PRC licensing, registration or other regulatory requirements, with existing policies or with requirements or policies that may be adopted in the future. PRC laws and regulations governing the validity of these contractual arrangements are uncertain and the relevant government authorities have broad discretion in interpreting these laws and regulations.

If our corporate structure and contractual arrangements are deemed by the MIIT or the MOFCOM or other regulators having competent authority to be illegal, either in whole or in part, we may lose control of our consolidated VIE and have to modify such structure to comply with regulatory requirements. However, there can be no assurance that we can achieve this without material disruption to our business. Further, if our corporate structure and contractual arrangements are found to be in violation of any existing or future PRC laws or regulations, the relevant regulatory authorities would have broad discretion in dealing with such violations, including:

 

    revoking our business and operating licenses;

 

    levying fines on us;

 

    confiscating any of our income that they deem to be obtained through illegal operations;

 

    shutting down our services;

 

    discontinuing or restricting our operations in China;

 

    imposing conditions or requirements with which we may not be able to comply;

 

    requiring us to change our corporate structure and contractual arrangements;

 

    restricting or prohibiting our use of the proceeds from overseas offering to finance our consolidated VIE’s business and operations; and

 

    taking other regulatory or enforcement actions that could be harmful to our business.

Furthermore, new PRC laws, rules and regulations may be introduced to impose additional requirements that may be applicable to our corporate structure and contractual arrangements. See “— Substantial uncertainties exist with respect to the enactment timetable, interpretation and implementation of the draft PRC Foreign Investment Law, and its enactment may materially and adversely affect our business, results of operations and financial condition.” Occurrence of any of these events could materially and adversely affect our business, results of operations and financial condition. In addition, if the imposition of any of these penalties or requirement to restructure our corporate structure causes us to lose the rights to direct the activities of our consolidated VIE or our right to receive its economic benefits, we would no longer be able to consolidate the financial results of such VIE in our consolidated financial statements. However, we do not believe that such actions would result in the liquidation or dissolution of our company, our wholly-owned subsidiary in China or our consolidated VIE or its subsidiaries. See “Our History and Corporate Structure — Contractual Arrangements among Shanghai Quyuan, Shanghai Jifen and Its Shareholders.”

Contractual arrangements in relation to our consolidated VIE may be subject to scrutiny by the PRC tax authorities and they may determine that our consolidated VIE owes additional taxes, which could negatively affect our results of operations and financial condition and the value of your investment.

Under applicable PRC laws and regulations, arrangements and transactions among related parties may be subject to audit or challenge by the PRC tax authorities. The PRC enterprise income tax law requires every enterprise in China to submit its annual enterprise income tax return together with a report on transactions with its related parties to the relevant tax authorities. The tax authorities may impose reasonable adjustments on taxation if they have identified any related party transactions that are inconsistent with arm’s length principles. We may face material and adverse tax consequences if the PRC tax authorities determine that the contractual arrangements among our wholly-owned PRC subsidiary, Shanghai Quyun, our consolidated VIE and its

 

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shareholders were not entered into on an arm’s length basis in such a way as to result in an impermissible reduction in taxes under applicable PRC laws, regulations and rules, and adjust their income in the form of a transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in a reduction of expense deductions recorded by Shanghai Quyun or our consolidated VIE for PRC tax purposes, which could in turn increase their tax liabilities without reducing their tax expenses. In addition, if our wholly-owned PRC subsidiary, Shanghai Quyun, requests the shareholders of our consolidated VIE to transfer their equity interests in our consolidated VIE at nominal or no value pursuant to these contractual arrangements, such transfer could be viewed as a gift and subject the relevant subsidiary to PRC income tax. Furthermore, the PRC tax authorities may impose late payment fees and other penalties on our PRC subsidiary, Shanghai Quyun, and consolidated VIE for adjusted but unpaid taxes according to applicable regulations. Our financial position could be materially and adversely affected if the tax liabilities of our PRC subsidiary, Shanghai Quyun, and consolidated VIE increase, or if they are required to pay late payment fees and other penalties.

We may lose the ability to use and enjoy assets held by our consolidated VIE that are material to the operation of our business if the entity goes bankrupt or becomes subject to a dissolution or liquidation proceeding.

Our consolidated VIE holds substantially of all our assets. Under the contractual arrangements, our consolidated VIE may not and its shareholders may not cause it to, in any manner, sell, transfer, mortgage or dispose of its assets or its legal or beneficial interests in the business without our prior consent. However, in the event that the shareholders of our consolidated VIE breach these contractual arrangements and voluntarily liquidate our consolidated VIE, or our consolidated VIE declares bankruptcy and all or part of its assets become subject to liens or rights of third-party creditors, or are otherwise disposed of without our consent, we may be unable to continue some or all of our business activities, which could materially and adversely affect our business, results of operations and financial condition. If our consolidated VIE undergoes a voluntary or involuntary liquidation proceeding, independent third-party creditors may claim rights to some or all of these assets, thereby hindering our ability to operate our business, which could materially and adversely affect our business, results of operations and financial condition.

If the custodians or authorized users of our controlling non-tangible assets, including chops and seals, fail to fulfill their responsibilities, or misappropriate or misuse these assets, our business and operations may be materially and adversely affected.

Under PRC law, legal documents for corporate transactions, including agreements and contracts that our business relies on, 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 the relevant local branch of the SAIC. We generally execute legal documents by affixing chops or seals, rather than having the designated legal representatives sign the documents.

We have three major types of chops — corporate chops, contract chops and finance chops. We use corporate chops generally for documents to be submitted to government agencies, such as applications for changing business scope, directors or company name, and for legal letters. We use contract chops for executing leases and commercial contracts. We use finance chops generally for making and collecting payments, including issuing invoices. Use of corporate chops and contract chops must be approved by our legal department and administrative department, and use of finance chops must be approved by our finance department. The chops of our subsidiaries and consolidated VIE and its subsidiaries are generally held by the relevant entities so that documents can be executed locally. Although we usually utilize chops to execute contracts, the registered legal representatives of our subsidiaries and consolidated VIE and its subsidiaries have the apparent authority to enter into contracts on behalf of such entities without chops, unless such contracts set forth otherwise.

In order to maintain the physical security of our chops, we generally have them stored in secured locations accessible only to the designated key employees of our legal, administrative or finance departments. Our designated legal representatives generally do not have access to the chops. Although we have approval

 

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procedures in place and monitor our key employees, including the designated legal representatives of our subsidiaries and consolidated VIE and its subsidiaries, the procedures may not be sufficient to prevent all instances of abuse or negligence. There is a risk that our key employees or designated legal representatives could abuse their authority, for example, by binding our subsidiaries and consolidated VIE and its subsidiaries with contracts against our interests, as we would be obligated to honor these contracts if the other contracting party acts in good faith in reliance on the apparent authority of our chops or signatures of our legal representatives. If any designated legal representative obtains control of the chop in an effort to obtain control over the relevant entity, we would need to have a shareholder or board resolution to designate a new legal representative and to take legal action to seek the return of the chop, apply for a new chop with the relevant authorities, or otherwise seek legal remedies for the legal representative’s misconduct. If any of the designated legal representatives obtains and misuses or misappropriates our chops and seals or other controlling intangible 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 while distracting management from our operations, and our business and operations may be materially and adversely affected.

Substantial uncertainties exist with respect to the enactment timetable, interpretation and implementation of the draft PRC Foreign Investment Law, and its enactment may materially and adversely affect our business, results of operations and financial condition.

The MOFCOM published a discussion draft of the proposed Foreign Investment Law in January 2015 aiming to, upon its enactment, replace the major existing laws and regulations governing foreign investment in China. While the MOFCOM solicited comments on this draft, substantial uncertainties exist with respect to the enactment timetable, interpretation and implementation of the proposed legislation and the extent of revision to the currently proposed draft. The draft Foreign Investment Law, if enacted as proposed, may materially impact the entire legal framework regulating foreign investments in China.

Among other things, the draft Foreign Investment Law purports to introduce the principle of “actual control” in determining whether a company is considered a foreign invested enterprise, or an FIE. The draft Foreign Investment Law specifically provides that entities established in China but “controlled” by foreign investors will be treated as FIEs, whereas an entity organized in a foreign jurisdiction, but cleared by the MOFCOM as “controlled” by PRC entities and/or citizens, would nonetheless be treated as a PRC domestic entity for investment in the “restriction category” that could appear on any such “negative list.” In this connection, “control” is broadly defined in the draft law to cover any of the following summarized categories: (i) holding 50% or more of the voting rights or similar rights and interests of the subject entity; (ii) holding less than 50% of the voting rights or similar rights and interests of the subject entity but having the power to directly or indirectly appoint or otherwise secure at least 50% of the seats on the board or other equivalent decision making bodies, or having the voting power to materially influence the board, the shareholders’ meeting or other equivalent decision making bodies; or (iii) having the power to exert decisive influence, via contractual or trust arrangements, over the subject entity’s operations, financial, staffing and technology matters.

Once an entity is determined to be an FIE, and its investment amount exceeds certain thresholds or its business operation falls within a “negative list” purported to be separately issued by the State Council in the future, market entry clearance by the MOFCOM or its local counterparts would be required.

The “variable interest entity” structure, or VIE structure, has been adopted by many PRC-based companies, including us, to conduct business in the industries that are currently subject to foreign investment restrictions in China. Under the draft Foreign Investment Law, VIEs that are controlled via contractual arrangements would also be deemed as FIEs, if they are ultimately “controlled” by foreign investors. For any companies with a VIE structure in an industry category that is in the “restriction category” that could appear on any such “negative list,” the existing VIE structure may be deemed legitimate only if the ultimate controlling person(s) is/are of PRC nationality (either PRC state owned enterprises or agencies, or PRC citizens). Conversely, if the actual controlling person(s) is/are of foreign nationalities, then the VIEs will be treated as FIEs, in which case, the

 

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existing VIE structures will likely to be scrutinized and subject to foreign investment restrictions and approval from the MOFCOM and other supervising authorities such as MIIT. Any operation in the industry category on the “negative list” without market entry clearance may be considered as illegal.

However, there are significant uncertainties as to how the control status of our consolidated VIE would be determined under the enacted version of the Foreign Investment Law. In addition, it is uncertain whether any of the businesses that we currently operate or plan to operate in the future through our consolidated VIE would be on the to-be-issued “negative list” and therefore be subject to any foreign investment restrictions or prohibitions. If our consolidated VIE were deemed as an FIE under the enacted version of the Foreign Investment Law, and any of the businesses that we operate were in the “restricted” category on the to-be-issued “negative list,” such determination would materially and adversely affect the value of our ADSs. We also face uncertainties as to whether the enacted version of the Foreign Investment Law and the final “negative list” would mandate further actions, such as MOFCOM market entry clearance, to be completed by companies with existing VIE structure and whether such clearance can be timely obtained, or at all. If we were not considered as ultimately controlled by PRC domestic investors under the enacted version of the Foreign Investment Law, further actions required to be taken by us under the enacted Foreign Investment Law may materially and adversely affect our business, results of operations and financial condition.

In addition, our corporate governance practice may be materially impacted and our compliance costs could increase if we were not considered as ultimately controlled by PRC domestic investors under the Foreign Investment Law, if enacted as currently proposed. For instance, the draft Foreign Investment Law as proposed purports to impose stringent ad hoc and periodic information reporting requirements on foreign investors and the applicable FIEs. Aside from investment implementation report and investment amendment report that would be required for each investment and alteration of investment specifics, an annual report would be mandatory, and large foreign investors meeting certain criteria would be required to report on a quarterly basis. Any company found to be non-compliant with these information reporting obligations could potentially be subject to fines and/or administrative or criminal liabilities, and the persons directly responsible could be subject to criminal liabilities.

Risks Relating to Doing Business in China

Changes in the political and economic policies of the PRC government may materially and adversely affect our business, results of operations and financial condition and may result in our inability to sustain our growth and expansion strategies.

Substantially all of our operations are conducted in the PRC and substantially all of our revenue is sourced from the PRC. Accordingly, our business, results of operations and financial condition are affected to a significant extent by economic, political and legal developments in the PRC.

The PRC economy differs from the economies of most developed countries in many respects, including the extent of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. Although the PRC government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets, and the establishment of improved corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the government. In addition, the PRC government continues to play a significant role in regulating industry development by imposing industrial policies. The PRC government also exercises significant control over China’s economic growth by allocating resources, controlling payment of foreign currency-denominated obligations, setting monetary policy, regulating financial services and institutions and providing preferential treatment to particular industries or companies.

While the PRC economy has experienced significant growth in the past three decades, growth has been uneven, both geographically and among various sectors of the economy. The PRC government has implemented

 

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various measures to encourage economic growth and guide the allocation of resources. Some of these measures may benefit the overall PRC economy, but may also have a negative effect on us. Our business, results of operations and financial condition could be materially and adversely affected by government control over capital investments or changes in tax regulations that are applicable to us. In addition, the PRC government has implemented in the past certain measures to control the pace of economic growth. These measures may cause decreased economic activity, which in turn could lead to a reduction in demand for our services and consequently materially and adversely affect our business, results of operations and financial condition.

There are uncertainties regarding the interpretation and enforcement of PRC laws, rules and regulations.

Substantially all of our operations are conducted in the PRC, and are governed by PRC laws, rules and regulations. Our PRC subsidiaries and consolidated VIE and its subsidiaries are subject to laws, rules and regulations applicable to foreign investment in China. The PRC legal system is a civil law system based on written statutes. Unlike the common law system, prior court decisions may be cited for reference but have limited precedential value.

In 1979, the PRC government began to promulgate a comprehensive system of laws, rules and regulations governing economic matters in general. The overall effect of legislation over the past three decades has significantly enhanced the protections afforded to various forms of foreign investment in China. However, China has not developed a fully integrated legal system, and recently enacted laws, rules and regulations may not sufficiently cover all aspects of economic activities in China or may be subject to significant degrees of interpretation by PRC regulatory agencies. In particular, because these laws, rules and regulations are relatively new, and because of the limited number of published decisions and the nonbinding nature of such decisions, and because the laws, rules and regulations often give the relevant regulator significant discretion in how to enforce them, the interpretation and enforcement of these laws, rules and regulations involve uncertainties and can be inconsistent and unpredictable. In addition, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all, and which may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until after the occurrence of the violation.

Any administrative and court proceedings in China may be protracted, resulting in substantial costs and diversion of resources and management attention. Since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to evaluate the outcome of administrative and court proceedings and the level of legal protection we enjoy than in more developed legal systems. These uncertainties may impede our ability to enforce the contracts we have entered into and could materially and adversely affect our business, results of operations and financial condition.

The approval of the China Securities Regulatory Commission, or the CSRC, may be required in connection with this offering under a PRC regulation. The regulation also establishes more complex procedures for acquisitions conducted by foreign investors that could make it more difficult for us to grow through acquisitions.

On August 8, 2006, six PRC regulatory agencies, including the MOFCOM, the State-Owned Assets Supervision and Administration Commission, or the SASAC, the State Administration of Taxation, the SAIC, the CSRC, and the State Administration of Foreign Exchange, or the SAFE, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rules, which came into effect on September 8, 2006 and were amended on June 22, 2009. The M&A Rules include, among other things, provisions that purport to require that an offshore special purpose vehicle that is controlled by PRC domestic companies or individuals and that has been formed for the purpose of an overseas listing of securities through acquisitions of PRC domestic companies or assets to obtain the approval of the CSRC prior to the listing and trading of such special purpose vehicle’s securities on an overseas stock exchange. On September 21, 2006, the CSRC published on its official website procedures regarding its approval of overseas listings by special purpose

 

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vehicles. However, substantial uncertainty remains regarding the scope and applicability of the M&A Rules to offshore special purpose vehicles.

While the application of the M&A Rules remains unclear, we believe, based on the advice of our PRC legal counsel, King & Wood Mallesons, that the CSRC approval is not required in the context of this offering because (i) our wholly-owned PRC subsidiary, Shanghai Quyun, was incorporated as a foreign-invested enterprise by means of foreign direct investments rather than by merger with or acquisition of any PRC domestic companies as defined under the M&A Rules, and (ii) there is no statutory provision that clearly classifies the contractual arrangement among our wholly-owned PRC subsidiary, Shanghai Quyun, and our consolidated VIE and its shareholders as transactions regulated by the M&A Rules. There can be no assurance that the relevant PRC government agencies, including the CSRC, would reach the same conclusion as our PRC legal counsel. If the CSRC or other PRC regulatory body subsequently determines that we need to obtain the CSRC’s approval for this offering or if the CSRC or any other PRC government authorities promulgates any interpretation or implements rules before our listing that would require us to obtain CSRC or other governmental approvals for this offering, we may face adverse actions or sanctions by the CSRC or other PRC regulatory agencies. In any such event, these regulatory agencies may impose fines and penalties on our operations in China, limit our operating privileges in China, delay or restrict the repatriation of the proceeds from this offering into the PRC or take other actions that could materially and adversely affect our business, results of operations, financial condition as well as our ability to complete this offering. The CSRC or other PRC regulatory agencies may also take actions requiring us, or making it advisable for us, to halt this offering before settlement and delivery of the ADSs offered by this prospectus. Consequently, if you engage in market trading or other activities in anticipation of and prior to settlement and delivery, you do so at the risk that such settlement and delivery may not occur. In addition, if the CSRC or other regulatory agencies later promulgate new rules or explanations requiring us to obtain their approvals for this offering, we may be unable to obtain waivers of such approval requirements. Any uncertainties and/or negative publicity regarding such approval requirements could materially and adversely affect the trading price of our ADSs.

These regulations also established additional procedures and requirements that are expected to make merger and acquisition activities in China by foreign investors more time-consuming and complex. For example, the M&A rules require that the MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise if (i) any important industry is concerned, (ii) such transaction involves factors that have or may have impact on the national economic security, or (iii) such transaction will lead to a change in control of a domestic enterprise which holds a famous trademark or PRC time-honored brand. The approval from the MOFCOM shall be obtained in circumstances where overseas companies established or controlled by PRC enterprises or residents acquire affiliated domestic companies. Mergers, acquisitions or contractual arrangements that allow one market player to take control of or to exert decisive impact on another market player must also be notified in advance to the MOFCOM when the threshold under the Provisions on Thresholds for Prior Notification of Concentrations of Undertakings, or the Prior Notification Rules, issued by the State Council in August 2008 is triggered. In addition, the security review rules issued by the MOFCOM that became effective in September 2011 specify that mergers and acquisitions by foreign investors that raise “national defense and security” concerns and mergers and acquisitions through which foreign investors may acquire de facto control over domestic enterprises that raise “national security” concerns are subject to strict review by the MOFCOM, and the rules prohibit any activities attempting to bypass a security review, including by structuring the transaction through a proxy or contractual control arrangement. We may grow our business in part by acquiring other companies operating in our industry. Complying with the requirements of the new regulations to complete such transactions could be time-consuming, and any required approval processes, including approval from the MOFCOM, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share. See “Regulations — Regulations Related to Mergers and Acquisitions and Overseas Listings.”

 

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PRC laws and regulations mandate complex procedures for some acquisitions of Chinese companies by foreign investors, which could make it more difficult for us to make acquisitions in China.

PRC laws and regulations, such as the M&A Rules, and other relevant rules, established additional procedures and requirements that are expected to make merger and acquisition activities in China by foreign investors more time-consuming and complex, including requirements in some instances that the MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise, or that the approval from the MOFCOM be obtained in circumstances where overseas companies established or controlled by PRC enterprises or residents acquire affiliated domestic companies. PRC laws and regulations also require certain merger and acquisition transactions to be subject to a merger control security review. In August 2011, the MOFCOM promulgated the Rules on Implementation of Security Review System, or MOFCOM Security Review Rules, effective from September 1, 2011, further provide that, when deciding whether a specific merger or acquisition of a domestic enterprise by foreign investors is subject to a security review by the MOFCOM, the principle of substance over form should be applied and foreign investors are prohibited from bypassing the security review requirement by structuring transactions through proxies, trusts, indirect investments, leases, loans, control through contractual arrangements of offshore transaction. Factors that the MOFCOM considers in its review are whether (i) an important industry is involved, (ii) such transaction involves factors that have had or may have an impact on national economic security and (iii) such transaction will lead to a change in control of a domestic enterprise that holds a well-known PRC trademark or a time-honored PRC brand. If a business of any target company that we plan to acquire falls into the ambit of security review, we may not be able to successfully acquire such company. Complying with the requirements of the relevant regulations to complete any such transaction could be time-consuming, and any required approval process, including approval from the MOFCOM, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business.

PRC regulations relating to investments in offshore companies by PRC residents may subject our PRC-resident beneficial owners or our PRC subsidiaries to liability or penalties, limit our ability to inject capital into our PRC subsidiaries or limit our PRC subsidiaries’ ability to increase their registered capital or distribute profits.

The SAFE promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Offshore Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, on July 4, 2014, which replaced the former circular commonly known as “SAFE Circular 75” promulgated by the SAFE on October 21, 2005. SAFE Circular 37 requires PRC residents to register with local branches of the SAFE in connection with their direct establishment or indirect control of an offshore entity, for the purpose of overseas investment and financing, with such PRC residents’ legally owned assets or equity interests in domestic enterprises or offshore assets or interests, referred to in SAFE Circular 37 as a “special purpose vehicle.” Pursuant to SAFE Circular 37, “control” refers to the act through which a PRC resident obtains the right to carry out business operation of, to gain proceeds from or to make decisions on a special purpose vehicle by means of, among others, shareholding entrustment arrangement. SAFE Circular 37 further requires amendment to the registration in the event of any significant changes with respect to the special purpose vehicle, such as increase or decrease of capital contributed by PRC individuals, share transfer or exchange, merger, division or other material event. In the event that a PRC shareholder holding interests in a special purpose vehicle fails to fulfill the required SAFE registration, the PRC subsidiaries of that special purpose vehicle may be prohibited from making profit distributions to the offshore parent and from carrying out subsequent cross-border foreign exchange activities, and the special purpose vehicle may be restricted in its ability to contribute additional capital into its PRC subsidiaries. Moreover, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for evasion of foreign exchange controls. 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, 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.

 

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Mr. Eric Siliang Tan and Mr. Lei Li have completed the SAFE registration pursuant to SAFE Circular 37 in 2017. We have notified substantial beneficial owners of ordinary shares who we know are PRC residents of their filing obligation. Nevertheless, we may not be aware of the identities of all of our beneficial owners who are PRC residents. We do not have control over our beneficial owners and there can be no assurance that all of our PRC-resident beneficial owners will comply with SAFE Circular 37 and subsequent implementation rules, and there is no assurance that the registration under SAFE Circular 37 and any amendment will be completed in a timely manner, or will be completed at all. The failure of our beneficial owners who are PRC residents to register or amend their foreign exchange registrations in a timely manner pursuant to SAFE Circular 37 and subsequent implementation rules, or the failure of future beneficial owners of our company who are PRC residents to comply with the registration procedures set forth in SAFE Circular 37 and subsequent implementation rules, may subject such beneficial owners or our PRC subsidiaries to fines and legal sanctions. Failure to register or comply with relevant requirements may also limit our ability to contribute additional capital to our PRC subsidiaries and limit our PRC subsidiaries’ ability to distribute dividends to our company. These risks may materially and adversely affect our business, results of operations and financial condition.

Any failure to comply with PRC regulations regarding employee equity incentive 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 equity 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. After our company becomes an overseas listed company upon completion of this offering, we and our directors, executive officers and other employees who are PRC residents and who have been granted options will be subject to the Notice on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly Listed Company, issued by SAFE in February 2012, according to which, employees, directors, supervisors and other management members participating in any equity incentive plans of an overseas publicly listed company who are PRC residents are required to register with SAFE through a domestic qualified agent, which could be a PRC subsidiary of such overseas listed company, and complete certain other procedures. We will make efforts to comply with these requirements upon completion of our initial public offering. However, there can be no assurance that they can successfully register with SAFE in full compliance with the rules. Failure to complete the SAFE registrations may subject them to fines and legal sanctions and may also limit the ability to make payment under our equity incentive plans or receive dividends or sales proceeds related thereto, or our ability to contribute additional capital into our wholly-foreign owned enterprise in China and limit our wholly-foreign owned enterprise’s ability to distribute dividends to us. We also face regulatory uncertainties that could restrict our ability to adopt additional equity incentive plans for our directors and employees under PRC law.

We rely to a significant extent on dividends and other distributions on equity paid by our principal operating subsidiaries to fund offshore cash and financing requirements. Any limitation on the ability of our PRC operating subsidiaries to make payments to us could materially and adversely affect our ability to conduct our business.

We are a holding company and rely to a significant extent on dividends and other distributions on equity paid by our principal operating subsidiaries and on remittances from the consolidated VIE for our offshore cash and financing requirements, including the funds necessary to pay dividends and other cash distributions to our shareholders, fund inter-company loans, service any debt we may incur outside of China and pay our expenses. When our principal operating subsidiaries or the consolidated VIE incur additional debt, the instruments governing the debt may restrict their ability to pay dividends or make other distributions or remittances to us. Furthermore, the laws, rules and regulations applicable to our PRC subsidiaries and certain other subsidiaries

 

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permit payments of dividends only out of their retained earnings, if any, determined in accordance with applicable accounting standards and regulations.

Under PRC laws, rules and regulations, each of our subsidiaries incorporated in China is required to set aside at least 10% of its net income each year to fund certain statutory reserves until the cumulative amount of such reserves reaches 50% of its registered capital. These reserves, together with the registered capital, are not distributable as cash dividends. As a result of these laws, rules and regulations, our subsidiaries incorporated in China are restricted in their ability to transfer a portion of their respective net assets to their shareholders as dividends, loans or advances. Certain of our subsidiaries did not have any retained earnings available for distribution in the form of dividends as of December 31, 2017. In addition, registered share capital and capital reserve accounts are also restricted from withdrawal in the PRC, up to the amount of net assets held in each operating subsidiary.

Limitations on the ability of our consolidated VIE to make remittance to the wholly-foreign owned enterprise and on the ability of our subsidiaries to pay dividends to us could limit our ability to access cash generated by the operations of those entities, including to make investments or acquisitions that could be beneficial to our businesses, pay dividends to our shareholders or otherwise fund and conduct our business.

We may be treated as a resident enterprise for PRC tax purposes under the PRC Enterprise Income Tax Law, and we may therefore be subject to PRC income tax on our global income.

Under the modified Enterprise Income Tax Law and its implementing rules, enterprises established under the laws of jurisdictions outside of China with “de facto management bodies” located in China may be considered PRC tax resident enterprises for tax purposes and may be subject to the PRC enterprise income tax at the rate of 25% on their global income. “De facto management body” refers to a managing body that exercises substantive and overall management and control over the production and business, personnel, accounting books and assets of an enterprise. The State Administration of Taxation issued the Notice Regarding the Determination of Chinese-Controlled Offshore-Incorporated Enterprises as PRC Tax Resident Enterprises on the Basis of De Facto Management Bodies, or Circular 82, on April 22, 2009. Circular 82 provides certain specific criteria for determining whether the “de facto management body” of a Chinese-controlled offshore-incorporated enterprise is located in China. Although Circular 82 only applies to offshore enterprises controlled by PRC enterprises, not those controlled by foreign enterprises or individuals, the determining criteria set forth in Circular 82 may reflect the State Administration of Taxation’s general position on how the “de facto management body” test should be applied in determining the tax resident status of offshore enterprises, regardless of whether they are controlled by PRC enterprises. If we were to be considered a PRC resident enterprise, we would be subject to PRC enterprise income tax at the rate of 25% on our global income. In such case, our profitability and cash flow may be materially reduced as a result of our global income being taxed under the Enterprise Income Tax Law. We believe that none of our entities outside of China is a PRC resident enterprise for PRC tax purposes. However, the tax resident status of an enterprise is subject to determination by the PRC tax authorities and uncertainties remain with respect to the interpretation of the term “de facto management body.”

Dividends payable to our foreign investors and gains on the sale of our ADSs or ordinary shares by our foreign investors may become subject to PRC tax.

Under the modified Enterprise Income Tax Law and its implementation regulations issued by the State Council, a 10% PRC withholding tax is applicable to dividends payable to investors that are non-resident enterprises, which do not have an establishment or place of business in the PRC or which have such establishment or place of business but the dividends are not effectively connected with such establishment or place of business, to the extent such dividends are derived from sources within the PRC. Similarly, any gain realized on the transfer of ADSs or ordinary shares by such investors is also subject to PRC tax at a current rate of 10%, subject to any reduction or exemption set forth in applicable tax treaties or under applicable tax arrangements between jurisdictions, if such gain is regarded as income derived from sources within the PRC. If

 

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we are deemed a PRC resident enterprise, dividends paid on our ordinary shares or ADSs, and any gain realized from the transfer of our ordinary shares or ADSs, would be treated as income derived from sources within the PRC and would as a result be subject to PRC taxation. Furthermore, if we are deemed a PRC resident enterprise, dividends payable to individual investors who are non-PRC residents and any gain realized on the transfer of ADSs or ordinary shares by such investors may be subject to PRC tax at a current rate of 20%, subject to any reduction or exemption set forth in applicable tax treaties or under applicable tax arrangements between jurisdictions. If we or any of our subsidiaries established outside China are considered a PRC resident enterprise, it is unclear whether holders of our ADSs or ordinary shares would be able to claim the benefit of income tax treaties or agreements entered into between China and other countries or areas. If dividends payable to our non-PRC investors, or gains from the transfer of our ADSs or ordinary shares by such investors, are deemed as income derived from sources within the PRC and thus are subject to PRC tax, the value of your investment in our ADSs or ordinary shares may decline significantly.

We and our shareholders face uncertainties with respect to indirect transfers of equity interests in PRC resident enterprises or other assets attributed to a Chinese establishment of a non-Chinese company, or immovable properties located in China owned by non-Chinese companies.

On February 3, 2015, the State Administration of Taxation issued the Bulletin on Issues of Enterprise Income Tax on Indirect Transfers of Assets by Non-PRC Resident Enterprises, or Bulletin 7, which partially replaced and supplemented previous rules under the Notice on Strengthening Administration of Enterprise Income Tax for Share Transfers by Non-PRC Resident Enterprises, or SAT Circular 698, issued by the State Administration of Taxation, on December 10, 2009. Pursuant to this Bulletin 7, 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 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 “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 consists 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. 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. On October 17, 2017, the State Administration of Taxation promulgated the Announcement of the State Administration of Taxation on Issues Concerning the Withholding of Non-resident Enterprise Income Tax at Source, or SAT Circular 37, which became effective on December 1, 2017, and SAT Circular 698 then was repealed with effect from December 1, 2017. SAT Circular 37, among other things, simplified procedures of withholding and payment of income tax levied on non-resident enterprises.

 

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There is uncertainty as to the application of 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 Bulletin 7. For transfer of shares in our company by investors that are non-PRC resident enterprises, our PRC subsidiaries may be requested to assist in the filing under Bulletin 7. As a result, we may be required to expend valuable resources to comply with 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, which may materially and adversely affect our results of operations and financial condition.

We are subject to restrictions on currency exchange.

All of our revenue is denominated in Renminbi. The Renminbi is currently convertible under the “current account,” which includes dividends, trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans, including loans we may secure from our onshore subsidiary or consolidated VIE. Currently, certain of our PRC subsidiaries may purchase foreign currency for settlement of “current account transactions,” including payment of dividends to us, without the approval of the SAFE by complying with certain procedural requirements. However, the relevant PRC governmental authorities may limit or eliminate our ability to purchase foreign currencies in the future for current account transactions. Foreign exchange transactions under the capital account remain subject to limitations and require approvals from, or registration with, the SAFE and other relevant PRC governmental authorities. Since a significant amount of our future revenue and cash flow will be denominated in Renminbi, any existing and future restrictions on currency exchange may limit our ability to utilize cash generated in Renminbi to fund our business activities outside of the PRC or pay dividends in foreign currencies to our shareholders, including holders of our ADSs, and may limit our ability to obtain foreign currency through debt or equity financing for our onshore subsidiary and consolidated VIE.

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 this offering to make loans to our PRC subsidiaries and our consolidated VIE, or to make additional capital contributions to our PRC subsidiaries.

In utilizing the proceeds of this offering, we, as an offshore holding company, are permitted under PRC laws and regulations to provide funding to our PRC subsidiaries, which are treated as foreign-invested enterprises under PRC laws, through loans or capital contributions. However, loans by us to our PRC subsidiaries to finance their activities cannot exceed statutory limits and must be registered with the local counterpart of SAFE and capital contributions to our PRC subsidiaries are subject to the requirement of making necessary filings in the Foreign Investment Comprehensive Management Information System, and registration with other governmental authorities in China.

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 Circular 19, effective on June 1, 2015, in replacement of the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of the Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises, or SAFE Circular 142, the Notice from the State Administration of Foreign Exchange on Relevant Issues Concerning Strengthening the Administration of Foreign Exchange Businesses, or Circular 59, and the Circular on Further Clarification and Regulation of the Issues Concerning the Administration of Certain Capital Account Foreign Exchange Businesses, or Circular 45. According to Circular 19, the flow and use of the Renminbi capital converted from foreign currency-denominated registered capital of a foreign-invested company is regulated such that Renminbi capital may not be used for the issuance of Renminbi entrusted loans, the repayment of inter-enterprise loans or the repayment of banks loans that have been transferred to a third party.

 

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Although Circular 19 allows Renminbi 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 Renminbi 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. Thus, it is unclear whether SAFE will permit such capital to be used for equity investments in the PRC in actual practice. 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 Circular 16, effective on June 9, 2016, which reiterates some of the rules set forth in Circular 19, but changes the prohibition against using Renminbi capital converted from foreign currency-denominated registered capital of a foreign-invested company to issue Renminbi entrusted loans to a prohibition against using such capital to issue loans to non-associated enterprises. Violations of SAFE Circular 19 and Circular 16 could result in administrative penalties. Circular 19 and Circular 16 may significantly limit our ability to transfer any foreign currency we hold, including the net proceeds from this offering, to our PRC subsidiaries, which may adversely affect our liquidity and our ability to fund and expand our business in the PRC.

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 VIE and its subsidiaries, each a PRC domestic company. Meanwhile, we are not likely to finance the activities of our consolidated VIE and its subsidiaries by means of capital contributions given the restrictions on foreign investment in the businesses that are currently conducted by our consolidated VIE and its subsidiaries.

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 to our PRC subsidiaries or any consolidated VIE or future capital contributions by us to our PRC subsidiaries. As a result, uncertainties exist as to our ability to provide prompt financial support to our PRC subsidiaries or consolidated VIE and its subsidiaries when needed. If we fail to complete such registrations or obtain such approvals, our ability to use foreign currency, including the proceeds we received from this 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.

Fluctuations in exchange rates could result in foreign currency exchange losses and could materially reduce the value of your investment.

The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions and the foreign exchange policy adopted by the PRC government. On July 21, 2005, the PRC government changed its policy of pegging the value of the Renminbi to the U.S. dollar. Following the removal of the U.S. dollar peg, the Renminbi appreciated more than 20% against the U.S. dollar over the following three years. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the Renminbi and the U.S. dollar remained within a narrow band. Since June 2010, the Renminbi has fluctuated against the U.S. dollar, at times significantly and unpredictably. On November 30, 2015, the Executive Board of the International Monetary Fund completed the regular five-year review of the basket of currencies that make up the Special Drawing Right, or the SDR, and decided that with effect from October 1, 2016, Renminbi is determined to be a freely usable currency and will be included in the SDR basket as a fifth currency, along with the U.S. dollar, the Euro, the Japanese yen and the British pound. In the fourth quarter of 2016, the Renminbi has depreciated significantly in the backdrop of a surging U.S. dollar and persistent capital outflows of China. With the development of the foreign exchange market and progress towards interest rate liberalization and Renminbi internationalization, the PRC government may in the future announce further changes to the exchange rate system, and we cannot assure you that the 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 the Renminbi and the U.S. dollar in the future.

 

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Substantially all of our revenue and costs are denominated in Renminbi. We are a holding company and we rely on dividends paid by our operating subsidiaries in China for our cash needs. Any significant revaluation of Renminbi may materially and adversely affect our results of operations and financial position reported in Renminbi when translated into U.S. dollars, and the value of, and any dividends payable on, the ADSs in U.S. dollars. To the extent that we need to convert U.S. dollars we receive from this offering into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we would receive. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amount.

The audit report included in this prospectus is prepared by an auditor who is not inspected by the Public Company Accounting Oversight Board and, as such, our investors are deprived of the benefits of such inspection.

Our independent registered public accounting firm that issues the audit report included in our prospectus filed with the SEC, as auditors of companies that are traded publicly in the United States and a firm registered with the U.S. Public Company Accounting Oversight Board, or the PCAOB, is required by the laws of the U.S. to undergo regular inspections by the PCAOB to assess its compliance with the laws of the U.S. and professional standards. Because our auditors are located in the People’s Republic of China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities, our auditors are not currently inspected by the PCAOB.

Inspections of other firms that the PCAOB has conducted outside China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. This lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating our auditor’s audits and its quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.

The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our consolidated financial statements.

If additional remedial measures are imposed on the “big four” PRC-based accounting firms, including our independent registered public accounting firm, in administrative proceedings brought by the SEC alleging such firms’ failure to meet specific criteria set by the SEC with respect to requests for the production of documents, we could be unable to timely file future financial statements in compliance with the requirements of the Exchange Act.

Starting 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 United States and Chinese law. Specifically, for certain United States listed companies operating and audited in mainland China, the SEC and the PCAOB sought to obtain from the Chinese accounting firms access to their audit work papers and related documents. The firms were, however, advised and directed that under Chinese law they could not respond directly to the United States regulators on those requests, and that requests by foreign regulators for access to such papers in China had to be channeled through 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 Chinese accounting firms, including our independent registered public accounting firm. In January 2014, the administrative law judge reached an initial decision to impose penalties on the firms including a temporary suspension of their right to practice before the SEC. The accounting firms filed a petition for review of the initial decision. On February 6, 2015, before a

 

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review by the commissioners of the SEC 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 they fail to meet specified criteria, the SEC retains authority to impose a variety of additional remedial measures on the firms depending on the nature of the failure. Remedies for any future noncompliance could include, as appropriate, an automatic six-month bar on a single firm’s performance of certain audit work, commencement of a new proceeding against a firm, or in extreme cases the resumption of the current proceeding against all four firms.

In the event that the SEC restarts the administrative proceedings, depending upon the final outcome, listed companies in the United States with major PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the PRC, which could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act, including possible delisting. Moreover, any negative news about any such future proceedings against these audit firms may cause investor uncertainty regarding China-based, United States listed companies and the market price of our ADSs may be adversely affected.

If our independent registered public accounting firm were 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 consolidated financial statements, our consolidated 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 delay or abandonment of this offering, delisting of our ADSs from the [NYSE/NASDAQ] or deregistration from the SEC, or both, which would substantially reduce or effectively terminate the trading of our ADSs in the United States.

Risks Relating to This Offering

There has been no public market for our shares or ADSs prior to this offering, and you may not be able to resell our ADSs at or above the price you paid, or at all.

Prior to this offering, there has been no public market for our shares or ADSs. We will apply to list our ADSs representing ordinary shares on the [NYSE/NASDAQ]. Our ordinary shares will not be listed on any exchange or quoted for trading on any over-the-counter trading system. If an active trading market for our ADSs does not develop after this offering, the market price and liquidity of our ADSs will be materially and adversely affected.

Negotiations with the underwriters will determine the initial public offering price for our ADSs which may bear no relationship to their market price after the initial public offering. There can be no assurance that an active trading market for our ADSs will develop or that the market price of our ADSs will not decline below the initial public offering price.

The trading price of our ADSs may be volatile, which could result in substantial losses to you.

The trading prices of our ADSs are likely to be volatile and could fluctuate widely due to factors beyond our control. This may happen because of broad market and industry factors, like the performance and fluctuation in the market prices or the underperformance or deteriorating financial results of other listed companies based in China. The securities of some of these companies have experienced significant volatility since their initial public offerings, including, in some cases, substantial price declines in the trading prices of their securities. The trading performances of other Chinese companies’ securities after their offerings, including technology companies and mobile content feed platforms, may affect the attitudes of investors toward Chinese companies listed in the United States, which consequently may impact the trading performance of our ADSs, regardless of our actual operating performance. In addition, any negative news or perceptions about inadequate corporate governance

 

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practices or fraudulent accounting, corporate structure or matters of other Chinese companies may also negatively affect the attitudes of investors towards Chinese companies in general, including us, regardless of whether we have conducted any inappropriate activities. Furthermore, securities markets may from time to time experience significant price and volume fluctuations that are not related to our operating performance, such as the large decline in share prices in the United States, China and other jurisdictions in late 2008, early 2009, the second half of 2011 and in 2015, which may have a material and adverse effect on the trading price of our ADSs.

In addition to the above factors, the price and trading volume of our ADSs may be highly volatile due to multiple factors, including the following:

 

    regulatory developments affecting us or our industry;

 

    announcements of studies and reports relating to the quality of our credit offerings or those of our competitors;

 

    changes in the economic performance or market valuations of other mobile content feed platforms;

 

    actual or anticipated fluctuations in our quarterly results of operations and changes or revisions of our expected results;

 

    changes in financial estimates by securities research analysts;

 

    conditions in the markets for mobile content feed and targeted advertising services;

 

    announcements by us or our competitors of new product and service offerings, acquisitions, strategic relationships, joint ventures, capital raisings or capital commitments;

 

    additions to or departures of our senior management;

 

    fluctuations of exchange rates between the Renminbi and the U.S. dollar;

 

    release or expiry of lock-up or other transfer restrictions on our outstanding shares or ADSs; and

 

    sales or perceived potential sales of additional ordinary shares or ADSs.

If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, the market price for our ADSs and trading volume could decline.

The trading market for our ADSs will depend in part on the research and reports that securities or industry analysts publish about us or our business. If research analysts do not establish and maintain adequate research coverage or if one or more of the analysts who covers us downgrades our ADSs or publishes inaccurate or unfavorable research about our business, the market price for our ADSs would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, we could lose visibility in the financial markets, which, in turn, could cause the market price or trading volume for our ADSs to decline.

As our initial public offering price is substantially higher than our net tangible book value per share, you will experience immediate and substantial dilution.

If you purchase ADSs in this offering, you will pay more for your ADSs than the amount paid by our existing shareholders for their ordinary shares on a per ADS basis. As a result, you will experience immediate and substantial dilution of approximately US$             per ADS (assuming no exercise of the underwriters’ option to purchase additional ADSs), representing the difference between our pro forma net tangible book value per ADS of US$            , as of             , 2018, after giving effect to this offering. In addition, you will experience further dilution to the extent that our ordinary shares are issued upon the vesting of any share awards under our equity incentive plans. All of the ordinary shares issuable under our then equity incentive plans will be issued at a purchase price on a per ADS basis that is less than the public offering price per ADS in this offering. See “Dilution” for a more complete description of how the value of your investment in our ADSs will be diluted upon completion of this offering.

 

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We have not determined a specific use for the net proceeds from this offering, and we may use these proceeds in ways with which you may not agree.

We have not determined a specific use for the net proceeds of this offering, and our management will have considerable discretion in deciding how to apply these proceeds. You will not have the opportunity to assess whether the proceeds are being used appropriately before you make your investment decision. You must rely on the judgment of our management regarding the application of the net proceeds of this offering. We cannot assure you that the net proceeds will be used in a manner that will improve our results of operations or increase our ADS price, nor that these net proceeds will be placed only in investments that generate income or appreciate in value.

Because we do not expect to pay cash dividends in the foreseeable future after this offering, you may not receive any return on your investment unless you sell your ordinary shares or ADSs for a price greater than that which you paid for them.

We currently intend to retain most, if not all, of our available funds and any future earnings after this offering 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. See “Dividend Policy.” Therefore, you should not rely on an investment in our ADSs as a source for any future dividend income.

Our board of directors has complete discretion as to whether to distribute dividends. 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 after this offering 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.

Substantial future sales or perceived potential sales of our ADSs in the public market could cause the price of our ADSs to decline.

Sales of our ADSs in the public market after this offering, or the perception that these sales could occur, could cause the market price of our ADSs to decline significantly. Upon completion of this offering, we will have              ordinary shares outstanding, including             ordinary shares represented by ADSs newly issued in connection with this offering, assuming the underwriters do not exercise their option to purchase additional ADSs. All ADSs representing our ordinary shares sold in this offering will be freely transferable by persons other than our “affiliates” without restriction or additional registration under the U.S. Securities Act of 1933, as amended, or the Securities Act. All of the other ordinary shares outstanding after this offering will be available for sale, upon the expiration of the lock-up periods described elsewhere in this prospectus beginning from the date of this prospectus (if applicable to such holder), subject to volume and other restrictions as applicable under Rule 144 and Rule 701 under the Securities Act. Any or all of these ordinary shares may be released prior to the expiration of the applicable lock-up period at the discretion of the designated representatives. To the extent shares are released before the expiration of the applicable lock-up period and sold into the market, the market price of our ADSs could decline significantly. See “Shares Eligible for Future Sale — Lock-up Agreements.”

Certain major holders of our ordinary shares after completion of this offering will have the right to cause us to register under the Securities Act the sale of their shares, subject to the applicable lock-up periods in connection with this offering. Registration of these shares under the Securities Act would result in ADSs representing these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the registration. Sales of these registered shares in the form of ADSs in the public market could cause the price of our ADSs to decline significantly.

 

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You, as holders of ADSs, may have fewer rights than holders of our ordinary shares and must act through the depositary to exercise those rights.

Holders of ADSs do not have the same rights of our shareholders and may only exercise the voting rights with respect to the underlying ordinary shares in accordance with the provisions of the deposit agreement. Under our amended and restated articles of association, the minimum notice period required to convene a general meeting will be [ten] days. When a general meeting is convened, you may not receive sufficient notice of a shareholders’ meeting to permit you to withdraw your ordinary shares to allow you to cast your vote with respect to any specific matter. In addition, the depositary and its agents may not be able to send voting instructions to you or carry out your voting instructions in a timely manner. We will make all reasonable efforts to cause the depositary to extend voting rights to you in a timely manner, but there can be no assurance that you will receive the voting materials in time to ensure that you can instruct the depositary to vote your ADSs. Furthermore, the depositary and its agents will not be responsible for any failure to carry out any instructions to vote, for the manner in which any vote is cast or for the effect of any such vote. As a result, you may not be able to exercise your right to vote and you may lack recourse if your ADSs are not voted as you requested. In addition, in your capacity as an ADS holder, you will not be able to call a shareholders’ meeting.

Your rights to pursue claims against the depositary as a holder of ADSs are limited by the terms of the deposit agreement and the deposit agreement may be amended or terminated without your consent.

Under the deposit agreement, any action or proceeding against or involving the depositary, arising out of or based upon the deposit agreement or the transactions contemplated thereby or by virtue of owning the ADSs may only be instituted in a state or federal court in New York, New York, and you, as a holder of our ADSs, will have irrevocably waived any objection which you may have to the laying of venue of any such proceeding, and irrevocably submitted to the exclusive jurisdiction of such courts in any such action or proceeding. However, the depositary may, in its sole discretion, require that any dispute or difference arising from the relationship created by the deposit agreement be referred to and finally settled by an arbitration conducted under the terms described in the deposit agreement. Also, we may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs after an amendment to the deposit agreement, you agree to be bound by the deposit agreement as amended. See “Description of American Depositary Shares” for more information.

Your right to participate in any future rights offerings may be limited, which may cause dilution to your holdings.

We may from time to time distribute rights to our shareholders, including rights to acquire our securities. However, we cannot make rights available to you in the U.S. unless we register both the rights and the securities to which the rights relate under the Securities Act or an exemption from the registration requirements is available. Under the deposit agreement, the depositary will not make rights available to you unless both the rights and the underlying securities to be distributed to ADS holders are either registered under the Securities Act or exempt from registration under the Securities Act. We are under no obligation to file a registration statement with respect to any such rights or securities or to endeavor to cause such a registration statement to be declared effective and we may not be able to establish a necessary exemption from registration under the Securities Act. Accordingly, you may be unable to participate in our rights offerings in the future and may experience dilution in your holdings.

You may not receive cash dividends if the depositary decides it is impractical to make them available to you.

The depositary will pay cash dividends on the ADSs only to the extent that we decide to distribute dividends on our ordinary shares or other deposited securities, and we do not have any present plan to pay any cash dividends in the foreseeable future. See “Dividend Policy.” To the extent that there is a distribution, the depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on our ordinary shares or other deposited securities after deducting its fees and expenses. You will

 

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receive these distributions in proportion to the number of ordinary shares your ADSs represent. However, the depositary may, at its discretion, decide that it is inequitable or impractical to make a distribution available to any holders of ADSs. For example, the depositary may determine that it is not practicable to distribute certain property through the mail, or that the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may decide not to distribute such property to you.

We will incur increased costs and become subject to additional regulations and requirements as a result of becoming a public company, which could lower our profits or make it more difficult to run our business.

Upon completion of this offering, we will become 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 [NYSE/NASDAQ], impose various requirements on the corporate governance practices of 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. In addition, 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 control and disclosure controls and procedures. We also expect that operating as a public company will 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 will 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.

In the past, shareholders of a public company often brought securities class action suits against the company following periods of instability in the market price of that company’s 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, which could harm our results of operations and require us to incur significant expenses to defend the suit. 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 materially and adversely affect our business, results of operations and financial condition.

You may be subject to limitations on transfer of your ADSs.

Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deems it 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.

[Our amended and restated memorandum and articles of association contain anti-takeover provisions that could discourage a third party from acquiring us, which could limit our shareholders’ opportunity to sell their shares, including ordinary shares represented by our ADSs, at a premium.

We have adopted amended and restated articles of association to be effective upon the completion of this offering that contain provisions to limit the ability of others to acquire control of our company or cause us to

 

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engage in change-of-control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. For example, our board of directors has the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix their designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our ordinary shares, in the form of ADS or otherwise. Preferred shares could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preferred shares, the price of our ADSs may fall and the voting and other rights of the holders of our ordinary shares and ADSs may be materially and adversely affected.]

Certain judgments obtained against us by our shareholders may not be enforceable.

We are an exempted company incorporated under the laws of the Cayman Islands. Substantially all of our assets are located outside the United States. In addition, substantially all of our directors and executive officers and the experts named in this prospectus reside outside the United States, and most of their assets 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 them 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, China or other relevant jurisdiction may render you unable to enforce a judgment against our assets or the assets of our directors and officers and/or their assets. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforcement of Civil Liabilities.”

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 Law (2016 Revision) of the Cayman Islands (as amended) and the common law of the Cayman Islands. The rights of shareholders to take action against the directors, actions by minority shareholders and the fiduciary duties of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from 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 of 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 have a less developed body of securities laws than the United States. Some states in the United 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 or to obtain copies of lists of shareholders of these companies. Our directors will have discretion under the second amended and restated memorandum and articles of association expected to be effective immediately prior to completion of this offering, 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 you to obtain the information needed to establish any facts necessary for a shareholder resolution 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

 

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they would as public shareholders of a company incorporated in the U.S. For a discussion of significant differences between the provisions of the Companies Law (2016 Revision) of the Cayman Islands and the laws applicable to companies incorporated in the U.S. and their shareholders, see “Description of Share Capital — Differences in Corporate Law.”

We are a foreign private issuer within the meaning of the rules under the Exchange Act, and as such we are exempted from certain provisions applicable to U.S. domestic public companies.

Because we qualify as a foreign private issuer under the Exchange Act, we are exempted from certain provisions of the securities rules and regulations in the United States that are applicable to United States domestic issuers, including: (i) the rules under the Exchange Act requiring the filing with the SEC of quarterly reports on Form 10-Q or current reports on Form 8-K; (ii) the sections of the Exchange Act regulating the solicitation of proxies, consents, or authorizations in respect of a security registered under the Exchange Act; (iii) 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 (iv) the selective disclosure rules by issuers of material nonpublic information under Regulation FD.

We are required to file an annual report on Form 20-F within four months of the end of each fiscal year. In addition, we intend to publish our results on a quarterly basis as press releases, distributed pursuant to the rules and regulations of the [NYSE/NASDAQ]. Press releases relating to financial results and material events will also be furnished to the SEC on Form 6-K. However, the information we are required to file with or furnish to the SEC will be less extensive and less timely compared to that required to be filed with the SEC by United States domestic issuers. As a result, you may not be afforded the same protections or information that would be made available to you were you investing in a U.S. domestic issuer.

We are an emerging growth company 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 various 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 of Sarbanes-Oxley Act of 2002 for so long as we are an emerging growth company. 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.

The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards. However, we have elected to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted for public companies. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.

We may be or may become a passive foreign investment company, or PFIC, which could result in adverse United States tax consequences to United States investors.

Based on the past and projected composition of our income and assets, and the valuation of our assets, including goodwill, we do not believe we were a passive foreign investment company (a “PFIC”), for our most recent taxable year, and we do not expect to become a PFIC in the current taxable year or the foreseeable future, although there can be no assurance in this regard.

In general, we will be a PFIC for any taxable year in which:

 

    at least 75% of our gross income is passive income, or

 

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    at least 50% of the value (determined based on a quarterly average) of our assets is attributable to assets that produce or are held for the production of passive income, which include cash, such as cash raised in this offering.

The determination of whether we are a PFIC is made annually. Accordingly, it is possible that we may become a PFIC in the current or any future taxable year due to changes in our asset or income composition. Because we have calculated the value of our goodwill by taking into account the market value of our ADSs, a decrease in the price of our ADSs may also result in our becoming a PFIC.

In addition, there is uncertainty as to the treatment of our corporate structure and ownership of our consolidated VIE for United States federal income tax purposes. For United States federal income tax purposes, we consider ourselves to own the equity of our consolidated VIE. If it is determined, contrary to our view, that we do not own the equity of our consolidated VIE for United States federal income tax purposes (for instance, because the relevant PRC authorities do not respect these arrangements), we may be treated as a PFIC.

If we are a PFIC for any taxable year during which you hold our ADSs or ordinary shares, our PFIC status could result in adverse United States federal income tax consequences to you if you are a United States Holder, as defined under “Taxation — Certain United States Federal Income Tax Considerations.” For example, if we are or become a PFIC, you may become subject to increased tax liabilities under United States federal income tax laws and regulations, and will become subject to burdensome reporting requirements. See “Taxation — Certain United States Federal Income Tax Considerations — Passive Foreign Investment Company.” There can be no assurance that we will not be a PFIC for the current or any future taxable year.

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/NASDAQ] corporate governance listing standards; these practices may afford less protection to shareholders than they would enjoy if we complied fully with the [NYSE/NASDAQ] corporate governance listing standards.

We are a company incorporated in the Cayman Islands, and we will apply to list our ADSs on the [NYSE/NASDAQ]. The [NYSE/NASDAQ] market 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/NASDAQ] corporate governance listing standards.

For instance, we are not required to: (i) have a majority of the board be independent; (ii) have a compensation committee or a nominating and corporate governance committee consisting entirely of independent directors; or (iii) have regularly scheduled executive sessions with only independent directors each year.

We intend to rely on some of these exemptions. As a result, you may not be provided with the benefits of certain corporate governance requirements of the [NYSE/NASDAQ].

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA

This prospectus contains forward-looking statements that involve risks and uncertainties, including statements based on our current expectations, assumptions, estimates and projections about us and our industry. The forward-looking statements are contained principally in the sections entitled “Prospectus Summary,” “Risk Factors,” “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Industry” and “Business.” These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements. In some cases, these forward-looking statements can be identified by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “potential,” “continue,” “is/are likely to” or other similar expressions. The forward-looking statements included in this prospectus relate to, among others:

 

    our goal and strategies;

 

    our ability to maintain and strengthen our position as a leader amongst content aggregators in China’s mobile content feed industry;

 

    our expansion plans;

 

    our ability to monetize through advertising and other products and services that we plan to introduce;

 

    our future business development, financial condition and results of operations;

 

    our expectation regarding the use of proceeds from this offering;

 

    PRC laws, regulations, and policies relating to the Internet and Internet content providers; and

 

    general economic and business conditions.

This prospectus also contains market data relating to the mobile content feed industry in China, including market position, market size, and growth rates of the markets in which we participate, that are based on industry publications and reports. This prospectus contains statistical data and estimates published by Analysys International, including a report which we commissioned Analysys International to prepare and for which we paid a fee. This information involves a number of assumptions, estimates and limitations. These industry publications, surveys and forecasts generally indicate that their information has been obtained from sources believed to be reliable, although they do not guarantee the accuracy or completeness of such information. Nothing in such data should be construed as advice. We have not independently verified the accuracy or completeness of the data contained in these industry publications and reports. The mobile content feed industry in China may not grow at the rates projected by market data, or at all. The failure of these markets to grow at the projected rates may materially and adversely affect our business and the market price of our ADSs. If any one or more of the assumptions underlying the market data turns out to be incorrect, actual results may differ from the projections based on these assumptions. In addition, projections, assumptions and estimates of our future performance and the future performance of the industry in which we operate is necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors” and elsewhere in this prospectus. You should not place undue reliance on these forward-looking statements.

The forward-looking statements made in this prospectus relate only to events or information as of the date on which the statements are made in this prospectus. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date on which the statements are made or to reflect the occurrence of unanticipated events. You should read this prospectus and the documents that we have referred to in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect.

 

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USE OF PROCEEDS

We estimate that we will receive net proceeds from this offering of approximately US$            , or approximately US$             if the underwriters exercise their over-allotment option in full, after deducting underwriting discounts and commissions and the estimated offering expenses payable by us and based upon an assumed initial offering price of US$             per ADS (the mid-point of the estimated public offering price range shown on the front cover of this prospectus). A US$1.00 increase (decrease) in the assumed initial public offering price of US$             per ADS would increase (decrease) the net proceeds to us from this offering by US$            , after deducting the estimated underwriting discounts and commissions and estimated aggregate offering expenses payable by us and assuming no change to the number of ADSs offered by us as set forth on the cover page of this prospectus.

We plan to use the net proceeds of this offering as follows:

 

    up to approximately US$             million for expanding and enhancing our content offerings;

 

    up to approximately US$             million for product development and technology infrastructure;

 

    up to approximately US$             million for marketing and promotion of our products and branding; and

 

    the balance for general corporate purposes, including potential acquisitions and investments (although we are not currently negotiating any such acquisitions or investments).

The foregoing represents our intentions as of the date of this prospectus with respect of the use and allocation of the net proceeds of this offering based upon our present plans and business conditions, but our management will have significant flexibility and discretion in applying the net proceeds of the offering. The occurrence of unforeseen events or changed business conditions may result in application of the proceeds of this offering in a manner other than as described in this prospectus.

To the extent that the net proceeds we receive from this offering are not immediately applied for the above purposes, we intend to invest our net proceeds in short-term, interest bearing, debt instruments or bank deposits.

In utilizing the proceeds of this offering, we, as an offshore holding company, are permitted under PRC laws and regulations to provide funding to our PRC subsidiary only through loans or capital contributions and to our consolidated VIE only through loans. Subject to satisfaction of applicable government registration and approval requirements, we may extend inter-company loans to our PRC subsidiary or make additional capital contributions to our PRC subsidiary to fund its capital expenditures or working capital. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, if at all. For further information, see “Risk Factors — Risks Relating to Doing Business in China — 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 this offering to make loans to our PRC subsidiaries and our consolidated VIE, or to make additional capital contributions to our PRC subsidiaries.”

 

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DIVIDEND POLICY

Since inception, we have not declared or paid any dividends on our shares. We do not have any present plan to pay any dividends on our ordinary shares or ADSs in the foreseeable future. We intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.

Any other future determination to pay dividends will be made at the discretion of our board of directors and may be based on a number of factors, including our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant. If we pay any dividends, we will pay our ADS holders to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares.” Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars.

We are an exempted company incorporated in the Cayman Islands. In order for us to distribute any dividends to our shareholders and ADS holders, we may rely on dividends distributed by our PRC subsidiaries. Certain payments from our PRC subsidiaries to us may be subject to PRC withholding income tax. In addition, regulations in the PRC currently permit payment of dividends of a PRC company only out of accumulated distributable after-tax profits as determined in accordance with its articles of association and the accounting standards and regulations in China. Each of our PRC subsidiaries is required to set aside at least 10% of its after-tax profit based on PRC accounting standards every year to a statutory common reserve fund until the aggregate amount of such reserve fund reaches 50% of the registered capital of such subsidiary. Such statutory reserves are not distributable as loans, advances or cash dividends.

 

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CAPITALIZATION

The following table sets forth our capitalization as of December 31, 2017 presented on:

 

    an actual basis;

 

    a pro forma basis to reflect the automatic conversion of all our outstanding convertible redeemable preferred shares (including series A, series A1, series B1 and series B2 convertible redeemable preferred shares) into 15,422,829 of our ordinary shares immediately upon the completion of this offering; and

 

    a pro forma as adjusted basis to give effect to (i) the automatic conversion of all our outstanding convertible redeemable preferred shares (including series A, series A1, series B1 and series B2 convertible redeemable preferred shares) into 15,422,829 of our ordinary shares immediately upon the completion of this offering, and (ii) the issuance and sale of the ordinary shares in the form of ADSs offered hereby at an assumed initial public offering price of US$             per ADS, the mid-point of the estimated public offering price range shown on the front cover of this prospectus, after deducting underwriting discounts, commissions and estimated offering expenses payable by us and assuming no exercise of the underwriters’ option to purchase additional ADSs.

The pro forma and pro forma as adjusted information below is illustrative only and our capitalization following the closing of this offering is subject to adjustment based on the initial public offering price of our ADSs and other terms of this offering determined at pricing. You should read this table in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

     As of December 31, 2017  
     Actual     Pro Forma      Pro Forma
as Adjusted
 
     RMB     US$     RMB      US$      RMB      US$  
     (in thousands)  

Total mezzanine equity

     273,895       42,097       —          —          

Shareholders’ deficit:

               

Ordinary shares (US$0.0001 par value; 493,681,319 shares authorized, 34,062,500 shares issued as of December 31, 2017, 24,062,500 shares outstanding as of December 31, 2017;              shares issued and outstanding on a pro-forma basis as of December 31, 2017 (unaudited))

     16       2             

Additional paid-in capital

     8,856       1,362             

Treasury stock (US$0.0001 par value; 10,000,000 shares as of December 31, 2017; 10,000,000 on a pro-forma basis as of December 31, 2017 (unaudited))

     —         —               

Accumulated other comprehensive income

     25       4             

Accumulated deficit

     (117,457     (18,053           

Total shareholders’ deficit

     (108,560     (16,685           
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total mezzanine equity and shareholders’ deficit

     165,335       25,412             
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

 

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DILUTION

If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per ADS and our net tangible book value per ADS after this offering. Dilution results from the fact that the initial public offering price per ordinary share is substantially in excess of the book value per ordinary share attributable to the existing shareholders for our presently outstanding ordinary shares and holders of our convertible redeemable preferred shares which will automatically convert into our ordinary shares upon the completion of this offering.

Our net tangible book value as of December 31, 2017 was approximately US$             million, or US$             per ordinary share as of that date, and US$             per ADS. Net tangible book value represents the amount of our total consolidated assets, less the amount of our intangible assets, goodwill and total consolidated liabilities. Dilution is determined by subtracting net tangible book value per ordinary share from our consolidated total assets, after giving effect to (i) the automatic conversion of all of our outstanding convertible redeemable preferred shares into ordinary shares immediately upon the completion of this offering and (ii) the issuance and sale by us of shares in the form of ADSs in this offering at an assumed initial public offering price of US$             per ADS (the mid-point of the estimated initial public offering price range shown on the front cover page of this prospectus) after deduction of the underwriting discounts and commissions and estimated offering expenses payable by us.

Without taking into account any other changes in net tangible book value after December 31, 2017, other than to give effect to (i) the automatic conversion of all of our outstanding convertible redeemable preferred shares into ordinary shares immediately upon the completion of this offering and (ii) the issuance and sale by us of ordinary shares in the form of ADSs in this offering at an assumed initial public offering price of US$             per ADS (the mid-point of the estimated initial public offering price range shown on the front cover page of this prospectus) after deduction of the underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of December 31, 2017 would have been US$             million, or US$             per outstanding ordinary share and US$             per ADS. This represents an immediate increase in net tangible book value of US$             per ordinary share and US$             per ADS to the existing shareholders and an immediate dilution in net tangible book value of US$             per ordinary share and US$             per ADS to investors purchasing ADSs in this offering.

The following table illustrates such dilution:

 

     Per
Ordinary
Share
     Per ADS  

Actual net tangible book value per share as of December 31, 2017

   US$                   US$               

Pro forma net tangible book value per share after giving effect to the automatic conversion of all of our outstanding convertible redeemable preferred shares into ordinary shares

     

Pro forma as adjusted net tangible book value per share after giving effect to (i) the automatic conversion of all of our outstanding convertible redeemable preferred shares into ordinary shares and (ii) this offering

     

Assumed initial public offering price

     

Dilution in net tangible book value per share to new investors in the offering

     

The amount of dilution in net tangible book value to new investors in this offering set forth above is calculated by deducting (i) the pro forma net tangible book value after giving effect to the automatic conversion of our outstanding convertible redeemable preferred shares from (ii) the pro forma net tangible book value after giving effect to the automatic conversion of our convertible redeemable preferred shares and this offering.

The following table summarizes, on a pro forma basis as of December 31, 2017, the differences between existing shareholders, including holders of our convertible redeemable preferred shares, and the new investors

 

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with respect to the number of ordinary shares (in the form of ADSs or shares) purchased from us, the total consideration paid and the average price per ordinary share and per ADS paid before deducting the underwriting discounts and commissions and estimated offering expenses. The total number of ordinary shares does not include ordinary shares underlying the ADSs issuable upon the exercise of the option to purchase additional ADSs granted to the underwriters.

 

    

 

Ordinary Shares
Total

   

 

Total
Consideration

    US$
Average
Price per
Ordinary
Share
Equivalent
     Average
Price per
ADS
Equivalent
 
     Number      Percent     Amount      Percent       

Existing shareholders

                   US$                   US$      US$  

New investors

          US$          US$      US$  
  

 

 

    

 

 

   

 

 

    

 

 

      

Total

          US$            
  

 

 

    

 

 

   

 

 

    

 

 

      

A US$1.00 increase (decrease) in the assumed public offering price of US$             per ADS (the mid-point of the estimated initial public offering price range shown on the front cover page of this prospectus) would increase (decrease) our pro forma net tangible book value after giving effect to the offering by US$             million, the pro forma net tangible book value per ordinary share and per ADS after giving effect to this offering by US$             per ordinary share and US$             per ADS and the dilution in pro forma net tangible book value per ordinary share and per ADS to new investors in this offering by US$             per ordinary share and US$             per ADS, assuming no change to the number of ADS offered by us as set forth on the front cover page of this prospectus, and after deducting underwriting discounts and commissions and other offering expenses.

The pro forma information discussed above is illustrative only. Our net tangible book value following the completion of this offering is subject to adjustment based on the actual initial public offering price of our ADSs and other terms of this offering determined at pricing.

The discussion and tables above take into consideration the automatic conversions of all of our outstanding convertible redeemable preferred shares immediately upon the completion of this offering, and they do not take into consideration of any outstanding share options. As of the date of this prospectus, there are also (i) 2,004,725 ordinary shares issuable upon exercise of outstanding share options, (ii) 959,416 ordinary shares available for future issuance upon the exercise of future grants under our 2018 equity incentive plan and (iii) 211,724 series B2 convertible redeemable preferred shares to be issued pursuant to a warrant that has been exercised by an investor. If any of these options are exercised, there will be further dilution to new investors.

 

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EXCHANGE RATE INFORMATION

Substantially all of our operations are conducted in the PRC and substantially all of our revenue is denominated in Renminbi. This prospectus contains translations of Renminbi amounts into U.S. dollars at specific rates solely for the convenience of the reader. Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this prospectus were made at a rate of RMB6.5063 to US$1.00, the exchange rate set forth in the H.10 statistical release of the Federal Reserve Board on December 29, 2017. We make no representation that the Renminbi or U.S. dollar amounts referred to in this prospectus could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of Renminbi into foreign exchange and through restrictions on foreign trade. On April 13, 2018, the noon buying rate for Renminbi was RMB6.2725 to US$1.00.

The following table sets forth information concerning exchange rates between the Renminbi and the U.S. dollar for the periods presented. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this prospectus or will use in the preparation of our periodic reports or any other information to be provided to you. For all dates and periods, the exchange rate refers to the exchange rate as set forth in the H.10 statistical release of the Federal Reserve Board.

 

     Noon Buying Rate  

Period

   Period End      Average(1)      Low      High  
     (RMB per US$1.00)  

2013

     6.0537        6.1412        6.2438        6.0537  

2014

     6.2046        6.1704        6.2591        6.0402  

2015

     6.4778        6.2869        6.4896        6.1870  

2016

     6.9430        6.6549        6.9580        6.4480  

2017

     6.5063        6.7350        6.9575        6.4773  

October

     6.6328        6.6254        6.6533        6.5712  

November

     6.6090        6.6200        6.6385        6.5967  

December

     6.5063        6.5932        6.6210        6.5063  

2018

           

January

     6.2841        6.4232        6.5263        6.2841  

February

     6.3329        6.3182        6.3471        6.2649  

March

     6.2726        6.3174        6.3565        6.2685  

April (through April 13)

     6.2725        6.2889        6.3045        6.2655  

 

Source: Federal Reserve Statistical Release

(1) Annual averages are calculated using the average of the rates on the last business day of each month during the relevant year. Monthly averages are calculated using the average of the daily rates during the relevant month.

 

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ENFORCEMENT OF CIVIL LIABILITIES

We are incorporated under the laws of the Cayman Islands as an exempted company with limited liability. We are incorporated in the Cayman Islands because of certain benefits associated with being a Cayman Islands company, such as political and economic stability, an effective judicial system, a favorable tax system, the absence of foreign exchange control or currency restrictions and the availability of professional and support services. However, the Cayman Islands has a less developed body of securities laws as compared to the United States and provides protections for investors to a lesser extent. In addition, Cayman Islands companies may not have standing to sue before the federal courts of the United States.

Substantially all of our operations are conducted in the PRC, and substantially all of our assets are located in the PRC. In addition, most of our directors and officers are residents of jurisdictions other than the United States and all or a substantial portion of their assets are located outside the United States. As a result, it may be difficult for investors to effect service of process within the United States upon us or these persons, or to enforce against us or them judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States. It may also be difficult for you to enforce in United States courts judgments obtained in United States courts based on the civil liability provisions of the United States federal securities laws against us and our officers and directors.

We have appointed is Law Debenture Corporate Service Inc. as our agent to receive service of process with respect to any action brought against us in the United States District Court for the Southern District of New York under the federal securities laws of the United States or of any state in the United States or any action brought against us in the Supreme Court of the State of New York in the County of New York under the securities laws of the State of New York.

Walkers, our counsel as to Cayman Islands law, and King & Wood Mallesons, our counsel as to PRC law, have advised us that there is uncertainty as to whether the courts of the Cayman Islands or the PRC would, respectively, (1) recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States and (2) entertain original actions brought in the Cayman Islands or the PRC against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States.

Walkers has informed us that the uncertainty with regard to Cayman Islands law relates to whether a judgment obtained from the United States courts under the civil liability provisions of the securities laws will be determined by the courts of the Cayman Islands as penal or punitive in nature. If such a determination is made, the courts of the Cayman Islands will not recognize or enforce the judgment against a Cayman company. Because the courts of the Cayman Islands have yet to rule on whether such judgments are penal or punitive in nature, it is uncertain whether they would be enforceable in the Cayman Islands. Walkers has further advised us that a final and conclusive judgment in the federal or state courts of the United States under which a sum of money is payable, other than a sum payable in respect of taxes, fines, penalties or similar charges, may be subject to enforcement proceedings as a debt in the courts of the Cayman Islands under the common law doctrine of obligation.

In addition, Walkers has advised us that there is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the Cayman Islands will generally recognize as a valid judgment, a final and conclusive judgment in personam obtained in the federal or state courts in the United States under which a sum of money is payable (other than a sum of money payable in respect of multiple damages, taxes or other charges of a like nature or in respect of a fine or other penalty) and would give a judgment based thereon provided that such judgment (i) is final and conclusive, (ii) is one in respect of which the foreign court had jurisdiction over the defendant according to Cayman Islands conflict of law rules; (iii) is either for a liquidated sum not in respect of penalties or taxes or a fine or similar fiscal or revenue obligations or, in certain circumstances, for in personam non-money relief, and (iv) was neither obtained in a manner, nor is of a kind enforcement of which is contrary to natural justice or the public policy of the Cayman Islands.

 

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King & Wood Mallesons has advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedure Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedure Law based either on treaties between China and the country where the judgment is made or on principles of reciprocity between jurisdictions. King & Wood Mallesons has advised us further that under PRC law, a foreign judgment, which does not otherwise violate basic legal principles, state sovereignty, safety or social public interest, may be recognized and enforced by a PRC court, based either on treaties between China and the country where the judgment is made or on principles of reciprocity between jurisdictions. As there existed no treaty or other form of reciprocity between China and the United States governing the recognition and enforcement of judgments as of the date of this prospectus, including those predicated upon the liability provisions of the United States federal securities laws, there is uncertainty whether and on what basis a PRC court would enforce judgments rendered by United States courts.

 

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OUR HISTORY AND CORPORATE STRUCTURE

We launched our flagship mobile application, Qutoutiao, in June 2016. We primarily operate our business through our consolidated VIE, Shanghai Jifen, and its subsidiaries. To facilitate financing offshores, we incorporated Qtech Ltd. in July 2017. Through a series of transactions, Qtech Ltd. then became our ultimate holding company.

We currently conduct our business primarily through the following subsidiaries, consolidated VIE and its subsidiaries:

 

    Shanghai Jifen, our consolidated VIE, primarily engages in the operation of our Qutoutiao mobile application;

 

    Shanghai Xike Information Technology Service Co., Ltd., or Shanghai Xike, primarily engages in the operation of our Qudoupai mobile application;

 

    Anhui Zhangduan Internet Technology Co., Ltd., or Anhui Zhangduan, primarily engages in content management;

 

    Beijing Qukandian Internet Technology Co., Ltd., or Beijing Qukandian, primarily engages in content procurement; and

 

    Shanghai Dianguan Internet Technology Co., Ltd., or Shanghai Dianguan, our subsidiary in China acquired in February 2018, primarily provides advertising services.

Our Corporate Structure

The following diagram illustrates our corporate structure as of the date of this prospectus. Except as otherwise specified, equity interests depicted in this diagram are held as to 100%. The relationships between Shanghai Quyun, Shanghai Jifen and its shareholders as illustrated in this diagram are governed by contractual arrangements and do not constitute equity ownership.

 

LOGO

 

(1) Mr. Eric Siliang Tan, Mr. Lei Li, Tianjin Shanshi Technology L.P. and Shanghai Xihu Cultural Transmission Co., Ltd. held 45%, 15%, 20% and 20% equity interest in Shanghai Jifen, respectively.

 

     Both Tianjin Shanshi Technology L.P. and Shanghai Xihu Cultural Transmission Co., Ltd. are controlled by Mr. Eric Siliang Tan.

 

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(2) We acquired Shanghai Dianguan in February 2018.

 

(3) Include Anhui Zhangduan, Beijing Qukandian, Shanghai Xike and Shanghai Tuile Information Technology Service Co., Ltd.

Contractual Arrangements among Shanghai Quyun and Shanghai Jifen and its Shareholders

PRC laws and regulations place certain restrictions on foreign investment in and ownership of internet-based businesses. Accordingly, we conduct our operations mainly through Shanghai Jifen, or the consolidated VIE, and its subsidiaries. We effectively control the consolidated VIE through a series of contractual arrangements with the consolidated VIE, its shareholders and Shanghai Quyun, as described in more detail below, which collectively enables us to:

 

    exercise effective control over our consolidated VIE and its subsidiaries;

 

    receive substantially all the economic benefits of our consolidated VIE; and

 

    have an exclusive option to purchase all or part of the equity interests in the equity interest in or all or part of the assets of Shanghai Jifen when and to the extent permitted by PRC law.

As a result of these contractual arrangements, we are the primary beneficiary of Shanghai Jifen and its subsidiaries. We have consolidated their financial results in our consolidated financial statements in accordance with U.S. GAAP.

In the opinion of King & Wood Mallesons, our PRC legal counsel:

 

    the ownership structures of Shanghai Quyun and our consolidated VIE in China, both currently and immediately after giving effect to this offering, do not and will not violate any applicable PRC law, regulation, or rule currently in effect; and

 

    the contractual arrangements among Shanghai Quyun, Shanghai Jifen and its shareholders governed by PRC laws are valid, binding and enforceable in accordance with their terms and applicable PRC laws, rules, and regulations currently in effect, and will not violate any applicable PRC law, regulation, or rule currently in effect.

However, we have been further advised by our PRC legal counsel, King & Wood Mallesons, that there are substantial uncertainties regarding the interpretation and application of current and future PRC laws, rules and regulations. In particular, in January 2015, the MOFCOM published a discussion draft of the proposed Foreign Investment Law for public review and comments. Among other things, the draft Foreign Investment Law expands the definition of foreign investment and introduces the principle of “actual control” in determining whether a company is considered a foreign-invested enterprise, or an FIE. Under the draft Foreign Investment Law, VIEs would also be deemed as FIEs, if they are ultimately “controlled” by foreign investors, and be subject to restrictions on foreign investments. However, the draft law has not arrived at a position on what actions will be taken with respect to the existing companies with the “variable interest entity” structure, whether or not these companies are controlled by Chinese parties. It is uncertain when the draft may be signed into law, if at all, and whether any final version would have substantial changes from the draft. Accordingly, the PRC regulatory authorities may in the future take a view that is contrary to the opinion of our PRC legal counsel. We have been further advised by our PRC legal counsel that if the PRC government finds that the agreements that establish the structure for operating our business do not comply with PRC government restrictions on foreign investment in the aforesaid business we engage in, we could be subject to severe penalties including being prohibited from continuing operations. See “Risk Factors — Risks Relating to Our Corporate Structure.”

All the agreements under our contractual arrangements are governed by PRC laws and provide for the resolution of disputes through arbitration in China. For additional information, see “Risk Factors — Risks Relating to Our Corporate Structure — Any failure by our consolidated VIE or its shareholders to perform their obligations under our contractual arrangements with them would have a material adverse effect on our business.” Such arbitration provisions have no effect on the rights of our shareholders to pursue claims against us under United States federal securities laws.

 

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The following is a summary of the currently effective contractual arrangements by and among our wholly-owned subsidiary, Shanghai Quyun, our consolidated VIE, Shanghai Jifen, and its subsidiaries, and the shareholders of Shanghai Jifen.

Agreements that Provide Us with Effective Control over Our Consolidated VIE and Its Subsidiaries

Equity Interest Pledge Agreement. Pursuant to the equity interest pledge agreement, each shareholder of Shanghai Jifen has pledged all of such shareholder’s equity interest in Shanghai Jifen as a security interest to respectively guarantee Shanghai Jifen and its shareholders’ performance of their obligations under the relevant contractual arrangement, which include the voting rights proxy agreement, loan agreement, exclusive technology and consulting service agreement and exclusive option agreement. If Shanghai Jifen or any of its shareholders breaches their contractual obligations under these agreements, Shanghai Quyun, as pledgee, will be entitled to certain rights regarding the pledged equity interests. In the event of such breaches, Shanghai Quyun’s rights include being paid in priority with the equity interest of Shanghai Jifen based on the monetary valuation that such equity interest is converted into or from the proceeds from auction or sale of the equity interest. Each of the shareholders of Shanghai Jifen agrees that, during the term of the equity interest pledge agreements, such shareholder shall not transfer the equity interest, place or permit the existence of any security interest or other encumbrance on the equity interest or any portion thereof, without the prior written consent of Shanghai Quyun, except for the performance of the relevant contractual agreement. Shanghai Quyun is entitled to receive dividends distributed on the equity interest of Shanghai Jifen, and Shanghai Jifen’s shareholders may receive dividends distributed on the equity interest only with prior written consent of Shanghai Quyun. The equity interest pledge agreement remains effective until all obligations under the relevant contractual agreements have been fully performed and all secured indebtedness have been fully paid.

Voting Rights Proxy Agreement. Pursuant to the voting rights proxy agreement, each shareholder of Shanghai Jifen has irrevocably authorized Shanghai Quyun to exercise the following rights relating to all equity interests held by such shareholder in Shanghai Jifen during the term of the voting rights proxy agreement: to act on behalf of such shareholder as its exclusive agent and attorney with respect to all matters concerning its shareholding in Shanghai Jifen, including without limitation: (1) proposing and attending shareholders’ meetings of Shanghai Jifen; (2) exercising all the shareholder’s voting rights such shareholder is entitled to under the laws of China and Shanghai Jifen’s articles of association, including but not limited to designate and appoint on behalf of such shareholder the directors and other senior management members of Shanghai Jifen. During the period that each of Shanghai Quyun and Shanghai Jifen remain in operation, the voting rights proxy agreement shall be irrevocable and continuously effective and valid for ten years from the execution date unless otherwise agreed to by all parties. Upon the expiration of the original term or any renewal term of the voting rights proxy agreement, the agreement shall be automatically renewed for an additional one year period unless, at least 30 days prior to the expiration date, Shanghai Quyun provides notice to the other parties to the voting rights proxy agreement not to renew the agreement.

Agreement that Allow Us to Receive Economic Benefits from our Consolidated VIE and Its Subsidiaries

Exclusive Technology and Consulting Service Agreement. Under the exclusive technology and consulting service agreement, Shanghai Jifen appoints Shanghai Quyun as its exclusive services provider to provide Shanghai Jifen with comprehensive technical support, business support and relevant consulting services during the term of the exclusive technology and consulting service agreement. In return, Shanghai Ouyun is entitled to receive a monthly service fee from Shanghai Jifen at an amount to be determined at the sole discretion of Shanghai Quyun. Shanghai Quyun shall have exclusive and proprietary ownership, rights and interests in any and all intellectual properties arising out of or created during the performance of the exclusive technology and consulting service agreement. Unless terminated in accordance with the provisions of the exclusive technology and consulting service agreement or in accordance with other agreements between the parties, the exclusive cooperation agreement shall remain effective for ten years from the execution date of the exclusive technology and consulting service agreement. Upon the expiration of the exclusive technology and consulting cooperation agreement, Shanghai Quyun has the sole discretion to extend the term of the agreement to any date by written notice to Shanghai Jifen. Shanghai Quyun may terminate the agreement at any time by providing 30 days’ prior written notice to Shanghai Jifen.

 

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Agreements that Provides Us with the Option to Purchase the Equity Interest in Shanghai Jifen

Loan Agreement. Shanghai Quyun entered into a loan agreement with each shareholder of Shanghai Jifen in October 2017. Pursuant to the loan agreement, Shanghai Quyun has granted an interest-free loan to each shareholder of Shanghai Jifen, the amount of which are to be separately agreed to between Shanghai Quyun and Shanghai Jifen in writing, which may only be used by such shareholder for the purpose of capital contribution to Shanghai Jifen as to its business development. Shanghai Quyun also has agreed to provide Shanghai Jifen with unconditional financial support pursuant to the loan agreement. The shareholders of Shanghai Jifen pledge all of its share equity in Shanghai Jifen as security for the outstanding loans. Unless other agreed by all the parties of the loan agreement, the term of the loan is the earlier of ten years, the end of Shanghai Quyun’s operation or the end of Shanghai Jifen’s operation. Shanghai Quyun also has the right to accelerate the date of maturity of such loans at its sole discretion. Upon maturity, Shanghai Quyun or its designated third party may purchase the equity interests in Shanghai Jifen held by the shareholders of Shanghai Jifen at a price equal to the lowest allowable amount for a similar transaction pursuant to relevant PRC laws, rules and regulations instead of cash repayment. The loan agreement also prohibits the shareholders of Shanghai Jifen from entering into any transactions that could materially affect the assets, liabilities, interests or operations of Shanghai Jifen or its subsidiaries without prior written consent from Shanghai Quyun.

Exclusive Option Agreement. Pursuant to the exclusive option agreement, each of Shanghai Jifen’s shareholders has irrevocably granted Shanghai Quyun an unconditional and exclusive right to purchase, or designate one or more persons agreed by the board of directors of Shanghai Quyun to purchase the equity interests in Shanghai Jifen then held by its shareholders once or at multiple times at any time in part or in whole at Shanghai Quyun’s sole and absolute discretion to the extent permitted by PRC laws. The purchase price of the optioned interests shall be the minimum price permitted under PRC laws when Shanghai Quyun exercises equity interest purchase option. The shareholders of Shanghai Jifen have agreed the consideration received from the exercise of such equity interest purchase option shall be used to settle the outstanding loans under the loan agreement as described above and/or transferred back to Shanghai Quyun as permitted under relevant PRC laws. Shanghai Jifen and its shareholders have agreed that, without Shanghai Quyun’s prior written consent, Shanghai Jifen shall not, among others, in any manner supplement, change or amend the articles of association of Shanghai Jifen; increase or decrease its registered capital, change its structure of registered capital in other manners; sell, transfer, mortgage or dispose of in any other manner any legal or beneficial interest in the equity interests in Shanghai Jifen held by such shareholders, or allow the encumbrance thereon; entry into, inherit, or tolerant any existence of any loan or other debtor-creditor relationship with any third party; enter into any material contract outside the ordinary course of business; merge with any other persons or make any investments; or distribute dividends. The initial term of this agreement is ten years, which will be renewed at the sole discretion of Shanghai Quyun. Shanghai Quyun may terminate the agreement at any time by providing 30 days’ prior written notice to Shanghai Jifen.

 

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SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA

The following selected consolidated statements of comprehensive loss data and selected consolidated statements of cash flows data for the years ended December 31, 2016 and 2017 and selected consolidated balance sheets data as of December 31, 2016 and 2017 have been derived from our audited consolidated financial statements included elsewhere in this prospectus.

Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. Our historical results are not necessarily indicative of results to be expected for any future period. The following selected consolidated financial data for the periods and as of the dates indicated are qualified by reference to, and should be read in conjunction with, our consolidated financial statements and related notes and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” both of which are included elsewhere in this prospectus.

Selected Consolidated Statements of Comprehensive Loss Data

 

     Year Ended December 31,  
     2016     2017  
     RMB     US$     RMB     US$  
     (in thousands, except for percentages, share and per share data)  

Revenues:

        

Advertising revenue

     57,880       8,896       512,883       78,829  

Other revenue

     74       11       4,170       641  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net revenues

     57,954       8,907       517,053       79,470  
  

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenues(1)

     7,178       1,103       76,481       11,755  

Gross profit

     50,776       7,804       440,572       67,715  

Operating expenses(1):

        

Research and development

     2,627       404       15,317       2,354  

Sales and marketing

     54,633       8,397       494,724       76,038  

General and administrative

     4,427       680       25,947       3,988  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     61,687       9,481       535,988       82,380  
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations(2)

     (10,911     (1,677     (95,416     (14,665
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest income

     51       8       673       104  

Others, net

     (2     (0     (17     (3
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income tax expenses

     (10,862     (1,670     (94,760     (14,564

Income tax expenses

     —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (10,862     (1,670     (94,760     (14,564
  

 

 

   

 

 

   

 

 

   

 

 

 

Accretion to convertible redeemable preferred shares redemption value

     —         —         (6,012     (924

Net loss attributable to Qtech Ltd.’s ordinary shareholders

     (10,862     (1,670     (100,772     (15,488
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

        

Foreign currency translation adjustment, net of nil tax

     —         —         24       3  
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss attributable to Qtech Ltd.

     (10,862     (1,670     (100,748     (15,485
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share attributable to Qtech Ltd.

        

– Basic and diluted

     (0.45     (0.07     (4.19     (0.64

 

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     Year Ended December 31,  
     2016      2017  
     RMB      US$      RMB      US$  
     (in thousands, except for percentages, share and per share data)  

Weighted average number of ordinary shares used in per share calculation:

           

– Basic and diluted

     24,062,500        24,062,500        24,062,500        24,062,500  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Cost of revenues and operating expenses from transactions with related parties are set forth below for the periods indicated:

 

     Year Ended December 31,  
     2016      2017  
     RMB      US$      RMB      US$  
     (in thousands)  

Cost of revenues

     120        18        484        74  

Research and development

     166        26        220        34  

Sales and marketing

     74        11        950        146  

General and administrative

     2,664        409        15,134        2,326  

 

(2) We recognized share-based compensation expenses of RMB0.4 million (US$0.1 million) and RMB3.4 million (US$0.5 million) in 2016 and 2017, respectively.

Selected Consolidated Balance Sheets Data

 

     As of December 31,  
     2016      2017  
     RMB      US$      RMB      US$  
     (in thousands)  

Cash and cash equivalents

     269        41        278,458        42,798  

Short-term investments

     12,370        1,901        129,770        19,945  

Total current assets

     29,758        4,574        466,208        71,655  

Total assets

     29,896        4,594        476,581        73,249  

Registered users’ loyalty payable

     1,023        157        20,977        3,224  

Accrued liabilities related to user loyalty programs

     24,509        3,767        187,003        28,742  

Total liabilities

     41,087        6,315        311,246        47,837  

Mezzanine equity

     —          —          273,895        42,097  

Total shareholders’ deficits

     (11,191      (1,720      (108,560      (16,685

 

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Selected Consolidated Statements of Cash Flows Data

 

     Year Ended December 31,  
     2016      2017  
     RMB      US$      RMB      US$  
     (in thousands)  

Selected Consolidated Cash Flows Data:

           

Net cash provided by operating activities

     12,719        1,955        132,226        20,323  

Net cash used in investing activities

     (12,523      (1,925      (121,919      (18,738

Net cash provided by financing activities

     —          —          272,121        41,824  

Net increase in cash and cash equivalents

     196        30        282,428        43,409  

Effect of exchange rate changes on cash and cash equivalents

     —          —          (4,239      (652

Cash and cash equivalents at beginning of the year

     73        11        269        41  

Cash and cash equivalents at the end of the year

     269        41        278,458        42,798  

Key Operating Metrics

We regularly review a number of key operating metrics to evaluate our business and measure our performance. The table below sets forth key operating metrics relating to the Qutoutiao mobile application.

 

    For the Three Months Ended  
    September 30     December 31     March 31     June 30     September 30     December 30  
    2016     2017  
    (in millions, except for percentages and per user data)  

Registered users as of the end of the period

    4.6       11.3       17.8       28.0       46.8       72.8  

Average MAUs during the period

    1.7       3.9       5.7       8.8       16.0       24.2  

Average DAUs during the period

    0.5       1.5       2.5       3.9       6.4       9.5  

Average daily PVs during the period

    8.4       26.3       47.9       82.5       135.0       225.5  

Video PVs as a percentage of total PVs during the period (%)

    2.4       5.7       4.2       6.9       11.1       28.4  

Average daily time spent per DAU during the period (minutes)

    27.2       29.0       31.3       33.7       34.0       32.3  

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes that appear in this prospectus. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and in this prospectus, particularly in the section titled “Risk Factors.”

Overview

Our flagship mobile application, Qutoutiao, meaning “fun headlines” in Chinese, aggregates articles and short videos uploaded onto our platform and presents customized feeds to users based on each user’s profile, behavior and social relationships. These feeds are optimized in real time through our proprietary machine learning algorithm as we gain new insights into each user. Covering a broad range of interests, Qutoutiao is focused on humor, stories and other light entertainment content that delight and inspire. In addition to articles and short videos, we plan to diversify our content offerings into literatures, games, live streaming, animations and comics, creating a comprehensive light entertainment content ecosystem. Qutoutiao has rapidly gained popularity since its launch in June 2016, with approximately 24.2 million average MAUs and 9.5 million average DAUs in the three months ended December 31, 2017.

Our rapidly increasing and engaged user base has provided us with strong monetization potentials. We currently generate revenue primarily by providing advertising services. We place advertisements on the main pages, topic pages as well as content pages of our mobile applications. When we first commenced our business, we collaborated with various third-party advertising platforms to place advertisements on our mobile applications. We later engaged an advertising agent who operate a programmatic advertising system to serve as our sales agent in selling our advertising solutions to other advertising agents and end advertisers. To enhance our platform’s monetization capabilities, we acquired such advertising agent in February 2018. We will utilize the programmatic advertising system of such advertising agent to power our advertising solutions. We will also begin to sell our advertising solutions to advertising agents or advertising customers directly. We believe that our differentiated user base represents an attractive demographic target for businesses.

We also generate revenue through the marketplace on Qutoutiao. We plan to capture additional monetization opportunities by continuing to expand our existing content formats and introducing new content formats. These opportunities include paid content such as literatures, games, animation and comics, as well as content-driven e-commerce and live streaming products.

Our total net revenues have increased rapidly from RMB58.0 million (US$8.9 million) in 2016 to RMB517.1 million (US$79.5 million) in 2017. As we focused on growing our user base and enhancing our services, we have incurred net losses of RMB10.9 million (US$1.7 million) in 2016 and RMB94.8 million (US$14.6 million) in 2017.

Key Factors Affecting Our Results of Operations

We believe the most significant drivers affecting our revenues are user engagement and our ability to monetize. On the other hand, we believe the most significant drivers affecting our costs and expenses are those related to our user acquisition and engagement efforts and content procurement.

User Base and Level of Engagement

Our fast growing and engaged user base has contributed to our ability to attract advertising customers to our advertising services and the significant growth in our revenue. Our average MAUs increased from approximately

 

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3.9 million in the three months ended December 31, 2016 to approximately 24.2 million in the three months ended December 31, 2017. Our average DAUs increased from approximately 1.5 million in the three months ended December 31, 2016 to approximately 9.5 million in the three months ended December 31, 2017. A continued increase in the number of DAUs, the amount of time they spent on our platform and the amount of content consumed by them will lead to increase in the number of advertisements served and potential clicks and impressions from users. User engagement in turn will depend on the quality and attractiveness of content on our platform and our continued ability to fine tune our understanding of users to deliver content that is most likely of interest them. Our ability to maintain high user engagement will also be affected by our planned introduction of new content formats, users’ reception to them and the growth in the volume of such content. Users’ engagement to these new content formats will help not only in driving demand for our advertising services but creating further monetization opportunities.

Our Ability to Monetize

Our current financial condition and results of operations depend substantially on the demand for our advertising solutions. Demand for our advertising solutions will be affected by the size of our user base and their continued engagement. Such demand will also be dependent on our ability to enhance the efficacy of our advertising solutions through technology and an even deeper understanding of our user base. In addition, we have started to operate our programmatic advertising system and focus on the direct sale of our advertising solutions in February 2018. Our ability to successfully expand the number of advertising agents or advertising customers and increase their advertising spending on our programmatic advertising system will affect our revenue growth.

We also intend to further monetize our user base by introducing paid content and other products and services in the future. The number of users that will pay for such future paid content and other products and services, and the average spending by such users, are affected by various factors, including the volume and diversity of such content that we offer, or the interest among our users in paying for such content, products or services. Changes to any of the above or other factors, many of which are beyond our control, will affect our revenues.

Cost of User Acquisition and Engagement

Our user loyalty programs have contributed to the significant growth in the number of our registered users and high user engagement. The cost of users’ rewards associated with our user loyalty programs is recognized as sales and marketing expenses. Majority of such cost is currently associated with engagement-based rewards to promote user engagement and retention, with the remainder related to referral-based rewards to acquire new registered users. We design our user loyalty programs to ensure the cost of the rewards provided is appropriate in relation to the growth of our business. Our ability to ensure that our user loyalty programs will continue to advance strong growth in user base and keep user engaged at a manageable cost level will affect our results of operations. Furthermore, we have started to and will continue to explore other online and offline marketing channels to promote brand awareness and supplement our user loyalty programs. Such efforts may affect our overall user acquisition and engagement costs in the future.

Content Procurement

We encourage our content provider to actively contribute quality content that will resonate with our users by implementing a system in which fees paid to them are related to the number of views of the content they contribute. These fees are accounted for as part of our cost of revenues. Our ability to balance our content procurement cost while ensuring content providers continue to contribute content that is attractive to users will affect our results of operations going forward. We will also need to manage the relevant content cost while taking into account its revenue potential to ensure value are realized. Furthermore, as additional content formats are introduced, we may enter into different content procurement arrangements with content providers, affecting our content procurement cost structure.

 

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Key Operating Metrics

We regularly review a number of key operating metrics to evaluate our business and measure our performance. The table below sets forth key operating metrics relating to the Qutoutiao mobile application.

 

     For the Three Months Ended  
     September 30,      December 31,      March 31,      June 30,      September 30,      December 31,  
     2016      2017  
     (in millions, except for percentages and per user data)  

Registered users as of the end of the period

     4.6        11.3        17.8        28.0        46.8        72.8  

Average MAUs during the period

     1.7        3.9        5.7        8.8        16.0        24.2  

Average DAUs during the period

     0.5        1.5        2.5        3.9        6.4        9.5  

Average daily PVs during the period

     8.4        26.3        47.9        82.5        135.0        225.5  

Video PVs as a percentage of total PVs during the period (%)

     2.4        5.7        4.2        6.9        11.1        28.4  

Average daily time spent per DAU during the period (minutes)

     27.2        29.0        31.3        33.7        34.0        32.3  

We view registered users as a measure of the size of our user base, and we view average MAUs and average DAUs as measures of the size of active user base and user engagement. Registered users, average MAUs and average DAUs rapidly increased during the periods presented. Increases in these measures were mainly driven by our user loyalty programs, light entertainment-oriented content and content recommendation technology.

We monitor average daily PVs to quantify the amount of content viewed by users. Average daily PVs rapidly increased during the periods presented, which was driven by the expansion of our user base as well as the quality and relevance of our content. We have improved the breadth and quality of short videos on our platform given videos’ increasing popularity among our users. As a result, video PVs as a percentage of total PVs increased during the periods presented.

We monitor average daily time spent per DAU to measure the level of user engagement on our platform. Average daily time spent per DAU increased from approximately 29 minutes in the three months ended December 31, 2016 to approximately 32 minutes in the three months ended December 31, 2017, which reflects an increase in user stickiness.

Key Components of Our Results of Operations

Revenues

We generate most of our revenues from advertising services. The following table sets forth a breakdown of our revenues, both in absolute amount and as a percentage of our net revenues, for the periods indicated.

 

     Year Ended December 31,  
     2016      2017  
     RMB      US$      %      RMB      US$      %  
     (in thousands, except for percentages)  

Revenues:

                 

Advertising revenue

     57,880        8,896        99.9        512,883        78,829        99.2  

Other revenue

     74        11        0.1        4,170        641        0.8  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net revenues

     57,954        8,907        100.0        517,053        79,470        100.0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

We charge our advertising services mainly on a cost-per-click, or CPC, basis, and in certain circumstances, on a cost-per-thousand-impressions, or CPM, basis.

Baidu, which is our largest customer and operates a third-party advertising platform, contributed 69.6% and 43.5% of our net revenues in 2016 and 2017, respectively. Baidu also accounted for 90.3% and 59.8% of our

 

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accounts receivable as of December 31, 2016 and 2017, respectively. To enhance our platform’s monetization capabilities, we acquired an advertising agent in February 2018 that operates a programmatic advertising system. We expect this system will allow us to reduce our reliance on third-party advertising platforms such as Baidu. Prior to our acquisition of this advertising agent in February 2018, we engaged such advertising agent to serve as our sales agent in selling our advertising solutions to other second-tier advertising agents and end advertisers. In 2017, 26.2% of our total net revenues were generated through this advertising agent. These second-tier advertising agents and end advertisers are our customers as they select our mobile applications to place their advertisement and our performance obligation is to provide the underlying advertising display services to them. We recognize advertising revenue from this advertising agent on a gross basis as clicks are delivered on a CPC basis. We also engage certain other advertising agents in selling our advertising solutions to our advertising customers.

In addition, we collaborate with various third-party advertising platforms to place advertisements on our platform. Under our arrangements with these advertising platforms, these advertising platforms are our customers and our performance obligation is to provide traffic to these advertising platforms. As such, we recognize advertising revenue on the net amount as impressions or clicks are delivered on a CPC or CPM basis. We have started to reduce the utilization of third-party advertising platforms in 2017 and we expect such collaboration to continue to decrease in the future as we further increase direct sales of our advertising solutions. However, certain of these third-party advertising platforms were historically our largest customers and may continue to contribute a significant portion of our net revenues in the near future.

We also generate additional revenues primarily from the sale of merchandise by merchandise suppliers through the marketplace on Qutoutiao. A user pays the purchase price for a merchandise to us. We deduct our commission related to the merchandise and remit the remainder to the relevant merchandise supplier.

Cost of Revenues

The following table sets forth the components of our cost of revenues, both in absolute amount and as a percentage of our net revenues, for the periods indicated.

 

     Year Ended December 31,  
     2016      2017  
     RMB      US$      %      RMB      US$      %  
     (in thousands, except for percentages)  

Cost of revenues(1):

                 

Content procurement costs

     —          —          —          22,862        3,514        4.4  

Bandwidth costs

     1,947        299        3.4        16,682        2,564        3.2  

Cultural development fee and surcharges

     1,950        299        3.4        17,020        2,616        3.3  

Others

     3,281        504        5.7        19,917        3,061        3.9  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total cost of revenues

     7,178        1,103        12.5        76,481        11,755        14.8  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Cost of revenues from transactions with related parties are set forth below for the periods indicated:

 

     Year Ended December 31,  
     2016      2017  
     RMB      US$      %      RMB      US$      %  
     (in thousands, except for percentages)  

Cost of revenues-related party

     120        18        0.2        484        74        0.1  

Content Procurement Costs. Represent fees paid to content providers. We did not incur such content procurement costs in 2016. Content available through our platform at that time were primarily derived from publicly available sources as we were still in the process of developing our online content upload system for content providers to upload content. Fees paid to content providers relate to the number of views of content contributed by the respective content providers. However, the relevant arrangements with each content provider may differ.

 

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Bandwidth Costs. Represent fees we pay to service providers for hosting our servers and for other telecommunications services.

Cultural Development Fee and Surcharges. Represent cultural development fee and certain surcharges levied. The provision of advertising services in China is subject to a cultural development fee at an applicable rate of 3% of net advertising revenue. The cultural development fee and surcharges recorded was RMB2.0 million (US$0.3 million) and RMB17.0 million (US$2.6 million) in 2016 and 2017, respectively.

Others. Our other costs of revenues include salaries and benefits for our personnel responsible for our revenues, including share-based compensation. Personnel responsible for our revenues include our content management personnel, and we expect the number of such employees to increase in the future given the significant growth in the amount of content on our platform. Our other costs of revenues also include commissions paid to advertising agents to serve as our sales agents, direct costs incurred relating to our content editing cost, rental cost, depreciation and other miscellaneous costs. We do not expect to incur commissions paid to advertising agents in the future after our acquisition of an advertising agent in February 2018.

Operating Expenses

The following table sets forth our operating expenses, both in absolute amount and as a percentage of our net revenues, for the periods indicated.

 

     Year Ended December 31,  
     2016      2017  
     RMB      US$      %      RMB      US$      %  
     (in thousands, except for percentages)  

Operating expenses(1):

                 

Research and development

     2,627        404        4.5        15,317        2,354        3.0  

Sales and marketing

     54,633        8,397        94.3        494,724        76,038        95.7  

General and administrative

     4,427        680        7.6        25,947        3,988        5.0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total operating expenses

     61,687        9,481        106.4        535,988        82,380        103.7  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Operating expenses from transactions with related parties are set forth below for the periods indicated:

 

     Year Ended December 31,  
     2016      2017  
     RMB      US$      %      RMB      US$      %  
     (in thousands, except for percentages)  

Research and development-related party

     166        26        0.3        220        34        0.0  

Sales and marketing-related party

     74        11        0.1        950        146        0.2  

General and administrative-related party

     2,664        409        4.6        15,134        2,326        2.9  

Research and Development. Our research and development expenses consist primarily of salaries and benefits for our research and development personnel, including share-based compensation, rental expenses and deprecation related to properties and servers utilized by our research and development personnel.

Sales and Marketing. Our sales and marketing expenses consist primarily of cost of users’ rewards associated with our user loyalty programs which increased from RMB50.9 million (US$7.8 million) in 2016 to RMB419.6 million (US$64.5 million) in 2017, representing 87.8% and 81.2% of our net revenues in 2016 and 2017, respectively. Cost of users’ rewards is comprised of amount of rewards redeemed by users during a specific period and the change in estimated liabilities as to accumulated unredeemed rewards during such period. Pursuant to our user agreements, we can adjust at any time the minimum amount of rewards that must be earned before users can redeem their rewards. As such, change to such threshold in any specific period will affect the

 

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amount of sales and marketing expenses recorded during such period. For additional information on the accounting policy of our loyalty programs, see “— Critical Accounting Policies, Judgments and Estimates — Loyalty Programs.”

Our sales and marketing expenses also consist of advertising and marketing expenses through third-party online and offline channels primarily to promote brand awareness, which increased from RMB171.5 thousand (US$26.4 thousand) in 2016 to RMB41.9 million (US$6.4 million) in 2017, representing 0.3% and 8.1% of our net revenues in 2016 and 2017, respectively. Other sales and marketing expenses include short mobile messaging expenses and salaries and benefits for our sales and marketing personnel, including share-based compensation.

General and Administrative. Our general and administrative expenses consist primarily of salaries and benefits for our general and administrative personnel, including share-based compensation, office expense and professional service fees.

Taxation

Cayman Islands

We are an exempted company incorporated in the Cayman Islands. Under the current laws of the Cayman Islands, we are not subject to tax based upon profits, income, gains or appreciations and there is no taxation in the nature of inheritance tax or estate duty. In addition, upon payment of dividends by us to our shareholders, no Cayman Islands withholding tax will be imposed.

Hong Kong

Our subsidiary incorporated in Hong Kong is subject to Hong Kong profit tax at a rate of 16.5%. No Hong Kong profit tax has been levied as we did not have assessable profit that was earned in or derived from the Hong Kong subsidiary during the periods presented. Hong Kong does not impose a withholding tax on dividends.

China

Generally, our subsidiaries and consolidated VIE and its subsidiaries in China are subject to enterprise income tax on their taxable income in China at a rate of 25%. The enterprise income tax is calculated based on the entity’s global income as determined under PRC tax laws and accounting standards.

Our revenues are subject to value-added tax at a rate of approximately 6%. The provision of advertising services in China is subject to a cultural development fee at an applicable rate of 3% of the net advertising revenue.

Any dividends paid by our wholly foreign-owned subsidiary in China to our intermediary holding company in Hong Kong will be subject to a withholding tax rate of 10%, unless the relevant Hong Kong entity satisfies all the requirements under the Arrangement between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion with respect to Taxes on Income and Capital and receives approval from the relevant tax authority, in which case the dividends paid to the Hong Kong subsidiary would be subject to withholding tax at the standard rate of 5%.

If our holding company in the Cayman Islands or any of our subsidiaries outside of China were deemed to be a “resident enterprise” under the PRC Enterprise Income Tax Law, it would be subject to enterprise income tax on its worldwide income at a rate of 25%.

Critical Accounting Policies, Judgments and Estimates

An accounting policy is considered critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time such estimate is made, and if different accounting

 

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estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements.

We prepare our consolidated financial statements in conformity with U.S. GAAP, which requires us to make judgments, estimates and assumptions. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experiences and various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from our expectations as a result of changes in our estimates. Some of our accounting policies require a higher degree of judgment than others in their application and require us to make significant accounting estimates.

The following descriptions of critical accounting policies, judgments and estimates should be read in conjunction with our consolidated financial statements and other disclosures included in this prospectus. When reviewing our consolidated financial statements, you should consider (i) our selection of critical accounting policies, (ii) the judgments and other uncertainties affecting the application of such policies and (iii) the sensitivity of reported results to changes in conditions and assumptions.

Consolidation of Variable Interest Entities

Foreign ownership in companies providing Internet-content is subject to certain restrictions under PRC laws and regulations. To comply with the PRC laws and regulations, we, through our wholly-owned subsidiary, Shanghai Quyun, entered into a set of contractual arrangements with Shanghai Jifen and its shareholders. The contractual arrangements between Shanghai Quyun, Shanghai Jifen and the shareholders of Shanghai Jifen allow us to:

 

    exercise effective control over Shanghai Jifen whereby having the power to direct Shanghai Jifen’s activities that most significantly drive the economic results of Shanghai Jifen;

 

    receive substantially all of the economic benefits and residual returns, and absorb substantially all the risks and expected losses from Shanghai Jifen as if it was their sole shareholder; and

 

    have an exclusive option to purchase all of the equity interests in Shanghai Jifen.

Our consolidated financial statements include the financial statements of our company, our subsidiaries, our consolidated VIE and its subsidiaries for which we are the primary beneficiary. All transactions and balances among our company, our subsidiaries, our consolidated VIE and its VIE’s subsidiaries have been eliminated upon consolidation.

A subsidiary is an entity in which we, directly or indirectly, control more than one half of the voting powers; or has the power to appoint or remove the majority of the members of the board of directors; or to cast a majority of votes at the meeting of directors; or has the power to govern the financial and operating policies of the investee under a statute or agreement among the shareholders or equity holders.

A consolidated VIE is an entity in which we, or our subsidiaries, through contractual agreements, bears the risks of, and enjoys the rewards normally associated with ownership of the entity. In determining whether we or our subsidiaries are the primary beneficiary, we considered whether it has the power to direct activities that are significant to the consolidated VIE’s economic performance, and also our obligation to absorb losses of the consolidated VIE that could potentially be significant to the consolidated VIE or the right to receive benefits from the consolidated VIE that could potentially be significant to the consolidated VIE. We hold all the variable interests of the consolidated VIE and its subsidiaries, and has been determined to be the primary beneficiary of the consolidated VIE.

In accordance with the contractual agreements among the Shanghai Quyun, Shanghai Jifen and the shareholders of Shanghai Jifen, we have power to direct activities of the consolidated VIE, and can have assets

 

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transferred out of the consolidated VIE. Therefore, we consider that there is no asset in the consolidated VIE that can be used only to settle obligations of the consolidated VIE, except for registered capital and PRC statutory reserves of the consolidated VIE and its subsidiaries, as of December 31, 2016 and 2017. As the consolidated VIE was incorporated as limited liability company under the PRC Company Law, the creditors do not have recourse to the general credit of our company for all the liabilities of the consolidated VIE.

As we are conducting our businesses in the PRC through Shanghai Jifen and its subsidiaries, we will, if needed, provide such support on a discretion basis in the future, which could expose us to a loss.

We believe that the contractual arrangements among Shanghai Quyun, Shanghai Jifen and the shareholders of Shanghai Jifen are in compliance with PRC law and are legally enforceable. However, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements and if the shareholders of our consolidated VIE were to reduce their interest in us, their interests may diverge from ours and that may potentially increase the risk that they would seek to act contrary to the contractual terms.

Our ability to control the consolidated VIE also depends on the voting rights proxy agreement and our company, through Shanghai Quyun, has to vote on all matters requiring shareholder approval in the consolidated VIE. As noted above, we believe this voting rights proxy agreement is legally enforceable but may not be as effective as direct equity ownership.

Revenue Recognition

Our main services are the provision of advertising services. We derive revenue from performing specified actions, i.e. a CPM or CPC basis. Revenue is recognized on a CPM or CPC basis as impressions or clicks are delivered. We also provide other services and recognizes revenue when the service is rendered. Our revenue is presented either on a gross or net basis which is further discussed below.

We recognize revenue when or as the control of the goods or services is transferred to the customer.

Gross Advertising Revenue

In the arrangement with a particular advertising agent, the advertising agent served as our sales agent in selling our advertising solutions to other second-tier advertising agents and end advertisers. These second-tier advertising agents and end advertisers are our customers as they select our mobile applications to place their advertisement and our performance obligation is to provide the underlying advertising display services to them. The advertising agent earns a commission of 2% of the advertising revenue in the arrangement in return for providing bidding system for placement on Qutoutiao. We control the advertising services as a principal and recognize advertising revenue on a gross basis as clicks are delivered.

We receive refundable advance payments from advertising customers through this advertising agent and reconcile the advertising revenue with this advertising agent on a weekly basis. If the advance payment deposited in us is not ultimately used for the advertisement on Qutoutiao, we refund the advance payment back to advertising customers through this advertising agent.

We also engaged advertising customers through other third-party advertising agents where revenue was accounted for on a gross basis in 2017. Those arrangements have been terminated as of December 31, 2017.

In addition, we also provide advertising service to advertising customers directly and recognize revenue on a gross basis as impressions are delivered.

Net Advertising Revenue

We also provide advertising services to third-party advertising platforms. In the arrangement with these advertising platforms, they are our customers and our performance obligation is to provide traffic to these

 

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advertising platforms. Therefore, we recognize advertising revenue based on the net amount as impressions or clicks are delivered.

We reconcile and settle the advertising revenue with these advertising platforms on a monthly basis.

Other Revenue

Our Qutoutiao mobile application includes an online marketplace which users can access and purchase merchandise offered by third-party merchandise suppliers. The merchandise suppliers are our customers as these suppliers are the primary obligor to provide goods and delivery service to the users and our performance obligation is to provide matching service for the suppliers. A user pays the purchase price for a merchandise to us. We deduct our commission related to the merchandise and remit the remainder to the relevant merchandise supplier. We act as an agent in this transaction and recognize revenue when the matching service is completed. We settle the payment with suppliers on a monthly basis.

Loyalty Programs

We offer loyalty programs for registered users of our mobile applications Qutoutiao and Quduopai to enhance user engagement and incentivize word-of-mouth referrals. Through the programs, we give users rewards and in certain cases cash credits for taking specific actions. Such actions primarily include referring new users to register on Qutoutiao or through the viewing or sharing of content, providing valuable comments and encourage inactive users to continue to use Qutoutiao. The cost of users’ rewards is recognized as sales and marketing expenses in the consolidated statements of operations and comprehensive loss.

On Qutoutiao, registered users can redeem earned rewards, which is in a form of cash credits reflecting the same amount of cash value, upon request. We offer our users the flexibility to choose a number of options to redeem rewards. The reward redemption options include (i) online cash out where a user can withdraw cash from his/her account after the cash credits balance exceeds a certain cash out threshold and (ii) purchasing merchandise through the marketplace on Qutoutiao.

On Quduopai, users can also earn cash credits, reflecting the same amount of cash value, that they may cash out when the cash credits balance exceeds a certain threshold. Users on Quduopai can also earn loyalty points, which can only be exchanged into coupons issued to us by a third-party that can then be used to purchase products or service on that third-party’s group buying website. We do not recognize any expenses or liability for those loyalty points earned on Quduopai since we do not bear any additional cost to settle these loyalty points awarded to users.

Our experience indicates that a certain portion of rewards is never redeemed by our registered users, which refers to as a “breakage”. The liability accrued for the reward is reduced by the estimated breakage that is expected to occur. We estimate breakage based upon analysis of relevant reward history and redemption pattern as well as considering the expiration period of the rewards under our user agreements. When assessing breakage, each user’s account is categorized into certain pools based on different ranges of outstanding rewards, and then further grouped into certain sub-groups on the basis of inactive days on our platform. The past reward redemption pattern in those sub-groups was used to estimate the respective breakage for the outstanding rewards in each sub-group at each period end. For the years ended December 31, 2016 and 2017, total costs related to the users’ rewards granted amounted to RMB52.8 million and RMB527.8 million, and total rewards redeemed amounted to RMB13.9 million and RMB244.9 million. As of December 31, 2016 and 2017, the total estimated breakage not accrued approximated to RMB13.3 million and RMB113.7 million, respectively.

Once the accumulated unredeemed rewards for an individual user exceeds the cash out threshold, we reclassify the balance into “registered users’ loyalty payable” in consolidated balance sheet as a monetary liability and reverses the amount of breakage originally assumed, if any. The registered users’ loyalty payable is derecognized only if (1) we pay the user and is relieved of our obligation for the liability by paying the users includes delivery of cash or (2) the user legally release us from the liability.

 

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The user’s agreement provides the rewards expire after one month. However, we may, at our discretion, provide rewards to our users even after one month expiration period.

Share-based Compensation and Valuation of Our Ordinary Shares

We grant share options to eligible employees and account for these share-based awards in accordance with ASC 718 Compensation — Stock Compensation.

Share-based awards are measured at the grant date fair value of the awards and recognized as expenses using straight-line vesting method, net of estimated forfeitures, if any, over the requisite service period, which is the vesting period. We estimate the forfeiture rate based on historical forfeitures of equity awards and adjust the rate to reflect changes in facts and circumstances, if any. We revise our estimated forfeiture rate if actual forfeitures differ from our initial estimates. Grant date fair values of the awards are calculated using the binomial option pricing model with the assistance from an independent appraiser. The binomial option pricing model is used to measure the value of the awards. The determination of the fair value is affected by the share price as well as assumptions regarding a number of complex and subjective variables, including the expected volatility, risk-free interest rates, exercise multiple, expected dividend yield and expected term.

We also granted options under our share incentive plans to the employees of other companies controlled by one of our co-founders. Such companies have provided administrative services to us, and we pay a fee charged at market rate for the services received, so no compensation expense is recognized for these grants. The fair value of these options is recognized as dividends to the co-founder in full at grant date.

In addition, we grant share options to consultants and account for these share-based awards in accordance with ASC 505-50, Equity-Based Payments to Non-Employees. We measure these options based on fair value of the options which are determined by using the binomial option pricing model. These options are measured as of the earlier of the date at which either: (1) commitment for performance by the non-employee has been reached; or (2) the non-employee’s performance is complete. Subsequent to the completion of the performance, the share-based award is assessed in accordance with ASC 815 to determine whether the award meets the definition of a derivative.

The binomial option pricing model is used to determine the fair value of the share options granted to employees and non-employees. The fair values of share options granted during the years ended December 31, 2016 and 2017 were estimated using the following assumptions:

 

     2016      2017  

Expected volatility(1)

     53.16% ~ 53.96%        51.61% ~ 52.41%  

Risk-free interest rate(2)

     2.74% ~ 3.02%        3.28% ~ 3.62%  

Exercise multiple

     2.8        2.8  

Expected dividend yield(3)

     0.00%        0.00%  

Contractual term

     10        10  

Expected forfeiture rate (post-vesting)

     0.00%        0.00%  

Fair value of the common share on the date of option grant (RMB)

     0.31 ~ 5.21        8.44 ~ 23.98  

 

(1) Expected volatility is estimated based on the average of historical volatilities of the comparable companies in the same industry as at the valuation dates.
(2) The risk-free interest rate of periods within the contractual life of the share option is based on the market yield of the Chinese sovereign bond with a maturity life equal to the expected life to expiration.
(3) We have no history or expectation of paying dividends on our ordinary shares.

Determining the fair value of the share options required us to make complex and subjective judgments, assumptions and estimates, which involved inherent uncertainty. Had we used different assumptions and

 

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estimates, the resulting fair value of the share options and the resulting share-based compensation expenses could have been different. Assumptions and estimates will not be necessary to determine the fair value of our ordinary shares upon the listing of our ADSs on the [NYSE]/[NASDAQ].

The following table sets forth the fair value of options under the 2017 equity incentive plan and ordinary shares estimated at the dates of option grants indicated below with the assistance from an independent valuation firm:

 

Date of Options Grant

   Options
Granted
     Exercise
Price
     Fair Value
of Option
     Fair Value
of Ordinary
Shares
     Discount for
Lack of
Marketability
    Discount
Rate
    Type of
Valuations
 

June 30, 2016

     7,994,923      US$ 0.0001      US$ 0.0460      US$ 0.0461        27.0     33.0     Retrospective  

September 30, 2016

     92,168      US$ 0.0001      US$ 0.2960      US$ 0.2961        25.0     32.0     Retrospective  

December 31, 2016

     36,418      US$ 0.0001      US$ 0.7503      US$ 0.7504        24.0     32.0     Retrospective  

March 31, 2017

     187,837      US$ 0.0001      US$ 1.2241      US$ 1.2242        20.0     32.0     Retrospective  

June 30, 2017

     636,277      US$ 0.0001      US$ 2.1158      US$ 2.1159        17.0     32.0     Retrospective  

September 30, 2017

     1,052,377      US$ 0.0001      US$ 3.5987      US$ 3.5988        16.0     31.0     Retrospective  

On January 3, 2018, 15,937,500 ordinary shares beneficially owned by our co-founders became restricted shares. In addition, we have granted an aggregate of 2,004,725 options under the 2018 equity incentive plan as of the date hereof.

Valuations of our ordinary shares were determined in accordance with the guidelines outlined in the American Institute of Certified Public Accountants’ Practice Aid, Valuation of Privately-Held Company Equity Securities Issued as Compensation, and with the assistance of an independent appraisal firm from time to time. The assumptions we use in the valuation model are based on future expectations combined with management judgment, with inputs of numerous objective and subjective factors, to determine the fair value of our ordinary shares, including the following factors:

 

    our operating and financial performance;

 

    current business conditions and projections;

 

    our stage of development;

 

    the prices, rights, preferences and privileges of our convertible preferred shares relative to our ordinary shares;

 

    the likelihood of occurrence of liquidity event or redemption event;

 

    any adjustment necessary to recognize a lack of marketability for our ordinary shares; and

 

    the market performance of industry peers.

In order to determine the fair value of our ordinary shares underlying each share-based award grant, we first determined our business enterprise value, or BEV, and then allocated the BEV to each element of our capital structure (convertible preferred shares and ordinary shares) using a hybrid method comprising the probability-weighted expected return method and the option pricing method. In our case, three scenarios were assumed, namely: (i) the liquidation scenario, in which the option pricing method was adopted to allocate the value between convertible preferred shares and ordinary shares, and (ii) the redemption scenario, in which the option pricing method was adopted to allocate the value between convertible preferred shares and ordinary shares, and (iii) the mandatory conversion scenario, in which equity value was allocated to convertible preferred shares and ordinary shares on an as-if converted basis. Increasing probability was assigned to the mandatory conversion scenario during 2017 in light of preparations for our initial public offering.

 

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In determining the fair value of our BEV, we applied the income approach/discounted cash flow, or DCF, analysis based on our projected cash flow using management’s best estimate as of the valuation date. The determination of the fair value of our ordinary shares requires complex and subjective judgments to be made regarding our projected financial and operating results, our unique business risks, the liquidity of our shares and our operating history and prospects at the time of valuation.

Fair value of our ordinary shares increased from US$0.0461 in June 2016 to US$8.0401 in December 2017 primarily due to (i) the organic growth of our business, as measured in terms of MAUs and average DAUs; (ii) a review of our actual financial performance achieved in 2017, which made our projected financials less uncertain and decreased our discount rate from 33.0% in June 2016 to 28.0% in December 2017; (v) series A and series A1 convertible redeemable preferred shares invested by external investors in September 2017 and November 2017, respectively, which improved our financial condition and (vi) the marketability discount decreased from 27.0% in June 2016 to 14.0% in December 2017.

In November 2017, Innotech Group Holdings Ltd. sold certain ordinary shares to several investors at US$7.28 per share. The transaction price was negotiated in reference to the price of the series A1 convertible redeemable preferred shares, and the investors were willing to pay the same price to purchase ordinary shares. In the first quarter of 2018, Innotech Group Holdings Ltd. and New Optimizer (BV) Ltd. sold certain ordinary shares to several investors at US$23.6 per share on average. The prices of these transactions were negotiated in reference to the prices of series B financings being contemplated at the time and in each case the seller agreed to repurchase the ordinary shares or cancel the transaction if the series B financings were not consummated at a certain valuation. Given such circumstances, the prices of these transactions are not representative of the fair value of our company’s ordinary shares at the respective times.

Management estimated that fair value of our ordinary shares increased significantly in 2018, due to improved operating metrics as well as potential synergies as a result of certain cooperation agreements with strategic investors our company introduced in early March.

Internal Control Over Financial Reporting

Prior to this offering, we have been a private company with limited accounting personnel and other resources with which to address our internal control and procedures and we were never required to evaluate our internal control within a specified period, and, as a result, we may experience difficulty in meeting these reporting requirements in a timely manner. Our management has not completed an assessment of the effectiveness of our internal control over financial reporting, and our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting. However, in the course of preparing and auditing our consolidated financial statements for the years ended December 31, 2016 and 2017, we and our independent registered public accounting firm identified one material weakness in our internal control over financial reporting as of December 31, 2017. In accordance with reporting requirements set forth by the SEC, a “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our company’s annual or interim consolidated financial statements will not be prevented or detected on a timely basis.

The material weakness identified relates to the lack of sufficient financial reporting and accounting personnel with appropriate knowledge of U.S. GAAP and SEC reporting requirements to formalize key controls over financial reporting and to prepare consolidated financial statements and related disclosures. Neither we nor our independent registered public accounting firm undertook a comprehensive assessment of our internal control under the Sarbanes-Oxley Act for purposes of identifying and reporting any weakness in our internal control over financial reporting. We and they are required to do so only after we become a public company. Had we performed a formal assessment of our internal control over financial reporting or had our independent registered public accounting firm performed an audit of our internal control over financial reporting, additional control weaknesses may have been identified.

 

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To remedy our identified material weakness subsequent to December 31, 2017, we plan to undertake steps to strengthen our internal control over financial reporting, including: (i) hiring more qualified resources including financial controller, equipped with relevant U.S. GAAP and SEC reporting experience and qualifications to strengthen the financial reporting function and to set up a financial and system control framework, (ii) implementing regular and continuous U.S. GAAP accounting and financial reporting training programs for our accounting and financial reporting personnel, (iii) establishing effective oversight and clarifying reporting requirements for non-recurring and complex transactions to ensure consolidated financial statements and related disclosures are accurate, complete and in compliance with SEC reporting requirements, and (iv) enhancing an internal audit function as well as engaging an external consulting firm to help us assess our compliance readiness under rule 13a-15 of the Exchange Act and improve overall internal control.

However, we cannot assure you that we will remediate our material weakness in a timely manner. See “Risk Factors — Risks Related to Our Business — If we fail to maintain proper and effective internal control, our ability to produce accurate financial statements on a timely basis could be impaired.”

As a company with less than US$1.07 billion in revenue 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 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, related to the assessment of the effectiveness of the emerging growth company’s internal control over financial reporting.

 

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Results of Operations

The following table sets forth a summary of our consolidated statements of comprehensive loss, both in absolute amount and as a percentage of our net revenues, for the periods inidicated. This information should be read together with our consolidated financial statements and related notes included elsewhere in this prospectus. The operating results in any period are not necessarily indicative of the results that may be expected for any future period.

 

     Year Ended December 31,  
     2016     2017  
     RMB     US$     %     RMB     US$     %  
     (in thousands, except for percentages)  

Revenues:

            

Advertising revenue

     57,880       8,896       99.9       512,883       78,829       99.2  

Other revenue

     74      
11
 
    0.1       4,170       641       0.8  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net revenues

     57,954       8,907       100.0       517,053       79,470       100.0  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenues(1)

     7,178      
1,103
 
    12.4       76,481       11,755       14.8  

Gross profit

     50,776      
7,804
 
    87.6       440,572       67,715       85.2  

Operating expenses(1):

            

Research and development

     2,627       404       4.5       15,317       2,354       3.0  

Sales and marketing

     54,633       8,397       94.3       494,724       76,038       95.7  

General and administrative

     4,427       680       7.6       25,947       3,988       5.0  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     61,687       9,481       106.4       535,988       82,380       103.7  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations(2)

     (10,911     (1,677     (18.8     (95,416     (14,665     (18.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income

     51       8       0.1       673       104       0.1  

Others, net

     (2     (0     (0.0     (17     (3     (0.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income tax expenses

     (10,862     (1,670     (18.7     (94,760     (14,564     (18.3

Income tax expenses

     —         —         —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (10,862     (1,670     (18.7     (94,760     (14,564     (18.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Accretion to convertible redeemable preferred shares redemption value

     —         —         —         (6,012     (924     1.2  

Net loss attributable to Qtech Ltd.’s ordinary shareholders

     (10,862     (1,670     (18.7     (100,772     (15,488     (19.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

            

Foreign currency translation adjustment, net of nil tax

     —         —         —         24       3       0.0  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss attributable to Qtech Ltd.

     (10,862     (1,670     (18.7     (100,748     (15,485     (19.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Cost of revenue and operating expenses from transactions with related parties are set forth below for the periods indicated:

 

     Year Ended December 31,  
     2016      2017  
     RMB      US$      %      RMB      US$      %  
     (in thousands, except for percentages)  

Cost of revenue

     120        18        0.2        484        74        0.1  

Research and development

     166        26        0.3        220        34        0.0  

Sales and marketing

     74        11        0.1        950        146        0.2  

General and administrative

     2,664        409        4.6        15,134        2,326        2.9  

 

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(2) We recognized share-based compensation expenses of RMB0.4 million (US$0.1 million) and RMB3.4 million (US$0.5 million) in 2016 and 2017, respectively.

Year Ended December 31, 2017 Compared to Year Ended December 31, 2016

Revenues. Our net revenues increased from RMB58.0 million (US$8.9 million) in 2016 to RMB517.1 million (US$79.5 million) in 2017 primarily due to an increase in our advertising revenue from RMB57.9 million (US$8.9 million) in 2016 to RMB512.9 million (US$78.8 million) and an increase in our other revenue from RMB74.0 thousand (US$11.3 thousand) in 2016 to RMB4.2 million (US$0.6 million) in 2017. Increases in our advertising revenue and other revenue were a result of increases in our MAUs, DAUs and our ability to monetize. This has enabled us to increase clicks on advertisements on our platform from approximately 162.9 million in 2016 to approximately 1,506.1 million in 2017. On the other hand, revenue per click, calculated as our advertising revenue divided by clicks on advertisements on our platform, decreased from approximately RMB0.36 (US$0.05) in 2016 to approximately RMB0.34 (US$0.05) in 2017.

Cost of Revenues. Our cost of revenues increased from RMB7.2 million (US$1.1 million) in 2016 to RMB76.5 million (US$11.8 million) in 2017 primarily due to the continued growth of our business. Cost of revenues as a percentage of our net revenues increased from 12.4% in 2016 to 14.8% in 2017 primarily due to (i) increased content procurement costs in 2017 which we did not incur in 2016 as we primarily sourced content from publicly available sources at that time, and (ii) increased salaries and benefits paid associated with an increase in the number of employees responsible for content management in 2017.

Gross Profit. Our gross profit increased from RMB50.8 million (US$7.8 million) in 2016 to RMB440.6 million (US$67.7 million) in 2017. Gross margin decreased from 87.6% in 2016 to 85.2% in 2017.

Operating Expenses. Our total operating expenses increased from RMB61.7 million (US$9.5 million) in 2016 to RMB536.0 million (US$82.4 million) in 2017.

 

    Research and development. Our research and development expenses increased from RMB2.6 million (US$0.4 million) in 2016 to RMB15.3 million (US$2.4 million) in 2017. The increase was primarily due to the continued growth of our business. Research and development expenses as a percentage of our net revenues decreased from 4.5% in 2016 to 3.0% in 2017.

 

    Sales and marketing. Our sales and marketing expenses increased from RMB54.6 million (US$8.4 million) in 2016 to RMB494.7 million (US$76.0 million) in 2017. This was primarily due to increase in cost of users’ rewards associated with our user loyalty programs from RMB50.9 million (US$7.8 million) in 2016 to RMB419.6 million (US$64.5 million) in 2017, representing 87.8% and 81.2% of our net revenues in 2016 and 2017, respectively. Decrease in cost of users’ rewards as a percentage of our net revenues was primarily due to enhanced efficiency in acquiring and engaging users through our user loyalty programs and the increase in our ability to monetize our user base. Increase in our sales and marketing expenses was also due to increase in advertising and marketing expenses to promote brand awareness from RMB171.5 thousand (US$26.4 thousand) in 2016 to RMB41.9 million (US$6.4 million) in 2017, representing 0.3% and 8.1% of our net revenues in 2016 and 2017, respectively. The result of the foregoing contributed to an increase in sales and marketing expenses as a percentage of our net revenues from 94.3% in 2016 to 95.7% in 2017.

 

    General and administrative. Our general and administrative expenses increased from RMB4.4 million (US$0.7 million) in 2016 to RMB25.9 million (US$4.0 million) in 2017. The increase was primarily due to continued growth of our business. General and administrative expenses as a percentage of our net revenues decreased from 7.6% in 2016 to 5.0% in 2017.

Interest income. Our interest income increased from RMB50.8 thousand (US$7.8 thousand) in 2016 to RMB0.7 million (US$0.1 million) in 2017, primarily due to an increase in the average amount of our cash and cash equivalents in 2017 as compared to 2016.

Income tax expenses. We did not incur any income tax expenses in either of 2016 or 2017 due to tax loss status.

 

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Net loss. As a result of the foregoing, our net loss increased from RMB10.9 million (US$1.7 million) in 2016 to RMB94.8 million (US$14.6 million) in 2017.

Liquidity and Capital Resources

Our primary sources of liquidity have been issuance of equity securities and cash provided by operating activities, which have historically been sufficient to meet our working capital and capital expenditure requirements.

In 2016 and 2017, net cash provided by operating activities was RMB12.7 million (US$2.0 million) and RMB132.2 million (US$20.3 million), respectively.

As of December 31, 2017, we had cash and cash equivalents of approximately RMB278.5 million (US$42.8 million), as compared to cash and cash equivalents of approximately RMB268.6 thousand (US$41.2 thousand) as of December 31, 2016.

Through our user loyalty programs, we give users rewards and in certain cases cash credits for taking specific actions. We record registered users’ loyalty payable and accrued liabilities related to users’ loyalty programs on our consolidated balance sheets. For further information, see “— Critical Accounting Policies, Judgments and Estimates — Loyalty Programs.” Registered users’ loyalty payable was RMB1.0 million (US$0.2 million) and RMB21.0 million (US$3.2 million) as of December 31, 2016 and 2017, respectively. Accrued liabilities related to users’ loyalty programs were RMB24.5 million (US$3.8 million) and RMB187.0 million (US$28.7 million) as of December 31, 2016 and 2017, respectively.

We believe that our existing cash and cash equivalents and anticipated cash flows from operating activities will be sufficient to meet our anticipated working capital requirements, including liabilities related to our user loyalty programs, and capital expenditures in the ordinary course of business for the next 12 months from the completion of this offering. We may, however, need additional cash resources in the future if we experience changes in business condition or other developments, or if we find and wish to pursue opportunities for investments, acquisitions, capital expenditures or similar actions. If we determine that our cash requirements exceed the amount of cash and cash equivalents we have on hand at the time, we may seek to issue equity or debt securities or obtain credit facilities. The issuance and sale of additional equity would result in further dilution to our shareholders. The incurrence of indebtedness would result in increased fixed obligations and could result in operating covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all.

Our ability to manage our working capital, including receivables and other assets and liabilities and accrued liabilities, may materially affect our financial condition and results of operations.

 

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The following table sets forth a summary of our cash flows for the periods indicated:

 

     Year Ended December 31,  
     2016      2017  
     RMB      US$      RMB      US$  
     (in thousands)  

Selected Consolidated Cash Flows Data:

           

Net cash provided by operating activities

     12,719        1,955        132,226        20,323  

Net cash used in investing activities

     (12,523      (1,925      (121,919      (18,738

Net cash provided by financing activities

     —          —          272,121        41,824  

Net increase in cash and cash equivalents

     196        30        282,428        43,409  

Effect of exchange rate changes on cash and cash equivalents

     —          —          (4,239      (652

Cash and cash equivalents at beginning of the year

     73        11        269        41  

Cash and cash equivalents at the end of the year

     269        41        278,458        42,798  

Operating Activities

Net cash provided by operating activities was RMB132.2 million (US$20.3 million) in 2017, primarily due to net loss of RMB94.8 million (US$14.6 million), adjusted for (i) share-based compensation of RMB3.4 million (US$0.5 million) and (ii) depreciation of RMB0.3 million (US$51 thousand) and (iii) changes in working capital. Adjustment for changes in working capital primarily consisted of (i) an increase in accrued liabilities related to user loyalty programs of RMB162.5 million (US$25.0 million) due to our continued efforts to increase user acquisition and engagement, (ii) an increase in advances from advertising customers of RMB39.1 million (US$6.0 million) due to an increase in advance payment by advertising customers for our advertising solution, (iii) an increase in registered users’ loyalty payable of RMB20.0 million (US$3.1 million), (iv) an increase in tax payable of RMB19.9 million (US$3.1 million) and (v) an increase in accrued liabilities and other current liabilities of RMB19.3 million (US$3.0 million), which was partially offset by (i) an increase in accounts receivables of RMB32.1 million (US$4.9 million) relating to the continued growth of our advertising services and (ii) an increase in prepayments and other current assets of RMB13.8 million (US$2.1 million).

Net cash provided by operating activities was RMB12.7 million (US$2.0 million) in 2016, primarily due to net loss of RMB10.9 million (US$1.7 million), adjusted for (i) share-based compensation of RMB0.4 million (US$0.1 million) and (ii) depreciation of RMB21 thousand (US$3.3 thousand) and (iii) changes in working capital. Adjustment for changes in working capital primarily consisted of (i) an increase in accrued liabilities related to user loyalty programs of RMB24.5 million (US$3.8 million) and (ii) an increase in accounts payable of RMB5.1 million (US$0.8 million), which was partially offset by (i) an increase in accounts receivables of RMB9.7 million (US$1.5 million) and (ii) an increase in amounts due from a related party of RMB5.0 million (US$0.8 million).

Investing Activities

Net cash used in investing activities was RMB121.9 million (US$18.7 million) in 2017, which was primarily attributable to (i) purchase of short-term investments of RMB539.4 million (US$82.9 million) in time deposits and money market funds and (ii) purchase of property and equipment and intangible assets of RMB4.5 million (US$0.7 million), which was partially offset by proceeds from maturity of short-term investments of RMB422.0 million (US$64.9 million).

Net cash used in investing activities was RMB12.5 million (US$1.9 million) in 2016, which was primarily attributable to purchase of short-term investments of RMB45.3 million (US$7.0 million), which was partially offset by proceeds from maturity of short-term investments of RMB32.9 million (US$5.1 million).

 

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Financing Activities

Net cash provided by financing activities was RMB272.1 million (US$41.8 million) in 2017, which was primarily attributable to proceeds from the issuance of series A and series A-1 convertible redeemable preferable shares, net of issuance costs.

We did not have any cash provided by or used in financing activities in 2016.

Capital Expenditures

We made capital expenditures of RMB4.5 million (US$0.7 million) in 2017. Our capital expenditures were mainly used for purchases of property and equipment. We will continue to make capital expenditures to meet the expected growth of our business.

Commitments

The following table sets forth our contractual obligations as of December 31, 2017:

 

     Payment due by period  
     Total      Less than
1 Year
     1 – 3 Years      3 – 5 Years      More than
5 Years
 
     RMB      US$      RMB  
     (in thousands)  

Operating lease commitments

     16,504        2,537        8,582        7,922        —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     16,504        2,537        8,528        7,922        —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Off-balance Sheet Arrangements

We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder’s equity, or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

Holding Company Structure

Qtech Ltd. is a holding company with no material operations of its own. We conduct our operations through our subsidiaries, consolidated VIE and its subsidiaries in China. As a result, Qtech Ltd.’s ability to pay dividends depends upon dividends paid by our PRC subsidiaries. If our existing PRC subsidiaries or any newly formed ones incur debt on their own behalf in the future, the instruments governing their debt may restrict their ability to pay dividends to us. In addition, our wholly foreign-owned subsidiary in China is permitted to pay dividends to us only out of its retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Under PRC law, each of our subsidiaries, our consolidated VIE and its subsidiaries in China are required to set aside at least 10% of its after-tax profits each year, if any, to fund certain statutory reserve funds until such reserve funds reach 50% of its registered capital. In addition, our wholly foreign-owned subsidiary in China may allocate a portion of its after-tax profits based on PRC accounting standards to enterprise expansion funds and staff bonus and welfare funds at its discretion, and our consolidated VIE and its subsidiaries may allocate a portion of its after-tax profits based on PRC accounting standards to a discretionary surplus fund at their discretion. The statutory reserve funds and the discretionary funds are not distributable as cash dividends. Remittance of dividends by a wholly foreign-owned company out of China is subject to examination by the banks designated by SAFE. Our PRC subsidiaries have not paid dividends and will not be able to pay dividends until they generate accumulated profits and meet the requirements for statutory reserve funds.

 

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Inflation

Since inception, inflation in China has not materially affected our results of operations. According to the National Bureau of Statistics of China, the year-over-year percent changes in the consumer price index for December 2015, December 2016 and September 2017 were increases of 1.6%, 1.9% and 1.6%, respectively. Although we have not been materially affected by inflation in the past, we may be affected if China experiences higher rates of inflation in the future.

Quantitative and Qualitative Disclosures about Market Risk

Foreign Exchange Risk

Substantially all of our revenues and substantially all of our expenses are denominated in Renminbi. The functional currency of our company and our Hong Kong subsidiary is the U.S. dollar. The functional currency of our subsidiaries in the PRC, the consolidated VIE and its subsidiaries is the Renminbi. We use Renminbi as our reporting currency. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency at the rates of exchange ruling at the balance sheet date. Transactions in currencies other than the functional currency during the year are converted into functional currency at the applicable rates of exchange prevailing when the transactions occurred. Transaction gains and losses are recognized in the statements of operations. We do not have a foreign currency translation adjustment, net, in 2016 but recorded a gain in foreign currency translation adjustment, net, of RMB25 thousand (US$4 thousand) in 2017.

We do not believe that we currently have any significant direct foreign exchange risk and have not used any derivative financial instruments to hedge exposure to such risk. Although in general our exposure to foreign exchange risks should be limited, the value of your investment in our ADSs will be affected by the exchange rate between the U.S. dollar and the Renminbi because the value of our business is effectively denominated in Renminbi, while our ADSs will be traded in U.S. dollars.

The conversion of Renminbi into foreign currencies, including U.S. dollars, is based on rates set by the PBOC. The PRC government allowed the Renminbi to appreciate by more than 20% against the U.S. dollar between July 2005 and July 2008. Between July 2008 and June 2010, the exchange rate between the Renminbi and the U.S. dollar had been stable and traded within a narrow band. Since June 2010, the Renminbi has fluctuated against the U.S. dollar, at times significantly and unpredictably. On November 30, 2015, the Executive Board of the International Monetary Fund (IMF) completed the regular five-year review of the basket of currencies that make up the Special Drawing Right, or the SDR, and decided that with effect from October 1, 2016, Renminbi is determined to be a freely usable currency and will be included in the SDR basket as a fifth currency, along with the U.S. dollar, the Euro, the Japanese yen and the British pound. In the fourth quarter of 2016, the Renminbi has depreciated significantly in the backdrop of a surging U.S. dollar and persistent capital outflows of China. With the development of the foreign exchange market and progress towards interest rate liberalization and Renminbi internationalization, the PRC government may in the future announce further changes to the exchange rate system, and we cannot assure you that the 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 the Renminbi and the U.S. dollar in the future.

To the extent that we need to convert U.S. dollars into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we receive from the conversion. Conversely, if we decide to convert Renminbi into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amounts available to us.

We estimate that we will receive net proceeds of approximately US$                 million from this offering if the underwriters do not exercise their option to purchase additional ADSs, after deducting underwriting discounts

 

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and commissions and the estimated offering expenses payable by us, based on the initial offering price of US$                 per ADS, the mid-point of the estimated range of the initial public offering price. Assuming that we convert the full amount of the net proceeds from this offering into Renminbi, a 10% appreciation of the U.S. dollar against the Renminbi, from the exchange rate of RMB                 for US$1.00 as of                 , 2018 to a rate of RMB                 to US$1.00, will result in an increase of RMB                 million in our net proceeds from this offering. Conversely, a 10% depreciation of the U.S. dollar against the Renminbi, from the exchange rate of RMB                 for US$1.00 as of                 , 2018 to a rate of RMB                 to US$1.00, will result in a decrease of RMB                 million in our net proceeds from this offering.

Interest Rate Risk

We have not been exposed to material risks due to changes in market interest rates, and we have not used any derivative financial instruments to manage our interest risk exposure. However, we cannot provide assurance that we will not be exposed to material risks due to changes in market interest rate in the future.

After the completion of this offering, we may invest the net proceeds we receive from the offering in interest-earning instruments. Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board, or FASB, issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”, a new standard on revenue which will supersede the revenue recognition requirements in ASC 605. The new standard, as amended, sets forth a single comprehensive model for recognizing and reporting revenues. The new guidance requires us to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new guidance requires us to apply the following steps: (1) identify the contract with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, we satisfy a performance obligation. The standard also requires additional financial statement disclosures that will enable users to understand the nature, amount, timing and uncertainty of revenues and cash flows relating to customer contracts. The standard is effective for us for fiscal years, and interim periods within those years, beginning on or after January 1, 2018. Early adoption is permitted but not before the original effective date of January 1, 2017. We have adopted the standard using the full retrospective method.

In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments — Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”). The main objective of this update is to enhance the reporting model for financial instruments to provide users of financial statements with more decision-useful information. ASU 2016-01 changes how entities measure certain equity investments and present changes in the fair value of financial liabilities measured under the fair value option that are attributable to their own credit. The guidance also changes certain disclosure requirements and other aspects of current U.S. GAAP. ASU 2016-01 is effective for annual reporting periods, and interim periods within those years beginning after December 15, 2017. Early adoption by public entities is permitted only for certain provisions. We will adopt ASU 2016-01 in the first quarter of year 2018 and does not believe the adoption will have material impact on our consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases” (“ASU 2016-02”). Under the new guidance, lessees will be required to recognize a lease liability and a lease asset for all leases, including operating leases, with a term greater than 12 months on its balance sheet. The update also expands the required quantitative and qualitative disclosures surrounding leases. This update is effective for fiscal years beginning after

 

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December 15, 2018 and interim periods within those fiscal years, with earlier application permitted. We expect to adopt the new standard in the first quarter of 2019 on a modified retrospective basis and is currently in the process of evaluating the impact of ASU 2016-02 on our consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments — Credit Losses” (“ASU 2016-13”), which introduces new guidance for credit losses on instruments within its scope. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments, including, but not limited to, trade and other receivables, held-to-maturity debt securities, loans and net investments in leases. The new guidance also modifies the impairment model for available-for-sale debt securities and requires the entities to determine whether all or a portion of the unrealized loss on an available-for-sale debt security is a credit loss. The standard also indicates that entities may not use the length of time a security has been in an unrealized loss position as a factor in concluding whether a credit loss exists. The ASU is effective for public companies for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted for all entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We are in the process of evaluating the impact of ASU 2016-13 on our consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230), a consensus of the FASB’s Emerging Issues Task Force” (“ASU 2016-15”). The new guidance is intended to reduce the diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The ASU is effective for public companies for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including interim periods within those fiscal years. An entity that elects early adoption must adopt all of the amendments in the same period. The guidance requires application using a retrospective transition method. We have early adopted ASU 2016-15 in the current year and the adoption had no material impact on our consolidated financial statements.

In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows” (“ASU 2016-18”). This ASU affects all entities that have restricted cash or restricted cash equivalents and are required to present a statement of cash flows under Topic 230. ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. This update will become effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019, and early adoption is permitted in any interim or annual period. We have early adopted ASU 2016-18 in the current year and the adoption had no material impact on our consolidated financial statements.

In May 2017, the FASB issued ASU No. 2017-09, “Compensation — Stock compensation (Topic 718): Scope of modification accounting” (“ASU 2017-09”), which clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. ASU 2017-09 is effective prospectively for all companies for annual periods beginning on or after December 15, 2017, and early adoption is permitted. We have early adopted ASU 2017-05 in the current year and the adoption had no material impact on our consolidated financial statements.

 

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INDUSTRY OVERVIEW

Growth of Mobile Internet Market in China

The mobile Internet population in China has experienced substantial growth. According to the Analysys Report, the number of mobile Internet users in China grew from 652.0 million in 2013 to 970.6 million in 2017, representing a CAGR of 10.5%, and is projected to further increase to 1,104.2 million in 2020, representing a CAGR of 4.4%.

Mobile Internet Users in China

 

LOGO

 

(1) Calculated as the number of mobile Internet users as percentage of total population.

Source: The Analysys Report

According to the Analysys Report, as of December 31, 2017, the number of mobile Internet users in tier-3 and below cities reached 495.8 million, representing 51.1% of the total number of mobile Internet users in China. The number of mobile Internet users in tier-3 and below cities has grown and is expected to continue to grow at a faster rate than those in tier-1 and tier-2 cities. This growth is largely attributable to the relatively low mobile Internet penetration rate in China’s tier-3 and below cities.

Mobile Internet Users by City Tiers in China

 

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Source: The Analysys Report

 

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According to the Analysys Report, mobile Internet users in tier-3 and below cities typically live a slower pace of life and have lower financial pressures, rapidly increasing disposable income, limited access to traditional offline entertainment venues and closed social circles, as compared to users from tier-1 and tier-2 cities. This has resulted in such users’ high propensity to spend on entertainment, especially on mobile entertainment, according to the Analysys Report.

China Mobile Content Feed Platform Market

As the capabilities of mobile devices and speed of mobile networks have continued to improve, mobile devices have become the primary channel for many in China to access Internet content. However, early mobile content applications were often designed and premised upon personal computer programs or websites, which led to suboptimal experience on mobile devices. The ubiquitous nature of mobile Internet also means users need short content during brief and fragmented moments of personal time when they are otherwise idle. Lastly, the explosion in the volume and diversity of content available on the Internet calls for services that discover and deliver relevant content to users.

Mobile content feed platforms emerged as an answer to these needs. A mobile content feed application typically employs a single-column, “waterfall” like presentation with endless streams of consecutive content. This presentation is particularly suitable for mobile devices because the user interface is intuitive and designed to conveniently access and view short content during brief and fragmented time periods. Mobile content feed platforms often leverage artificial intelligence to recommend content to users based on their profiles and behaviors, fulfilling the need for personalized content.

These features contributed to the rapid growth and popularity of mobile content feed platforms. Formation of the value chain associated with such platforms has also progressed rapidly. Given the need for personalized content, many mobile content feed platforms have developed the ability to analyze and understand users’ behaviors. Such capabilities enable these platforms to provide targeted and effective advertising solutions, creating significant monetization opportunities. On the content supply side, mobile content feed platforms source content from traditional and Internet media outlets, freelancers as well as users, and these content providers are compensated based on content views relating to the content they have contributed, forming an inter-dependent relationship.

After years of evolution, mobile content feed platforms can be roughly divided into three main categories: content aggregators, short video platforms and news portals.

Content Aggregators

As forerunners of the mobile content feed platform market in China, content aggregators utilize content recommendation technology powered by big data and artificial intelligence to deliver personalized content to users. Instead of producing content in-house, content aggregators source content from third parties and distribute such content to users based on their profiles and behaviors. According to the Analysys Report, MAUs and average DAUs of China’s content aggregators increased by 58.4% and 55.4%, respectively, from 194.7 million and 90.5 million in December 2016, respectively, to 308.3 million and 140.6 million in December 2017, respectively. Content aggregators were able to enjoy significant growth due to the overwhelmingly massive amount of content that is available and users’ desire to quickly discover and access content that interests them, especially content that can satisfy their niche interests.

 

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The below table sets forth information as to the competitive landscape of China’s content aggregator market.

For the Month of December 2017

 

Content Aggregator

   Monthly
Penetration
Rate(1)
    Ranking      Daily
Penetration
Rate(2)
    Ranking      Average Number of
Mobile Application
Launches

per User per Day
     Ranking  

Jinritoutiao

     23.93     1        17.24     1        8.06        1  

Tiantiankuaibao

     5.42     2        3.81     2        4.23        4  

Qutoutiao

     3.52     3        2.16     3        6.46        2  

Yidianzixun

     1.80     4        1.00     4        6.13        3  

Top Ten News

     0.33     5        0.09     5        3.72        5  

 

Source: The Analysys Report

Notes:
(1) Calculated as the content aggregator’s MAUs as a percentage of overall mobile Internet MAUs.
(2) Calculated as the content aggregator’s average DAUs as a percentage of overall mobile Internet average DAUs.

As China’s mobile aggregator market is new and evolving, information regarding the market, our competitors and their respective market position involves a number of assumptions, estimates and limitations. We have not independently verified the accuracy or incompleteness of the data contained in the table above.

According to the Analysys Report, the current and expected trends and growth drivers in China’s content aggregator market include:

 

    Popularity of short videos. Content aggregators started out by distributing articles and pictures only. Most of them have started to distribute, and increased the proportion of, short videos due to the popularity of such content format among users.

 

    Inclination towards user-generated content. Content aggregators previously shifted their content sources slowly from professional media publishers to freelancers, and now are shifting towards content generated by users. User-generated content has demonstrated ability to enhance stickiness and social connection among users and has become increasingly popular.

 

    Demand for entertainment content. Most content aggregators initially distributed news only, but they have started to distribute an increasing proportion of entertainment content to meet users’ demand for easy-to-digest content during brief and fragmented time periods.

 

    Penetration into tier-3 and below cities. Given saturation of the content aggregator market in tier-1 and tier-2 cities, tier-3 and below cities are becoming an important growth driver.

Short Video Platforms

Short video platforms focus purely on videos as compared to content aggregators and news portals, which provide content in multiple formats. Short videos are typically less than five minutes in length and require shorter time commitments in creation and consumption. Short videos also require lower bandwidth compared to longer video formats. Popularity of short videos among mobile users have increased significantly in 2017. According to the Analysys Report, MAUs and average DAUs of China’s short video platforms increased by 169.5% and 90.3%, respectively, from 163.0 million and 46.2 million in December 2016, respectively, to 439.3 million and 87.8 million in December 2017, respectively.

China News Portal Market

News portals are the mobile equivalent to traditional web portals and most such mobile applications originated from web portal companies. News portals originally produced their content in-house, and later

 

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supplemented their in-house content with third-party content. Content recommendations on news portals are also increasingly conducted automatically with the aid of algorithms, rather than manually by editors. According to the Analysys Report, MAUs and average DAUs of China’s news portals increased by 33.2% and 10.0%, respectively, from 280.1 million and 125.4 million in December 2016, respectively, to 373.2 million and 138.0 million in December 2017, respectively. According to the Analysys Report, news portals are expected to face continued fierce competitive pressure from content aggregators and short video platforms, and their user growth is expected to lag behind the overall growth rate of the mobile content feed platform market.

Monetization Opportunities for Content Aggregators

The size of the mobile Internet advertising market in China grew from RMB13.4 billion in 2013 to RMB247.1 billion in 2017, representing a CAGR of 107.1%, and is projected to further increase to RMB407.8 billion in 2020, representing a CAGR of 18.2%, according to the Analysys Report.

Mobile Internet Advertising Market Size in China

 

LOGO

 

Source: The Analysys Report

According to the Analysys Report, the size of the content aggregator market in China grew from RMB0.2 billion in 2013 to RMB26.2 billion in 2017, representing a CAGR of 221.8%, and is projected to further increase to RMB56.5 billion in 2020, representing a CAGR of 29.2%, offering significant opportunity for growth.

 

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Content Aggregator Market Size in China

 

LOGO

 

Source: The Analysys Report

In addition to advertising, content aggregators have other significant monetization opportunities, including mobile entertainment. Spending on education, culture and entertainment is growing rapidly in China, and has increased from approximately 10.6% of per capita total consumption expenditure in 2013 to 11.4% in 2017. The size of the mobile entertainment market in China grew from RMB23.7 billion in 2013 to RMB120.6 billion in 2016, representing a CAGR of 71.9%, and is projected to further increase to RMB234.4 billion in 2020, representing a CAGR of 18.1%, according to the Analysys Report. As content aggregators continue to expand their content offerings, they will be able to leverage on their understanding of users’ behaviors to offer content and other products and services that will capture the entertainment spending of users.

 

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BUSINESS

Overview

We deliver fun and personalized content to mobile users in China.

Our flagship mobile application, Qutoutiao, meaning “fun headlines” in Chinese, aggregates articles and short videos uploaded onto our platform and presents customized feeds to users based on each user’s profile, behavior and social relationships. These feeds are optimized in real time through our proprietary machine learning algorithm as we gain new insights into each user. Covering a broad range of interests, Qutoutiao is focused on humor, stories and other light entertainment content that delight and inspire. In addition to articles and short videos, we plan to diversify our content offerings into literatures, games, live streaming, animations and comics, creating a comprehensive light entertainment content ecosystem.

Qutoutiao has rapidly gained popularity since its launch in June 2016. Qutoutiao had approximately 24.2 million average MAUs and 9.5 million average DAUs in the three months ended December 31, 2017. Qutoutiao ranks third among all mobile content aggregators in China in terms of both monthly penetration rate and daily penetration rate in December 2017, according to the Analysys Report.

We strategically target users from tier-3 and below cities in China because of the enormous opportunities in this underserved market. More than half of China’s mobile Internet users live in tier-3 and below cities but mobile Internet penetration rate in these cities is still relatively low, according to the Analysys Report. Such users are typically faced with lower financial pressures and generally have a slower pace of life. Moreover, they have fast increasing disposable income and high propensity to spend on mobile Internet entertainment. These factors contribute to a significant need for entertainment content while also create strong monetization potential. Users from tier-3 and below cities also tend to have different interests and preferences than users from tier-1 and tier-2 cities. We believe our experience with these users has enabled us to gain a significant understanding of their entertainment needs. Qutoutiao’s light entertainment-oriented and easily digestible content is designed to resonate with such users and provides us with a significant advantage to capture this underserved market.

Our rapid growth since the launch of Qutoutiao was also in large part due to our innovative user account system and gamified user loyalty program. We believe we are a pioneer in the mobile content feed industry in applying such loyalty program. Registered users can earn rewards by referring new users to register on Qutoutiao or by viewing content or engaging in other activities on Qutoutiao. Although rewards only translate into trivial monetary amounts, we believe they nurture users’ competitive psyche and emotional connection to Qutoutiao. The loyalty programs create a strong viral effect, which we believe enables us to enjoy lower user acquisition cost compared to acquiring users through online advertising. Users on Qutoutiao also remain highly engaged through our differentiated and extensive content capable of capturing their various niche interests coupled with gamified experience. In addition, almost all users remain logged on to their accounts while accessing Qutoutiao, enabling us to better understand their behaviors.

We strive to provide quality and relevant content to our users by focusing on content sourcing and delivery. As of December 31, 2017, there were more than 126,000 content providers on Qutoutiao comprised of freelancers and professional media outlets. In December 2017, there were approximately 2.5 million content uploaded to Qutoutiao, out of which approximately 1.4 million were videos. We introduced a separate mobile application in May 2017 that allows users to produce and submit videos. Such user generated videos represented approximately 61.7% of all videos uploaded to Qutoutiao in December 2017 as compared to approximately 35.3% in June 2017.

We currently generate revenue primarily by providing advertising services. We plan to explore additional monetization opportunities as we grow our user base and introduce additional content formats, such as literatures, games and live streaming.

 

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Our net revenues have increased rapidly from RMB58.0 million (US$8.9 million) in 2016 to RMB517.1 million (US$79.5 million) in 2017. As we focused on growing our user base and enhancing our services, we have incurred net losses of RMB10.9 million (US$1.7 million) in 2016 and RMB94.8 million (US$14.6 million) in 2017.

Our Strengths

We believe our success to date is largely attributable to the following key competitive strengths.

Leading Mobile Content Aggregator

We operate a leading mobile platform that intelligently delivers personalized light entertainment content to users in China. As of December 31, 2017, Qutoutiao had approximately 72.8 million total registered users, representing more than six times increase from approximately 11.3 million as of December 31, 2016. Average MAUs for Qutoutiao reached approximately 24.2 million in the three months ended December 31, 2017, representing more than six times increase from average MAUs of approximately 3.9 million in the three months ended December 31, 2016. Average DAUs for Qutoutiao reached approximately 9.5 million in the three months ended December 31, 2017, representing more than six times increase from the average DAUs of approximately 1.5 million in the three months ended December 31, 2016. Qutoutiao ranks third among all mobile content aggregators in China in terms of both monthly penetration rate and daily penetration rate in December 2017, according to the Analysys Report.

We strategically target users from tier-3 and below cities in China. According to the Analysys Report, the number of mobile Internet users in tier-3 and below cities has grown and is expected to continue to grow at a faster rate than those in tier-1 and tier-2 cities in China. By leveraging our market leadership and our platform’s light entertainment-oriented and easily digestible content, we believe that we are uniquely positioned to capture such opportunity in this enormous yet underserved market.

Effective User Acquisition Supported by Social-based User Loyalty Programs

We believe we are a pioneer in the mobile content feed industry in applying gamified user loyalty programs. We incentivize our users to voluntarily invite their families and friends to become our registered users by providing both existing and new registered users with rewards. Such word-of-mouth referral approach creates a strong viral effect, which we believe enables us to enjoy lower user acquisition cost compared to acquiring users through online advertising. Amongst our approximately 72.8 million registered users as of December 31, 2017, approximately 87% were referred by other registered users.

We believe as a first mover, we have established highly sophisticated programs refined through extensive experience that are difficult to successfully replicate. Our programs strike a careful balance between its efficacy in user acquisition and impeding those users that are merely registering on and referring our mobile applications to obtain rewards. Such programs also serve to imprint increased desire for users to further engage with our mobile applications after they become our registered users. We believe our user acquisition approach has enabled, and will continue to enable, us to effectively and efficiently strengthen our market presence and attract users.

Powerful Account System Driving High User Engagement

We enjoy high user engagement partly thanks to our user account system and gamified user experience. Users can earn rewards for viewing and sharing content, posting comments, as well as by engaging in various other activities, such as encouraging inactive users in their social circle to re-engage with Qutoutiao. We also create fun tasks such as daily missions to tap into the competitive reward psyche of users. Since rewards can only

 

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be earned while logged on, we enjoy high logged-on rate among our users, which was approximately 95.8% of DAUs on average in December 2017, compared to other mobile content feed platforms where many users are not registered or not logged on. This gives us the ability to track users’ long-term behaviors, based on which we can improve content recommendation and introduce new features and services effectively.

Our user account system also results in users becoming accustomed to spending cash credits in their accounts to purchase merchandise on our online marketplace, as well as linking their mobile payment accounts with Qutoutiao account. We believe such users are more inclined to supplement their spending on our platform with additional funds, creating enhanced monetization opportunities for content and other products and services we aim to provide in the future.

Differentiated and Extensive Content Offerings

We primarily focus on providing light entertainment content that will most resonate with our target users, who live in tier-3 and below cities in China. We provide content that covers topics such as entertainment, humor, anecdote, relationship, family, health, food and pets to capture the interests of our users. Such approach contrasts with many other content feed platforms in China that design their content for users from tier-1 and tier-2 cities and concentrate on current affairs such as political and economic news.

As of December 31, 2017, there were more than 126,000 content providers who actively upload content to Qutoutiao. They are comprised of a combination of freelancers and professional media outlets. In addition, the users of Quduopai also upload short videos onto our platform. This enables us to provide an extensive and comprehensive range of content, including long-tail content appealing to various niche interests of users, further spearing user engagement. Increased user engagement serve to further drive content providers to become even more active in uploading content, including more long-tail content, as well as attract even more content providers, creating a virtuous cycle.

Intelligent Content Delivery Supported by Data Capabilities

Our strong data analytics capabilities propelled by robust technology infrastructure have enabled us to effectively and efficiently discover and deliver content to users. Through the collection of an extensive amount of user data as to their profiles, behaviors and social relationships, we can develop a highly pertinent interest and social graphs for each user. Based on our deep understanding of users’ interests, we are able to continuously refine content feeds in real time to deliver content that is most likely of interest to each user, thereby increasing user stickiness. In the three months ended December 31, 2017, the average daily time spent per DAU reached approximately 32 minutes, an increase from approximately 29 minutes in the three months ended December 31, 2016. Our content recommendation engine is designed to understand users’ interests and recommend content to advance such interest or for users to discover innate interests that they may not have previously identified, rather than converge recommendation into a repeated static set of content with the same issues or topics based on similar content users already viewed. As our user base grows, increasingly larger volume of data will further augment the accuracy and capability of our content recommendation engine.

Visionary and Experienced Management Team

Our visionary and experienced management team has been essential in driving the growth of our business. Our co-founder and executive chairman, Mr. Eric Siliang Tan, together with our co-founder, director and chief executive officer, Mr. Lei Li, are the foundational pillars of our company and have delivered strong business results leveraging their over 20 years of combined Internet industry experience. Other members of our senior management team are also instrumental in growing our business with their proven track record in their areas of expertise. Co-founders and majority of the senior management team members have worked together previously, further enhancing the stability and consistency of our vision.

 

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Our Strategies

We aim to create a leading comprehensive light entertainment content ecosystem in China. To achieve this goal, we plan to pursue the following growth strategies.

Expand Our User Base

The entertainment needs of users from tier-3 and below cities in China represent enormous yet underserved opportunities, according to the Analysys Report. These users represent the largest yet underpenetrated mobile Internet user base in China with fast increasing disposable income and a high propensity to spend on entertainment. As such, we will continue to enhance our gamified referral-based viral user acquisition strategy focusing on users from tier-3 and below cities to rapidly grow our user base. Furthermore, we will adopt additional channels to acquire users and promote brand awareness, including through offline channels, and develop other measures to complement existing user acquisition efforts to penetrate additional market segments.

Strengthen Social Features and Promote User Generated Content

Social relationships of users have underpinned the rapid growth of our business and will continue to be critical going forward. We intend to develop additional social features and functions on our platform, such as content recommendation based on pages viewed by friends on the platform. We also plan to enhance the commenting and discussion features on our platform. Such efforts will enable us to further engage our users and create stronger social bonding and communications amongst them. In addition, we aim to promote our users to generate more short videos. This will serve not only as a supplementary content source to further increase content richness, but will also serve to enhance user interactions and stickiness.

Enrich Our Content Offerings

Our long-term goal is to build a comprehensive light entertainment ecosystem in China to fulfill users’ diversified entertainment needs. We aim to increase our content provider base, refine our content provider incentive system and optimize our content distribution algorithm. We will continue to improve the breadth and quality of short videos on our platform given videos’ increasingly popularity among our users. We will also enrich our content offerings by diversifying into literatures, games, live streaming, animations and comics to further enhance user experience and engagement.

Enhance Monetization Capabilities

We currently generate most of our revenues from advertising. We intend to enhance our advertising solutions by strengthening the performance of our proprietary programmatic advertising system. We believe our strategic move to reduce the utilization of third-party advertising platforms and focus on expanding our advertising customer base and advertising agents directly will further boost our advertising revenue.

We plan to capture additional monetization opportunities by introducing new content formats. These opportunities include paid content such as literatures, games, animation and comics, as well as content-driven e-commerce and live streaming products. In addition, we intend to increase the number of our paying users by raising their awareness of our paid content and other products and services.

Invest in Technology

Based on big data analysis of our extensive user information, including users’ social relationships, we will further enhance our content recommendation engine. We will also optimize our advertising solution by improving our real-time predictive click-through rate model and offering superior user targeting. In addition, we will focus on enhancing our content management and delivery capabilities through increasing adoption of artificial intelligence based technology and greater level of automation to achieve higher operational efficiency and scalability.

 

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Selectively Pursue Acquisition and Investment Opportunities

We plan to strengthen our platform around our light entertainment theme through selective strategic acquisitions and investments in the future. Such potential opportunities include those involving content, technology and other strategic resources to complement our platform that will provide users with an even greater entertainment experience. Moreover, we will leverage our large user base and the ecosystem surrounding our platform to cradle other complementary initiatives and mobile applications to foster our business expansion and enhance our competitiveness.

Our Mobile Applications

We primarily deliver content through Qutoutiao, which is our flagship mobile application and means “fun headlines” in Chinese. Qutoutiao aggregates articles and videos uploaded from content providers and presents real-time customized feeds to users based on each user’s profile, behavior and social relationships.

The table below sets forth key operating metrics relating to the Qutoutiao mobile application.

 

     For the Three Months Ended  
     September 30      December 31      March 31      June 30      September 30      December 30  
     2016      2017  
     (in millions, except for percentages and per user data)  

Registered users as of the end of the period

     4.6        11.3        17.8        28.0        46.8        72.8  

Average MAUs during the period

     1.7        3.9        5.7        8.8        16.0        24.2  

Average DAUs during the period

     0.5        1.5        2.5        3.9        6.4        9.5  

Average daily PVs during the period

     8.4        26.3        47.9        82.5        135.0        225.5  

Video PVs as a percentage of total PVs during the period (%)

     2.4        5.7        4.2        6.9        11.1        28.4  

Average daily time spent per DAU during the period (minutes)

     27.2        29.0        31.3        33.7        34.0        32.3  

Feeds are presented to users on both the main page of Qutoutiao and topic pages. Both the main page and topic pages are customized for each user using our content recommendation engine. Topic pages include, among others, videos, entertainment, humor, anecdote, relationship, family, health, food and pets. A user may also search content or follow specific content providers. Users may save their favorite content pages as well as indicate the content pages that they dislike.

We promote social interaction among users to engage them more closely with the content they have viewed as well as with each other. Users may post comments and engage in discussions with other users by responding to comments. A user can also share content through a variety of means, including emails, messaging applications or social networks.

We also offer Quduopai, which is a separate mobile application from Qutoutiao and allows users to create, upload and view videos. User generated videos can be viewed by other users of Quduopai after being screened by our content management system for quality and appropriateness. We also selectively deliver popular videos from Quduopai through Qutoutiao, which enables such videos to reach a broader audience and further enriches the content offerings on Qutoutiao.

Our mobile applications include an online marketplace which users can purchase merchandise offered by third-party merchandise suppliers. This allows us to enhance user stickiness and benefits users by enabling them to spend cash credits earned in their accounts, while also encourage users to supplement their spending on our platform with additional funds and thus creating additional monetization opportunities for us. We select

 

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competitively-priced merchandise that we expect will be of interest to our users based on users’ purchasing power and preferences. Each merchandise supplier is responsible for shipping the merchandise directly to users. Popular offerings on our platform include consumer electronics, home appliances, cosmetics and accessories.

User Account Systems and Loyalty Programs

Our rapid growth since the launch of Qutoutiao was in large part due to our innovative user account system and gamified user loyalty program. Registered users can earn rewards and in certain cases cash credits by referring other users to register on Qutoutiao or by engaging in various activities on Qutoutiao while logged on to their accounts.

Rewards are automatically exchanged into cash credits at the end of each day based on an exchange rate determined by us. As stated in our user agreement, we have the sole discretion in determining such exchange rate. A user can only withdraw cash credits from the user’s account after the balance exceeds a minimum amount, which is determined at our sole discretion and adjusted by us from time to time. We have implemented mechanisms aimed to determine if users actually viewed the relevant content and anti-fraud system to prevent potential abuse.

Referral-based Rewards

Our registered users earn rewards when they make referrals through a master-apprentice social feature in which a user, who is the master, invites others to download and register on our Qutoutiao mobile application, who will become such user’s apprentices. After an apprentice registers with us, the master is eligible to receive rewards or cash credits in installment based the apprentice’s continued activities on Qutoutiao. Based on our policy in the fourth quarter of 2017, referral reward is generally around RMB3 of cash credits (or equivalent rewards) per referral. The master may receive additional rewards if the apprentice remains active on our platform such as by viewing content. We are thus able to leverage the embedded social relationships of each user and prompt our users to voluntarily invite their families and friends to become our registered users. However, if an apprentice takes on his or her own apprentice, the master is not eligible to receive any rewards based on such further referrals.

Engagement-based Rewards

A user is eligible to receive rewards for engaging in various activities on our Qutoutiao mobile application. Such activities include viewing and sharing content, providing valuable comments and encourage inactive users to continuously re-engage with Qutoutiao. Based on our policy in the fourth quarter of 2017, a typical reward for viewing content translates into approximately RMB0.006 of cash credits per article or video. We also create fun tasks such as daily missions to tap into the competitive reward psyche of users.

User Account System and Loyalty Program for Quduopai

We offer a separate user account system and loyalty program for Quduopai. Users can earn cash credits that they can withdraw after the balance exceeds a minimum amount, which is determined at our sole discretion and adjusted by us from time to time. Users can also earn loyalty points, which can only be exchanged into coupons issued to us by a third-party that can then be used to purchase products or service on that third-party’s e-commerce website.

Our Content

We strive to become the light entertainment content platform of choice for more and more users. We believe that light entertainment-oriented and easily digestible content resonates with mobile users, and we primarily deliver content that can be viewed by users during a short period of time. The articles on our platform generally

 

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contain both images and short texts and can be read within one minute; and more than half of the videos on our platform run less than two minutes. Because of the short time required to view our content, users are likely to repeatedly visit our platform when they are looking for light entertainment. In the three months ended December 31, 2017, the average daily time spent per DAU on Qutoutiao was approximately 32 minutes. We aim to deliver quality and relevant content to users, and content sourcing, management and recommendation are among core focuses of our operations.

Content Sourcing

As of December 31, 2017, there were more than 126,000 content providers on Qutoutiao comprised of freelancers and professional media outlets. We operate an online content upload system and the Quduopai mobile application for content providers to prepare and upload content. Fees paid to content providers relates to the amount of views associated with such content.

A content provider that is new to our online content upload system is required to go through a registration and approval process. Each content provider is required to sign an agreement electronically in the registration process. The agreement provides, among other things, that (i) we are authorized to deliver content submitted by the content provider free of charge; (ii) the content provider acknowledges that it will not deliver illegal or inappropriate content through our platform; and (iii) we have the right to screen, sort and monitor content, and we may remove any illegal or inappropriate content without notifying the content provider. We have the right to freeze an account for any violations of the rules, such as plagiarism or submission of inappropriate content.

After its registration with us, a content provider can prepare and upload content electronically through the online content upload system. The system also allows each content provider to track its performance on a real-time basis, including information such as the number of views, comments, shares and saves for its content.

Quduopai is our mobile application which allows users to create, upload and view video content through their mobile phones. For further information, see “— Our Mobile Applications.” Since the introduction of Quduopai in May 2017, we have experienced a significant increase in user generated videos. User generated videos represented approximately 61.7% of all videos uploaded to Qutoutiao in December 2017 as compared to approximately 35.3% in June 2017.

Content Management

As a gatekeeper for our platform, our content management system is designed to ensure both the quality and appropriateness of information presented to users, which include content and comment postings. Content may be declined for quality reasons, such as videos or pictures of low resolution or duplicative content. We also decline content and comment postings that appear to violate relevant laws and regulations or are otherwise inappropriate for our platform. We undertake an efficient and thorough screening process that involves both algorithm-based screening and manual review. We have also implemented a complaint procedure that enables us to identify inappropriate content utilizing our users’ feedback.

 

    Algorithm-based Screening. We apply algorithms to screen texts as well as images and videos. Our system screens texts based on pre-set key words, and we utilize artificial intelligence to identify inappropriate images and videos. The screening system automatically declines content that did not meet the standards of our platform and flags suspicious content for manual review by our content management team.

 

    Manual Review. Our content management team, which consisted of 294 employees as of December 31, 2017, is responsible for monitoring all information before delivery through our platform. The content management team reviews suspicious content identified in the algorithm-based screening process and makes the final decision as to whether to decline such content. Given the complexity and diversity of information submitted to our platform, our content management team also reviews all content that were not earlier flagged in the algorithm-based screening process.

 

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    Complaint Procedure. A user may submit a complaint about a specific content through our mobile applications. The user is prompted to identify the basis for the complaint, such as duplication to pre-existing content, violation of law, factual mistake, low quality or plagiarism. The user also needs to provide a written commentary to support the complaint. We remove the relevant content if we conclude that the complaint is valid. In addition, while the complaint is under review, we may also temporarily block the relevant content from being further delivered until we can investigate the complaint and reach a conclusion.

Content Recommendation

Our platform intelligently delivers personalized light entertainment content to users. The content recommendation process involves the following components.

 

    Content Tagging. Each content piece is labeled with tags that are associated with its topics. Before submitting an article or video, the content provider may provide up to six tags. Such tags range from general topics such as “entertainment news” to specific topics such as the name of an actor. We utilize both algorithm-based screening and manual review to further refine such tags. Furthermore, our smart video tagging technology uses deep learning that further increases the accuracy of tags. Our technology also automatically selects and displays to users the most appropriate “cover images” for videos. We believe our technology greatly improves the quality and relevance of video content shown to our users, thereby enhancing user experience.

 

    Interest and Social Graphs. Through an automated process, we develop interest and social graphs for each user based on such person’s profile, behavior and social relationships. User’s behavior also provides us with a granular view of the topics and content characteristics that likely are of interest to the user. We assess the user’s desired content characteristics through technologies including natural language processing, image analysis, and content tagging. In addition, the interest and social graphs take into account the user’s social relationships with other users and such other users’ interests and behaviors.

 

    Recommendation. Our content recommendation engine suggests content based on each user’s interest and social graphs, and continuously receives behavioral data inputs to update and refine its recommendations in real time to identify content that is most likely of interest to each user.

Monetization

We place advertisements on our main pages, topic pages as well as content pages. We believe that our differentiated user base represents an attractive demographic target for businesses.

When we first commenced our business, we collaborated with various third-party advertising platforms to fill advertisement spaces on our mobile applications. We later engaged advertising agents to serve as our sales agents in selling our advertising solutions to other advertising agents and end advertisers. To enhance our platform’s monetization capabilities, we acquired an advertising agent in February 2018 that operates a programmatic advertising system. This system will serve to power our advertising solutions while reducing the use of third-party advertising platforms.

Our programmatic advertising system utilizes a bidding system for advertising customers to bid for targeted audience on our platform. Our programmatic advertising system considers a wide range of parameters to determine which advertisement to show, including price bid, predicted click-through rate and content relevance, to dynamically maximize our revenue potential. Our advertising technology aims to maximize our revenue potential by rewarding the more relevant advertisement with a more prominent position, despite the potentially lower price bid of such advertisement. We actively monitor the advertisements placed to help ensure their relevance.

 

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Customers for our programmatic advertising system are comprised of advertising agents and end advertisers. We have our own sales personnel who are responsible to support and monitor the performances of advertising agents and to attract advertising customers to use our programmatic advertising system directly. We enter into standard agreements with advertising agents generally for a term of one year. Our advertising agents are responsible for identifying end advertisers, confirming payments and setting up accounts on our programmatic advertising system for advertising customers. We provide ongoing trainings to advertising agents to familiarize them with the functionalities and capabilities of our programmatic advertising system. These advertising agents are responsible for collecting and submitting the relevant documentation and licenses from advertising customers for our approval to open an account on our programmatic advertising system, and are also liable for any infringement of third-party rights or violation of regulatory requirements caused by advertisements placed by their end advertisers.

Baidu, which is our largest customer and operates a third-party advertising platform, contributed 69.6% and 43.5% of our net revenues in 2016 and 2017, respectively. Baidu also accounted for 90.3% and 59.8% of our accounts receivable as of December 31, 2016 and 2017, respectively. We supply traffic to the customer’s platform through advertisements placed on our mobile applications. Baidu and us have entered into a membership registration agreement, which contains standard terms and conditions generally applicable to companies that utilize Baidu’s advertising platform. Pursuant to the agreement, we are required to comply with the relevant laws and regulations as well as Baidu’s guidelines for its platform participants, including prohibitions on fraudulent clicks and other improper means to generate online traffic. Baidu has the right to terminate the agreement at any time.

Through collaboration with third-party merchandise suppliers, Qutoutiao include an online marketplace which users can access and purchase merchandise offered by third-party merchandise suppliers. We do not carry any inventory, and each merchandise supplier is responsible for shipping the merchandise directly to users. A user pays the purchase price for a merchandise to us. We deduct our commission related to the merchandise and remit the remainder to the relevant merchandise supplier.

Technology

We have focused on and will continue to invest in our technological infrastructure. Our business is supported by the following key technologies.

 

    Interest and Social Graphing. Through an automated process, we develop interests and social graphs for each user based on such person’s profile, behavior and social relationships. We are able to gain a fairly accurate picture of a user’s profile, including age, gender and location, based on the user’s behavior on our platform. The user’s behavior also provides us with a granular view of the topics that likely are of interests to him or her. We assess the user’s desired content characteristics through technologies including natural language processing, image analysis, and content tagging. The interest and social graphs take into account the user’s social relationships with other users and such other users’ interests, including their behaviors. We continuously refine each user’s graphs based on the user’s behavior over time through artificial intelligence.

 

    Content Recommendation Engine. Our content recommendation engine recommends content based on user behavior, and continuously receives behavioral data inputs to update and refine its recommendations in real time to identify content that is most likely of interest to each user. Our content recommendation engine is capable of processing large quantities of data, and currently can handle several billion inputs per day. In addition, new content is aggregated and recommended in real time from among millions of new content added, ensuring that our users will not miss content that may interest them when they next update their view in our mobile application.

 

   

Advertising. Our advertising technology enables advertising customers to bid for audience and automatically deliver relevant, targeted promotional links to users. Our system rewards the more relevant advertisement with a more prominent position, despite the potentially lower price bid of such advertisement. Our audience segmentation technology helps ensure the relevance of advertisements