Form 20-F
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 20-F

 

 

(Mark One)

¨ REGISTRATION STATEMENT PURSUANT TO SECTION 12(B) OR 12(G) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2015.

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

¨ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report                     

For the transition period from                      to                     

Commission file number: 001-35145

 

 

NQ MOBILE INC.

(Exact name of Registrant as specified in its charter)

 

 

N/A

(Translation of Registrant’s name into English)

Cayman Islands

(Jurisdiction of incorporation or organization)

No. 4 Building, 11 Heping Li East Street

Dongcheng District, Beijing 100013

The People’s Republic of China

(Address of principal executive office)

Roland Wu, Chief Financial Officer

Tel: +86 (10) 8565-5555

E-mail: roland@nq.com

Fax: +86 (10) 8565-5518

No. 4 Building

11 Heping Li East Street

Dongcheng District

Beijing 100013

The People’s Republic of China

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Exchange on Which Registered

Class A common shares, par value US$0.0001 per share   New York Stock Exchange*

 

* Not for trading, but only in connection with the listing on New York Stock Exchange of the American depositary shares, or the ADSs. Currently, one ADS represents five Class A common shares.

 

 

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None

(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

(Title of Class)

 

 

Indicate the number of outstanding shares of each of the Issuer’s classes of capital or common stock as of the close of the period covered by the annual report. 408,985,937 Class A common shares (excluding 13,516,810 Class A common shares represented by ADSs that are reserved for issuance upon the exercise of outstanding options and 892,495 Class A common shares represented by ADSs that have been repurchased but not cancelled), par value US$0.0001 per share, and 50,352,971 Class B common shares, par value US$0.0001 per share, as of December 31, 2015.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934    Yes  ¨    No  x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ¨   Accelerated filer  x   Non-accelerated filer  ¨

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP  x   

International Financial Reporting Standards as issued

by the International Accounting Standards Board  ¨

   Other  ¨

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.    Item 17  ¨    Item 18  ¨

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  ¨    No  ¨

 

 

 

 


Table of Contents

TABLE OF CONTENTS

 

INTRODUCTION

     1   

FORWARD-LOOKING STATEMENTS

     2   

PART I

     2   
  ITEM 1.   

IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS

     2   
  ITEM 2.   

OFFER STATISTICS AND EXPECTED TIMETABLE

     2   
  ITEM 3.   

KEY INFORMATION

     3   
  ITEM 4.   

INFORMATION ON THE COMPANY

     43   
  ITEM 4A.   

UNRESOLVED STAFF COMMENTS

     67   
  ITEM 5.   

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

     68   
  ITEM 6.   

DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

     97   
  ITEM 7.   

MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

     108   
  ITEM 8.   

FINANCIAL INFORMATION

     111   
  ITEM 9.   

THE OFFER AND LISTING

     114   
  ITEM 10.   

ADDITIONAL INFORMATION

     116   
  ITEM 11.   

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     129   
  ITEM 12.   

DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

     130   

PART II

     133   
  ITEM 13.   

DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

     133   
  ITEM 14.   

MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

     133   
  ITEM 15.   

CONTROLS AND PROCEDURES

     133   
  ITEM 16.   

[RESERVED]

     135   
  ITEM 16A.   

AUDIT COMMITTEE FINANCIAL EXPERT

     135   
  ITEM 16B.   

CODE OF ETHICS

     135   
  ITEM 16C.   

PRINCIPAL ACCOUNTANT FEES AND SERVICES

     135   
  ITEM 16D.   

EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

     136   
  ITEM 16E.   

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

     136   
  ITEM 16F.   

CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

     136   
  ITEM 16G.   

CORPORATE GOVERNANCE

     136   
  ITEM 16H.   

MINE SAFETY DISCLOSURE

     137   

PART III

     138   
  ITEM 17.   

FINANCIAL STATEMENTS

     138   
  ITEM 18.   

FINANCIAL STATEMENTS

     138   
  ITEM 19.   

EXHIBITS

     138   

SIGNATURES

     142   

 

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INTRODUCTION

Unless otherwise indicated and except where the context otherwise requires, references in this annual report on Form 20-F to:

 

    “active user account” for a specific period means a registered user account that has accessed our services at least once during such relevant period; beginning in the third quarter of 2014, the operating metrics of “active user accounts” and “monthly active user accounts,” or MAUs, have been redefined to encompass active user accounts for many businesses not included in our user account metrics for prior periods. As such, the MAUs presented for periods since 2014 should not be compared to previously reported operating metrics in historical periods. The MAUs for 2014 and future periods are expected to be better aligned with the key underlying trends of our company as a mobile internet platform company focused on driving mobile consumer traffic and engagement that can be monetized. The MAU statistics do not include users we can indirectly reach through the installation of our advertising software development kit platforms into third-party applications, although such indirect users generate impressions and search traffic that we can monetize outside of the user accounts generated directly by our own portfolio of applications;

 

    “ADSs” refers to American depositary shares, representing our Class A common shares; each ADS represents five Class A common shares;

 

    “Dollars” or “US$” refers to the legal currency of the United States;

 

    “premium user account” means a user account that generates revenues either through direct payment or through indirect payment from third party developers and advertisers. We only present the premium user accounts metric for 2013, and will only present the redefined active user accounts metric from 2014 onward. Historically, as we diversified and expanded the monetization of our active user accounts in 2013, we replaced the paying user accounts metric we previously presented for 2011 and 2012, which refers to user accounts that have paid or subscribed for our premium services during the relevant period, with the premium user accounts metric. Therefore, the number of premium user accounts we presented for 2013 should not be compared with the number of paying user accounts we presented for 2011 and 2012;

 

    “registered user account” means a user account that was registered with us. We calculate registered user accounts for any particular period as the cumulative number of user accounts at the end of the relevant period. Because every time a person activates one of our mobile products after the initial installation, a unique registered user account is generated, and each person can install and activate more than one of our products on his or her smart device, each smart device could be associated with more than one of our registered user accounts. In addition, each person could have more than one smart device with our mobile products installed and activated. Consequently, the number of registered user accounts we present in this annual report for historical periods overstates the number of persons who were our registered users, and references to “registered user accounts” are only for periods prior to 2014. From 2014 onwards, we intend to only present “active user account” information (as defined above), including MAUs, for each quarter;

 

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

 

    “shares” or “common shares” refers to our Class A and Class B common shares, par value US$0.0001 per share;

 

    “we,” “us,” “our company,” “our,” and “NQ” refer to NQ Mobile Inc. and its subsidiaries and consolidated affiliated entities, as the context may require.

 

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FORWARD-LOOKING STATEMENTS

This annual report contains forward-looking statements that involve risks and uncertainties. All statements other than statements of historical facts are forward-looking statements. These forward-looking statements are made under the “safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995. 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.

You can identify these forward-looking statements by words or phrases such as “may,” “will,” “expect,” “is expected to,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “is/are likely to” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include, but are not limited to, statements about:

 

    our goals and strategies;

 

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

 

    the expected growth of the industries that we operate in China and globally;

 

    our expectations regarding demand for and market acceptance of our products and services;

 

    our expectations regarding the retention and strengthening of our relationships with key business partners and customers;

 

    competition in our industries in China and globally;

 

    relevant government policies and regulations relating to our industries; and

 

    our acquisition strategy, and our ability to successfully integrate past or future acquisitions with our existing operations.

You should thoroughly read this annual report and the documents that we refer to herein with the understanding that our actual future results may be materially different from and/or worse than what we expect. Other sections of this annual report, including the Risk Factors and Operating and Financial Review and Prospects sections, discuss factors which could adversely impact our business and financial performance. Moreover, we operate in an evolving environment. New risk factors emerge from time to time and it is not possible for our management to predict all risk factors, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. We qualify all of our forward-looking statements by these cautionary statements.

You should not rely upon forward-looking statements we make as predictions of future events. The forward-looking statements made in this annual report relate only to events or information as of the date on which the statements are made in this annual report. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law.

PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

 

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ITEM 3. KEY INFORMATION

 

A. Selected Financial Data

The following table presents the selected consolidated financial information for our company. The selected consolidated statements of comprehensive income (loss) data for the three years ended December 31, 2013, 2014 and 2015 and the consolidated balance sheet data as of December 31, 2014 and 2015 have been derived from our audited consolidated financial statements, which are included in this annual report beginning on page F-1. Our selected consolidated statements of comprehensive income (loss) data for the years ended December 31, 2011 and 2012 and our consolidated balance sheet data as of December 31, 2011, 2012 and 2013 have been derived from our audited consolidated financial statements not included in this annual report. We reclassified our revenues into the following categories beginning in 2013: mobile value added services (including consumer mobile security and mobile games), enterprise mobility, advertising services and other services. As a result, we reclassified the presentation of the revenue categories for the years ended December 31, 2011, 2012 in conformity with these new revenue categories. Our selected consolidated financial statements are prepared and presented in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. Our historical results for any period are not necessarily indicative of results to be expected for any future period. You should read the following selected financial information in conjunction with the consolidated financial statements and related notes and the information under “Item 5. Operating and Financial Review and Prospects” included elsewhere in this annual report.

 

     For the Year ended December 31,  
     2011     2012     2013     2014     2015  
     (in thousands of dollars, except for share, per share and per ADS data)  

Consolidated Statements of Comprehensive Income Data:

          

Net revenues:

          

Service Revenues

          

Mobile value added services

              36,202                 68,335               103,519               106,103               139,588   

Advertising services

     4,306        8,889        36,623        72,903        71,721   

Enterprise mobility

     —          3,249        14,174        16,035        27,416   

Other services

     163        1,992        3,559        4,641        5,352   

Product Revenues

          

Enterprise mobility

     —          9,303        38,827        132,642        162,614   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenues

     40,671        91,768        196,702        332,324        406,691   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenues

          

Cost of services

     (8,057     (16,773     (43,557     (98,235     (158,446

Cost of products sold

     —          (8,966     (37,371     (128,416     (160,906
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenues (1)

     (8,057     (25,739     (80,928     (226,651     (319,352
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     32,614        66,029        115,774        105,673        87,339   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

          

Selling and marketing expenses (1)

     (7,955     (17,396     (25,810     (29,962     (26,752

General and administrative expenses (1)

     (14,024     (36,776     (77,026     (131,001     (65,458

Research and development expenses (1)

     (5,095     (9,585     (17,437     (25,665     (29,020
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     (27,074     (63,757     (120,273     (186,628     (121,230
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents
     For the Year ended December 31,  
     2011     2012     2013     2014     2015  
     (in thousands of dollars, except for share, per share and per ADS data)  

Income/(Loss) from operations

     5,540        2,272        (4,499     (80,955     (33,891
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income/(expense), net

     1,342        3,193        411        (5,360     (4,662

Realized gain on available-for-sale investments

     29        —          5        65        1,435   

Realized gain on disposal of a subsidiary

     —          —          —          —          56,211   

Impairment loss

     —          —          —          (5,967     (15,452

Foreign exchange (loss)/gain, net

     3,011        67        1,784        (391     (1,693

Gain on change of interest in an associate

     —          943        —          —          —     

Other income, net

     306        3,364        2,083        19,514        6,778   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income/(Loss) before income taxes

     10,228        9,839        (216     (73,094                8,726   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income tax expense

     (97     (420     (1,117     (5,518     (9,243

Share of profit from an associate

     119        543        —         —         —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income/(loss)

     10,250        9,962        (1,333     (78,612     (517

Net loss/(income) attributable to the non-controlling interest

     1        (532     (523     2,125        911   

Net income attributable to the mezzanine classified non-controlling interest

     —          —          —          (251     (1,697
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income/(loss) attributable to NQ Mobile Inc.

     10,251        9,430        (1,856     (76,738     (1,303
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Accretion of redeemable convertible preferred shares

     (535     —          —          —          —     

Allocation of net income to participating preferred shareholders

     (1,595     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income/(loss) attributable to common shareholders

     8,121        9,430        (1,856     (76,738     (1,303
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income/(loss)

     10,250        9,962        (1,333     (78,612     (517
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

          

Foreign currency translation adjustments

     1,249        390        4,808                      362        (38,191

Comprehensive income/(loss)

              11,499                 10,352                   3,475        (78,250     (38,708
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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     For the Year ended December 31,  
     2011      2012     2013     2014     2015  
     (in thousands of dollars, except for share, per share and per ADS data)  

Comprehensive loss/(income) attributable to the non-controlling interest

     1         (532     (523     2,103        4,869   

Comprehensive income attributable to the mezzanine classified non-controlling interest

     —           —          —          (251     (1,697
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income/ (loss) attributable to NQ Mobile Inc.

     11,500         9,820        2,952        (76,398     (35,536
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings/(loss) per Class A and Class B common shares

           

Basic

     0.05         0.04        (0.01     (0.19     (0.003

Net earnings/ (loss) per Class A and Class B common shares

           

Diluted

     0.04         0.04        (0.01     (0.19     (0.003

Net earnings/ (loss) per ADS (2)

           

Basic

     0.23         0.20        (0.03     (0.95     (0.014

Net earnings/ (loss) per ADS (2)

           

Diluted

     0.21         0.18        (0.03     (0.95     (0.014

Weighted average number of common shares outstanding

           

Basic

     173,373,462         235,257,651        273,981,547        403,443,828        466,691,632   

Diluted

     193,537,974         255,722,551        273,981,547        403,443,828        466,691,632   

 

(1) Share-based compensation expenses included:

 

     For the Year ended December 31,  
     2011      2012      2013      2014      2015  
     (in thousands of dollars)  

Cost of revenues

     130         214         370         263         164   

Selling and marketing expenses

     1,923         2,342         2,310         1,430         683   

General and administrative expenses

         7,895           20,534           50,708           81,129           16,077   

Research and development expenses

     724         1,453         2,016         1,022         (366

 

(2) Each ADS represents five Class A common shares. Net earnings/(loss) per ADS is calculated based on net earnings/(loss) per Class A and Class B common shares multiplied by five.

 

     As of December 31,  
     2011      2012      2013      2014      2015  
     (in thousands of dollars)  

Summary Consolidated Balance Sheet Data:

              

Cash and cash equivalents

     69,510         18,862         179,718         152,984         118,572   

Total current assets

     156,258         199,856         417,292         420,285         386,300   

Total assets

     160,482         247,718         609,362         833,808         802,142   

Total current liabilities

     12,231         32,286         93,883         93,238         276,521   

 

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     As of December 31,  
     2011      2012      2013      2014      2015  
     (in thousands of dollars)  

Total liabilities

     12,231         34,369         269,206         274,897         283,500   

Mezzanine equity

     —           —           —           21,854         4,211   

Total shareholders’ equity

     148,251         213,349         340,156         537,057         514,431   

 

Non-GAAP Financial Measures

To supplement the net income/ (loss) presented in accordance with U.S. GAAP, we use adjusted net income/ (loss) as a non-GAAP financial measure. We define adjusted net income/ (loss) as net income/ (loss) excluding share-based compensation expenses. We present adjusted net income/ (loss) because it is used by our management to evaluate our operating performance, in addition to net income/ (loss) prepared in accordance with U.S. GAAP. We also believe it is useful supplemental information for investors and analysts to assess our operating performance without the effect of non-GAAP adjustments.

The use of adjusted net income/ (loss) has material limitations as an analytical tool. A limitation of using non-GAAP cost of revenues, operating expenses, income from operations and net income, excluding share-based compensation expenses, is that these items have been and may continue to be significant expenses in our business for the foreseeable future. In addition, because adjusted net income/ (loss) is not calculated in the same manner by all companies, it may not be comparable to other similar titled measures used by other companies. In light of the foregoing limitations, you should not consider adjusted net income/ (loss) as a substitute for or superior to net income/ (loss) prepared in accordance with U.S. GAAP. We encourage investors and others to review our financial information in its entirety and not rely on a single financial measure.

The following table sets forth the calculation of adjusted net income/ (loss), which is determined by adding back non-GAAP adjustments to our net income/ (loss) presented in accordance with U.S. GAAP.

 

     For the Year Ended December 31,  
     2011      2012      2013     2014     2015  
     (in thousands of dollars)  

Net income/ (loss)

     10,250         9,962         (1,333     (78,612     (517

Add: share-based compensation expenses

     10,672         24,543         55,404        83,844        16,558   

Adjusted net income

     20,922         34,505         54,071        5,232        16,041   

Selected Operating Data

We monitor certain key operating metrics that we believe are important to our financial performance. As our business evolves and we continue to gain further insight into our growing business, we may change the method of calculating our key operating metrics to address uncertainties in these metrics or add new key operating metrics to reflect the changes in our business.

Beginning in the third quarter of 2014, we redefined the operating metrics of monthly active user accounts, or MAUs, to include many businesses previously not included in our user account metrics. As such, the MAUs presented herein should not be compared to operating metrics previously reported in historical periods because there is not a way to meaningfully compare such results. The MAU statistics do not include the users addressed by the installation of our advertising SDK into third-party applications. These indirect users generate impressions and search traffic that we can monetize outside of the user accounts generated directly by our own portfolio of products and applications.

Our average MAUs for the three months ended December 31, 2015 was 198.2 million.

 

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For your reference, we have included the description and tables for the operating metrics reported previously for our historical periods below, but please note that the metrics presented below should not be compared to the MAU operating metric reported above for the periods since the third quarter of 2014, and we intend to only present the MAU operating metric going forward.

The following tables set forth our registered user accounts as of December 31, 2011, 2012, and 2013 as well as the average monthly active user accounts, average monthly paying user accounts and average monthly premium user accounts for the three months ended December 31, 2011, 2012 and 2013. Our registered user accounts overstate the actual number of our individual registered users, and our active, paying and premium user accounts derived from our operational system may differ from the actual numbers of active, paying and premium users. For more information, see “Item 3. Key Information—D. Risk Factors — Risks Related to Our Business and Industry — The number of our registered user accounts overstates the number of unique individuals who register to use our products. Our active, paying and premium user account figures may differ from the actual numbers of active, paying and premium users.”

 

     For the Year Ended December 31,  
            2011                    2012                    2013         
     (in millions)  

Cumulative registered user accounts (excluding FL Mobile* cumulative registered user accounts)

     146.7         283.4         480.8   

FL Mobile cumulative registered user accounts

     —           67.4         106.9   

Total cumulative registered user accounts

     146.7         350.8         587.7   

 

     For the Three Months Ended December 31,  
            2011                    2012                    2013         
     (in millions)  

Average monthly active user accounts (excluding FL Mobile average monthly active user accounts)

     52.3         97.7         136.0   

FL Mobile average monthly active user accounts

     —           12.5         20.4   

Total average monthly active user accounts

     52.3         110.2         156.4   

Average monthly paying user accounts

     5.6         8.9         —     

Average monthly premium user accounts

     —           —           15.6   

 

* “FL Mobile“ refers to FL Mobile Jiutian Technology Co., Ltd, also previously translated as Feiliu Jiutian Technology Co., Ltd.

 

B. Capitalization and Indebtedness

Not applicable.

 

C. Reasons for the Offer and Use of Proceeds

Not applicable.

 

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D. Risk Factors

Risks Related to Our Business and Industry

Our Freemium subscription business model may not continue to be successful, and our business and results of operations may be materially and adversely affected.

We offer a diverse portfolio of consumer mobile security services to users globally through a “Freemium” business model. Our Freemium business model provides users with free services and the ability to upgrade to a selection of premium services either by paying subscription fees or engaging in an offer wall and advertising services. Our offer wall, launched in March 2013, provides a selection of self-developed and third-party sponsored applications, including mobile games. The offer wall allows users to accumulate points for downloading these applications and to use such points to upgrade to our premium services, as an alternative to paying subscription fees for the premium services. The success of our Freemium business model depends on, among other factors, our ability to convert our user accounts into premium user accounts and our ability to encourage user spending on additional products and services and user engagement in our advertising platform and mobile games. Although we constantly monitor and research user needs, we may be unable to meet user demands on a continuous basis or anticipate future user demands, which may adversely affect our ability to convert free user accounts into premium user accounts and materially and adversely affect our business and results of operations. Current premium users may also choose not to renew their subscriptions, click on our mobile advertisement or pay for mobile games through our offer wall. In addition, we may not be able to maintain and increase the prices of our premium products and services, which may have material and adverse effects on our growth and prospects.

The mobile security, privacy and productivity industry may not grow as quickly as expected, which may materially and adversely affect our business and prospects of future growth.

A portion of our business and prospects depend on the continued development of the mobile security, privacy and productivity industry in China and overseas. As an industry with intense competition, the mobile security, privacy and productivity industry has only begun to experience substantial growth in recent years both in terms of number of users and revenues. We cannot assure you, however, that the industry will continue to grow as rapidly as it has in the past. The growth of the mobile security, privacy and productivity industry is affected by numerous factors, such as users’ general communication experience, technological innovations, development of smart devices and other mobile devices, development of mobile Internet-based telecommunication services and applications, regulatory changes and the macroeconomic environment. If the mobile security, privacy and productivity industry in China or globally does not grow as quickly as expected or if we fail to benefit from such growth by successfully implementing our business strategies, our business and prospects may be materially and adversely affected.

Our business is subject to the risks of international operations, which could significantly affect our financial condition and operating results.

We have international operations, and international expansion continues to form a component of our growth strategy. Expanding and maintaining our business internationally exposes us to a number of risks, including:

 

    our ability to select the appropriate geographical regions for overseas expansion;

 

    difficulty in identifying appropriate local wireless carriers, handset companies, retail distributors and/or joint venture partners and establishing and maintaining good cooperation relationships with them;

 

    difficulty in understanding and keeping up with local market dynamics and industry culture and development;

 

    fluctuations in currency exchange rates;

 

    compliance with applicable foreign laws and regulations, including import and export requirements, foreign exchange controls and cash repatriation restrictions, data privacy requirements, labor laws, and anti-competition regulations; and

 

    increased costs associated with doing business in foreign jurisdictions.

Our financial condition and operating results also could be significantly affected by these and other risks associated with overseas activities. Furthermore, we have implemented policies and procedures designed to facilitate compliance with laws and regulations in foreign jurisdictions applicable to us, but there can be no assurance that our employees, contractors or agents will not violate such laws and regulations or our policies. Any such violations could individually or in the aggregate materially and adversely affect our financial condition and operating results.

 

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We have pursued and may continue to pursue acquisitions, investments, joint ventures or other strategic alliances, which may be unsuccessful or may expose us to additional risk.

We plan to grow both organically and through acquisitions, investments, joint ventures or other strategic alliances when appropriate opportunities arise. For example, in 2014 and 2015, we acquired 100% or majority equity interest in a number of entities, including but not limited to Beijing Trustek Technology Co., Ltd., or Trustek, Beijing Showself Technology Co., Ltd, or Showself, Linkmotion Holdings Ltd., or Linkmotion, Beijing Century Hetu Software Technology Co., Ltd. or Century Hetu, Glory Team Ltd., or Glory, among others. These and any past and future acquisitions, investments, joint ventures and strategic alliances may expose us to new operational, regulatory and market risks, as well as risks associated with additional capital requirements, including risks associated with the assimilation of new operations, technologies and personnel, unforeseen or hidden liabilities, the inability to generate sufficient revenue to offset the costs and expenses of acquisitions, and potentially significant loss of investments. We may not be able to identify suitable future acquisition or investment candidates or alliance partners. If we fail to identify appropriate candidates or partners, or fail to complete the desired acquisitions, investments or alliances after identifying the appropriate candidates or partners, we may not be able to implement our business strategies effectively or efficiently. Furthermore, we may not be able to maintain a satisfactory relationship with our joint venture or other partners or handle other risks associated with our alliances, which could adversely affect our business and results of operations. Our ability to successfully integrate acquired companies and their operations and our ability to benefit from our alliances, including joint ventures and investments, may be adversely affected by a number of factors. These factors include but are not limited to diversion of management’s attention, difficulties in retaining personnel, unanticipated problems or legal liabilities, and tax and accounting issues.

If we fail to integrate acquired companies efficiently, our earnings, revenues, gross margins, operating margins and business operations could be negatively affected. Furthermore, the acquired companies may not perform to our expectations for various reasons, including legislative or regulatory changes that affect the products and services in which the acquired companies specialize and the loss of key personnel and customer accounts.

In addition, we issued share incentive awards to the shareholders of certain entities that we acquired in connection with the acquisitions. Such issuances may dilute your interest in our company, and could have a material adverse effect on the price of our ADSs.

If we are not able to realize the benefits envisioned for our acquisitions, investments, joint ventures or other strategic alliances, our overall profitability and growth plans may be adversely affected.

The limited operating history of Trustek could make it difficult to compete in the future of the growing enterprise mobility segment.

Trustek primarily provides enterprise mobility solutions and services, including system management, application development, business intelligence and maintenance services. It is difficult to evaluate the viability and sustainability of the business of Trustek, due to the entity’s limited operating history and the fact that the enterprise mobility sector in China is still in its early stages. The success of Trustek depends on, among other factors:

 

    ability to maintain and extend our position as a leading provider of mobile services to enterprises in China;

 

    ability to continue to obtain and offer services catered to the needs of enterprises in China and to attract and retain a large customer base; and

 

    ability to continue to research, develop and upgrade technology to support the evolving needs of enterprises.

 

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The highly competitive environment for gaming publishers and operators related to FL Mobile Jiutian Technology Co., Ltd., or FL Mobile, and the proposed divestment of FL Mobile both make it difficult to evaluate FL Mobile’s future prospects and results of operations.

We conduct our mobile game publishing business through FL Mobile. It is difficult to evaluate the sustainability of FL Mobile’s business because of the highly competitive nature of the game publishing and operating business with mobile games. As a result, FL Mobile is exposed to the risks and uncertainties experienced by companies in evolving industries and the mobile game industry in China in particular.

Our success in mobile game operations through FL Mobile depends on, among other factors:

 

    our ability to maintain and extend our position as the leading mobile game operator in China;

 

    our ability to continue to obtain and offer new and creative mobile games to attract and retain a larger user base and increase user activity;

 

    our ability to maintain and expand our distribution network; and

 

    our ability to upgrade our technology and infrastructure to support increased traffic and expanded offerings of products and services.

In addition, we are in the process to divest FL Mobile business, which might divert attention of management team of both FL Mobile and us and bring other uncertainties to FL Mobile’s operation. In August 2015, we entered into a legally binding framework agreement (the “FL Framework Agreement”) with Beijing Jinxin Rongda Investment Management Co., Ltd.( “Beijing Jinxin”), a subsidiary of Tsinghua Holdings Co., Ltd., to sell our entire stake in FL Mobile Inc., including FL Mobile Inc. and/or its subsidiaries and the assets controlled by FL Mobile Inc. and/or its subsidiaries. This FL Framework Agreement will be terminated at the earlier of (a) one year after its execution, and (b) all parties entering into a binding final agreement. All shareholders of FL Mobile Inc. agreed to sell to Beijing Jinxin the entire stake in FL Mobile Inc. that they held for no less than RMB 4 billion. In January 2016, FL Mobile was reorganized as a majority owned subsidiary of Beijing Technology. In February 2016, Beijing Technology, Beijing Jinxin, and Shanghai Houfeng Investment Co., Ltd., the controlling shareholder of Gansu Huangtai Wine-Marketing Industry Co., Ltd., or Gansu Huangtai, a company listed on the Shenzhen Stock Exchange, contemplated a transaction, pursuant to which Gansu Huangtai would acquire the entire stake of FL Mobile. In March 2016, however, we were informed by Beijing Jinxin that Gansu Huangtai was not able to proceed further with such proposed transaction and Beijing Jinxin remained committed to the binding FL Framework Agreement and would work with us on the completion of the divestment of FL Mobile. In March 2016, as a further arrangement of the FL Mobile Divestment, Dr. Vincent Wenyong Shi, our chairman of the board and chief operating officer as well as the chairman of FL Mobile, entered into a termination and share purchase agreement with FL Mobile and us, pursuant to which Dr. Shi would acquire 22% equity interest in FL Mobile by terminating the relevant contractual arrangements and paying us a total consideration of RMB880 million (US$135.5 million).

Failure to maintain relationships with top mobile game developers and to maintain operating rights for popular mobile games would adversely and materially affect the financial results of our mobile game operations.

FL Mobile identifies and develops relationships with top mobile game developers in China and overseas to obtain the operating rights for popular mobile games. Revenues derived from mobile game operations contributed to a significant portion of FL Mobile’s total revenues in the year ended December 31, 2015. If FL Mobile fails to renew the operating rights for popular games after the relevant contracts expire or fails to continually obtain rights to operate new popular games in the future, the financial results of our mobile game operations will be adversely and materially affected.

The mobile games that we offer have finite commercial lifespans.

The mobile games that we offer have finite commercial lifespans. While we seek to extend the commercial lifespans of our mobile games by upgrading such games from time to time to include new features that appeal to existing players and attract new players, revenues generated by each mobile game may be expected to decline as each game approaches the more mature stages of its commercial lifespans. If we fail to extend the commercial lifespans of our mobile games sufficiently, our business and results of operations may be materially and adversely affected.

 

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The mobile game industry is new and rapidly changing, which makes it difficult to evaluate our business and prospects.

The mobile game industry is new and rapidly changing. The growth of the mobile game industry and the level of demand and market acceptance of our mobile game content are subject to a high degree of uncertainty. Our future operating results will depend on numerous factors affecting the mobile game industry, many of which are beyond our control, including changes in user demographics, tastes and preferences and general economic conditions, particularly economic conditions adversely affecting discretionary consumer spending.

There is no assurance that mobile games will continue to be popular in China or elsewhere. A decline in the general popularity of mobile games may adversely affect our business and prospects. In addition, government authorities or industry organizations may adopt new standards that apply to game development. New technologies and new standards may require increases in expenditure for game development and operations, and we will need to adapt our business to cope with the changes and support these new services to be successful.

The future growth of the mobile advertising industry in China is uncertain.

The mobile advertising industry in China has evolved rapidly in recent years, with developments such as the introduction of new business models, the development of user preferences, market entry by new competitors, regulatory oversight and the adoption of new strategies by existing competitors. We expect each of these trends to continue, and we must continue to adapt our strategy to successfully compete in our target market. There are numerous other technologies and business models in varying stages of development, such as portable tablet computers, netbooks or other mobile Internet handsets involving next generation mobile technologies, which could render certain current technologies or applications obsolete. Accordingly, it is extremely difficult to accurately predict user acceptance and demand for our mobile advertising solutions and the size, composition and growth of the mobile advertising industry. Furthermore, given the limited history and rapidly evolving nature of these markets, we cannot predict the price that users will be willing to pay for mobile advertising services or whether users will have concerns over security, reliability, cost and quality of service associated with mobile advertising services. If acceptance of our mobile advertising services is different than anticipated, our ability to maintain or increase our revenues and profits could be materially and adversely affected.

The revenue model for our mobile entertainment applications and platforms may not remain effective, which may affect our ability to retain existing users and attract new users and materially and adversely affect our business, financial condition and results of operations.

We operate mobile entertainment applications and platforms using a virtual items-based revenue model whereby users can access the entertainment on our platform for free, and have the option of purchasing in-channel virtual items. We have generated, and expect to continue to generate, a substantial majority of our mobile entertainment applications and platforms revenues using this revenue model.

We may not be able to continue to successfully implement this virtual items-based revenue model for mobile entertainment applications and platforms, as popular performers may leave our platform and we may be unable to attract new talent that can attract users or cause such users to increase the amount of time spent engaging and money spent on purchasing in-channel virtual items on our platform.

Furthermore, under our current arrangements with certain popular performers and channel owners, we share with them a portion of the revenues we derive from the sales of in-channel virtual items on our mobile entertainment applications and platforms. In the future, the amount we pay to these performers and channel owners may increase or we may fail to reach mutually acceptable terms with these performers or channel owners, which may adversely affect our revenues or cause popular performers and channel owners to leave our platform.

 

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Undetected errors, flaws or failures in our products or services, failure to update or to respond to events with sufficient speed and efficiency, or failure to maintain updated knowledge repositories could harm our reputation or reduce market acceptance of our products and services.

Our products and services may contain errors, flaws or failures that may only become apparent after their release, especially in terms of updated versions. We receive user feedback in connection with errors, flaws or failures in our products and services from time to time, and such errors, flaws or failures may also come to our attention during our internal testing process. We generally have been able to resolve such errors, flaws or failures in a timely manner, but we cannot assure you that we will be able to detect and resolve all of them effectively or in a timely manner. Undetected errors, flaws or failures in our services and products or failure to detect new security threats or issues or respond to such events with sufficient speed and efficiency may adversely affect user experience and cause our users to stop using our services and products, which could materially and adversely affect our business and results of operations.

In addition, although we maintain comprehensive repositories of mobile viruses, malware and spam massages, which also help to increase the efficiency and accuracy of our mobile security, privacy and productivity products and services, any failure on our part to maintain such updated repositories may materially and adversely affect our business and results of operations.

Failure to maintain effective customer support could harm our reputation and our ability to retain both consumer and enterprise customers, which may materially and adversely affect our results of operations.

Our business is significantly affected by the overall size of our user base and our ability to monetize our user base, which in turn are determined by, among other factors, their experience with our services and products. Customer support, including customer service and technical support, is critical to retaining current users and attracting potential users for both our consumer and enterprise businesses. For example, if we otherwise fail to provide effective customer service, our users may be less inclined to use our services or recommend us to other potential users, and may switch to our competitors’ mobile services. Some China-based Internet companies have experienced group complaints, sometimes organized by their competitors or people attempting to profit from such complaints. If we face similar group complaints in a short time frame, we may not be able to effectively handle customer service requests from our users. Failure to maintain effective customer support could harm our reputation and our ability to retain both consumer and enterprise customers, which may materially and adversely affect out results of operations.

If we fail to execute our business model of continually adding compelling new services and monetizing of our active user base, our business, results of operations and financial condition will be materially and adversely affected.

We may be unsuccessful in executing our business model of adding compelling new services and monetizing our active user base for our consumer mobile business. Historically, our primary means of monetizing our active user base has been to provide our users with diversified security, privacy and productivity service offerings. For example, we have introduced services catering to families which include security and privacy services. If our family service or other new services are not accepted by our users, our business and financial performance will suffer. In addition, we may introduce new services beyond our current offerings, which may not be accepted by users and, as a result, affect our revenue growth and operations. If we cannot develop or maintain additional channels of monetizing our active user base and introduce additional services that users find compelling, we will not be able to continue our growth and increase our revenues and profitability. This includes our ability to deliver applications and services to consumers that are more engaging then security and productivity service solutions and deliver the traffic rates necessary to successfully grow our advertising revenues.

If we fail to successfully diversify our user acquisition channels or to successfully acquire new premium users through new channels for our consumer mobile security products and services, our business, results of operations and financial condition will be materially and adversely affected.

The growth of our consumer mobile security business depends on the expansion of our user base and the acquiring of new premium users for the related products and services. We continue to diversify our user acquisition channels, especially in international markets. If we fail to continue to acquire new users through additional new channels or the new channels fail to meet our expectation to generate new premium users, our business, results of operations and financial condition will be materially and adversely affected.

 

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We operate in a rapidly evolving industry. If we fail to keep up with technological developments and mobile device users’ changing requirements, our business, financial condition and results of operations may be materially and adversely affected.

The mobile Internet industry is rapidly evolving and subject to continued technological developments. Our success depends on our ability to keep up with these technological developments and the resulting changes in user behavior. For example, an increasing number of mobile users have been able to access the Internet via an increasing number of different platforms, including Android, Symbian, iOS, BlackBerry OS and Windows Phone. Given that we operate in a rapidly evolving industry, we also need to continuously anticipate new security challenges and industry changes and respond to such changes in a timely and effective manner. There may be changes in the industry landscape as different types of platforms compete with one another for market share. For example, the Android platform has experienced faster growth than other competing platforms in recent years and has now become the more dominant platform among the smart device operating systems. If we do not adapt our products and services to such changes in an effective and timely manner as more platforms become available or certain platforms become dominant in the future, we may suffer loss in market share, and although we invest significant resources in research and development, we cannot predict the evolution of smart device operating systems or platforms in terms of releases, features, application programming interfaces, integrated security, privacy and productivity features. If access to existing smart device operating systems or platforms are changed in any way, thereby adversely affecting our ability to maintain, develop, sell, offer or distribute our products and services, our business, financial condition and results of operations may be materially and adversely affected.

Furthermore, changes in technology may require substantial capital expenditures in research and development as well as in modification of products, services or infrastructure. If we fail to keep up with technological developments and continue to innovate to meet the needs of our users, our products and services may become less attractive to users, which in turn may adversely affect our competitiveness, results of operations and prospects.

We may not be able to continue using or adequately protect our intellectual property rights, which could harm our business and competitive position.

We believe that patents, trademarks, trade secrets, copyright, and other intellectual property we use are important to our business. We rely on a combination of patent, trademark, copyright and trade secret protection laws in China and other jurisdictions, as well as confidentiality procedures and contractual provisions to protect our intellectual property. Some of the intellectual property used in our business operations is held by our founders and a third party. We have entered into license agreements to use such intellectual property for our business operations, but if the individuals holding such intellectual property fail to perform under these license agreements or if the agreements are terminated for any reason, our business and results of operations may be negatively impacted, and if we are deemed to be using such intellectual property without due authorization, we may become subject to legal proceedings or sanctions which could harm our business and results of operations. In addition, we have also invested significant resources to develop our own intellectual property. Failure to maintain or protect intellectual property rights could harm our business, and any unauthorized use of our intellectual property by third parties may adversely affect our current and future revenues, our reputation and ultimately, our overall business.

The validity, enforceability and scope of protection available under intellectual property laws with respect to the mobile and Internet industries in China, where a significant part of our business is located, are uncertain and still evolving. Implementation and enforcement of PRC intellectual property-related laws have historically been somewhat deficient. Accordingly, protection of intellectual property rights in China may not be as effective as in the United States or other countries. Furthermore, policing unauthorized use of proprietary technology is difficult and expensive, and we may need to resort to litigation to enforce or defend patents issued to us or to determine the enforceability, scope and validity of our proprietary rights or those of others. Such litigation and an adverse determination in any such litigation, if any, could result in substantial costs and diversion of resources and management attention, which could harm our overall business and competitive position.

 

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We may not be able to manage our expansion effectively and our current and planned resources may not be adequate to support our expanding operations; consequently, our business, results of operations and prospects may be materially and adversely affected.

We intend on continuing to expand the scale of our operations outside of China through investments and acquisitions. Rapid expansion may expose us to new challenges and risks. To manage the further expansion of our business and the growth of our operations and personnel, we need to continuously expand and enhance our infrastructure and technology as well as improve our operational and financial systems, procedures and controls. We also need to expand, train and manage our growing employee base. In addition, our management will be required to obtain, maintain or expand relationships with wireless carriers, handset manufacturer partners, chipmakers and other third-party business partners. We cannot assure you that our current and planned personnel, infrastructure, systems, procedures and controls will be adequate to support our expanding operations. If we fail to manage our expansions effectively, our business, results of operations and prospects may be materially and adversely affected.

We have historically derived a majority of our revenues from our smart device users, which may be affected by fluctuations in the smart device market.

We derive a significant amount of our net revenues for the years ended December 31, 2013, 2014 and 2015 from mobile value added services, including mobile games and entertainment, mobile security, privacy and productivity applications, for smart devices. Additionally, the advertising segment is derived from users and traffic generated on smart devices. Any significant downturn in the overall demand for smart devices could adversely affect the demand for the mobile games and entertainment, mobile security, privacy and productivity applications that we provide, which in turn would materially reduce our revenues. Although the smart device market has grown rapidly in recent years, it is uncertain whether the number of smart devices to be manufactured will grow at a similar rate in the future. To the extent that our future revenues substantially depend on the sales of smart devices, our business would be vulnerable to any downturns in the smart device market.

A significant portion of our revenues historically have been attributable to the users of a limited number of wireless carriers and smart device manufacturers, and if we are unable to maintain these key relationships or establish new relationships with additional wireless carriers and smart device manufacturers, our revenues would be adversely affected.

In the value-added telecommunications market, wireless carriers and handset manufacturers generally have the power to select software and application suppliers. We have established strong relationships with certain wireless carriers and handset manufacturers, and we anticipate that a limited number of wireless carriers and handset manufacturers, particularly smart device manufacturers, will continue to be responsible for a significant percentage of our revenues within the mobile value added services segment for the foreseeable future. However, there is no assurance that we would be able to continue our current arrangements with these wireless carriers and handset manufacturers on similarly favorable terms or at all, and we are not guaranteed any minimum level of revenues from them. We cannot assure you that revenues derived from collaboration with such wireless carriers and handset manufacturers will reach or exceed historical levels in any future period. The loss of one or more of such key wireless carriers or smart device manufacturers, whether due to a change of control or bankruptcy or other causes, a reduction in mobile devices with our products preinstalled, or our failure to attract additional key wireless carriers and handset manufacturers, would adversely affect our revenues.

 

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We depend on wireless carriers and mobile payment service providers as well as other third-party service providers for the collection of a portion of our consumer mobile security revenues, and any loss or deterioration of our relationship with wireless carriers, mobile payment service providers or any of these third-party service providers may result in disruptions to our business operations and the loss of revenues.

For the years ended December 31, 2012 and 2013, a substantial portion of our revenues were collected through third-party service providers, including but not limited to the payment channels of wireless carriers. We cooperate with wireless carriers, either directly or through mobile payment service providers, and wireless carriers provide us with billing and collection services for a fixed percentage of the total billing. If we cooperate with wireless carriers through mobile payment service providers and prepaid card distributors, we share the payments with the mobile payment service providers and prepaid card distributors. Approximately 30.4% and 15.5% of our net revenues were collected through wireless carriers and mobile payment service providers in the years ended December 31, 2012 and 2013. In 2014 and 2015, however, net revenues collected from these channels became immaterial and fell below 3.5% and 2.2% of our total net revenues respectively due to a strategic business adjustment. Although we expect such percentage to remain immaterial in the future, we expect to continue to rely on wireless carriers and/or mobile payment service providers to collect a part of our revenues. If the payment channels or collection systems of any third-party service providers we use for the collection of our revenues malfunction or become unavailable, we may experience delays associated with attempts to resolve the problems, which may result in a loss of revenues to us. Such problems may be particularly serious if a wireless carrier is involved, because several large wireless carriers hold dominant positions in their respective markets and therefore may have significant influence over a portion of our revenue collection efforts. In addition, any loss or deterioration of our relationships with wireless carriers or mobile payment service providers may result in disruptions to our business operations, the loss of our revenues and a material and adverse effect on our financial condition and results of operations.

A significant percentage of our consumer mobile security revenue comes from subscriptions to our premium products, which may not be renewed.

Historically, a significant majority of our active user accounts for consumer mobile security have used our free services. Our growth strategy in the consumer security segment of our business is based in part on offering premium products and services on top of our free products and services and to attract users to enter into new subscriptions or renew existing subscriptions. To the extent we are not able to attract existing users to renew subscriptions to our services or attract existing users to purchase new premium products and services, our ability to generate revenues from consumer mobile security services would be adversely affected. We generally provide our premium products and services pursuant to one-month, three-month, six-month or one-year subscriptions, after which the relevant products or services either cease to operate or are no longer updated with the latest mobile security threats, rendering such products or services increasingly less useful as new mobile security threats emerge. In 2012 and 2013, our consumer mobile security subscription revenues accounted for 74.0% and 42.1% of our total revenues, respectively. However, in 2014 and 2015, our consumer mobile security subscription revenues accounted for only 17.1% and 5.0% of our total net revenues, respectively, due to strategic business transition. While we offer our premium user accounts the option to renew their subscriptions, a portion of them choose not to renew. Any failure to maintain or improve the renewal rates of our subscriptions or to attract new subscriptions could have a material adverse effect on our results of operations. Uncertainty about the renewal rates of our subscription users also limits visibility with respect to future revenues from subscriptions to premium consumer mobile security services.

The success of our business depends on our ability to maintain and enhance strong brands; failure to do so may result in a reduced number of user accounts and material and adverse effects on our business, financial condition and results of operations.

We believe that maintaining and enhancing our “NQ Mobile”, “NQ” and other brands is of significant importance to the success of our business. A well-recognized brand is critical to increasing the number of our user accounts and, in turn, enhancing our attractiveness to our channel partners, including wireless carriers, third-party developers, mobile device manufacturers and others. Since the mobile Internet industry is highly competitive, maintaining and enhancing our brands depends largely on our ability to retain our current market position in China and the rest of the world, and retaining such position may be difficult and expensive.

Historically, with our comprehensive and reliable mobile security, privacy and productivity services, we have established our reputation and our market position. In addition to our NQ brand, we hold a host of other brand names such as “FL Mobile,” “Ranknow”, “Vlife”, “Music Radar” and “ LOGO ” through FL Mobile, Tianya, Huayong, Yinlong and Showself, respectively. In 2015, we also rebranded several of these separate applications into the Showself brand including Showself Desktop and Lockscreen, Showself Music Radar, and Showself Live Video. The Showself platform of applications is of significant importance to the future success of our entertainment strategy. We have conducted various marketing and brand promotion activities to enhance our brand names and intend to continue to conduct such marketing and promotional activities, we, however cannot assure you that these promotional activities will be successful and achieve the brand promotion effect we expect. In addition, our users may not positively associate these brands with NQ Mobile. Any failure to maintain and enhance our brands may result in a reduction in the number of user accounts and material and adverse effects on our business, financial condition and results of operations.

 

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Any negative publicity and allegations against us or our affiliates may adversely affect our brand, public image and reputation, which may seriously harm our ability to attract and retain users and business partners and result in material adverse impact on our business, results of operations and prospects.

Negative publicity and allegations about us, our products and services, our financial results or our market position, including by short sellers or investment research firms, may adversely affect our brand, public image and reputation, seriously harm our ability to attract and retain users and result in material adverse impact on our results of operations and prospects. For example, on March 15, 2011, a program broadcast by China Central Television Station reported various complaints of certain alleged fraudulent practices by us and by FL Mobile, including allegations of uploading malware or viruses to imported mobile phones to promote our mobile security products. We were subject to negative publicity as a result. We and FL Mobile both interviewed employees and examined or tested the mobile software products in question, in addition to submitting the software products to third-party testing centers established by authoritative government agencies for review, and did not find any evidence of malware or alleged fraudulent practices. In December 2012, an article published on seekingalpha.com made certain allegations concerning the operating data of our company. Additionally, in April 2015, an article on Reddit alleged that the encryption method used in NQ Mobile Vault did not provide sufficient security to users, and this allegation lead to the removal of TRUSTe Certified Privacy Seal of NQ Mobile Vault.

Starting from October 2013, Muddy Waters LLC, an unrelated third party, issued several reports containing various allegations against us, after which the trading price of our ADSs declined sharply and several shareholder class action lawsuits were filed against us and some of our directors and senior executive officers. Following an independent investigation, we have rejected the allegations set out in the reports as false and have been actively defending ourselves in the shareholder class action lawsuits, but our share price fluctuated after such negative publicity. Negative publicity in relation to our services, products or business operations in general, regardless of their veracity, could seriously harm our brand, public image and reputation, which in turn may result in a loss of users and business partners and have a material adverse effect on our business, results of operation and prospects.

We have been named as a defendant in putative shareholder class action lawsuits that could have a material adverse impact on our business, financial condition, results of operation, cash flows and reputation.

We will have to defend against the putative shareholder class action lawsuits described in “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings—Litigation,” including any appeals of such lawsuits should our initial defense be unsuccessful. We are currently unable to estimate the possible loss or possible range of loss, if any, associated with the resolution of these lawsuits. In the event that our initial defense of these lawsuits is unsuccessful, there can be no assurance that we will prevail in any appeal. Any adverse outcome of these cases, including any plaintiff’s appeal of a judgment in these lawsuits, could have a material adverse effect on our business, financial condition, results of operation, cash flows and reputation. In addition, there can be no assurance that our insurance carriers will cover all or part of the defense costs, or any liabilities that may arise from these matters. The litigation process may utilize a significant portion of our cash resources and divert management’s attention from the day-to-day operations of our company, all of which could harm our business. We also may be subject to claims for indemnification related to these matters, and we cannot predict the impact that indemnification claims may have on our business or financial results.

Failure to timely collect accounts receivable could negatively affect our operations and cash flows and results of operation.

Our business depends on our ability to successfully obtain payments of amounts owed to us for the services and products we provide.

 

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We generally offer third parties whose billing and payment systems we use credit terms ranging from 60 to 210 days for overseas payment and from 30 to 90 days for domestic payment. The accounts receivable from overseas wireless carriers, mobile payment service providers, third-party payment processors and prepaid card distributors have longer settlement periods in general. We are working to reduce the settlement periods but cannot assure you that we will be successful. Substantially all of our accounts receivable are due from wireless carriers, mobile payment service providers, third-party payment processors, prepaid card distributors, Trustek’s customers and other partners and customers of our recently acquired businesses such as Showself as of the date of this annual report. Failure to timely collect our receivables from them, especially from overseas mobile payment service providers, third-party payment processors prepaid card distributors, and enterprise mobility customers may adversely affect our results of operations and cash flows. Our wireless carriers, mobile payment service providers, third-party payment processors, prepaid card distributors or enterprise mobility customers may from time to time experience cash flow difficulties. Consequently, they may delay their payments to us or fail to pay us at all. Any delay in payment or the inability of current or potential wireless carriers, mobile payment service providers, third-party payment processors, prepaid card distributors or enterprise mobility customers to pay us may significantly harm our cash flow and profitability.

As of December 31, 2013, 2014 and 2015, our accounts receivable, net of allowance for doubtful accounts, wereUS$81.9 million, US$88.7 million and US$87.5million, respectively. We establish a provision for doubtful accounts based upon an assessment of specific evidence indicating doubtful collection, historical experience, account balance aging and prevailing economic conditions. If our provision for doubtful accounts turns out to be insufficient for the relevant periods, our business and results of operations may be adversely affected.

We are highly reliant on the Apple platform for a significant portion of our mobile games revenues. If Apple changes its standard terms and conditions for developers or operators and the mobile game approval process in a way that is detrimental to us, our mobile games and advertising business could be materially and adversely affected.

To date, FL Mobile has derived a significant portion of its mobile game revenues and acquired a significant number of its mobile game players through the Apple platform. We expect this will continue in the near future. FL Mobile is subject to Apple’s standard terms and conditions for application developers and operators, which govern the promotion, distribution and operation of games and payment collection on the Apple platform, and which are subject to changes by Apple at its sole discretion at any time. Our business may be harmed if Apple discontinues or limits our access to its platform, terminates or does not renew our contractual relationship, modifies its terms of service or other policies with us, establishes more favorable relationships with one or more of our competitors, or develops its own competitive offerings.

In addition, mobile games for sales on the Apple platform are subject to approval by Apple. Apple has complete control over the approval of each mobile game submitted to the Apple platform. The terms and policies for the mobile game approval process are very broad and subject to interpretation and frequent changes by Apple. If Apple changes its standard terms and conditions for developers or operators and the mobile game approval process in a way that is detrimental to us, our mobile games and advertising business could be materially and adversely affected. Furthermore, any negative publicity and allegations against us may affect our relationship with Apple, and Apple may remove our mobile games from its platform without giving any specific reason.

We may face increasing competition, which could reduce our market share and materially and adversely affect our business and results of operations.

The mobile Internet industry is highly competitive. The industry is characterized by the frequent introduction of new products and services, short product life cycles, evolving industry standards, continual improvement in performance characteristics, rapid adoption of technological and product advancements, as well as price sensitivity on part of users. On the mobile security front, we compete directly with (i) domestic PC/mobile security vendors such as Qihoo 360, Tencent, Cheatah Mobile and Kingsoft, (ii) overseas security software providers such as Avast, Symantec, McAfee, AVG, Trend Micro, F-Secure and Kaspersky, and (iii) other emerging companies offering mobile security products, such as Lookout. While we have focused on providing mobile security services since the founding of our company, most of our competitors are traditional PC anti-virus providers who later entered into the mobile security market.

For our mobile game business, we compete primarily with other mobile game operators in China, such as Chukong Holdings Ltd, China Mobile Games & Entertainment Group Ltd, iDreamSky Technology Ltd and KunLun. For our enterprise mobility business, we compete primarily with various hardware resellers and mobility services providers, including NationSky, a business we divested in December 2015.

 

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For many of our emerging businesses and applications including Showself, Vlife, Doreso and our advertising business, we face competitions from other internet platform businesses including Tencent, Qihoo 360, Baidu as well as from more specialized Internet services providers like YY, 9158.com and Shazam, to name a few.

We may also face competition from alliances between our existing and new competitors, and new competitors may also emerge from time to time. With more entrants into the industry, aggressive price cutting by competitors may result in downward pressure on our gross margins and profitability in the future. Some of our existing and potential competitors may have greater financial, technological and marketing resources, stronger relationships with mobile ecosystem participants and a larger portfolio of offerings than we do. Some of our competitors or potential competitors may have greater development experience and resources than we have. If there are new entrants in the market or intensified competition among existing competitors, we may have to provide more favorable revenue-sharing arrangements to mobile ecosystem participants working with us, or cut the prices of our product and service offerings to retain and attract users which could adversely affect our profitability. If we fail to compete effectively, our market share would decrease and our results of operations would be materially and adversely affected.

Significant changes in the policies, guidelines or practice of wireless carriers with respect to mobile applications and other content may result in lower revenues or additional costs for us and materially and adversely affect our business operations, financial condition and results of operations.

Governments in the PRC or elsewhere in the world may from time to time issue new policies or guidelines, requesting or stating their requirements for certain actions to be taken by all wireless carriers. A significant change in wireless carriers’ policies or guidelines may cause our revenues to decrease or operating costs to increase. We cannot assure you that our financial condition and results of operations will not be materially and adversely affected by government policy or guideline changes.

For example, beginning in January 2010, China Mobile implemented a series of measures targeted at further improving the user experience from mobile handset embedded services. Under these measures, mobile applications and other content that are embedded in handsets are required to introduce additional notices and confirmations to users when being purchased. In addition, services based on SMS short codes will be required to be more tailored to the specific mobile applications and content offerings or mobile payment service providers. Such measures make it more burdensome for users to purchase services and products, and, as a result, some users purchased fewer applications or ceased purchasing altogether. If similar or more stringent measures are imposed by the government or wireless carriers in the future, our business and results of operations may be materially and adversely affected.

We cannot assure you that any of the governments in the regions we operate or any wireless carriers we work with will not introduce additional requirements with respect to the procedures for ordering monthly subscriptions or single-transaction downloads of mobile services and products, notifications to users, the billing of user accounts or other consumer protection measures or adopt other policies that may require significant changes in the way we promote and sell the applications, any of which could have a material adverse effect on our financial condition and results of operations.

Disruption or failure of our cloud-client computing platform and our servers could impair our users’ mobile experience and adversely affect our reputation and results of operations.

Our ability to provide our mobile security users with high-security mobile experience depends on the continuous and reliable operation of our cloud-client computing platform and servers. Disruptions, failures, unscheduled service interruptions or decrease in the connection speed could hurt our reputation and cause our users to switch to our competitors’ products and services. Our systems are vulnerable to damage or interruption as a result of fires, floods, earthquakes, power losses, telecommunication failures, undetected errors in the software, computer viruses, hacking and other attempts to harm our network and servers. We may experience network or service interruptions in the future despite our continuous efforts to improve our network and servers. If we experience frequent or persistent disruptions to our network or servers, whether caused by failures of our own systems or those of third-party payment processors, our users’ mobile experience may be negatively affected, which in turn, may have a material adverse effect on our reputation and results of operations. We cannot assure you that we will be successful in minimizing the frequency or duration of these interruptions.

 

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We can not assure that users will follow our guidelines at all time and we may be forced to follow more restrictive procedures if policy mandates. This may result adverse affects on our operations and financial conditions within the entertainment businesses.

Since mobile entertainment applications, including our Showself platform of services and offerings relies upon user-generated content for which we do not have direct control. Given the strict policies around content in China and elsewhere in the World, we have rigid procedures and guidelines in place for users to conduct their programming. However, users may not follow those guidelines from time to time and we may be forced to follow more restrictive procedures if policy mandates, which will likely have adverse impact on the traffic of our platforms and discourage the creation of user generated contents. This may result adverse affects on our operations and financial conditions within the entertainment businesses.

We may be subject to litigation for user-generated content provided on our platform, which may be time-consuming and costly to defend.

Our mobile entertainment applications are open to the public for posting user-generated content. Although we have required our users to post only legally compliant and inoffensive materials and have set up screening procedures, our screening procedures may fail to screen out all potentially offensive or non-compliant user-generated content and, even if properly screened, a third party may still find user-generated content postings on our platform offensive and take action against us in connection with the posting of such information. As with other companies who provide user-generated content on their websites, we have had to deal with such claims in the past and anticipate that such claims will increase as user-generated content becomes more popular in China. Any such claim, with or without merit, could be time-consuming and costly to defend, and may result in litigation and divert management’s attention and resources.

We may be subject to liability for user complaints concerning our products and services which may cause fines or penalties and adversely affect our business operations.

In recent years, the PRC government has adopted several administrative rules governing and reinforcing the supervision over paid services and products delivered over the Internet. Under these administrative rules, telecommunications and Internet information providers are required to follow a formal procedure in handling user complaints, and the activities such as arbitrary charges or trapped charges are subject to severe penalties from the relevant authorities. Failure to comply with these administrative rules may subject us to liabilities including refund, damages payments to users or, in the most serious scenario, suspension of our business. In addition, if we are unable to duly resolve user complaints in a timely manner in the future, or if the PRC government promulgates regulations or administrative rules that have more restrictive provisions or more severe penalties, our business operations may be adversely affected.

Our business may be adversely affected if we fail to ensure the security and privacy of confidential user information.

A significant barrier to the development of wireless business is the secure transmission of confidential information over wireless networks. We rely on proprietary encryption and authentication technology to provide the security and authentication necessary to effect secure transmission of confidential user information and to protect such information, such as user name and password. While we have not experienced any material breach of our security measures to date, there can be no assurance that advances in technology capabilities, new discoveries in the field of cryptography, or other events or developments will not result in a compromise or breach of the algorithms used by us to protect user information. A party that is able to circumvent these security measures could misappropriate proprietary information or cause interruptions in our operations.

 

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Intensifying legal protection for the confidential information of users may subject us to greater liability. For example, the Ministry of Industry and Information Technology, or MIIT, has promulgated “Several Provisions on Regulating the Market Order of Internet Information Services” to ensure a level playing ground for website operators in China and to enhance protection to Internet users in areas such as Internet security, web advertising and data protection. The provisions came into effect on March 15, 2012. These provisions echo the Chinese government’s policy of intensifying protection of personal privacy. Internet information service providers are required to obtain users’ consent prior to collecting any users’ personal information or disclosing it to a third party. Non-compliance with these protection requirements may incur a fine of RMB10,000 to RMB30,000. On December 28, 2012, the Standing Committee of Congress of the PRC issued the Decision on Strengthening Internet Information Protection, reiterating that Internet service providers must explicitly specify the purpose, way, scope of collecting users’ individual information and obtain users’ consent prior to such collection. The Internet service provider is also prohibited from sending unsolicited commercial information to users. Non-compliance with these provisions may result in civil, administrative or criminal penalties. Pursuant to the Ninth Amendment to the Criminal Law issued by the Standing Committee of the National People’s Congress in August 2015 and becoming effective in November 2015, any internet service provider that fails to fulfill the obligations related to internet information security administration as required by applicable laws and refuses to rectify upon orders, shall be subject to criminal penalty for the result of (i) any dissemination of illegal information in large scale; (ii) any severe effect due to the leakage of the client’s information; (iii) any serious loss of criminal evidence; or (iv) other severe situation, and any individual or entity that (i) sells or provides personal information to others in a way violating the applicable law, or (ii) steals or illegally obtain any personal information, shall be subject to criminal penalty in severe situation.

We may be required to expend significant capital and other resources to protect against security breaches or to alleviate problems caused by such breaches. Concerns over the security and privacy of user information, including concerns regarding potential misuse of private user information to commit crimes such as identity theft, may inhibit the wireless business generally, and our mobile security, privacy and productivity products and services in particular. To the extent that our activities involve the storage and transmission of personal data or proprietary information, security breaches could damage our reputation and expose us to a risk of loss or litigation and possible liability. There can be no assurance that our security measures will prevent security breaches, and failure to prevent such security breaches may have a material adverse effect on our business, prospects, financial condition and results of operations.

Our results of operations, financial performance and business may be adversely affected by potential intellectual property rights infringement claims against us.

We could face claims by others that we are improperly using intellectual property owned by them or otherwise infringing upon their rights in intellectual property. For example, intellectual property disputes may arise in relation to certain third-party produced mobile software programs that we make available for download. Irrespective of the validity or the successful assertion of any such claims, we could incur costs in either defending or settling any intellectual property disputes alleging infringement. Intellectual property litigation against us could potentially force us to, among other things, cease offering the challenged mobile application, develop non-infringing alternatives or obtain licenses from the owners of the infringed intellectual property. We may not be successful in developing such alternatives or in obtaining such licenses on reasonable terms or at all and our results of operations, financial performance and business may be materially and adversely affected.

We have granted, and may continue to grant, stock options and restricted shares, which may result in increased share-based compensation expenses.

We adopted two share incentive plans, the 2007 Global Share Plan and the 2011 Share Incentive Plan (together, the “Plans”). We granted awards such as options and restricted shares to directors, executive officers, employees, third-party consultants, business partners both pursuant to and outside of the Plans and pursuant to contractual arrangements in some of our acquisitions. See “Item 6. Directors, Senior Management and Employee — B. Compensation of Directors and Executive Officers — Share Incentive Plans” for detailed discussion. For the years ended December 31, 2013, 2014 and 2015, we recorded US$55.4 million, US$83.8 million and US$16.6 million, respectively, in share-based compensation expenses. As of March 15, 2016, 118,325 restricted shares and options to purchase 22,211,445 common shares of our company were outstanding. As of March 15, 2016, 442,740 restricted ADSs were also granted and outstanding under the 2011 Share Incentive Plan.We believe the granting of stock options and restricted shares is of significant importance to our ability to attract and retain key personnel, employees and third-party consultants, and we will continue to grant stock options and restricted shares to key personnel, employees, third-party consultants and business partners in the future. However, the share-based compensation expenses we incur will reduce our income from operations. We have incurred, and expect to continue to incur, share-based compensation expenses, which may have a material and adverse effect on our results of operations.

 

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Our quarterly revenues and operating results may fluctuate, which makes our results of operations difficult to predict and may cause our quarterly results of operations to fall short of expectations.

Our quarterly revenues and operating results have fluctuated in the past and may continue to fluctuate depending upon a number of factors, including, among others, the demand for our products and services, the launch of new products and services, policy changes of wireless carriers, and our revenue-sharing arrangements with mobile ecosystem participants. For our enterprise mobility business, we experience seasonality driven by our corporate customers’ mobile device and enterprise software procurement cycles. For example, China based corporations often procure information technology related products and services in the second half of the year. Thus, we typically derive a larger portion of enterprise mobility revenues in the second half of the year. Many of these factors are out of our control. For these reasons, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our quarterly and annual revenues and costs and expenses as a percentage of our revenues may be significantly different from our historical or projected rates. Our operating results in future quarters may fall below expectations. Any of these events could cause the price of our ADSs to fall.

The continuing and collaborative efforts of our senior management and key employees are crucial to our success, and our business may be harmed if we were to lose their services.

Our success depends on the continuous efforts and services of our experienced senior management team, particularly Dr. Vincent Wenyong Shi, our co-founder and Chairman of the Board, and Zemin Xu, our chief executive officer and director, both experienced leaders with a successful track record of developing products and services. Additionally, the senior management and key employees of our key subsidiaries and consolidated affiliated entities are also critical to the success of our overall strategy and growth objectives.

If one or more of our executives or other key personnel or the senior management and key employees of our key subsidiaries and consolidated affiliated entities are unable or unwilling to continue to provide us with their services, we may not be able to replace them easily or at all, our business may be severely disrupted, our financial condition and results of operations may be materially and adversely affected, and we may incur additional expenses to recruit, train and retain personnel. Although members of our senior management team remain committed to our company, we cannot assure you that we will continue to be able to find successors for every senior management member who may resign. Competition for management and key personnel is intense and the pool of qualified candidates is limited. We may not be able to retain the services of our executives or key personnel, or attract and retain experienced executives or key personnel in the future. If any of our executive officers or key employees join a competitor or forms a competing company, we may lose our superiority in technological design and development. Each of our executive officers and key employees has entered into an employment agreement with us, which contains non-competition provisions. However, if any dispute arises between us and our executives or key employees, these agreements may not be enforceable in China, where these executives and key employees reside, in light of uncertainties with China’s legal system. See “— Risks Relating to Doing Business in China — Uncertainties with respect to the PRC legal system could adversely affect us.” In addition, if one or more of our executives or other key personnel do not act in the best interests of our company when a conflict of interest arises, our business, prospects and reputation may be harmed.

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

The global financial markets experienced significant disruptions in 2008 and the recovery from such disruptions was uneven. The world economy is facing new challenges, including the recent and projected slowdown of the Chinese economy. There remains uncertainty over the long-term effects of the monetary and fiscal policies adopted by the central banks and financial authorities of some of the world’s leading economies, including China’s. There have also been concerns over unrest in different areas of the world, including the radical actions of Islamic State in Iraq and Syria, which have resulted in market volatility. Economic conditions in China are sensitive to global economic conditions as well as changes in domestic economic and political policies and the expected or perceived overall economic growth rate in China. Since the demand for high-end mobile applications is particularly sensitive to macroeconomic conditions, our business and prospects may be affected by the macroeconomic environment. Any negative impact to the global or Chinese economy may have a material and adverse effect on our business, results of operations and financial condition, and continued turbulence in the international markets may materially and adversely affect our ability to access the capital markets to meet liquidity needs.

 

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We may offer our products and services to persons in countries targeted by economic sanctions of the United States government through third-party distributors and download services, which may adversely affect our reputation and prospective investors, may decide not to invest in our shares, thereby potentially reducing our share price.

The U.S. government has enacted laws and regulations, including laws and regulations administered by the Office of Foreign Assets Control, or the U.S. Economic Sanctions Laws that impose restrictions upon U.S. persons with respect to activities or transactions with certain countries, governments, entities and individuals that are the subject of U.S. Economic Sanctions Laws, or the Sanctions Targets. U.S. persons are also prohibited from facilitating such activities or transactions. We do not actively seek to provide our products and services to Sanctions Targets, have not generated any revenue from the distribution of our products and services in countries that are Sanctions Targets, and do not intend to do so in the future. However, as we make free products available for download on the Internet and have third-party distributors for our products outside of China, there may be instances where our products and services eventually become available to Sanctions Targets through different channels and without any active distribution by us in these regions. We believe the U.S. Economic Sanctions Laws under their current terms are not applicable to our activities. However, we cannot assure you that our products would not be available to Sanctions Targets, or that we would be able to effectively prevent Sanctions Targets from using our products and services in the future. If such transactions occur, our reputation could be adversely affected, and investors in the United States may choose not to invest in, and to divest any investments in, companies that are associated even indirectly with Sanctions Targets, all of which could have a material and adverse effect on the price of our shares and the value of your investment in us.

The number of our registered user accounts overstates the number of unique individuals who register to use our products. Our active, paying and premium user account figures may differ from the actual numbers of active, paying and premium users.

We define registered user accounts for a period, presented in this annual report for historical periods prior to 2014, as the cumulative number of user accounts at the end of the period. Because every time a person activates one of our mobile products after the initial installation, a unique registered user account is generated, and each person can install and activate more than one of our products on his or her smart devices, each smart device could be associated with more than one of our registered user accounts. In addition, each person could have more than one smart device with our mobile products installed and activated. Consequently, the actual number of unique individual users of our products and services is lower than the number of registered user accounts we provide in this annual report, where differences could be potentially significant.

We define active user accounts for a specific period as the registered user accounts that have accessed our services at least once during such period. We define paying user accounts for a specific period, presented in this annual report for historical periods from 2010 through 2012, as user accounts that have paid or subscribed for our premium services during the relevant period. We define premium user accounts for a specific period, presented in this annual report for the three months ended December 31, 2013, as user accounts that generate revenues either through direct payment or through indirect payment from third-party developers and advertisers. The numbers of active, paying and premium user accounts derived from our operational system for the periods presented may differ from the actual numbers of active, paying and premium users for such periods.

 

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If we fail to establish or maintain an effective system of internal controls, we may be unable to accurately report our financial results or prevent fraud, and investor confidence and the market price of our shares may, therefore, be adversely impacted.

We are subject to reporting obligations under the U.S. securities laws. Among other things, the SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, adopted rules requiring every public company, including us, to include a report from management on the effectiveness of its internal control over financial reporting in its second annual report on Form 20-F. In addition, beginning at the same time, an independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting. We began to be subject to these requirements since the annual report for the fiscal year ended December 31, 2012.

Our management has concluded that our internal control over financial reporting is effective as of December 31, 2015. See “Item 15. Controls and Procedures — Management’s Annual Report on Internal Control over Financial Reporting.” Our independent registered public accounting firm has issued an attestation report, which has concluded that our internal control over financial reporting is effective as of December 31, 2015. However, if we fail to maintain effective internal control over financial reporting in the future, our management and our independent registered public accounting firm may not be able to conclude that we have effective internal control over financial reporting at a reasonable assurance level. This could in turn result in the loss of investor confidence in the reliability of our financial statements and negatively impact the trading price of our ADSs. Furthermore, we have incurred and anticipated that we will continue to incur considerable costs, management time and other resources in an effort to maintain compliance with Section 404 and other requirements of the Sarbanes-Oxley Act.

We have limited business insurance coverage, which could expose us to substantial costs and diversion of resources that in turn may have an adverse effect on our results of operations and financial condition.

Insurance companies in China currently do not offer as extensive an array of insurance products as insurance companies do in more developed economies. Consistent with customary industry practice in China, we do not maintain specific business interruption insurance or real property insurance, although we do maintain a directors, officers and company liability insurance policy for the protection of our company and our directors and officers. We have determined that the costs of insuring for these risks and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. Uninsured damage to any of our equipment or buildings or a significant product liability claim may result in our incurring substantial costs and the diversion of resources, which could have an adverse effect on our results of operations and financial condition.

We face risks of epidemics and other disasters, which could severely disrupt our business operations.

Our business could be materially and adversely affected by the outbreak of epidemics such as H1N1, avian influenza, severe acute respiratory syndrome, SARS, and Ebola. In recent years, there have been breakouts of epidemics in China and globally. Our business operations could be disrupted if one or more of our employees’ contract, or are suspected of having contracted, any highly contagious diseases such as H1N1, avian influenza, SARS or Ebola, since it could cause our employees to be quarantined or our offices to be quarantined or disinfected. Any prolonged recurrence of epidemics or other adverse public health developments could adversely affect economic activities and require the temporary closure of one or more of our offices. Such closures could severely disrupt our business operations and adversely affect our results of operations. In addition, our results of operations could be adversely affected to the extent that any outbreak of epidemics harms the global economy in general and the Chinese economy in particular.

In addition, our business operations are vulnerable to interruption and damage from man-made or natural disasters, including wars, acts of terrorism, snowstorms, earthquakes, fire, floods, environmental accidents, power loss, communications failures and similar events. If any man-made or natural disaster were to occur in the future, our ability to operate our business could be seriously impaired.

 

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Risks Related to Our Corporate Structure

If the PRC government finds that the agreements that establish the structure for operating our businesses in China do not comply with PRC governmental restrictions on foreign investment in telecommunication business, or if these regulations or the interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations.

Current PRC laws and regulations place certain restrictions on foreign ownership of companies that engage in telecommunication business, including mobile application providers. Specifically, foreign ownership in a value-added telecommunication mobile payment service provider may not exceed 50%. We currently conduct our operations in China principally through contractual arrangements among our wholly owned subsidiary NQ Beijing, our consolidated affiliated entity Beijing Technology and its shareholders. Beijing Technology and its subsidiaries hold the licenses and permits necessary to conduct our businesses in China. Our contractual arrangements with Beijing Technology and its shareholders enable us to exercise effective control over Beijing Technology and its subsidiaries and consolidate their financial results. For a detailed discussion of these contractual arrangements, see “Item 4. Information of the Company — C. Organizational Structure.”

The Circular Regarding Strengthening the Administration of Foreign Investment in and Operation of Value Added Telecommunications Business, issued by the MIIT in July 2006, reiterated the regulations on foreign investment in telecommunications businesses, which require foreign investors to set up foreign-invested enterprises and obtain a business operating license to conduct any value-added telecommunications business in China. Under this circular, a domestic company that holds a telecommunications value-added services operation license is prohibited from leasing, transferring or selling the license to foreign investors in any form, and from providing any assistance, including providing resources, websites or facilities, to foreign investors that conduct any value added telecommunications business illegally in China. Furthermore, the relevant trademarks and domain names that are used in the value-added telecommunications business must be owned by the local license holder. This circular further requires each telecommunications value-added services operation license holder to have the necessary facilities for its approved business operations and to maintain such facilities in the regions covered by its license. In addition, all value-added telecommunications mobile payment service providers are required to maintain network and information security in accordance with the standards set forth under relevant PRC regulations. Due to a lack of interpretative materials from the regulator, it is unclear what impact this circular might have on us or the other Chinese telecommunications and Internet companies that have adopted the same or similar corporate and contractual structures as ours.

 

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The MIIT issued a circular in 2006 that emphasizes restrictions on foreign investment in value-added telecommunications businesses. In addition, a notice issued in 2009 by the General Administration of Press and Publication, or the GAPP, the National Copyright Administration, and the National Office of Combating Pornography and Illegal Publications states that foreign investors are not permitted to invest in online game operating businesses in China or to exercise control over or participate in the operation of such businesses through indirect means. The MIIT and the GAPP jointly issued Administrative Provisions on Online Publishing Services in 2016, which became effective on March 10, 2016, stated that foreign-invested enterprises are not permitted to engage in online publishing services, and the internet publishers must secure approval, or the Internet Publication license, from GAPP to conduct Internet publication activities, including operating of online games. Due to a lack of interpretative materials from the relevant PRC authorities, there are uncertainties regarding whether PRC authorities would consider our corporate structure and contractual arrangements to be a kind of foreign investment in value-added telecommunications services or online game operation businesses. Besides, the MIIT issued the Catalog of Telecom Service on February 28, 2015 based on the version of 2013 (“2015 Catalog”), according to 2015 Catalog, the readjustment maintains the fundamental classification structure of the previous version, namely, telecommunication services are divided into two main categories of basic telecommunication services and value-added telecommunication services. Regarding the Value-added telecommunication services, 2015 Catalog has combined and readjusted the subcategories under the previous Class 1 and Class 2 of value-added telecommunication services. The new Class 1 value-added telecommunication services is defined as services based on facilities and resources, while the new Class 2 value-added telecommunication services is defined as services based on public application platform. In the meantime, the 2015 Catalogue clarifies details of the content distribution internet services, the encoding and code conversion services, and subdivides the internet date center services, call center and information services. Specifically, the call center services (B24) has been divided into domestic call center services (B24-1) and offshore call center services (B24-2) for the purposes of further encouraging development of offshore call center services. To accommodate development of new technology and business in telecommunication industry, the 2015 Catalogue subdivides the information services into 5 subcategories: (i) the information dissemination platform and delivery services; (ii) the information searching services; (iii) the information community services; (iv) the information instant interaction services; and (v) the information protection and processing services, based on the specific forms of services and in accordance with the organization, delivery and other technical characteristics of information services. According to Regulations on the Main Functions, Internal Organization and Staffing of GAPP issued by the General Office of the State Council on July 11, 2008 and its interpretation circulars, GAPP is authorized to approve online games before their launch on the Internet, while the PRC Ministry of Culture, or the MOC is authorized to administer and regulate the overall online game industry. Once an online game is launched on the Internet, it will be regulated only by the MOC, and if an online game is launched on the Internet without the prior GAPP approval, the MOC is the authority responsible for investigating the matter. On September 7, 2009, the State Commission Office for Public Sector Reform, or the SCOPSR issued a circular for interpreting certain provisions of the Regulations on Three Provisions, in relation to comprehensive enforcement by GAPP, the MOC and the State Administration of Radio, Film and Television over animation, online game and cultural market. The interpretation states that: (1) the regulatory authority with overall administrative responsibility for the oversight of online games is the MOC, and GAPP’s authority of administration over online games (other than pre-examination and approval before publication of online games on the Internet) has been granted to the MOC; (2) only the authority of pre-examination and approval for the publication of online games is retained by GAPP, but such authority is subject to the MOC’s overall administration and is only limited to the stage prior to the games being brought online for operation; (3) once the games are online, they will be completely administrated and regulated by the MOC; and (4) the MOC is the sole regulator which has the authority to penalize online game operators who failed to obtain the pre-examination and approval from GAPP. On the other hand, GAPP does not have direct administrative jurisdiction over such activities. According to such circular issued by SCOPSR, we thus believe that the provision of the GAPP Notice discussed above with respect to regulation of online game operation does not apply to us or our PRC subsidiaries, nor does it affect our control over our PRC subsidiaries. While we are not aware of any online game companies which use the same or similar contractual arrangements as ours having been penalized or ordered to terminate operations by PRC authorities claiming that the arrangements constituted foreign investment in value-added telecommunication services or a kind of control over or participation in the operation of online game operating businesses through indirect means, it is unclear whether and how the various regulations of the PRC authorities might be interpreted or implemented in the future.

Although we believe we are in compliance with current PRC regulations, we cannot assure you that the PRC government would agree that these 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 the PRC government determines that we do not comply with applicable laws and regulations, it could revoke our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues, block our websites, impose additional conditions or requirements with which we may not be able to comply, or take other regulatory or enforcement actions against us that could be harmful to our business. The imposition of any of these penalties would result in a material and adverse effect on our ability to conduct our business. The PRC government may also require us to restructure our operations entirely if it comes to find that our contractual arrangements do not comply with applicable laws and regulations. It is unclear how such mandatory restructuring could impact our business and operating results, as the PRC government has not yet found such contractual arrangements to be in non-compliance. However, any such restructuring may cause significant disruption to our business operations.

 

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The relevant regulatory authorities would have broad discretion in dealing with such violations. In 2011, various media sources reported that the CSRC prepared a report proposing pre-approval by a competent central government authority of offshore listings by China-based companies with variable interest entity structures, such as ours, that operate in industry sectors subject to foreign investment restrictions. However, it is unclear whether the CSRC officially issued or submitted such a report to a higher level government authority or what any such report provides, or whether any new PRC laws or regulations relating to variable interest entity structures will be adopted or what they would provide. In addition, if the imposition of any of these penalties causes us to lose our rights to direct the activities of our consolidated affiliated entities and their respective subsidiaries or the right to receive their economic benefits, this may result in our being unable to control, and hence unable to consolidate, the consolidated affiliated entities and their respective subsidiaries.

We rely on contractual arrangements with Beijing Technology and its shareholders for our operations, which may not be as effective as direct ownership in providing operational control and may negatively affect our ability to conduct our business.

Since PRC laws restrict foreign equity ownership in companies engaged in value-added telecommunication businesses like us in China, we rely on contractual arrangements with Beijing Technology, and its shareholders to operate our business in China. Although we registered the equity pledge agreement with the shareholders of our subsidiaries so that we are able to enforce the pledge against any third parties, these contractual arrangements may not be as effective as direct ownership in providing us with control over Beijing Technology. Beijing Technology and its shareholders may fail to take certain actions required for our business or fail to follow our instructions despite their contractual obligations to do so. If they fail to perform their obligations under their respective agreements with us, we may have to rely on legal remedies under PRC law, including seeking specific performance or injunctive relief, which may not be effective. See Item 7. Major Shareholders and Related Party Transactions — B. Related Party Transactions — Contractual Arrangements.”

Although we have been advised by Jincheng Tongda & Neal, our PRC legal counsel, that each contract under these contractual arrangements with Beijing Technology above is valid, binding and enforceable under current PRC laws and regulations, these contractual arrangements may not be as effective in providing us with control over Beijing Technology as direct ownership of them. In addition, Beijing Technology or its shareholders may breach the contractual arrangements. We cannot assure you that when conflicts of interest arise, Beijing Technology and its shareholders will act completely in our interests or those conflicts of interests will be resolved in our favor. In any such event, we would have to rely on legal remedies under PRC law.

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 law and any disputes would be resolved in accordance with PRC legal procedures. Uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements, which may make it difficult to exert effective control over Beijing Technology, and our ability to conduct our business may be negatively affected.

Substantial uncertainties exist with respect to the enactment timetable, interpretation and implementation of draft PRC Foreign Investment Law and it may impact the viability of our current corporate structure, corporate governance and business operations.

The Minister of Commerce, or MOFCOM, published a discussion draft of the proposed Foreign Investment Law (the “Draft”) in January 2015 aiming to, upon its enactment, replace the trio of existing laws regulating foreign investment in China. The Draft embodies an expected PRC regulatory trend to rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic investments. The comment period of the Draft required by MOFCOM ended on February 17, 2015. The Draft, if enacted as proposed, may materially impact the viability of our current corporate structure, corporate governance and business operations in following aspects:

Firstly, the Draft 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, the entities established in China but “controlled” by foreign investors will be treated as FIEs, whereas an entity set up in a foreign jurisdiction would nonetheless be, upon market entry clearance by the MOFCOM, treated as a PRC domestic investor provided that the entity is “controlled” by PRC entities and/or citizens. In this connection, “control” is broadly defined in the draft law to cover the following summarized categories: (i) holding, directly or indirectly, not less than 50% of shares, equities, share of properties, voting rights or other similar rights of the enterprise; (ii) holding, directly or indirectly, less than 50% of shares, equities, share of properties, voting rights or other similar rights of the enterprise, but falling under any of the following circumstances: (1) having the right to directly or indirectly appoint not less than half of the members of the board of directors or other similar decision-making body of the enterprise; (2) having the ability to ensure that its nominees occupy not less than half of seats in the board of directors or other similar decision-making body of the enterprise; or (3) holding voting rights sufficient to impose significant impacts on any resolution of the board of shareholders, at the general meeting of shareholders, or of the board of directors or other decision-making body of the enterprise; or (iii) having the power to exert decisive influence, via contractual or trust arrangements, over the subject entity’s operations, financial matters or other key aspects of business operations. Once an entity is determined to be an FIE, it will be subject to the foreign investment restrictions or prohibitions set forth in a “negative list,” to be separately issued by the State Council later, if the FIE is engaged in the industry listed in the negative list. Unless the underlying business of the FIE falls within the negative list, which calls for market entry clearance by the MOFCOM, prior approval from the government authorities as mandated by the existing foreign investment legal regime would no longer be required for establishment of the VIE.

 

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The “variable interest entity” structure, or VIE structure, has been adopted by many PRC-based companies, including us, to obtain necessary licenses and permits in the industries that are currently subject to foreign investment restrictions in China. Under the Draft, variable interest entities that are controlled via contractual arrangement would also be deemed as FIEs, if they are ultimately “controlled” by foreign investors. Therefore, for any companies with a VIE structure in an industry category that is on the “negative list,” the VIE structure may be deemed legitimate only if the ultimate controlling person(s) is/are of PRC nationality (either PRC companies or PRC citizens). Conversely, if the actual controlling person(s) is/are of foreign nationalities, then the variable interest entities will be treated as FIEs and any operation in the industry category on the “negative list” without market entry clearance may be considered as illegal. Moreover, for the enterprises which are not incorporated under the laws of China (foreign investors) but are “controlled” by Chinese investors, they may submit documentary evidence to apply for identifying their investment as the investment by Chinese investors when they applying for the market entry clearance to engage in any investment as set out in the “negative list” in China. The competent authorities of foreign investment will grant the review opinion on whether the said investment is identified as the investment by Chinese investors.

Through our dual-class share structure, our controlling shareholder RPL Holdings Limited, or RPL, which is beneficially owned by three PRC citizens, namely Mrs. Lingyun Guo, Dr. Vincent Wenyong Shi and Mr. Xu Zhou, possesses and controls 53.9% of the total voting power of our company, which means that we may submit documentary evidence to apply for identifying our investment as the investment by Chinese investors. However, the Draft has not taken a position on what actions shall be taken with respect to the existing companies with a VIE structure, whether or not these companies are controlled by Chinese parties, while it is soliciting comments from the public on this point. Moreover, it is uncertain whether the mobile internet industry, in which our variable interest entities operate, will be subject to the foreign investment restrictions or prohibitions set forth in the “negative list” to be issued. If the enacted version of the Foreign Investment Law and the final “negative list” mandate further actions, such as MOFCOM market entry clearance, to be completed by companies with existing VIE structure like us, we face uncertainties as to whether such clearance can be timely obtained, or at all.

Besides, the Draft imposes 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 are required at each investment and alteration of investment specifics, an annual report is mandatory, and large foreign investors meeting certain criteria are required to report on a quarterly basis. Any company found to be non-compliant with such information reporting obligations may potentially be subject to fines and/or administrative or criminal liabilities, and the persons directly responsible may be subject to criminal liabilities.

Finally, the transition from the current regulatory regime to the new regime: The Draft sets out basic principles on how to deal with issues which may arise during the transition period. FIEs are provided a 3-year transition period to change its legal form and governance structures so as to align with the Company Law, the Partnership Law and the Individual Proprietor Enterprise Law. Before completion of such change, the Three FIE Laws remain in place.

Contractual arrangements with Beijing Technology may result in adverse tax consequences to us.

Under applicable PRC tax laws and regulations, arrangements and transactions among related parties may be subject to audit or scrutiny by the PRC tax authorities. We could face material and adverse tax consequences if the PRC tax authorities were to determine that the contractual arrangements among our subsidiaries, Beijing Technology and its shareholders of were not entered into on an arm’s-length basis and therefore constituted unfavorable transfer pricing arrangements. An unfavorable transfer pricing arrangements could, among others, result in an upward adjustment on taxation. In addition, the PRC tax authorities may impose late payment penalties and interest on Beijing Technology for the adjusted but unpaid taxes. Our results of operations may be materially and adversely affected if Beijing Technology’s’ tax liabilities increase significantly and they are required to pay late payment penalties and interest.

 

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The shareholders of Beijing Technology may have potential conflicts of interest with us, which may materially and adversely affect our business and financial condition.

Certain shareholders of Beijing Technology are our founders or executive officers. Conflicts of interest may arise between the dual roles of those individuals who are both executive officers of our company and shareholders of Beijing Technology. We do not have existing arrangements to address potential conflicts of interest between those individuals and our company and cannot assure you that when conflicts arise, those individuals will act in the best interest of our company or that such conflicts will be resolved in our favor. If we cannot resolve any conflicts of interest or disputes between us and those individuals, we would have to rely on legal proceedings, which may materially disrupt our business. There is also substantial uncertainty as to the outcome of any such legal proceeding.

We may rely principally on dividends and other distributions on equity paid by our PRC and HK subsidiaries to fund any cash and financing requirements we may have. Any limitation on the ability of our PRC and HK subsidiaries to pay dividends to us could have a material adverse effect on our ability to conduct our business.

We are a holding company, and we rely principally on dividends and other distributions on equity paid by our wholly owned subsidiaries for our cash and financing requirements, including the funds necessary to pay dividends and other cash distributions to our shareholders and service any debt we may incur. If these wholly owned subsidiaries, such as NQ Beijing, incur debt on its own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other distributions to us. In addition, the PRC tax authorities may require us to adjust our taxable income under the contractual arrangements we currently have in place with our consolidated affiliated entities in a manner that would materially and adversely affect their ability to pay dividends and other distributions to us.

Under PRC laws and regulations, our subsidiaries may pay dividends only out of its cumulative profits as determined in accordance with PRC accounting standards and regulations. In addition, they are required to set aside at least 10% of their cumulative after-tax profits each year, if any, to fund certain statutory reserve funds, until the aggregate amount of such a fund reaches 50% of their respective registered capital. Although the statutory reserves can be used, among other ways, to increase the registered capital and eliminate future losses in excess of retained earnings of the respective companies, the reserve funds are not distributable as cash dividends except in the event of liquidation. At their discretion, they may allocate a portion of their after-tax profits based on PRC accounting standards to staff welfare and bonus funds. These reserve funds and staff welfare and bonus funds are not distributable as cash dividends. The registered capital of NQ Beijing is US$50 million. As of December 31, 2012, NQ Beijing turned into cumulative profit pursuant to PRC accounting standards since its inception and therefore, in accordance with applicable PRC laws and regulations, it set aside US$7.7 million and US$7.3 million statutory reserve as of December 31, 2014 and 2015, respectively.

Furthermore, cash transfers from our PRC subsidiaries to our subsidiaries outside of China are subject to PRC government control of currency conversion. Restrictions on the availability of foreign currency may affect the ability of our PRC subsidiaries and consolidated affiliated entities to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency denominated obligations. See “Item 3. Key Information — D. Risk Factors— Risks Related to Doing Business in China—Governmental control of currency conversion may limit our ability to utilize our revenues effectively and affect the value of your investment.”

Any limitation on the ability of NQ Beijing to pay dividends or make other distributions to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends, or otherwise fund and conduct our business. See “Item 3. Key Information — D. Risk Factors — Risks Related to Doing Business in China — Our global income and the dividends that we may receive from our PRC subsidiaries may be subject to PRC taxes under the PRC Enterprise Income Tax Law, which may have a material adverse effect on our results of operations.”

 

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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 making loans to our PRC subsidiaries and consolidated affiliated entities or making additional capital contributions to our PRC subsidiaries, which may materially and adversely affect our liquidity and our ability to fund and expand our business.

We are an offshore holding company conducting our operations in China through our PRC subsidiaries and consolidated affiliated entities. We may make loans to our PRC subsidiaries and consolidated affiliated entities, or we may make additional capital contributions to our PRC subsidiaries.

Any loans we issue to our PRC subsidiaries, which is treated as a foreign-invested enterprise under PRC law, are subject to PRC regulations and foreign exchange loan registrations. Pursuant to Article 18 of the Provisional Rules on Management of Foreign Debt effective on March 1, 2003, the total amount of foreign debts of a foreign-invested company shall be subject to a statutory limit which is the difference between the amount of total investment and the amount of registered capital of such foreign-invested company. The current amount of total investment and amount of registered capital of our PRC subsidiaries are US$176.054 million and US$134.15 million, respectively, and the current statutory limits on the loans to the PRC subsidiary is US$41.904 million. Such statutory limits can increase if the amount of total investment of the PRC subsidiary increases; under PRC laws and regulations, the maximum amount of total investment of a foreign-invested company with a registered capital of more than US$12 million shall not exceed three times of its registered capital. For example, loans by us to NQ Beijing to finance its activities cannot exceed statutory limits and must be registered with the local counterpart of the State Administration of Foreign Exchange, or SAFE. We may also decide to finance NQ Beijing by means of capital contributions. These capital contributions must be approved by the PRC Ministry of Commerce or its local counterpart. Due to the restrictions imposed on loans in foreign currencies extended to any PRC domestic companies, we are not likely to make such loans to our consolidated affiliated entities, such as Beijing Technology. However, if such loans become necessary for the operations of our PRC subsidiaries or consolidated affiliated entities, these statutory limits and other restrictions may materially and adversely affect our liquidity and ability to fund operations in the PRC by limiting us as a source of cash for these PRC entities. Meanwhile, we are also not likely to finance the activities of our consolidated affiliated entities by means of capital contributions due to regulatory restrictions relating to foreign investment in PRC domestic enterprises engaged in our line of business.

We may also decide to finance our PRC subsidiary by means of capital contributions. These capital contributions must be approved by the MOC or its local counterpart. In addition, SAFE issued a circular in September 2008, SAFE Circular 142, regulating the conversion by a foreign-invested enterprise of foreign currency registered capital into RMB by restricting how the converted RMB may be used. SAFE Circular 142 provides that the RMB capital converted from foreign currency registered capital of a foreign-invested enterprise may only be used for purposes within the business scope approved by the applicable government authority and unless otherwise provided by law, may not be used for equity investments within the PRC. Although on July 4, 2014, the SAFE issued the Circular of the SAFE on Relevant Issues Concerning the Pilot Reform in Certain Areas of the Administrative Method of the Conversion of Foreign Exchange Funds by Foreign-invested Enterprises, or SAFE Circular 36, which launched a pilot reform of the administration of the settlement of the foreign exchange capitals of foreign-invested enterprises in certain designated areas from August 4, 2014 and some of the restrictions under SAFE Circular 142 will not apply to the settlement of the foreign exchange capitals of the foreign-invested enterprises established within the designate areas and such enterprises are allowed to use its RMB capital converted from foreign exchange capitals to make equity investment, our PRC subsidiary is not established within the designated areas. On March 30, 2015, SAFE promulgated Circular 19, to expand the reform nationwide. Circular 19 came into force and replaced both Circular 142 and Circular 36 on June 1, 2015. Circular 19 allows foreign-invested enterprises to make equity investments by using RMB fund converted from foreign exchange capital. However, Circular 19 continues to prohibit foreign-invested enterprises from, among other things, using RMB fund converted from its foreign exchange capitals for expenditure beyond its business scope, providing entrusted loans or repaying loans between non-financial enterprises. In addition, SAFE strengthened its oversight of the flow and use of the RMB capital converted from foreign currency registered capital of a foreign-invested company. The use of such RMB capital may not be altered without SAFE’s approval, and such RMB capital may not in any case be used to repay RMB loans if the proceeds of such loans have not been used.

 

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Violations of these Circulars could result in severe monetary or other penalties. These circulars may significantly limit our ability to use RMB converted from the net proceeds of this offering to fund the establishment of new entities in China by our PRC subsidiary, to invest in or acquire any other PRC companies through our PRC subsidiary, or to establish new variable interest entities in the PRC.

In light of the various requirements imposed by PRC regulations on loans to and direct investment in PRC entities by offshore holding companies, including SAFE Circular 19, we cannot assure you that we will be able to complete the necessary government registrations or obtain the necessary government approvals on a timely basis, if at all, with respect to future loans by us to our PRC subsidiaries or any consolidated affiliated entities or with respect to future capital contributions by us to our PRC subsidiaries. If we fail to complete such registrations or obtain such approvals, our ability to capitalize or otherwise fund our PRC operations may be negatively affected, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

Risks Related to Doing Business in China

Changes in China’s economic, political or social conditions or government policies could have a material adverse effect on our business and operations.

A significant portion of our business, assets, and operations are located in China. Accordingly, our business, financial condition, results of operations and prospects may be influenced, to a considerably degree, by political, economic and social conditions in China generally and by continued economic growth in China as a whole.

The Chinese economy differs from the economies of most developed countries in many respects, including the level of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. Although the Chinese government has implemented measures since the late 1970s 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 Chinese government. In addition, the Chinese government continues to play a significant role in regulating industry development by imposing industrial policies. The Chinese government also exercises significant control over China’s economic growth through allocating resources, controlling payment of foreign currency-denominated obligations, setting monetary policy, and providing preferential treatment to particular industries or companies.

While the Chinese economy has experienced significant growth over the past decades, growth has been uneven, both geographically and among various sectors of the economy. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures may benefit the overall Chinese economy, but may have a negative effect on us. For example, our financial condition, results of operations and cash flows may be adversely affected by government control over capital investments or changes in tax regulations. In addition, in the past the Chinese government has implemented certain measures, including interest rate increases, to control the pace of economic growth. These measures may cause decreased economic activity in China, which may adversely affect our business and operating results.

Uncertainties with respect to the PRC legal system could adversely affect us.

We conduct our business in China primarily through our PRC subsidiaries and consolidated affiliated entities, including but not limited to Beijing Technology and its subsidiaries. Our operations in China are governed by PRC laws and regulations. Our PRC subsidiaries are foreign-invested enterprises and are subject to laws and regulations applicable to foreign investment in China and, in particular, laws applicable to foreign-invested enterprises. 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.

 

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In 1979, the PRC government began to promulgate a comprehensive system of laws 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 investments in China. However, China has not developed a fully integrated legal system, and recently enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, the interpretation and enforcement of these laws and regulations involve uncertainties. Since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be difficult to evaluate the outcome of administrative and court proceedings and the level of legal protection we enjoy. For example, China enacted a new Anti-Monopoly Law, which became effective on August 1, 2008. Because the Anti-Monopoly Law and related regulations are still relatively new, there have been very few court rulings or judicial or administrative interpretations on certain key concepts used in the law. As a result, there is still uncertainty as to how the enforcement and interpretation of the Anti-Monopoly Law may affect our business and operations.

Furthermore, 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, which may have a retroactive effect. As a result, we may not be aware of our violation of any of these policies and rules until sometime after the violation. In addition, any administrative and court proceedings in China may be protracted, resulting in substantial costs and diversion of resources and management attention.

We may be adversely affected by the complexity, uncertainties and changes in PRC regulation of the licenses and permits required for the telecommunications and software development industries in China.

The PRC government extensively regulates the telecommunications and software development industries, including foreign ownership of, and the licensing and permit requirements pertaining to, companies in the telecommunication industry. These laws and regulations are relatively new and evolving, and their interpretation and enforcement involve significant uncertainty.

As a result, there are uncertainties relating to the regulation of the telecommunication business in China, particularly evolving licensing practices. This means that permits, licenses or operations at some of our companies may be subject to challenge, or we may fail to obtain permits or licenses that applicable regulators may deem necessary for our operations or we may not be able to obtain or renew certain permits or licenses to maintain their validity. The major permits and licenses that could be involved include, without limitation, the Value-Added Telecommunications Services Operation Permit issued by the MIIT and the Telecommunications and Information Services Operation Permit issued by the Beijing Communications Administration. New laws and regulations may be promulgated that will regulate telecommunication activities and additional licenses may be required for our operations. If our operations do not comply with these new regulations at the time they become effective, or if we fail to obtain any licenses required under these new laws and regulations, we could be subject to penalties.

On July 13, 2006, the Ministry of Information Industry, which was the predecessor of the MIIT, issued the Notice of the Ministry of Information Industry on Intensifying the Administration of Foreign Investment in Value-added Telecommunications Services. This notice prohibits domestic telecommunication services providers from leasing, transferring or selling telecommunications business operating licenses to any foreign investor in any form, or providing any resources, websites or facilities to any foreign investor for their illegal operation of a telecommunications business in China. According to this notice, either the holder of a value-Added telecommunication business operating license or its shareholders must directly own the domain names and trademarks used by such license holders in their provision of value-added telecommunication services. The notice also requires each license holder to have the necessary facilities, including servers, for its approved business operations and to maintain such facilities in the regions covered by its license.

Operating mobile online games in China requires a series of permits and approvals. For example, we have obtained a license from the Ministry of Culture with respect to the operation of mobile online games. In addition, the Internet publication of mobile online games requires pre-approval from the GAPP. We operate a substantial majority of our mobile online games in collaboration with third parties such as content providers, and such third parties are in charge of obtaining the approvals from GAPP. For the remaining mobile online games we operate, we are responsible for obtaining approvals from GAPP. Because the requirement for GAPP approval of mobile online games was imposed in late 2009 and the approval process is lengthy, GAPP has not yet approved some mobile online games that we operate. With respect to the games that we operate alone, we have not submitted applications for GAPP approval as we are first required to obtain an online publication license from GAPP. We have started the process of obtaining such a license. We cannot assure you that we can obtain an online publication license in a timely manner or at all.

 

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The interpretation and application of existing PRC laws, regulations and policies and possible new laws, regulations or policies relating to the telecommunications and software development industries have created substantial uncertainties regarding the legality of existing and future foreign investments in, and the businesses and activities of, telecommunication businesses in China, including our business. We cannot assure you that we have obtained all the permits or licenses required for conducting our business in China or will be able to maintain our existing licenses or obtain any new licenses if required by any new laws or regulations. There are also risks that we may be found to violate the existing or future laws and regulations given the uncertainty and complexity of China’s regulation of the telecommunications and software development industries. See “Item 4. Information on the Company — B. Business Overview — PRC Regulation.”

Regulation and censorship of information disseminated over the Internet and wireless telecommunication networks in China may adversely affect our business, and the mobile service providers with which we cooperate may be liable for information displayed on, retrieved from, or linked to their platforms.

China has enacted regulations governing telecommunication mobile service providers, Internet and wireless access and the distribution of news and other information over the Internet and wireless telecommunication networks. Under these regulations, mobile content publishers like us are prohibited from posting or displaying over the Internet or wireless networks content that, among other things, violates PRC laws and regulations, impairs the national dignity of China, or is obscene, superstitious, fraudulent or defamatory.

When Internet and mobile service providers find that any obscene, superstitious, fraudulent or defamatory information is transmitted on their platforms, they are required to terminate the transmission of such information or delete such information immediately, keep records, and report to relevant authorities. Mobile network operators like China Mobile, China Telecom and China Unicom also have their own policies prohibiting or restricting the distribution of inappropriate content. On December 15, 2009, the MIIT issued the Notice Regarding Plan for Further Regulating Obscene Materials on Mobile Phones, or Circular 672. Under Circular 672, mobile network operators are required to examine their business, promotional channels, as well as the business of their partners, and must immediately terminate such business if any obscene material is involved. Mobile service providers involved in distributing or publishing such obscene materials on mobile handsets are subject to immediate suspension or termination of cooperation with mobile network operators, and a violation will be reported to relevant authorities. Mobile network operators and mobile service providers must examine all websites accessed through mobile handsets and conduct full daily inspection of such websites. If any obscene material is found, access and transmission must cease and be reported to authorities. On June 3, 2010, the MOC issued the Online Game Measures, which became effective on August 1, 2010, according to which companies that plan to engage in the operation of online games, issuance of virtual currency and provision of virtual currency transaction services shall obtain a license from the provincial counterpart of the MOC. Online and mobile game operators are required to establish a self-censorship mechanism and ensure the lawfulness of the content of their games and corporate operations. The Administrative Measures for Content Self-review by Internet Culture Business Entities, or the Content Self-review Administrative Measure, which took effect in December 2013, require Internet culture business entities to review the content of products and services to be provided prior to providing such content and services to the public. The content management system of an Internet culture business entity is required to specify the responsibilities, standards and processes for content review as well as accountability measures, and is required be filed with the local provincial branch of the MOC.

As these regulations are relatively new and subject to interpretation by the relevant authorities, it may not be possible for us to determine in all cases the type of content that could result in liability for us as a mobile game operator. In addition, we may not be able to control or restrict the content of other content providers linked to or accessible through our mobile service providers. To the extent that regulatory authorities find any portion of the applications and content on our mobile service providers objectionable, they may require them to limit or eliminate the dissemination of such information or otherwise curtail the nature of such content on our mobile service providers, which may reduce our user traffic, which in turn decrease access to and downloading of our mobile games.

 

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If we fail to obtain and maintain the requisite licenses and approvals required under the complex regulatory environment applicable to our businesses in China, or if we are required to take compliance actions that are time-consuming or costly, our business, financial condition and results of operations may be materially and adversely affected.

The internet and mobile industries in China are highly regulated. We are required to obtain and maintain applicable licenses and approvals from different regulatory authorities in order to provide their current services. Under the current PRC regulatory scheme, a number of regulatory agencies, including but not limited to the State Administration of Press, Publication, Radio, Film and Television, or SARFT, the Ministry of Culture, or MOC, Ministry of Industry and Information Technology, or MIIT, and the State Council Information Office, or SCIO, jointly regulate all major aspects of the internet industry, including the mobile internet and mobile games businesses. Operators must obtain various government approvals and licenses for relevant mobile business.

We have obtained the ICP licenses for provision of internet information services and internet culture operation licenses for operation of online games. These licenses are essential to the operation of our business and are generally subject to regular government review or renewal. However, we cannot assure you that we can successfully renew these licenses in a timely manner or that these licenses are sufficient to conduct all of our present or future business.

Considerable uncertainties exist regarding the interpretation and implementation of existing and future laws and regulations governing our business activities. Although we do not believe our video sharing function in the user groups requires an internet audio/video program transmission license because such function does not constitute an internet audio/video program service under the Internet Audio/Video Program Services Categories (Provisional), or the Provisional Categories, issued by SARFT, in March 2010, we may be required to obtain an internet audio/video program transmission license from SARFT in order to provide video sharing function through the mobile networks. Further, we may be required to obtain an internet culture operation license for our Music Radar application. As of the date of this annual report, we have not yet to obtain an internet audio/video program transmission license or an internet culture operation license. In the event of any failure to meet the above-mentioned requirements, we may no longer be able to offer video sharing function or music content on our platform or application, which would have a material adverse effect on our business and results of operations. As for Tianya mobile healthcare applications, which provide healthcare consultation services, we are still communicating with competent authorities whether we are required to apply ICP license in order to cover the operation of electronic bulletin board system. If the competent authorities consider the license necessary, we will apply to expand the scope of our ICP license to cover electronic bulletin board system or apply for a new ICP license that includes electronic bulletin board system. We cannot assure you that we will not be found in violation of any future laws and regulations or any of the laws and regulations currently in effect due to changes in the relevant authorities’ interpretation of these laws and regulations. If we fail to complete, obtain or maintain any of the required licenses or approvals or make the necessary filings, we may be subject to various penalties, such as confiscation of the net revenues that were generated through the unlicensed internet or mobile activities, the imposition of fines and the discontinuation or restriction of our operations. Any such penalties may disrupt our business operations and materially and adversely affect our business, financial condition and results of operations.

Fluctuations in exchange rates may have a material adverse effect on your investment.

The value of the RMB against the U.S. dollar and other currencies is affected by, among others, changes in China’s political and economic conditions and China’s foreign exchange policies. The conversion of RMB into foreign currencies, including U.S. dollars, is based on exchange rates set by the People’s Bank of China. The PRC government allowed the RMB to appreciate by more than 20% against the U.S. dollar between July 2005 and July 2008. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the RMB and the U.S. dollar remained within a narrow band. Since June 2010, the RMB has fluctuated against the U.S. dollar, especially in 2015 significantly and unpredictably. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between the RMB and the U.S. dollar as well as other currencies in the future.

To the extent that we need to convert U.S. dollars into RMB for capital expenditures and working capital and other business purposes, appreciation of the RMB against the U.S. dollar would have an adverse effect on the RMB amount we would receive from the conversion. Conversely, if we decide to convert RMB into U.S. dollars for the purpose of making payments for dividends on our common shares or ADSs, strategic acquisitions or investments or other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect on the U.S. dollar amount available to us.

 

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A significant portion of our revenues and costs are denominated in RMB. At the Cayman Islands holding company level, we may receive dividends and other fees paid to us by our subsidiary in China. Any significant revaluation of the RMB may materially and adversely affect our cash flows, revenues, earnings and financial position, and the value of, and any dividends payable on, our ADSs in U.S. dollars. For example, an appreciation of the RMB against the U.S. dollar would make any new RMB denominated investments or expenditures more costly to us, to the extent that we need to convert U.S. dollars into RMB for such purposes. Conversely, a significant depreciation of the RMB against the U.S. dollar may significantly reduce the U.S. dollar equivalent of our earnings, which in turn could adversely affect the price of our ADSs.

Very limited hedging options are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedges may be limited and we may not be able to adequately hedge our exposure or at all. In addition, our currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currency. As a result, fluctuations in exchange rates may have a material adverse effect on your investment.

Governmental control of currency conversion may limit our ability to utilize our revenues effectively and affect the value of your investment.

The PRC government imposes controls on the convertibility of the RMB into foreign currencies and, in certain cases, the remittance of currency out of China. We receive a substantial part of our revenues in RMB, and the rest in foreign currencies such as U.S. dollars. Under our current corporate structure, our Cayman Islands holding company, to a large extent, relies on dividend payments from our wholly owned PRC subsidiary, NQ Beijing, and our wholly owned Hong Kong subsidiary, NQ International Ltd. (formerly known as NetQin International Limited), or NQ HK, to fund any cash and financing requirements we may have. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior SAFE approval by complying with certain procedural requirements. Therefore, NQ Beijing is able to pay dividends in foreign currencies to us without prior approval from SAFE. However, approval from or registration with appropriate government authorities is required where RMB is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of loans denominated in foreign currencies. The PRC government may also at its discretion restrict access to foreign currencies for current account transactions in the future. If the foreign exchange control system prevents us from obtaining sufficient foreign currencies to satisfy our foreign currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs. PRC regulations established complex procedures for certain acquisitions of PRC companies

Regulations about mergers and acquisition in the PRC may make it more difficult for us to pursue growth through acquisitions.

Six PRC regulatory agencies promulgated regulations effective on September 8, 2006 that are commonly referred to as the M&A Rules. See “Item 4. Information on the Company — B. Business Overview — PRC Regulation.” The M&A Rules establish procedures and requirements that could make some acquisitions of PRC companies by foreign investors more time-consuming and complex, including requirements in some instances that the Ministry of Commerce be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise. In addition, the national security review rules issued by the PRC governmental authorities in 2011 require acquisitions by foreign investors of domestic companies engaged in military related businesses or certain other industries that are crucial to national security to be subject to prior security review. We may expand our business in part by acquiring complementary businesses. Complying with the requirements of the M&A Rule, security review rules and other PRC regulations to complete such transactions could be time-consuming, and compliance with any required approval processes, including obtaining approval from the Ministry of Commerce, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.

 

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PRC regulations relating to the establishment of offshore special purpose vehicles, or SPVs, by PRC residents may subject our PRC resident beneficial owners or our PRC subsidiaries to liability or penalties, limit our ability to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to increase its registered capital or distribute profits to us, or may otherwise adversely affect us.

SAFE promulgated the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-Raising and Round-trip Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or SAFE Circular No. 75, on October 21, 2005. SAFE Circular No. 75 and other associated regulations require PRC residents and PRC corporate entities to register with local branches of SAFE in connection with their direct or indirect offshore investment activities. These regulations apply to our shareholders who are PRC residents and may apply to any offshore acquisitions that we make in the future. To further clarify and simplify the implementation of SAFE Circular No. 75, SAFE has issued various rules which established more specific and stringent supervision on the registration process required by Circular No. 75.

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 No. 37, on July 4, 2014, which replaced SAFE Circular No. 75. SAFE Circular No. 37 requires PRC residents to register with local branches of SAFE in connection with their direct establishment or indirect control of an offshore entity, or an SPV, for the purpose of overseas investment and financing, utilizing such PRC residents’ legally owned assets or equity interests in domestic enterprises or offshore. The term “control” under SAFE Circular No. 37 is broadly defined as the right to operate, rights as beneficiary or decision-making rights acquired by the PRC residents in the offshore SPVs or PRC companies by such means as acquisition, trust, proxy, voting rights, repurchase, convertible bonds or other arrangements. SAFE Circular No. 37 further requires amendment to the registration in the event of any significant changes with respect to the SPV, 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 SPV fails to fulfill the required SAFE registration, the PRC subsidiaries of that SPV may be prohibited from distributing profits to the offshore parent and from carrying out subsequent cross-border foreign exchange activities, and the SPV may be restricted in its ability to contribute additional capital into its PRC subsidiary. 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.

SAFE Circular No. 37 provides that PRC residents include both PRC citizens, meaning any individual who holds a PRC passport or resident identification card, and individuals who are non-PRC citizens but primarily reside in the PRC due to their economic ties to the PRC. We have requested all of our current shareholders and/or beneficial owners to disclose whether they or their shareholders or beneficial owners fall within the ambit of SAFE Circular No. 37 and its guidance and will urge relevant shareholders and beneficial owners, upon learning they are PRC residents, to make the necessary applications, filings and amendments as required under SAFE Circular No. 37 and other related rules. To our knowledge, all of our shareholders who are PRC citizens have completed initial registrations with a local SAFE branch as required under SAFE Circular No. 75 and will update their registrations to the extent required under Circular No. 37 and its implementing guidelines to reflect our latest ownership structure.

We have requested our current shareholders and/or beneficial owners to disclose whether they or their shareholders or beneficial owners fall within the coverage of Circular No. 37 and urge those who are PRC residents to register with the local SAFE branch as required under Circular No. 37. However, as SAFE Circular No. 37 was recently promulgated, there are substantial uncertainties on how this new rule will be implemented and interpreted. We cannot assure you that our current shareholders and/or beneficial owners or their shareholders or beneficial owners can successfully comply with registration requirements under SAFE Circular No. 37 and subsequent implementation rules in a timely fashion or at all. In addition, we may not be informed of the identities of all the PRC residents holding direct or indirect interest in our company, and we cannot provide any assurances that these PRC residents will comply with our request to make or obtain any applicable registrations or comply with other requirements required by SAFE Circular No. 37 or other related rules. Failure by our current or future shareholders or beneficial owners who are PRC residents to comply with the SAFE regulations may subject us to fines or other legal sanctions, restrict our cross-border investment activities, limit our PRC subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.

 

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Furthermore, it is unclear how these regulations, and any future regulation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant government authorities. We cannot predict how these regulations will affect our business operations or future strategy. For example, we may be subject to a more stringent review and approval process with respect to our foreign exchange activities, such as remittance of dividends and foreign-currency-denominated borrowings, which may adversely affect our financial condition and results of operations. In addition, if we decide to acquire a PRC domestic company, we cannot assure you that we or the owners of such company, as the case may be, will be able to obtain the necessary approvals or complete the necessary filings and registrations required by the foreign exchange regulations. This may restrict our ability to implement our acquisition strategy and could adversely affect our business and prospects.

We face uncertainty with respect to indirect transfers of equity interests in PRC resident enterprises by their non-PRC holding companies.

Pursuant to 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, or the SAT, on December 10, 2009 with retroactive effect from January 1, 2008, where a non-resident enterprise transfers the equity interests of a PRC resident enterprise indirectly via disposing of the equity interests of an overseas holding company, or an Indirect Transfer, and such overseas holding company is located in a tax jurisdiction that: (i) has an effective tax rate less than 12.5% or (ii) does not tax foreign income of its residents, the non-resident enterprise, being the transferor, shall report to the competent tax authority of the PRC resident enterprise this Indirect Transfer. Using a “substance over form” principle, the PRC tax authority may disregard the existence of the overseas holding company if it lacks a reasonable commercial purpose and was established for the purpose of reducing, avoiding or deferring PRC tax. As a result, gains derived from such Indirect Transfer may be subject to PRC tax at a rate of up to 10%. SAT Circular 698 also provides that, where a non-PRC resident enterprise transfers its equity interests in a PRC resident enterprise to its related parties at a price lower than the fair market value, the relevant tax authority has the power to make a reasonable adjustment to the taxable income of the transaction.

There is uncertainty as to the application of SAT Circular 698. For example, while the term “Indirect Transfer” is not clearly defined, it is understood that the relevant PRC tax authorities have the power to compel the cooperation of a wide range of foreign entities having no direct contact with China. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax rates in foreign tax jurisdictions, and the process and format of the reporting of an Indirect Transfer to the competent tax authority of the relevant PRC resident enterprise. In addition, there are not any formal declarations with regard to how to determine whether a foreign investor has adopted an abusive arrangement in order to reduce, avoid or defer PRC tax. As a result, we may become at risk of being taxed under SAT Circular 698 and we may be required to expend valuable resources to comply with SAT Circular 698 or to establish that we should not be taxed under the general anti-avoidance rule of the PRC Enterprise Income Tax Law, which may have a material adverse effect on our financial condition and results of operations.

Discontinuation of any of the preferential tax treatments or imposition of any additional taxes could adversely affect our financial condition and results of operations.

China passed an updated PRC Enterprise Income Tax Law, or the EIT Law, and its implementation rules, both of which became effective on January 1, 2008. The EIT Law significantly curtails tax incentives granted to foreign-invested enterprises under the PRC Enterprise Income Tax Law concerning Foreign-Invested Enterprises and Foreign Enterprises (or the Old EIT Law, which was effective from July 1, 1991 to December 31, 2007). The EIT Law, however, (i) reduces the statutory rate of the enterprise income tax from 33% to 25%, (ii) permits companies established before March 16, 2007 to continue to enjoy their existing tax incentives, adjusted by certain transitional phase-out rules promulgated by the State Council on December 26, 2007, and (iii) introduces new tax incentives, subject to various qualification criteria.

 

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The EIT Law and its implementation rules permit certain “high and new technology enterprises strongly supported by the state” which hold independent ownership of core intellectual property to enjoy a preferential enterprise income tax rate of 15% subject to certain new qualification criteria. Beijing Technology, our consolidated affiliated entity, was recognized by the Beijing Municipal Science and Technology Commission as a “high and new technology enterprise” on December 24, 2008, and therefore is eligible for the reduced 15% enterprise income tax rate. The qualification as a “high and new technology enterprise” is subject to review by the relevant authorities in China every three years. Beijing Technology was qualified as a high and new technology enterprise and has successfully renewed this status in late 2014, which enabled it to enjoy preferential income tax treatment through 2016. However, if Beijing Technology fails to maintain its “high and new technology enterprise” qualification or renew its qualification when the relevant term expires, its applicable enterprise income tax rate may increase to 25%, which could have a material adverse effect on our financial condition and results of operations. In addition, according to the Notice of the State Administration of Taxation on Further Clarifying the Standards for the Implementation of Preferential Policies Regarding Corporate Income Tax during the Transition Period issued on April 21, 2010, or Circular 157, where a resident enterprise is qualified as a high and new technology enterprise, and simultaneously is entitled to a term holiday under the phase-out rules of the EIT Law, the resident enterprise can choose either to enjoy the term holiday based on the phase-out tax rates (i.e., 18% for 2008, 20% for 2009, 22% for 2010, 24% for 2011 and 25% for 2012 and onwards) or enjoy the preferential tax rate of 15% as a high-tech enterprise. However, for taxable years 2008 through 2010, Beijing Technology applied a transitional tax rate of 7.5% as its applicable rate despite the provisions in Circular 157. This EIT rate has been approved by Beijing Haidian District State Tax Bureau as a transitional treatment to allow Beijing Technology to continue to enjoy its unexpired tax holiday under prior law. Since it is uncertain whether the State Administration of Taxation will enforce Circular 157 retrospectively, we cannot assure you that Beijing Technology will maintain the tax benefits it previously enjoyed, or that the local tax authorities will not, in the future, order the return of such tax benefits. NQ Beijing has already obtained the Software Enterprise Certification. Therefore, it qualifies for preferential tax treatment as a “software enterprise” under the EIT Law and is entitled to a two-year exemption from the first year it becomes profitable and a three-year 50% reduction in corporate income tax, upon its filing with its in-charge tax authority. In 2015, the applicable corporate income tax rate of NQ Beijing, NQ Tongzhou and FL Mobile was 12.5%, 0% for Century Hetu.

Preferential tax treatments granted to our subsidiaries and consolidated affiliated entities by the local governmental authorities are subject to review and may be adjusted or revoked at any time. The discontinuation of any preferential tax treatments currently available to us and our wholly owned PRC subsidiaries will cause our effective tax rate to increase, which could have a material adverse effect on our financial condition and results of operations. We cannot assure you that we will be able to maintain our current effective tax rate in the future.

Our financial condition and results of operations could be materially and adversely affected if the value added tax reforms in the PRC become unfavorable to our PRC subsidiaries or consolidated affiliated entities.

In 2012, China introduced a value added tax, or VAT, to replace the previous 5% business tax. Our PRC subsidiaries and the consolidated affiliated entities have been subject to VAT at a base rate of 6% since September 2012. The rules related to VAT are still evolving and the timing of the promulgation of the final tax rules or related interpretation is uncertain. Our financial condition and results of operations could be materially and adversely affected if the interpretation and enforcement of these tax rules become materially unfavorable to our PRC subsidiaries and consolidated affiliated entities.

Our global income and the dividends that we may receive from our PRC subsidiaries may be subject to PRC taxes under the PRC Enterprise Income Tax Law, which may have a material adverse effect on our results of operations.

Under the EIT Law, an enterprise established outside of China with its “de facto management body” within China is considered a resident enterprise and will be subject to enterprise income tax at the rate of 25% on its global income. The “de facto management body” is defined as the organizational body that effectively exercises overall management and control over production and business operations, personnel and human resources, finance and accounting, and properties of the enterprise. It remains unclear how the PRC tax authorities will interpret such a broad definition. On April 22, 2009, the SAT issued a circular, known as Circular 82, which provides certain specific criteria for determining whether the “de facto management body” of a PRC-controlled enterprise that is incorporated offshore is located in China. Under Circular 82, an offshore incorporated enterprise controlled by a PRC enterprise or a PRC enterprise group will be regarded as a PRC tax resident by virtue of having its “de facto management body” in China and will be subject to PRC enterprise income tax on its global income only if all of the following conditions are met: (i) the primary location of the day-to-day operational management is in the PRC; (ii) decisions relating to the enterprise’s financial and human resource matters are made or are subject to approval by organizations or personnel in the PRC; (iii) the enterprise’s primary assets, accounting books and records, company seals, and board and shareholder resolutions, are located or maintained in the PRC; and (iv) at least 50% of voting board members or senior executives habitually reside in the PRC. Further to Circular 82, the SAT issued a bulletin, known as SAT Bulletin 45, which became effective in September 2011, to provide more guidance on the implementation of Circular 82 and clarify the reporting and filing obligations of such “Chinese-controlled offshore incorporated resident enterprises.” SAT Bulletin 45 provides procedures and administrative details for the determination of resident status and administration on post-determination matters. Although both Circular 82 and SAT Bulletin 45 only apply to offshore enterprises controlled by PRC enterprises or PRC enterprise groups, not those controlled by PRC individuals or foreigners, the criteria set forth in the Circular 82 and SAT Bulletin 45 may reflect the SAT’s general position on how the “de facto management body” test should be applied in determining the tax resident status of all offshore enterprises, regardless of whether they are controlled by PRC enterprises, PRC enterprise groups or by PRC or foreign individuals.

 

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We do not believe that we or our oversea subsidiaries meet all of the conditions above and thus we do not believe that we or our oversea subsidiaries are PRC resident enterprises, though a substantial majority of the members of our management team as well as the management team of our offshore holding companies are located in China. However, we have been advised by our PRC counsel, Jincheng Tongda & Neal, that there remains uncertainty regarding the interpretation and implementation of the EIT Law and its implementation rules, and there is no assurance that we or our oversea subsidiaries will not be treated as a PRC resident enterprise. If we are considered a resident enterprise and earn income other than dividends from our PRC subsidiaries, a 25% enterprise income tax on our global income may significantly increase our tax burden and materially and adversely affect our cash flow and profitability. Dividends paid between PRC companies are not generally subject to PRC withholding tax. However, it is unclear whether this exemption applies to foreign companies considered PRC residents under the EIT law. Accordingly, if we or our oversea subsidiaries are treated as a PRC resident enterprise, it is uncertain whether dividends we or our oversea subsidiaries receive from our PRC subsidiaries would be subject to PRC withholding tax.

The enforcement of the Labor Contract Law and other labor-related regulations in the PRC may adversely affect our business and our results of operations.

China enacted the Labor Contract Law effective on January 1, 2008. The Labor Contract Law introduces specific provisions related to fixed-term employment contracts, part-time employment, probation, consultation with labor union and employee assemblies, employment without a written contract, dismissal of employees, severance, and collective bargaining, which together represent enhanced enforcement of labor laws and regulations. According to the Labor Contract Law, an employer is obliged to sign an unlimited-term labor contract with any employee who has worked for the employer for ten consecutive years. Further, if an employee requests or agrees to renew a fixed-term labor contract that has already been entered into twice consecutively, the resulting contract must have an unlimited term, with certain exceptions. The employer must also pay severance to an employee in nearly all instances where a labor contract, including a contract with an unlimited term, is terminated or expires. In addition, the government has continued to introduce various new labor-related regulations after the Labor Contract Law. Among other things, new annual leave requirements mandate that annual leave ranging from five to 15 days is available to nearly all employees and further require that the employer compensate an employee for any annual leave day the employee is unable to take in the amount of three times the employee’s daily salary, subject to certain exceptions. We cannot assure you that our employment practices do not or will not violate the Labor Contract Law and other labor-related regulations. If we are subject to severe penalties or incur significant liabilities in connection with labor disputes or investigations, our business and results of operations may be adversely affected.

Under the Social Insurance Law and the Administrative Measures on Housing Fund, employees are required to participate in pension insurance, work-related injury insurance, medical insurance, unemployment insurance, maternity insurance and housing funds and employers are required, together with their employees or separately, to pay the social insurance premiums and housing funds for their employees. These laws designed to enhance labor protection tend to increase our labor costs. In addition, as the interpretation and implementation of these regulations are still evolving, our employment practices may not be at all times be deemed in compliance with the regulations. As a result, we could be subject to penalties or incur significant liabilities in connection with labor disputes or investigations.

 

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Risks Related to Our ADSs

The trading price for our ADSs has been and may continue to be volatile.

The trading price of our ADSs has been and may continue to be subject to significant fluctuations. From January 1, 2015 to March 15, 2016, the trading price of our ADSs on the New York Stock Exchange ranged from US$2.80 to US$6.54 per ADS, and the closing price on March 15, 2016 was US$3.72 per ADS. The trading price for our ADSs may continue to be volatile and subject to wide fluctuations in response to factors including the following:

 

    regulatory developments in our target markets affecting us, our customers or our competitors;

 

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

 

    changes in the economic performance or market valuations of other companies that provide mobile security and management solutions;

 

    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 value-added telecommunication or Internet services industries;

 

    announcements by us or our competitors of new services, acquisitions, strategic relationships, joint ventures or capital commitments;

 

    additions to or departures of our senior management;

 

    sales or perceived potential sales of additional shares or ADSs;

 

    negative publicity and allegations about our company, our products and services, our financial results or our market position; and

 

    market and volume fluctuations in the stock market in general.

In addition, the stock market in general, and the market prices for companies with operations in China in particular have experienced volatility that might have been unrelated to the operating performance of such companies. The securities of some China-based companies that have listed their securities in the United States 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 the securities of these China-based companies after their offerings 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 practices or fraudulent accounting, corporate structure or other matters of other China-based companies, such as news of the SEC initiating administrative proceedings against and imposing sanctions on the China affiliates of the Big Four public accounting firms for refusing to produce audit work papers and other documents related to China-based companies under investigation by the SEC for potential accounting fraud, may also negatively affect the attitudes of investors towards China-based companies in general, including us, regardless of whether we have engaged in any inappropriate activities. The global financial crisis and the ensuing economic recessions in many countries have also contributed and may continue to contribute to extreme volatility in the global stock markets, 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, part of 2012, and since the beginning of 2016. These broad market and industry fluctuations may adversely affect the price of our ADSs, regardless of our operating performance.

 

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Provisions of our convertible notes could discourage an acquisition of us by a third party.

In October 2013, we issued an aggregate of US$172.5 million 4.00% convertible senior notes due in 2018. Certain provisions of our convertible senior notes could make it more difficult or more expensive for a third party to acquire us. The indentures for these convertible notes define a “fundamental change” to include, among other things: (1) any person or group gaining control of our company; (2) any recapitalization, reclassification or change of our ordinary shares or the ADSs as a result of which these securities would be converted into, or exchanged for, stock, other securities, other property or assets; (3) the adoption of any plan relating to the liquidation or dissolution of our company; (4) our ADSs ceasing to be listed on The New York Stock Exchange, The NASDAQ Global Select Market or The NASDAQ Global Market; or (5) any change in or amendment to the laws, regulations and rules in China that prohibits us from operating substantially all of the business operations and prevents us from continuing to derive substantially all of the economic benefits from our business operations. Upon the occurrence of a fundamental change, holders of these notes will have the right, at their option, to require us to repurchase all of their notes or any portion of the principal amount of such notes in integral multiples of US$1,000. In the event of a fundamental change, we may also be required to issue additional ADSs upon conversion of our convertible notes.

Because we do not expect to pay dividends in the foreseeable future, you must rely on price appreciation of our ADSs for return on your investment.

We currently intend to retain most, if not all, of our available funds and any future earnings to fund the development and growth of our business. As a result, we do not expect to pay any cash dividends in the foreseeable future. Therefore, you should not rely on an investment in our ADSs as a source for any future dividend income.

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 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 or common shares in the public market, or the perception that these sales could occur, could cause the market price of our ADSs to decline. If our shareholders sell substantial amounts of our ADSs, including those issued upon the exercise of outstanding options, in the public market, the market price of our ADSs could fall. Such sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate. If any existing shareholder or shareholders sell a substantial amount of shares, the prevailing market price for our ADSs could be adversely affected. In addition, if we pay for our future acquisitions in whole or in part with additionally issued common shares or ADSs, your ownership interests in our company would be diluted and this, in turn, could have a material adverse effect on the price of our ADSs.

You may not have the same voting rights as the holders of our common shares and may not receive voting materials in time to be able to exercise your right to vote.

Except as described in this annual report and in the deposit agreement, holders of our ADSs will not be able to exercise voting rights attaching to the shares represented by our ADSs on an individual basis. Holders of our ADSs will appoint the depositary or its nominee as their representative to exercise the voting rights attaching to the shares represented by the ADSs. You may not receive voting materials in time to instruct the depositary to vote, and it is possible that you, or persons who hold their ADSs through brokers, dealers or other third parties, will not have the opportunity to exercise a right to vote.

 

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Your right to participate in any future rights offerings may be limited, which may cause dilution to your holdings, and you may not receive cash dividends if it is impractical to make them available to you.

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 United States 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 and may experience dilution in your holdings.

The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on our common shares or other deposited securities after deducting its fees and expenses. You will receive these distributions in proportion to the number of common shares your ADSs represent. However, the depositary may, at its discretion, decide that it is 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.

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.

You may face difficulties in protecting your interests, and your ability to protect your rights through the U.S. federal courts may be limited because we are incorporated under Cayman Islands law, we conduct significant portion of our operations in China and a significant number of our directors and officers reside outside the United States.

We are incorporated in the Cayman Islands and currently conduct a significant portion of our operations in China through our PRC subsidiaries and consolidated affiliated entities. A significant number of our directors and officers reside outside the United States and a substantial portion of their assets are located outside of the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the Cayman Islands or in China in the event that you believe that their rights have been infringed under the securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of the Cayman Islands will generally recognize and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits.

Our corporate affairs are governed by our memorandum and articles of association, as amended and restated from time to time, and by the Companies Law (2013 Revision) and common law of the Cayman Islands. The rights of shareholders to take legal action against us and our directors, actions by minority shareholders and the fiduciary responsibilities of our directors 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 English common law, which provides persuasive, but not binding, authority. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands has a less developed body of securities laws than the United States and provides significantly less protection to investors. In addition, shareholders of Cayman Islands companies may not have standing to initiate a shareholder derivative action in U.S. federal courts.

 

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As a result, our public shareholders may have more difficulty in protecting their interests through actions against us, our management, our directors or our major shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States.

Our dual-class common share structure with different voting rights will limit your ability to influence corporate matters and could discourage others from pursuing any change of control transactions that holders of our Class A common shares and ADSs may view as beneficial.

Our common shares are divided into Class A common shares and Class B common shares. Holders of Class A common shares are entitled to one vote per share, while holders of Class B common shares are entitled to ten votes per share. We issued Class A common shares represented by our ADSs in our initial public offering. All of our outstanding common shares prior to the initial public offering were redesignated as Class B common shares and our outstanding preferred shares were automatically converted into Class B common shares upon the completion of our initial public offering. In addition, all options issued prior to the completion of our initial public offering entitle option holders to the equivalent number of Class B common shares once the options are vested and exercised. Due to the disparate voting powers attached to these two classes, certain shareholders have significant voting power of our outstanding common shares and have considerable influence over matters requiring shareholder approval, including election of directors and significant corporate transactions, such as a merger or sale of our company or our assets. In particular, as of March 15, 2016, our controlling shareholder RPL Holdings Limited owns approximately 10.5% of our outstanding common shares, representing 53.9% of our total voting power. This concentrated control will limit your ability to influence corporate matters and could discourage others from pursuing any potential merger, takeover or other change of control transactions that holders of Class A common shares and ADSs may view as beneficial and may depress the trading prices of our ADSs. Our memorandum and articles of association contain anti-takeover provisions that could adversely affect the rights of holders of our Class A common shares and ADSs.

Our memorandum and articles of association contain certain provisions that could limit the ability of others to acquire control of our company, including a provision that grants authority to our board directors to establish from time to time one or more series of preferred shares without action by our shareholders and to determine, with respect to any series of preferred shares, the terms and rights of that series. The provisions could have the effect of depriving our shareholders of the opportunity to sell their shares at a premium over the prevailing market price by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transactions.

Our corporate actions are substantially controlled by our directors, executive officers and other principal shareholders, who can exert significant influence over important corporate matters, which may reduce the price of our ADSs and deprive you of an opportunity to receive a premium for your shares.

As of March 15, 2016, our directors, executive officers and principal shareholders collectively hold approximately 55.8% of the total voting power of our outstanding common shares. These shareholders, if acting together, could exert substantial influence over matters such as electing directors and approving material mergers, acquisitions or other business combination transactions. If our founders and directors retain their shares in our company, they will continue to have substantial influence over our company in the foreseeable future. This concentration of ownership may also discourage, delay or prevent a change in control of our company, which could have the dual effect of depriving our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and reducing the price of our ADSs. These actions may be taken even if they are opposed by our other shareholders, including those who purchase our ADSs. In addition, these persons could divert business opportunities away from us to themselves or others.

We incur increased costs as a result of being a public company.

As a public company, we incur significant accounting, legal and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act, as well as rules subsequently implemented by the SEC and The New York Stock Exchange, have detailed requirements concerning corporate governance practices of public companies, including Section 404 relating to internal control over financial reporting. These and other rules and regulations applicable to public companies increase our accounting, legal and financial compliance costs and make certain corporate activities more time-consuming and costly. We cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.

 

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We may be classified as a passive foreign investment company, which could result in adverse United States federal income tax consequences to U.S. investors in the ADSs or common shares.

We will be classified as a “passive foreign investment company,” or “PFIC”, if, in the case of any particular taxable year, either (a) 75% or more of our gross income for such year consists of certain types of “passive” income or (b) 50% or more of the average quarterly value of our assets (as determined on the basis of fair market value) during such year produce or are held for the production of passive income (the “asset test”). Although the law in this regard is unclear, we treat our PRC consolidated affiliated entity (Beijing Technology) as being owned by us for United States federal income tax purposes, not only because we exercise effective control over the operation of such entity, but also because we are entitled to substantially all of the economic benefits associated with this entity, and, as a result, we consolidate its operating results in our consolidated financial statements.

Assuming that we are the owner of our PRC consolidated affiliated entity for United States federal income tax purposes, although not free from doubt, we do not believe that we were a PFIC in the taxable year ended December 31, 2015. However, there is a significant risk that we may become a PFIC for our current taxable year ending December 31, 2016 and future taxable years because of changes in the nature of our income and assets, our significant cash balances and because the value of our assets for purposes of the PFIC test will generally be determined by reference to the market price of our ADSs. Accordingly, fluctuations in the market price of our ADSs may cause us to become a PFIC for the current or future taxable years. The determination of whether we will be or become a PFIC will also be affected by how, and how quickly, we use our liquid assets. Under circumstances where we determine not to deploy significant amounts of cash for active purposes or our consolidated affiliated entity was not treated as owned by us for United States federal income tax purposes, our risk of being classified as a PFIC may substantially increase. Because there are uncertainties in the application of the relevant rules and PFIC status is a factual determination made annually after the close of each taxable year, there can be no assurance that we will not be a PFIC for the current taxable year or any future taxable year.

If we are classified as a PFIC in any taxable year, a U.S. Holder (as defined in “Item 10. Additional Information —E. Taxation—United States Federal Income Taxation”) may incur significantly increased United States income tax on gain recognized on the sale or other disposition of the ADSs or common shares and on the receipt of distributions on the ADSs or common shares and such holders may be subject to burdensome reporting requirements. Further, if we are classified as a PFIC for any year during which a U.S. Holder holds our ADSs or common shares, we generally will continue to be treated as a PFIC for all succeeding years during which such U.S. Holder holds our ADSs or common shares. For more information see “Item 10. Additional Information —E. Taxation—United States Federal Income Taxation.”

 

ITEM 4. INFORMATION ON THE COMPANY

 

A. History and Development of the Company

We commenced operations in October 2005, when our founders incorporated Beijing Technology in China. Beijing Technology is primarily engaged in the research and development of products and services related to mobile security, privacy and productivity. In March 2007, our founders incorporated NetQin Mobile Inc., the offshore holding company for our operations in China, in the Cayman Islands. We changed the name of NetQin Mobile Inc. to NQ Mobile Inc. in April 2012.

In May 2007, we established our wholly owned subsidiary, NQ Beijing, in China. In April 2010, we established NQ HK in Hong Kong, NQ HK became the directly wholly owned subsidiary of NQ Mobile Inc. and the immediate holding company of NQ Beijing, and currently conducts part of our business activities and operations outside of China.

 

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In September 2010, we purchased 33% of the equity interest in FL Mobile, and in November 2012, we increased our equity interest holding to 100%. In May 2014, we entered into a share purchase agreement with Bison Mobile Limited, pursuant to which Bison Mobile Limited agreed to purchase up to 3.75% of the equity interest in FL Mobile Inc., and we have the right but not the obligation to sell up to 2.13% of the equity interest in FL Mobile Inc. to other third party investors. As part of this transaction, we conducted a corporate reorganization in July 2014, under which (i) FL Mobile (Beijing) Co., Ltd. (“FL Beijing”), the wholly owned PRC subsidiary of FL HK, entered into a series of contractual agreements with FL Mobile, pursuant to which FL Beijing exercises effective control over FL Mobile and its subsidiaries and has the right to receive substantially all of their economic benefits and (ii) FL Mobile Inc. acquired 100% equity interest in Best Partners. As a result of the reorganization, FL Mobile became one of our consolidated affiliated entities. FL Mobile Inc. issued shares representing 4.94% of the equity interest to Bison Mobile Limited and other third party investors pursuant to the share purchase agreements entered into prior to December 31, 2014. The share purchase agreements have a redemption right if FL Mobile Inc. does not complete a qualified listing within 12 months after the share purchase is completed. FL Mobile Inc. failed to achieve a qualified IPO within 2015 and consequently we paid US$17.8 million to two shareholders of FL Mobile Inc., namely Bison Mobile Limited and Treasure Getter Limited to redeem the shares held by them. As of December 31, 2015, there were 0.91% equity interest of FL Mobile Inc. held by the other third party investors.

In May 2011, we completed an initial public offering of 7,750,000 ADSs. Each ADS represents five Class A common shares. On May 5, 2011, we listed our ADSs on the New York Stock Exchange under the symbol “NQ.”

In February 2012, Beijing Technology established QingYun (Tianjin) Financial Management Co., Ltd. (“Tianjin QingYun”) as its wholly owned subsidiary. Tianjin QingYun primarily engages in financial management services. As of the date of this annual report, we invested, through Tianjin QingYun, as a limited partner in five PRC limited liability partnerships to primarily make venture investments in China’s mobile Internet industry.

In May 2012, we acquired 55% of the equity interest in NationSky through Beijing Technology. Headquartered in Beijing, NationSky provides mobile services for enterprises in China. In July 2013, we acquired the remaining 45% of the equity interest in NationSky. We divested 100% of our interest in NationSky in December 2015.

In January 2013, we established our wholly owned subsidiary, NQ (Beijing) Co., Ltd. (“NQ Tongzhou”) in China. NQ Tongzhou primarily engages in software design and development for computer and mobile devices and other technology consulting services.

In 2013, we acquired 100% of the equity interest of Beijing Fanyue Information Technology Co., Ltd., (“Fanyue”), Beijing Tianya Co., Ltd. (“Tianya”) and Chengdu Ruifeng Technology Co., Ltd. (“Ruifeng”). Fanyue primarily provides off-line user acquisition services. Tianya mainly engages in mobile healthcare applications development and search engine marketing in the healthcare industry in China. Ruifeng primarily provides enterprise mobility system development and iOS training programs.

In September 2013, we acquired 100% of the equity interest in Best Partners Ltd. (“Best Partners”). Best Partners runs its business mainly through Beijing Wanpu Century Co., Ltd. (“Wanpu Century”), an offer-wall based mobile advertising company and Best Partners’ variable interest entity. Best Partners controlled Wanpu Century through Beijing Wanpu Media Technologies Co., Ltd. (“Wanpu Beijing”), a wholly owned subsidiary of Best Partners. In September 2013, we entered into a contractual arrangement with Wanpu Century, under which we obtained control over Wanpu Century through Wanpu Beijing. In November 2015, the contractual arrangement between Wanpu Century and us was terminated, and Wanpu Century was reorganized as a wholly owned subsidiary of FL Mobile.

In October 2013, we issued an aggregate of US$172.5 million 4.00% convertible senior notes due in 2018. Use of proceeds from the sale of the notes is for general corporate purposes, including working capital needs and potential acquisitions of complementary businesses.

In January 2014, we acquired 100% of the equity interest in Beijing Trustek Technology Co., Ltd. (“Beijing Trustek”). Beijing Trustek primarily provides enterprise mobility solutions and services, including system management, application development, business intelligence and maintenance services.

In September 2013, we acquired 20% of the equity interest in Beijing Showself Technology Co., Ltd. (“Showself”). Showself primarily operates a live mobile social video platform. In May 2014, we acquired an additional 45% of the equity interest in Showself.

 

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In September 2014, we established our wholly owned subsidiary, Beijing NQ Mobile Co., Ltd. (“NQ Yizhuang”) in China. NQ Yizhuang primarily engages in software design and development for computer and mobile devices and other technology consulting services.

In June 2015, we acquired 67% of the equity interests in Linkmotion Holdings Ltd (“Linkmotion”). Linkmotion is primarily engaged in development of an optimized software and hardware in vehicle platform, in which everything is controlled by just one computer.

In June 2013, FL Mobile acquired 20% of equity interests in Beijing Century Hetu Software Technology Co., Ltd (“Century Hetu”), which primarily engaged in mobile game development and operation. In October, 2015, FL Mobile acquired the remaining equity interests of Century Hetu.

In August, 2015, we entered into a legally binding framework agreement (the “FL Framework Agreement”) with Beijing Jinxin Rongda Investment Management Co. Ltd. (“Beijing Jinxin”), a subsidiary of Tsinghua Holdings Co., Ltd., to sell our entire stake in FL Mobile Inc., including FL Mobile Inc. and/or its subsidiaries and the assets controlled by FL Mobile Inc. and/or its subsidiaries. This FL Framework Agreement will be terminated at the earlier of (a) one year after its execution, and (b) all parties entering into a binding final agreement. All shareholders of FL Mobile Inc. agreed to sell to Beijing Jinxin the entire stake in FL Mobile Inc. that they held for no less than RMB 4 billion. In January 2016 FL Mobile became a majority owned subsidiary of Beijing Technology through reorganization and termination of contractual arrangements. In February 2016, Beijing Technology, Beijing Jinxin, and Shanghai Houfeng Investment Co., Ltd., the controlling shareholder of Gansu Huangtai Wine-Marketing Industry Co., Ltd. ( “Gansu Huangtai”), a company listed on the Shenzhen Stock Exchange, contemplated a transaction, pursuant to which, Gansu Huangtai would acquire the entire stake of FL Mobile. In March 2016, however, we were informed by Beijing Jinxin that Gansu Huangtai was not able to proceed further with such proposed transaction and Beijing Jinxin remained committed to the binding FL Framework Agreement and would work with us on the completion of the divestment of FL Mobile. In March 2016, FL Mobile was reorganiazed as a majority owned subsidiary of Xinjiang NQ Mobile Venture Capital Investment Co., Ltd. As a further arrangement of the FL Mobile Divestment, later in March 2016, Dr. Vincent Wenyong Shi, our chairman and chief operating officer as well as the chairman of FL Mobile, entered into a termination and share purchase agreement with FL Mobile and us pursuant to which, Dr. Shi will acquire 22% equity interest in FL Mobile by terminating the relevant contractual arrangements and paying us a total consideration of RMB880 million (US$135.5 million).

In October 2015, FL Mobile Hong Kong Limited, which is a wholly owned subsidiary of FL Mobile Inc., acquired 100% of equity interests in Glory Team Ltd. (“Glory”). Glory primarily engages in publishing and operating mobile games overseas.

In December 2015, NQ Tongzhou established NQ Technology (Guizhou) Co., Ltd. (“NQ Guizhou”) in Guizhou Province of China as its wholly owned subsidiary. NQ Guizhou primarily engages in software design and development for computer and mobile devices and other technology consulting services.

In February 2016, Beijing Technology established Xinjiang NQ Mobile Venture Capital Investment Co., Ltd. (“Xinjiang NQ”) in Xinjiang Uygur Autonomous Region of China as its wholly owned subsidiary. Xinjiang NQ primarily engages in investment, venture capital consulting services and other services relating to venture capital.

PRC laws and regulations currently limit foreign ownership of companies that provide value-added telecommunications services. To comply with these restrictions, we conduct our operations in China primarily through contractual arrangements between our wholly owned PRC subsidiary NQ Beijing and our consolidated affiliated entity Beijing Technology. Beijing Technology and its subsidiaries hold the qualifications, licenses and permits necessary to conduct our operations in China.

 

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NQ Beijing has entered into a series of contractual agreements with Beijing Technology and its shareholders, which enable us to:

 

    exercise effective control over our consolidated affiliated entities;

 

    receive substantially all of the economic benefits of our consolidated affiliated entities in consideration for the technical and consulting services provided by and the intellectual property rights licensed by our wholly owned subsidiaries; and

 

    hold an exclusive option to purchase all of the equity interests in our consolidated affiliated entities when and to the extent permitted under PRC laws, regulations and legal proceedings.

As a result of these contractual arrangements, we are considered the primary beneficiary of our consolidated affiliated entities and have consolidated their financial results in our consolidated financial statements in accordance with U.S. GAAP. For a description of these contractual arrangements, see “Item 7. Major Shareholders and Related Party Transactions — B. Related Party Transactions.”

Our principal executive office and headquarter in Beijing is located at No. 4 Building, 11 Heping Li East Street, Dongcheng District, Beijing, 100013, the People’s Republic of China. Our telephone number at this address is +86 (10) 8565-5555. Our registered office in the Cayman Islands is located at Maples Corporate Services Limited, PO Box 309, Ugland House, Grand Cayman KY1-1104, Cayman Islands. Our agent for service of process in the United States is Law Debenture Corporate Services Inc., 400 Madison Avenue, 4th Floor, New York, New York 10017.

See “Item 5. Operating and Financial Review and Prospects—B. Liquidity and Capital Resources—Capital Expenditures” for a discussion of our capital expenditures.

 

B. Business Overview

Overview

We are a leading global provider of mobile Internet services. We have been a pioneer in the consumer mobile security industry since 2005 and have since built a portfolio of offerings including mobile game publishing platforms, mobile advertising platforms, mobile entertainment applications and platforms, mobile security and productivity applications as well as other mobile applications. We currently offer a variety of products and services to consumers and enterprises.

Our vision is to become a leading mobile Internet platform globally. We began our business by offering consumers mobile security services to address the fundamental and rapidly growing needs of smart device users. Over the years, our proprietary, cloud-based security solution has been recognized as effective solutions for detecting and combating mobile security threats. Building upon the success of our mobile security offerings, we expanded our product and service offerings to provide mobile privacy and productivity, and started to offer additional mobile value added services, such as mobile games, mobile entertainment applications and platforms and other mobile applications. We also started to offer a full set of enterprise mobility solutions. Additionally, we began offering our products and services to our channel partners to provide these products and services to their own users. We also enhanced our ability to monetize our mobile users through advertising, mobile games and technology licensing. Our products and services cater to the ever-expanding needs of consumers and enterprises in their usage of mobile devices, and we believe we are well positioned to capture market opportunities presented by the rapidly evolving mobile Internet industry.

 

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We offer products and services in the following main categories:

 

    Mobile value added services: Revenues generated from the mobile value added services are derived from the wide range of products and services that we offer to mobile users directly or through numerous channel partners. The majority of our mobile value added services revenues are derived from our mobile game publishing platforms, mobile entertainment applications and platforms, as well as our mobile security and productivity applications. The mobile game publishing revenues are generated through sales of in-game virtual items from numerous mobile games that are either developed or operated by FL Mobile as well as collecting licensing fees for self-developed games. Our live mobile social video platform, Showself, comprises the majority of our mobile entertainment revenues. Additionally, we generate subscription revenues through a Freemium business model from products including NQ Mobile Security Applications, Vault and Family Guardian.

 

    Advertising: The revenues generated from advertising services are derived mainly from the monetization and successful third party application referrals in our online and offline advertising networks which were the result of our acquisition of Wanpu Century and Fanyue. We generate advertising revenues mainly on a cost per action, or CPA, basis in the form of third-party application referrals through our advertising network platform and offline channels. We also offer banner advertising to advertisers through our various applications that charge on a cost per time, or CPT, basis. In addition to these online and offline ad network revenue sources, we also generate advertising revenues directly within our set of applications including our mobile security and productivity applications and other mobile applications such as healthcare-related search among others.

 

    Enterprise mobility: We offer mobility solutions and services, including system management, application development, business intelligence and maintenance services mainly through Trustek.

We provide a wide range of mobile security related services to address fundamental user requirements, which have allowed us to build a large user base while enhancing user engagement and loyalty. Our large user base provides us with significant monetization opportunities, such as up-selling our premium consumer mobile security and other mobile Internet services, cross-selling third-party mobile Internet applications on our platform as well as advertising.

Our cloud-based platform enables us to compile and update a database of information based on the usage and actions of our users. By knowing our users, we are able to deliver the most applicable mobile Internet services and advertisements, further enhancing our engagement, up-selling and cross-selling capabilities. This allows us to simultaneously deliver strengthened security products and services from our continuously increasing cloud-based repository of security threats, and also provide other relevant mobile Internet services and advertisements through our powerful database of user information. This continual strengthening of our security services as well as development of additional mobile Internet services based on our understanding of users enhance our platform for the purpose of attracting new users, resulting in a virtuous cycle that we believe allows us to continually acquire, engage, and monetize our use base. We have also opened this platform up and are now attracting other partners, including wireless carriers, third-party application developers and original equipment manufacturers, to utilize our technologies, products, services and solutions to engage and monetize their own mobile users as well.

We offer our products and services under our own brands and also as white label solutions that can be tailored to the specific requirements and offered under the brands of our channel partners. We also offer technology solutions and software development kit (SDK) platforms that enable our channel partners to expand their own business objectives, while we share in the revenues and results. In summary, we sell products directly to customers, through channel partners to customers, and also generate revenues by helping channel partners sell their own branded products and services that are powered by our solutions and technology. Additionally, we are now monetizing the traffic on our platform that is associated with our users who are interacting with our products and services directly and with our channel partners in the form of advertising, third party application referrals and offer wall/pay wall.

Products and Services

We began our business by offering mobile security products for consumers and subsequently expanded our portfolio to include a variety of products and services for consumers, enterprises, developers and advertisers. The products and services we currently offer are divided into three main categories: mobile value added services, advertising services and enterprise mobility products and services.

 

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Mobile Value added Services

 

  A. Mobile Game Publishing

Through FL Mobile, we publish both third-party and self-developed mobile games. In 2015, FL Mobile operated seven games that ranked among the top 100 grossing applications on Apple’s app store in China. The top revenue-contributing and most anticipated mobile games published and operated by FL Mobile during 2015 are:

 

    To Attack Cities and Capture Territories LOGO , developed by Aoshitang and exclusively published by FL Mobile, set in the Three Kingdoms period, unprecedently introduces the battle game with instant voice messaging. The experience of 24-hour real-time PVP battles distinguishes the game from other similar SLG games.

 

    Snap Three Kingdoms LOGO , is a 3D strategy card game developed by Hard Core studio. Users can fight real-time in 3D magnificent battlefields together with thousands of soldiers. It was launched in September 2013.

 

    The Tank Storm LOGO , developed by Ray Joy and exclusively published by FL Mobile, is the first SLG mobile game with a tank theme. The users can command the most famous types of tanks, either historical or current, and battle in various historical backgrounds and battlefields.

 

    Ost Chronicle LOGO , is developed by Loong Entertainment and exclusively published by FL Mobile Korea , a wholly owned subsidiary of FL Mobile. This RPG game has a gorgeous frame and wide worldview. Each battle field has a colorful storyline and perfect mission.

 

    Cang Qiong Bian LOGO , is a 3D MMORPG game developed by Zeus Interactive and exclusively published by FL Mobile Korea, a wholly owned subsidiary of FL Mobile. This game is based on the popular online fantasy novel which is very popular among Chinese netizens.

We generate revenues through operating and publishing contracts with game developers and receiving licensing fees for our self-developed games. Almost all games are free to play and we generate revenues through the sale of in-game virtual items.

 

  B. Mobile Entertainment Applications and Platforms

We acquired a controlling equity interest in Showself live mobile social video platform, vLife interactive wallpaper, and Doreso Music Radar in the second quarter of 2014, first quarter of 2014, and fourth quarter of 2013 respectively, and began consolidating revenues generated by these businesses in our MVAS segment.

In May 2015, we re-branded these businesses, among others, under the uniform “Showself” brand name, and now these businesses are:

Showself Live Video, which is a leading live mobile social video platform in China. It facilitates real-time video shows from thousands of hosts that perform on our platform, and enable mobile users (audiences) to interact and socialize with these hosts from their mobile devices. The platform also offers a series of in-show mobile games for our mobile users to play. The Showself Live Video revenues have grown significantly in 2015 from last year and have contributed approximately 32% of our total MVAS revenues in 2015.

Showself Desktop, which is our personalized interactive and programmable mobile desktop application offers a wide variety of dynamic and themed-wallpaper and desktop applications for millions of mobile users and devices in China and overseas markets.

 

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Showself Music Radar, which is our world leading solution provider of automatic audio content recognition services offers fast and precise audio search with advanced technology of signing and humming song recognition and can also be embedded and integrated with third party music services.

We monetize these businesses mainly through: i) sales of in-show virtual items; ii) premium content where users pay to download themed and branded content; and iii) advertising in many formats.

 

  C. Mobile Security, Privacy, Optimization, and Other Applications

We offer a wide range of products and services in the area of mobile security, privacy, optimization, personalized cloud, and family protection. Our current product offerings are in the following categories:

Mobile Security: Our mobile security product “NQ Mobile Security” protects users’ mobile data from viruses, malware, hackers, and spyware. We provide virus scanning, Internet Firewall, financial / social media account protection, and Anti-Eavesdropping. Through “NQ Mobile Easy Finder”, we enable users to remotely locate, track and lock, their lost phones, make phones sound an alarm, send screen messages and wipe phone data to prevent privacy leakage. We also provide data backup and restore tools in both products. “Call Blocker” is one of the most effective apps to prevent unwanted calls or texts. It can also detect and stop one-ring phone scams.

Mobile Privacy: Our mobile privacy product “NQ Mobile Vault” helps users’ control their pictures, videos, contacts, SMS and call logs private, and hiding them from prying eyes.

Mobile Optimization: Our mobile Optimization products “Android Booster” and “Super Task Killer” intelligently tune users’ smart devices to achieve optimum performance.

Family Protection: Our family protection product “NQ Family Guardian” allows parents to monitor and protect their children’s smart device activities. NQ Family Guardian’s unique suite of services for safety and monitoring comprises a mobile app that is downloaded and installed on the child’s smart devices along with a web-based control center that is accessible from any desktop or mobile browser. With this app, parents can set up protection for their children including browser blocking, app filtering, contact filtering, usage scheduling, communication monitoring, geo-fencing, location tracking and panic alarm.

We also provide a cloud security SDK that allows third-party developers to incorporate the function to their own applications and products.

Our consumer mobile products are offered directly under our various NQ brands as well as white labeled and branded by our various channel partners who sell their own versions of these products.

Advertising

The advertising segment consists of revenues we generate from the traffic generated by third party application developers who utilize our online and offline advertising networks as well as through direct advertising within our own traffic derived from our portfolio of applications and users. A significant portion of our advertising revenues in 2015 came from our online and offline advertising networks which were the result of our acquisitions of Wanpu Century and Fanyue in 2013. 

In addition to the advertising revenues generated through these advertising networks, we also generate advertising revenues from the portfolio of other mobile applications and channels. We charge our advertisers a pre-determined rate on a CPA basis, and our revenues generated from advertising services depend on the numbers of active users’ clicks and downloads. We generate advertising revenues from mobile game developers and other mobile application developers for utility, music, reading, e-commerce and travel. Through health care applications operated by our subsidiary Beijing Tianya Co., Ltd., or Tianya, we also generate advertising revenues from health care related industries.

 

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Enterprise mobility

Trustek primarily provides enterprise mobility solutions and services, including system management, application development, business intelligence and maintenance services and do maintain ownership of this business.

As employees and knowledge workers increasingly use bring-your-own-device (BYOD) smart mobile devices for both business and personal use, managing work productivity and keeping corporate owned information and sensitive employee data protected have become significant concerns for businesses and employees. We deliver a comprehensive suite of mobility solutions to our clients by architecting mobility strategies, sourcing suitable devices, optimizing and deploying devices and applications, and maintaining ongoing customer support during working hours.

User Acquisition Channels

We have established diversified user acquisition channels through strong relationships with key players in the global mobile ecosystem. We acquire users of our consumer mobile products through pre-installation/pre-load, retail, online channels and viral marketing.

Payment Channels

We collect net revenues from our consumer mobile products through a variety of payment channels. We operate globally with various channel partners that each utilizes different payment processing and collecting systems. We collect payment from our premium users for consumer mobile products through major wireless carriers, mobile payment service providers, prepaid card distributors, and third-party payment processors, including credit card and debit card companies.

Customer Support

For our consumer mobile security business, we operate a 24/7 global customer service center with trained professional staff for customer inquiries and technical support. We provide multiple support channels, including telephone, fax, SMS, email, instant messenger and online forums, among others, to address inquiries and collect user feedback. We deploy more than 60 customer service hotlines to provide multi-lingual assistance to answer user inquiries and resolve technical issues promptly. We have a team of highly trained customer service specialists and technology support personnel. For our mobile games business on the FL Mobile platform, we provide 12/7 multiple support channels, including online instant messenger and telephone hotline, to address inquiries and questions from our users. For our Mobile Entertainment Applications and Platforms, we provide 24/7 support channels. For our enterprise mobility business, Trustek provides customer support through a centralized customer service hotline that operates during working hours.

Research and Development

As of December 31, 2015, our research and development department consisted of 400 engineers and technicians, which does not include any headcount from NationSky given that business was divested in December 2015. Supervisors in charge of our research and development department have educational backgrounds from leading universities in China and have significant industry experience before joining us. We recruit our engineers throughout China and have established various recruiting and training programs with leading universities in China.

We will also continue to recruit, train, retain and motivate highly trained and qualified research and development staff to maintain our technological advantage. In addition, we will continue to apply for more patents in order to protect our new, innovative ideas and intellectual property.

 

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Intellectual Property

Our business success has benefited from our continuous efforts in obtaining and maintaining intellectual property protection, including and application and registration of patents, trademarks, copyrights and trade secrets. As of December 31, 2015, we had 274 patent registrations, applications and exclusive licenses in China and overseas, including but not limited to patents covering anti-virus, anti-spam firewall, anti-phishing, contact management, agenda management and parental controls, mobile game and advertising, enterprise mobile management. Some of these patents have been issued and are currently held by us, while others are still pending. As of December 31, 2015, 52 of our patents applications have been filed with the United States Patent and Trademark Office, or USPTO, and claim the benefits of initial patent applications, eight of which has been approved by USPTO. Some of the intellectual properties our company currently uses are held by individuals, all of whom have entered into assignment or exclusive patent licensing agreements with us. We have also made 402 copyright registrations and 154 trademark registrations and applications in China and overseas, and have applied with USPTO to register the word “NQ” and related logo as a trademark. In addition, we have 119 registered domain names, including www.NQ.com, our primary operation website, which we licensed from a third party (the “Licensor”) in July 2011. We have been granted an exclusive license for the use of the domain name of www.NQ.com for ten years from July 2011 to June 2021. Unless renewed, upon the expiration or earlier termination of this agreement, the Licensor shall have the right to license the domain name to any other party as the Licensor desires. However, if the Licensor intends to transfer the domain name to another party, we have a right of first refusal. In addition, the Licensor provides us ten years search engine optimization services from July 2011 to June 2021.

Our business operations substantially rely on the techniques covered by following patents: (1) a patent on a method and system to subscribe, configure and move mobile telephone software service conveniently, which was filed in China in September 2007 and has a corresponding U.S. patent application file in May 2010, both of which were granted; (2) a patent on a method and system for a self-learning intellectualized short message firewall for mobile terminals, which was filed in China in December 2009 and has a corresponding PCT application file in December 2010; (3) a patent on an anti-theft method and system for mobile terminals, which was filed in China in December 2012 and has a corresponding PCT application in March 2013; and (4) a patent on a method and system to show contents on mobile terminals, which was filed in China in October 2013. According to Article 42 of Chinese Patent Law, each of the four patents above would have a term of twenty years, starting from its application date.

We regard our copyrights, trademarks, trade secrets and similar intellectual property as our core assets, and rely on trademark and copyright law, trade secret protection and confidentiality and/or license agreements with our employees, suppliers and others to protect our proprietary rights. All of our research and development personnel have entered into confidentiality and proprietary information agreements or clauses with us. These agreements address intellectual property protection issues and require our employees to assign to us all of the inventions, designs, and technology they develop during their employment with us.

Seasonality

Seasonal fluctuations and industry cyclicality have had minimal effect on our consumer mobile application and services businesses in the past, and we expect this trend to continue for the foreseeable future. For our enterprise mobility business, we experience seasonality and fluctuations in our quarterly revenues which reflect the seasonal fluctuations driven by our customers’ procurement cycles for mobile devices and enterprise software. China-based enterprises typically procure IT related services toward the end of the year. As a result, our revenues in the second half of the year are higher than the first. Finally, the advertising business in general has seasonal factors that tend to show more strength in the second half of the year compared to the first half of the year. We expect to see this type of trend generally in advertising, especially as our own advertising network expands.

Competition

We compete primarily on the basis of user base, services portfolio, technology know-how, research and development capabilities as well as relationships with key players in the mobile ecosystem, such as wireless carriers, handset manufacturers, chipmakers, distributors and retailers and third-party payment processors. For a discussion of risks relating to competition, see “Item 3. Key Information—D. Risk Factors—Risks Related to Our Business and Industry—We may face increasing competition, which could reduce our market share and materially and adversely affect our business and results of operations.”

 

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The mobile services market in China and globally is competitive. On the mobile security front, we compete directly with (i) domestic PC/mobile security vendors such as Qihoo 360, Tencent, Cheetah Mobile and Kingsoft (ii) overseas security software providers such as Avast, Symantec, McAfee, AVG, Trend Micro, F-Secure and Kaspersky, and (iii) other emerging companies offering mobile security products, such as Lookout. While we have focused on providing mobile security services since the founding of our company, most of our competitors are traditional PC anti-virus providers who later entered into the mobile security market.

For our mobile game publishing business, we compete primarily with other mobile game operators in China, such as Chukong Holdings Ltd, China Mobile Games & Entertainment Group Ltd, iDreamSky Technology Ltd and KunLun. For our enterprise mobility business, our primary business is Trustek and will compete with among other integrated enterprise mobility service providers, including NationSky, a business we divested in 2015.

As a mobile Internet Platform business, including attracting, engaging, and monetizing mobile users across multiple products, services and applications and focusing on traffic, we compete in China with many of the largest platform companies including Tencent, Baidu and Qihoo 360. We also have numerous products, services and applications that compete on a stand-alone basis with other technology companies including, but not limited to, Shazam, YY, and numerous other advertising platforms and networks.

Insurance

Consistent with customary industry practice in China, we do not maintain specific business interruption insurance or real property insurance, although we do maintain a directors, officers and company liability insurance policy for the protection of our company and our directors and officers. Uninsured damage to any of our equipment or buildings or a significant product liability claim could have a material adverse effect on our results of operations. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Business and Industry—We have limited business insurance coverage, which could expose us to substantial costs and diversion of resources that in turn may have an adverse effect on our results of operations and financial condition.”

Legal Proceedings

From time to time, we may be subject to various claims or legal, arbitral or administrative proceedings that arise in the ordinary course of our business. For more information, see “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings.” Also see “Item 3. Key Information—D. Risk Factors — Risks Related to Our Business and Industry — Our results of operations, financial performance and business may be adversely affected by potential intellectual property rights infringement claims against us.”

PRC Regulation

The PRC government has imposed extensive and stringent measures to regulate the telecommunications and software development industries. The State Council of the PRC, or the State Council, the Ministry of Industry and Information Technology, or the MIIT (formerly the Ministry of Information Industry, or the MII), and other relevant authorities in the PRC have issued various regulations with respect to the telecommunications and software development industries. This section summarizes the principal PRC laws and regulations relevant to our business and operations.

Regulation on the Telecommunications Industry

Types of Telecommunications Services

On September 25, 2000, the State Council issued the Regulations on Telecommunications of the PRC, or the Regulations on Telecommunications, which was amended on July 29, 2014, and which regulates the telecommunications industry and other related activities and services within the PRC. The MIIT regulates the telecommunications industry on a national level while the provincial-level communications administrative bureaus, or the CABs, supervise and regulate the telecommunications industry in their respective administrative regions. The Regulations on Telecommunications classifies telecommunications services into two main categories: (1) core telecommunications services and (2) value-added telecommunications services, and further divides each main category into several sub-categories. According to the Catalog for Classification of Telecommunications Businesses, which became effective on April 1, 2003, and Catalog for Classification of Telecommunications Businesses (2015 version), which will be effective on March 1, 2016, our business operates under the provision of information services through mobile networks and the Internet, thus fitting into the category of value-added telecommunications services.

 

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Value-Added Telecommunications Services

Providers of value-added telecommunications services in the PRC are subject to examination and approval from, and require licenses issued by, the MIIT or the relevant CABs. Pursuant to the Regulation on Telecommunications, to provide value-added telecommunications services in more than two provinces, autonomous regions or centrally administered municipalities, the mobile payment service provider shall obtain the Transregional Value-Added Telecommunication Business Operation License from the MIIT; to provide value-added telecommunications services within one province, autonomous region or centrally administered municipality, the mobile payment service provider shall obtain the Value-Added Telecommunication Business Operation License from relevant CABs. On March 1, 2009, the MIIT issued the Administrative Measures for Licensing of Telecommunications Business Operations which set forth the basic requirements for a license to provide value-added telecommunications services in the PRC. Such requirements mainly include the following:

 

    the applicant is a duly incorporated company;

 

    the applicant has necessary funds and professional staff suitable for its business activities;

 

    the applicant has the reputation or capability of providing customers with long-term services;

 

    to operate value-added telecommunications services business across multiple provinces, autonomous regions or centrally administered municipalities, the applicant shall have a minimum registered capital of RMB10,000,000; to operate value-added telecommunications services business within a single province, autonomous region or centrally administered municipality, the applicant shall have a minimum registered capital of RMB1,000,000;

 

    the applicant has necessary premises, facilities and technical scheme; and

 

    the applicant and its major capital contributors and business managers have no record of violating rules on telecommunication supervision and administration during the past three years.

Short Message Services

On April 15, 2004, the MII issued the Notice on Certain Issues Regarding Regulating Short Message Services which specifies that only those telecommunications services providers that hold specific short message service licenses may provide such services in the PRC. The notice also requires short message services providers to censor the contents of short messages, to automatically collect information such as the time that short messages are sent and received and the telephone numbers or codes of the sending and receiving terminals and to keep such records for five months within the time each short message is delivered.

On May 19, 2015, the MII issued Administrative Provisions on Short Message Services (the “Regulation of SMS”), which was effective on June 30, 2015. The Regulation of SMS indicates that any SMS operators should obtain a telecommunications license under the law. Basic telecommunications service operators shall not provide network or service access used for business operations for SMS providers without a license. The Regulation of SMS clearly underlines that any entity or individual should not send commercial short messages to recipients without their consent or request. If a recipient consents to receiving and then clearly refuses to receive short messages, operators should stop sending him messages. In addition, SMS providers should introduce a complaint-handling mechanism, publish contract information and accept complaints relating to SMS.

 

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Telecommunications Networks Code Number Resources

On January 23, 2014, the MII issued the amendment of Administrative Measures on Telecommunications Networks Code Number Resources to administer the code number resources including mobile communications network code number. According to the administrative measures, the entity shall apply to the MII for a code number to be used in the inter-provincial operations and shall apply to the relevant CAB for a separate code number for intra-provincial operations. The administrative measures specify the qualifications for a code number, required application materials and application procedures.

Specifications for Telecommunications Services

On March 13, 2005, the MII issued the Specifications for Telecommunications Services specifying the telecommunications service qualities to which all telecommunications mobile payment service providers in the PRC should conform, which was effective on April 20, 2005. It also requires all telecommunications services providers to establish a sound service quality management system and make periodical reports to the relevant telecommunications authorities.

Foreign Investments in Value-Added Telecommunications Services Industry

Foreign direct investment in telecommunications services industry in China is regulated under Regulations on the Administration of Foreign-Invested Telecommunications Enterprises, or the FITE Regulations. The FITE Regulations were issued by the State Council on December 11, 2001 and amended by the State Council on September 10, 2008. According to the FITE Regulations, foreign investors’ ultimate equity interests in any entity providing value-added telecommunications services in the PRC may not exceed 50%. A foreign investor must demonstrate a good track record and prior experience in providing value-added telecommunications services outside the PRC prior to acquiring any equity interest in any value-added telecommunications services business in the PRC.

On July 13, 2006, the MII issued the Notice Regarding Strengthening the Administration of Foreign Investment in Operating Value-Added Telecommunications Businesses, or the MII Notice, which prohibits value-added telecommunications services operation license holders, including Trans-regional Value-Added Telecommunications Services Operation License and Telecommunications Value-Added Services Operation License holders, from leasing, transferring or selling their licenses to any foreign investors in any manner, or providing any resources, premises or facilities to any foreign investors for illegal operation of telecommunications services business in the PRC. The MII Notice also requires that, (1) value-added telecommunications services operation license holders or their shareholders must directly own the domain names and trademarks used by such license holders in their daily operations; (2) each license holder must have necessary facilities for its approved business operations and maintain such facilities in the regions specified by its license; and (3) all value-added telecommunications mobile payment service providers are required to maintain network and Internet security in accordance with the standards set forth in relevant PRC regulations. If a license holder fails to comply with the requirements in the MII Notice and fails to remedy such non-compliance within a designated period, the MIIT or relevant CABs may take administrative actions against such license holder, including revocation of their valued-added telecommunications services operation licenses. We provide our services through our controlled affiliated entity that own Value-Added Telecommunications Services Operation Licenses. We believe our controlled affiliated entity is in compliance with the MII Notice.

 

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The MOFCOM published a discussion draft of the proposed Foreign Investment Law (the “Draft”) in January 2015 aiming to, upon its enactment, replace the trio of existing laws regulating foreign investment in China. The Draft embodies an expected PRC regulatory trend to rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic investments. The MOFCOM is currently soliciting comments on the Draft and substantial uncertainties exist with respect to its enactment timetable, interpretation and implementation. The Draft, if enacted as proposed, may materially impact the viability of our current corporate structure, corporate governance and business operations. The Draft expands the definition of foreign investment and introduces the principle of “actual control” in determining whether a company is considered an FIE. Under the Draft, the entities established in China but “controlled” by foreign investors will be treated as FIEs, whereas an entity set up in a foreign jurisdiction would nonetheless be, upon market entry clearance by the MOFCOM, treated as a PRC domestic investor provided that the entity is “controlled” by PRC entities and/or citizens. In this connection, “control” is broadly defined in the draft law to cover the following summarized categories: (i) holding, directly or indirectly, not less than 50% of shares, equities, share of properties, voting rights or other similar rights of the enterprise; (ii) holding, directly or indirectly, less than 50% of shares, equities, share of properties, voting rights or other similar rights of the enterprise, but falling under any of the following circumstances: (1) having the right to directly or indirectly appoint not less than half of the members of the board of directors or other similar decision-making body of the enterprise; (2) having the ability to ensure that its nominees occupy not less than half of seats in the board of directors or other similar decision-making body of the enterprise; or (3) holding voting rights sufficient to impose significant impacts on any resolution of the board of shareholders, at the general meeting of shareholders, or of the board of directors or other decision-making body of the enterprise; or (iii) having the power to exert decisive influence, via contractual or trust arrangements, over the subject entity’s operations, financial matters or other key aspects of business operations. Once an entity is determined to be an FIE, it will be subject to the foreign investment restrictions or prohibitions set forth in a “negative list,” to be separately issued by the State Council later, if the FIE is engaged in the industry listed in the negative list. Unless the underlying business of the FIE falls within the negative list, which calls for market entry clearance by the MOFCOM, prior approval from the government authorities as mandated by the existing foreign investment legal regime would no longer be required for establishment of the FIE.

Under the Draft, variable interest entities that are controlled via contractual arrangement would also be deemed as FIEs, if they are ultimately “controlled” by foreign investors. Therefore, for any companies with a VIE structure in an industry category that is on the “negative list,” the VIE structure may be deemed legitimate only if the ultimate controlling person(s) is/are of PRC nationality (either PRC companies or PRC citizens). Conversely, if the actual controlling person(s) is/are of foreign nationalities, then the variable interest entities will be treated as FIEs and any operation in the industry category on the “negative list” without market entry clearance may be considered as illegal. Moreover, for the enterprises which are not incorporated under the laws of China (foreign investors) but are “controlled” by Chinese investors, they may submit documentary evidence to apply for identifying their investment as the investment by Chinese investors when they applying for the market entry clearance to engage in any investment as set out in the “negative list” in China. The competent authorities of foreign investment will grant the review opinion on whether the said investment is identified as the investment by Chinese investors.

Regulations Concerning Internet and Mobile Businesses

Online Music and Entertainment

On November 20, 2006, the MOC issued Several Suggestions of the MOC on the Development and Administration of Internet Music, or the Suggestions, which became effective on the same date. The Suggestions, among other things, reiterate the requirement for an internet service provider to obtain an internet culture operation license to carry out any business relating to internet music products. In addition, foreign investors are prohibited from operating internet culture businesses. However, the laws and regulations on internet music products are still evolving, and there have not been any provisions clarifying whether music products will be regulated by the Suggestions or how such regulation would be carried out.

On August 18, 2009, the MOC promulgated the Notice on Strengthening and Improving the Content Review of Online Music, or the Online Music Notice. According to the Online Music Notice, only “internet culture operating entities” approved by the MOC may engage in the production, release, dissemination (including providing direct links to music products) and importation of online music products. The content of online music shall be reviewed by or filed with the MOC. Internet culture operating entities should establish a strict self-monitoring system of online music content and set up a special department in charge of such monitoring.

 

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In 2011, the MOC greatly intensified its regulation of the provision of online music products. According to the series of Notices on Clearing Online Music Products that are in Violation of Relevant Regulations promulgated by the MOC since January 7, 2011, entities that provide any the following will be subject to relevant penalties or sanctions imposed by the MOC: (a) online music products or relevant services without obtaining corresponding qualifications, (b) imported online music products that have not passed the content review of the MOC or (c) domestically developed online music products that have not been filed with the MOC. Thus far, we believe that we have eliminated from our platform any online music products that may fall into the scope of those prohibited online music products thereunder.

Broadcasting Audio/Video Programs through the Internet

The Measures for the Administration of Publication of Audio-Visual Programs through Internet or Other Information Network, or the Audio-Visual Measures, promulgated by the SARFT on July 6, 2004 and put into effect on October 11, 2004, apply to the activities relating to the opening, broadcasting, integration, transmission or download of audio-visual programs using internet or other information network. Under the Audio-Visual Measures, to engage in the business of transmitting audio-visual programs, a license issued by SARFT is required. Foreign invested enterprises are not allowed to carry out such business.

On April 13, 2005, the State Council promulgated the Certain Decisions on the Entry of the Non-state-owned Capital into the Cultural Industry. On July 6, 2005, five PRC governmental authorities, including the MOC, the SARFT, the GAPP, the CSRC and the MOFCOM, jointly adopted the Several Opinions on Canvassing Foreign Investment into the Cultural Sector. According to these regulations, non-state-owned capital and foreign investors are not allowed to engage in the business of transmitting audio-visual programs through information networks.

To further regulate the provision of audio-visual program services to the public via the internet, including through mobile networks, within the territory of the PRC, the SARFT and the MIIT jointly promulgated the Administrative Provisions on Internet Audio-Visual Program Service, or the Audio-Visual Program Provisions, on December 20, 2007, which came into effect on January 31, 2008. Providers of internet audio-visual program services are required to obtain a License for Online Transmission of Audio-Visual Programs issued by SARFT, or complete certain registration procedures with SARFT. In general, providers of internet audio-visual program services must be either state-owned or state-controlled entities, and the business to be carried out by such providers must satisfy the overall planning and guidance catalog for internet audio-visual program service determined by SARFT. In a press conference jointly held by SARFT and MIIT to answer questions relating to the Audio-Visual Program Provisions in February 2008, SARFT and MIIT clarified that providers of internet audio-visual program services who engaged in such services prior to the promulgation of the Audio-Visual Program Provisions are eligible to register their business and continue their operation of internet audio-visual program services so long as those providers did not violate the relevant laws and regulations in the past. On May 21, 2008, SARFT issued a Notice on Relevant Issues Concerning Application and Approval of License for the Online Transmission of Audio-Visual Programs, which further sets out detailed provisions concerning the application and approval process regarding the License for Online Transmission of Audio-Visual Programs. The notice also states that providers of internet audio-visual program services that engaged in such services prior to the promulgation of the Audio-Visual Program Provisions are eligible to apply for the license so long as their violation of the laws and regulations is minor in scope and can be rectified in a timely manner and they have no records of violation during the last three months prior to the promulgation of the Audio-Visual Program Provisions. Further, on March 31, 2009, SARFT promulgated the Notice on Strengthening the Administration of the Content of Internet Audio-Visual Programs, which reiterates the pre-approval requirements for the audio-visual programs transmitted via the internet, including through mobile networks, where applicable, and prohibits certain types of internet audio-visual programs containing violence, pornography, gambling, terrorism, superstition or other similarly prohibited elements.

On March 17, 2010, the SARFT issued the Internet Audio-visual Program Services Categories (Provisional), or the Provisional Categories, which classified internet audio-visual program services into four categories.

In 2012, the SARFT and the State Internet Information Office of the PRC issued a Notice on Improving the Administration of Online Audio/Video Content Including Internet Drama and Micro Films. In 2013, SARFT released a Supplemental Notice on Improving the Administration of Online Audio/Video Content Including Internet Drama and Micro Films. This notice stresses that entities producing online audio/video content, such as internet dramas and micro films, must obtain a permit for radio and television program production and operation, and that online audio/video content service providers should not release any internet dramas or micro films that were produced by any entity lacking such permit. For internet dramas or micro films produced and uploaded by individual users, the online audio/video service providers transmitting such content will be deemed responsible as a producer. Further, under this notice, online audio/video service providers can only transmit content uploaded by individuals whose identity has been verified and such content shall comply with the relevant content management rules. This notice also requires that online audio/video content, including internet drama and micro films, be filed with the relevant authorities before release. As of the date of this annual report, we have not obtained an audio/video program transmission license, and we will apply to obtain the license.

 

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Regulations on Internet Publication and Cultural Products

The Tentative Measures for Internet Publication Administration, or Internet Publication Measures, were jointly promulgated by the General Administration of Press and Publication and the Ministry of Industry and Information Technology on June 27, 2002 and became effective on August 1, 2002. Pursuant to the Internet Publication Measures, any act by an internet information service provider to select, edit and process content or programs and to make such content or programs available on the internet for the public to read, use and download shall constitute an internet publication. The provision of online games is deemed an internet publication activity and therefore, an online game operator shall obtain an Internet Publishing License so that it can directly offer its online games to the public in the PRC. As of the date of this annual report, we have not yet obtained an internet publishing license, and are in the process of preparing the application documents.

Regulations on Online Games and Foreign Ownership Restrictions

Pursuant to the Guidance Catalog, the internet culture business (other than online music business) falls within the category of industries prohibiting foreign investment. On February 17, 2011, the Ministry of Culture issued the revised Interim Provisions on the Administration of Internet Culture, or the Internet Culture Interim Provisions, effective as of April 1, 2011. According to the Internet Culture Interim Provisions, “internet cultural products” are defined as including the online games specially produced for Internet and games reproduced or provided through Internet. Provision of operating Internet cultural products and related services is subject to the approval of the Ministry of Culture or its provincial counterpart.

On June 3, 2010, the Ministry of Culture promulgated the Provisional Administration Measures of Online Games, or the Online Game Measures, which came into effect on August 1, 2010. The Online Game Measures governs the research, development and operation of online games and the issuance and trading services of virtual currency. Under the Online Game Measures, all operators of online games, issuers of virtual currencies and providers of virtual currency trading services, or Online Game Business Operators, are required to obtain internet culture operation licenses. An internet culture operation license is valid for three years and in case of renewal, the renewal application should be submitted 30 days prior to the expiry date of such license.

In addition, Online Game Business Operators should request the valid identity certificate of game users for registration, and notify the public 60 days ahead of the termination of any online game operations or the transfer of online game operational rights. Online game business operators are also prohibited from (i) setting compulsory matters in the online games without game users’ consent; (ii) advertising or promoting the online games that contain prohibited content, such as anything that compromise state security or divulges state secrets; and (iii) inducing game users to input legal currencies or virtual currencies to gain online game products or services, by way of random draw or other incidental means. The Online Game Measures also states that the state cultural administration authorities will formulate the compulsory clauses of a standard online game service agreement, which have been promulgated on July 29, 2010 and are required to be incorporated into the service agreement entered into between online game business operators and game users, with no conflicts with the rest of clauses in such service agreements.

On July 11, 2008, the General Office of the State Council promulgated the Regulation on Main Functions, Internal Organization and Staffing of the General Administration of Press and Publication, or the Regulation on Three Provisions. On September 14, 2009, the Central Organization Establishment Commission issued the corresponding interpretations, or the Interpretations on Three Provisions. The Regulation on Three Provisions and the Interpretation on Three Provisions granted the Ministry of Culture overall jurisdiction to regulate the online game industry, and granted the General Administration of Press and Publication the authority to issue approvals for the internet publication of online games. Specifically, (i) the Ministry of Culture is empowered to administrate online games (other than the pre-examination and approval before internet publication of online games); (ii) subject to the Ministry of Culture’s overall administration, General Administration of Press and Publication is responsible for the pre-examination and approval of the internet publication of online games; and (iii) once an online game is launched, the online game will be only administrated and regulated by the Ministry of Culture. As of March 31, 2015, three of the 20 online games we offered had completed the filing with the Ministry of Culture. If we fail to complete, obtain or maintain any of the required licenses or approvals or make the necessary filings, we may be subject to various penalties, such as confiscation of the net revenues that were generated through online games, the imposition of fines and the discontinuation or restriction of our operations of online games.

 

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On September 28, 2009, the General Administration of Press and Publication, the National Copyright Administration and the National Working Group to Eliminate Pornography and Illegal Publications jointly issued the Circular on Consistent Implementation of the Stipulation on the Three Provisions of the State Council and the Relevant Interpretations of the State Commission for Public Sector Reform and the Further Strengthening of the Pre-examination and approval of Online Games and the Approval and Examination of Imported Online Games, or the GAPP Notice. The GAPP Notice explicitly prohibits foreign investors from directly or indirectly engaging in online game business in China, including through consolidated affiliated entities. Foreign investors are not allowed to indirectly control or participate in PRC operating companies’ online game operations, whether (i) by establishing other joint ventures, entering into contractual arrangements or providing technical support for such operating companies; or (ii) in a disguised form such as by incorporating or directing user registration, user account management or game card consumption into online game platforms that are ultimately controlled or owned by foreign companies. The GAPP Notice reiterates that the General Administration of Press and Publication is responsible for the examination and approval of the import and publication of online games and states that downloading from the internet is considered a publication activity, which is subject to approval from the General Administration of Press and Publication.

Regulations Relating to Internet Content and Information Security

The Administrative Measures on Internet Information Services specify that internet information services regarding news, publications, education, medical and health care, pharmacy and medical appliances, among other things, are to be examined, approved and regulated by the relevant authorities. Internet information providers are prohibited from providing services beyond those included in the scope of their ICP licenses or filings. Furthermore, these measures clearly specify a list of prohibited content. Internet information providers are prohibited from producing, copying, publishing or distributing information that is humiliating or defamatory to others or that infringes the lawful rights and interests of others. Internet information providers that violate the prohibition may face criminal charges or administrative sanctions by the PRC authorities. Internet information providers must monitor and control the information posted on their websites. If any prohibited content is found, they must remove the offensive content immediately, keep a record of it and report it to the relevant authorities. Beijing Momo, as an ICP license holder, is subject to these measures.

Internet information in China is also regulated and restricted from a national security standpoint. The Standing Committee of the National People’s Congress has enacted the Decisions on Maintaining Internet Security, which may subject violators to criminal punishment in China for any effort to: (i) gain improper entry into a computer or system of strategic importance; (ii) disseminate politically disruptive information; (iii) leak state secrets; (iv) spread false commercial information; or (v) infringe intellectual property rights. The Ministry of Public Security has promulgated measures that prohibit use of the internet in ways which, among other things, result in a leakage of state secrets or a spread of socially destabilizing content. As an ICP license holder, Beijing Momo is subject to the laws and regulations relating to information security.

In August 2013, the MOC issued the Administration Measures on Content Review by Internet Culture Operating Entities, or the Content Review Measures, which became effective on December 1, 2013. According to the Content Review Measures, an internet culture operating entity shall censor and review its products and services to be provided to the public to ensure that such products and services do not contain any content prohibited by law, and the censor record shall be kept for at least two years. Internet culture operating entities shall adopt technical measures to conduct real-time censor over the products and services, set up internal content control department and establish content control policies. If the internet culture operating entity identifies any illegal content, it shall immediately suspend the products or services containing such content and preserve relevant record, and, in the event that such illegal content might lead to material issues, report to provincial branch of MOC. Besides, under the Measures for the Administration of Medical Advertising stipulated by SAIC and MOH on November 10, 2006, any medical institution is allowed to publish any advertisement provided that it has obtained an Examination Certificate for Medical Advertisements. Besides, any advertising operator is obliged to check and examine the Examination Certificate for Medical Advertisements of the medical instruction who is intend to publish advertisements on such platform, as well as verification the contents of the advertisement. Based on the consequences, any advertising operator who infringes the Measures for the Administration of Medical Advertising will be disqualified by SAIC, as well as a warning or a fine of RMB100,000 or not more than RMB30,000.

 

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Regulations Concerning Advertising Businesses

Regulation on Advertising Business and Conditions on Foreign Investment

The SAIC is the primary governmental authority regulating advertising activities in China. Regulations that apply to advertising business primarily include:

Advertisement Law of the People’s Republic of China, promulgated by the Standing Committee of the National People’s Congress on October 27, 1994 and effective since February 1, 1995;

Administrative Regulations for Advertising, promulgated by the State Council on October 26, 1987 and effective since December 1, 1987; and

Implementation Rules for the Administrative Regulations for Advertising, promulgated by the State Council on January 9, 1988 and amended on December 3, 1998, December 1, 2000 and November 30, 2004, respectively.

According to the above regulations, companies that engage in advertising activities must each obtain, from the SAIC or its local branches, a business license which specifically includes operating an advertising business in its business scope. An enterprise engaging in advertising business within the specifications in its business scope does not need to apply for an advertising operation license, provided that such enterprise is not a radio station, television station, newspaper or magazine publisher or any other entity otherwise specified in the relevant laws or administrative regulations. Enterprises conducting advertising activities without such a license may be subject to penalties, including fines, confiscation of advertising income and orders to cease advertising operations. The business license of an advertising company is valid for the duration of its existence, unless the license is suspended or revoked due to a violation of any relevant laws or regulations.

PRC advertising laws and regulations set certain content requirements for advertisements in China, including, among other things, prohibitions on false or misleading content, superlative wording, socially destabilizing content or content involving obscenities, superstition, violence, discrimination or infringement of the public interest. Advertisers, advertising agencies, and advertising distributors are required to ensure that the content of the advertisements they prepare or distribute is true and in complete compliance with applicable laws. In providing advertising services, advertising operators and advertising distributors must review the supporting documents provided by advertisers for advertisements and verify that the content of the advertisements complies with applicable PRC laws and regulations. Prior to distributing advertisements that are subject to government censorship and approval, advertising distributors are obligated to verify that such censorship has been performed and approval has been obtained. Violation of these regulations may result in penalties, including fines, confiscation of advertising income, orders to cease dissemination of the advertisements and orders to publish an advertisement correcting the misleading information. Where serious violations occur, the SAIC or its local branches may revoke such offenders’ licenses or permits for their advertising business operations.

Under the Administrative Regulations on Foreign-Invested Advertising Enterprises, promulgated in 2008, there is no longer any maximum foreign shareholding percentage restriction applicable to foreign-invested advertising enterprises. However, foreign investors are required to have at least three years prior experience of operating an advertising business outside of China as their main business before receiving approval to directly own a 100% interest in an advertising company in China. Foreign investors with at least two years prior experience of operating an advertising business outside China as their main business are allowed to establish a joint venture with domestic advertising enterprises to operate an advertising business in China.

Regulations Concerning the Software Development Industry

Software Products

On March 5, 2009, the MIIT issued the Administrative Measures for Software Products, or the Measures for Software Products, to regulate the development, production, sale, and import and export of software products, including computer software, software embedded in information systems and equipment, and computer software provided in conjunction with other information or technology services. Any entity or individual shall not develop, produce, sell and import or export any software product which infringes upon the intellectual property rights of third parties, contains computer viruses, endangers computer system security, is not in compliance with the software standard specification of the PRC, or contains contents prohibited under PRC laws and regulations. To that end, for any software products and services, the Measures for Software Products require registration and filing with the provincial level software registration institutions authorized to accept and review software products registration applications. Once accepted for review, the software product registration application shall be filed with and publicly announced by the MIIT, and if no objection is received within a seven-working-day publication period, a software registration number and a software product registration certificate will be granted. A software registration certificate is valid for five years and may be renewed upon expiration.

 

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Software Enterprises

A PRC enterprise that develops one or more software products and meets the Certifying Standards and Administrative Measures for Software Enterprises (which was effective on February 6, 2013), promulgated by the MII, Ministry of Education, Ministry of Science and Technology and the State Administration of Taxation, or the SAT on October 16, 2000, can be certified as a “software enterprise.” The certification standards for software enterprises include the following:

 

    the applicant shall be an enterprise established in PRC which engages in the business of computer software development and production, system integration, application service, etc.;

 

    the enterprise develops one or more software products or possesses one or more intellectual property rights of software products, or provides technical services such as computer information system integration that has passed qualification and grade certification;

 

    the proportion of technical staff in the work of software development and technical service shall be no less than 50% of the total staff in the enterprise;

 

    the applicant shall possess relevant technical equipments and premises necessary for developing software and providing relevant services;

 

    the applicant shall possess methods and ability to safeguard the quality of the software products and the technical services;

 

    the development fund for software technique and products shall be above 8% of the enterprise’s annual software income; and

 

    the annual sale income of software shall be more than 35% of the total annual income of the enterprise, with the income of self-developed software more than 50% of the software sales income;

 

    the enterprise has clearly-established ownership, standardized management and complies with disciplines and laws.

Enterprises that qualified as “software enterprises” are entitled to certain preferential treatments in the PRC. According to the Circular on Relevant Policies for Encouraging the Development of the Software and Integrate Circuit Industries (Circular No. 25) (2000) by the Ministry of Finance and the State Administration of Taxation, or the SAT, newly-established software manufacturing enterprises (i.e. those established after July 1, 2000) may be exempt from income tax in the first two years of profitability and enjoy 50% income taxes reduction for the next three years, such policy is known as the “Two Free, Three Half” preferential policy. According to Circular on Income Tax Policies for Further Encouraging the Development of Software Industry and Integrated Circuit Industry (2011), a software production enterprise newly established within China may, upon certification, enjoy the Two Free, Three Half preferential treatment. On April 24, 2009, the Ministry of Finance and SAT promulgated the Notice on Several Issues Relevant to the Implementation of the Preferential Policies on Enterprise Income Tax, which states that, the software production enterprises and the integrated circuit production enterprises established prior to the end of 2007 may, upon certification, enjoy the preferential policies on the enterprise income tax reductions and exemptions within specified periods as provided in the Notice 2008 No. 1. An enterprise which became profitable in or before 2007 and started enjoying the enterprise income tax reductions and exemptions within specified periods may continue to enjoy the relevant preferential treatment from 2008 until the expiration of the specified periods.

 

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Regulations on Special Products for Computer Information System Safety

The manufacture and the sale of special products for computer information system safety are mainly regulated by the Protection Regulations for Computer Information System Safety of the PRC, which was promulgated by the State Council and become effective as of February 18, 1994 and the Administrative Measures for Inspection and Sales License of Special Products for Computer Information System Safety, which was promulgated by the Ministry of Public Security and became effective as of December 12, 1997. Pursuant to relevant articles in these laws and regulations, the manufacturer of special products for computer information system safety shall apply for a sales license for special products for computer information system safety before such products entering into the market and tag the mark of “Sales Permit” on a fixed place of such products. No individual or entity is allowed to sell special products for the computer information system safety without a mark of “Sales Permit.”

Foreign Investments in Software Development Industry

According to the Catalog of Industries for Guiding Foreign Investment amended in 2015, foreign investment is encouraged in the software development and production sector. As such, there are no restrictions on foreign investment in the software development industry in the PRC aside from business licenses and other permits that every software development entity in the PRC must obtain.

Regulations on Internet Domain Name and Content

Internet Domain Name

Internet domain names in the PRC are regulated by the Administrative Measures on the PRC Internet Domain Name, which were promulgated by the MII and which came into effect on December 20, 2004, and the CNNIC Implementing Rules of Domain Name Registration (2012). Domain name service organizations accept applications for network domain names; successful applicants become holders of the registered domain names after registration. Holders needs to pay operation fees on time to keep the registered domain names, otherwise the domain name registrar may revoke the domain names. In case there is any change to the registration information of a domain name, the holder shall file the changes with the domain name registrar within 30 days after such a change. The CNNIC is responsible for the administration of .cn domain names and domain names in Chinese language. Disputes in respect of domain names are regulated by the Measures on Resolution of Disputes regarding Domain Names which were issued by CNNIC and revised on May 28, 2012, and shall be settled by organizations approved by the CNNIC.

Content of Internet Information

Provision of Internet information services in the PRC is regulated by the Administrative Measures on Internet Information Services adopted by the State Council on September 20, 2000. According to these measures, provision of Internet information services regarding news, publication, education, medical and health care, pharmacy and medical appliances are subject to examination, approval and regulation by relevant authorities responsible for regulating these sectors. Internet content providers are not allowed to provide services beyond the scope of licensed or registered. The measures also provide a list of prohibited contents on the Internet. Internet information service providers are required to monitor and censor the information on their websites, and when prohibited content is found, they shall terminate the transmission immediately, keep the relevant record and report immediately to relevant authorities.

According to these measures, commercial Internet information service providers must obtain a License for Internet Content Providers, or ICP license, in order to engage in such business. Moreover, provision of ICP services in multiple provinces, autonomous regions and centrally administered municipalities may require a trans-regional ICP license.

 

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On November 6, 2000, the MII issued the Regulations for the Administration of Internet Electronic Notice Services to regulate the provision of information via Internet in the form of, among others, electronic bulletin boards, electronic whiteboards, electronic forums, Internet chat-rooms and message boards. The Internet electronic bulletin service providers are required to record the content and time of information released, the website or domain name in the electronic bulletin system, keep such records for at least 60 days, and to provide such information to the relevant authorities upon request.

Regulations on Technology Export

The Technology Import and Export Administrative Regulations of the PRC promulgated by the State Council on December 10, 2001 and the Regulations for the Implementation of the Trademark Law of PRC which came into effect on January 1, 2002, and revised on January 8, 2011, requires approval of imports and exports of restricted technology, and registration of contracts to import or export unrestricted technology. Software is part of the technology governed by this regime. To implement this requirement, the Administrative Measures for Registration of Technology Import and Export Contracts, or the Registration Measures, was promulgated by the Ministry of Commerce, or the MOFCOM and become effective on March 1, 2009; the Administrative Measures on Prohibited and Restricted Technology Exports, or the Technology Export Measures was jointly promulgated by the MOFCOM and the Ministry for Science and Technology and become effective on May 20, 2009, and the Administrative Measures on Prohibited and Restricted Technology Imports, or the Technology Import Measures was promulgated by the MOFCOM and become effective on March 1, 2009. Pursuant to these regulations, the technology within the prohibited list for import and/or export shall not be imported and/or exported, permit for import and/or export shall be obtained by the importer and/or exporter if the technology to be imported and/or exported are listed within the restricted list for import and/or export. For any import or export technology, the relevant department of commerce is responsible for the registration of contracts for such technology import or export.

Regulations on Intellectual Property Rights

Trademarks

Registered trademarks in the PRC are protected by the Trademark Law of the PRC which came into effect in 1982 and was revised in 1993, 2001 and 2013 and the Regulations for the Implementation of Trademark Law of PRC which came into effect in 2002 and was revised in 2014. A trademark can be registered in the PRC with the Trademark Office under the State Administration for Industry and Commerce, or the SAIC. The protection period for a registered trademark in the PRC is ten years starting from the date of registration and may be renewed if an application for renewal is filed within one year prior to expiration. If such an application cannot be filed within that period, an extension period of six months may be granted.

Copyright

Copyright in the PRC is protected by the Copyright Law of the PRC which was promulgated in 1990 and revised in 2001 and February 2010 and the Regulation for the Implementation of the Copyright Law of the PRC which was promulgated in September 2002 and revised in January 2013. Under the revised Copyright Law, copyright protections have been extended to information network and products transmitted on information network. Copyrights are reserved by the author, unless specified otherwise by the laws. According to Article 16 of the Copyright Law, if a work constitutes “work for hire”, the employer, instead of the employee, is considered the legal author of the work and will enjoy the copyrights of such “work for hire” other than rights of authorship. “Works for hire” include, (1) drawings of engineering designs and product designs, maps, computer software and other works for hire, which are created mainly with the materials and technical resources of the legal entity or organization with responsibilities being assumed by such legal entity or organization; (2) those works the copyrights of which are, in accordance with the laws or administrative regulations or under contractual arrangements, enjoyed by a legal entity or organization. The actual creator may enjoy the rights of authorship of such “work for hire.”

A copyright owner may transfer its copyrights to others or permit others to use its copyrighted works. Use of copyrighted works of others generally requires a licensing contract with the copyright owner. The protection period for copyrights in the PRC varies, with 50 years as the minimum. The protection period for a “work for hire” where a legal entity or organization owns the copyright (except for the right of authorship) is 50 years, expiring on December 31 of the fiftieth year after the first publication of such work.

 

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Measures for the Registration of Computer Software Copyright

In China, holders of computer software copyrights enjoy protections under the Copyright Law. China’s State Council and the State Copyright Administration have promulgated various regulations relating to the protection of software copyrights in China. Under these regulations, computer software that is independently developed and exists in a physical form is protected, and software copyright owners may license or transfer their software copyrights to others. Registration of software copyrights, exclusive licensing and transfer contracts with the Copyright Protection Center of China (previously, the State Copyright Administration) or its local branches is encouraged. Such registration is not mandatory under Chinese law, but can enhance the protections available to the registered copyrights holders. For example, the registration certificate is proof of protection.

Regulations on Dividend Distribution

The principal regulations governing distribution of dividends in foreign-invested enterprises include the Foreign-invested Enterprise Law promulgated by the Standing Committee of the National People’s Congress, as amended on October 31, 2000, and the Implementation Rules of the Foreign-invested Enterprise Law issued by the State Council, as amended on February 19, 2014.

Under these laws and regulations, foreign-invested enterprises in China may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, foreign-invested enterprises in China are required to allocate at least 10% of their respective net profits each year, if any, to fund certain reserve funds unless these reserves have reached 50% of the registered capital of the enterprises. Foreign-invested enterprises are not allowed to distribute profits until deficits of previous fiscal years have been made up.

Regulations on Foreign Currency Exchange

The principal regulations governing foreign currency exchange in the PRC are the Foreign Exchange Administration Regulations promulgated by the State Council, as amended on August 5, 2008, or the Foreign Exchange Regulations. Under the Foreign Exchange Regulations, the RMB is freely convertible for current account items, as long as true and lawful transaction basis is provided, but not for capital account items, such as capital transfer, direct investments, loans, repatriation of investments, investments in securities and derivatives outside of the PRC, unless the prior approval of the State Administration of Foreign Exchange, or the SAFE, is obtained and prior registration with the SAFE is made. Circular 78 ceased to be in effect and was replaced by the Circular for Relevant Issues on Foreign Exchange Administration on Domestic Individuals Participating in the Employee Stock Option Plan of An Overseas Listed Company, or Circular 7, promulgated by SAFE on February 15, 2012. Circular 7 modifies and simplifies the relevant procedures as provided by Circular 78.

On December 25, 2006, the People’s Bank of China issued the Administration Measures on Individual Foreign Exchange Control and its Implementation Rules were issued by the SAFE on January 5, 2007, both of which became effective on February 1, 2007. Under these regulations, all foreign exchange matters involve the employee stock ownership plan, stock option plan and other similar plans, participated by onshore individuals must be transacted upon approval from the SAFE or its authorized branch. On March 28, 2007, the SAFE promulgated the Operating Procedures for Administration of Domestic Individuals Participating in the Employee Stock Option Plan or Stock Option Plan of An Overseas Listed Company, or Circular 78 (which has been revised on February 15, 2012). Under Circular 78, PRC citizens who participate in stock incentive plans or equity compensation plans by an overseas publicly listed company are required to engage a PRC agent through the PRC subsidiaries of such overseas publicly-listed company, to complete certain foreign exchange registration procedures with respect to the plans upon the examination by, and approval of, the SAFE.

 

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Regulations on Offshore Financing

On October 21, 2005, the SAFE issued Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Corporate Financing and Roundtrip Investment through Offshore Special Purpose Vehicles, or Circular 75, which became effective as of November 1, 2005.

On July 4, 2014, the SAFE issued the Circular of the SAFE on Issues concerning Foreign Exchange Administration over the Overseas Investment and Financing and Round-trip Investment by Domestic Residents via Special Purpose Vehicles (“SAFE Circular No. 37”), which became effective as the date of issuance. Circular 75 shall be annulled simultaneously. Where the relevant provisions enacted previously are inconsistent with SAFE Circular No. 37, SAFE Circular No. 37 shall prevail. Under SAFE Circular No. 37, PRC residents to register with local branches of SAFE in connection with their direct establishment or indirect control of an offshore entity, or an SPV, for the purpose of overseas investment and financing, utilizing such PRC residents’ legally owned assets or equity interests in domestic enterprises or offshore. The term “control” under SAFE Circular No. 37 is broadly defined as the right to operate, rights as beneficiary or decision-making rights acquired by the PRC residents in the offshore SPVs or PRC companies by such means as acquisition, trust, proxy, voting rights, repurchase, convertible bonds or other arrangements. SAFE Circular No. 37 further requires amendment to the registration in the event of any significant changes with respect to the SPV, 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 SPV fails to fulfill the required SAFE registration, the PRC subsidiaries of that SPV may be prohibited from distributing profits to the offshore parent and from carrying out subsequent cross-border foreign exchange activities, and the SPV may be restricted in its ability to contribute additional capital into its PRC subsidiary. 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.

Under the relevant rules, failure to comply with the registration procedures set forth in SAFE Circular No. 37 may result in restrictions on the foreign exchange activities of the relevant onshore company, including higher requirement for registered capital, restrictions on the payment of dividends and other distributions to its offshore parent or affiliate and the capital inflow from the offshore entity, and may also subject relevant PRC residents to penalties under PRC foreign exchange administration regulations. Under relevant regulations, our PRC resident founders are required to register their investments in our company with the SAFE. SAFE promulgated the Notice on Further Simplifying and Improving the Administration of the Foreign Exchange Concerning Direct Investment in February 2015, which took effect on June 1, 2015. This notice has amended SAFE Circular 37 requiring PRC residents or entities to register with qualified banks rather than SAFE or its local branch in connection with their establishment or control of an offshore entity established for the purpose of overseas investment or financing.

PRC residents or entities who had contributed legitimate onshore or offshore interests or assets to SPVs but had not obtained registration as required before the implementation of the SAFE Circular 37 must register their ownership interests or control in the SPVs with qualified banks. An amendment to the registration is required if there is a material change with respect to the SPV registered, such as any change of basic information (including change of the PRC residents, name and operation term), increases or decreases in investment amount, transfers or exchanges of shares, and mergers or divisions. Failure to comply with the registration procedures set forth in SAFE Circular 37 and the subsequent notice, or making misrepresentation on or failure to disclose controllers of the foreign-invested enterprise that is established through round-trip investment, may result in restrictions being imposed on the foreign exchange activities of the relevant foreign-invested enterprise, including payment of dividends and other distributions, such as proceeds from any reduction in capital, share transfer or liquidation, to its offshore parent or affiliate, and the capital inflow from the offshore parent, and may also subject relevant PRC residents or entities to penalties under PRC foreign exchange administration regulations.

We are aware that our PRC resident beneficial owners subject to these registration requirements have registered with the Beijing SAFE branch and are in the process of updating the registration to reflect the recent changes to our corporate structure.

 

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Tax Regulations

Income Tax

On March 16, 2007, the PRC National People’s Congress, the Chinese legislature, passed the Enterprise Income Tax Law, and on December 6, 2007, the State Council issued the Implementation Regulations of the Enterprise Income Tax Law, both of which became effective on January 1, 2008. The Enterprise Income Tax Law and its Implementation Regulations, or the EIT Law, applies a uniform 25% enterprise income tax rate to both foreign-invested enterprises and domestic enterprises. Pursuant to the Notice of the State Council Regarding the Implementation of Transitional Preferential Policies for Enterprise Income Taxes issued on December 26, 2007, enterprises established prior to March 16, 2007, eligible for preferential tax treatment in accordance with the currently prevailing tax laws and administrative regulations shall, under the regulations of the State Council, gradually become subject to the EIT Law rate over a five-year transition period starting from the date of effectiveness of the EIT Law. In addition, certain enterprises may still benefit from income tax exemptions and reductions under the new tax law if they meet the definition of a “software enterprise” or a preferential tax rate of 15% under the new tax law if they meet the definition of “high and new technology enterprises.”

VAT in lieu of BT

On April 29, 2014, the State Administration of Taxation and the Ministry of Finance issued the Circular of the Ministry of Finance and the State Administration of Taxation on the Inclusion of Telecommunications Industry in the Pilot Collection of Value-Added Tax in Lieu of Business Tax, and on May 14, 2014, the State Administration of Taxation issued Announcement of the State Administration of Taxation on Promulgating the Interim Administrative Measures for the Collection of Value-Added Tax from Telecommunication Enterprises(the “Announcement”), both of which became effective on June 1, 2014. Pursuant to the Circular and the Announcement, Telecommunications industry is included in the pilot collection of value-added tax in lieu of business tax (hereinafter referred to as “VAT in lieu of BT”) upon approval of the State Council. Entities and individuals who provide telecommunications services within the territory of the PRC are VAT tax payers, who shall pay VAT instead of BT in accordance with the provisions of the Announcement and the Circular of the Ministry of Finance and the State Administration of Taxation on the Inclusion of the Railway Transport Industry and Postal Service Industry in the Pilot Collection of Value-Added Tax in Lieu of Business Tax, tax rate for basic telecommunications services is 11% and that for value-added telecommunications services is 6%.

Furthermore, under the EIT Law, enterprises established outside of China whose “de facto management bodies” are located in China are considered “resident enterprises.” Currently, there are no detailed rules or precedents governing the procedures and specific criteria for determining “de facto management body.”

Regulations Relating to Dividend Withholding Tax

The EIT Law imposes a withholding tax of 10% on dividends distributed by a foreign-invested enterprise to its immediate holding company outside China, if such immediate holding company is considered a “non-resident enterprise” without any establishment or place within China or if the received dividends have no connection with the establishment or place of such immediate holding company within China, unless such immediate holding company’s jurisdiction of incorporation has a tax treaty with China that provides for a different withholding arrangement. Holding companies in Hong Kong, for example, are subject to a 5% withholding tax rate.

In August 2015, the State Administration of Taxation promulgated the Administrative Measures for Non-Resident Taxpayers to Enjoy Treatments under Tax Treaties, or Circular 60, which became effective on November 1, 2015. Circular 60 provides that non-resident enterprises are not required to obtain pre-approval from the relevant tax authority in order to enjoy the reduced withholding tax rate. Instead, non-resident enterprises and their withholding agents may, by self-assessment and on confirmation that the prescribed criteria to enjoy the tax treaty benefits are met, directly apply the reduced withholding tax rate, and file necessary forms and supporting documents when performing tax filings, which will be subject to post-tax filing examinations by the relevant tax authorities. Accordingly, our Hong Kong subsidiary may be able to enjoy the 5% withholding tax rate for the dividends they receive from our PRC subsidiary, if it satisfies the conditions prescribed under Circular 81 and other relevant tax rules and regulations. However, according to Circular 81 and Circular 60, if the relevant tax authorities consider the transactions or arrangements we have are for the primary purpose of enjoying a favorable tax treatment, the relevant tax authorities may adjust the favorable withholding tax in the future.

 

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Labor Protection

Pursuant to the Employment Contracts Law of the People’s Republic of China, or ECL, promulgated by the Standing Committee of the National People’s Congress on June 29, 2007 and became effective on January 1, 2008 and the Implementing Regulations of the PRC Employment Contracts Law promulgated and effective on September 18, 2008, an employer establishes an employment relationship with an employee from the date when the employee is put to work, and a written employment contract shall be entered into on this same day. If an employment relationship has already been established with an employee but no written employment contract has been entered into simultaneously, a written employment contract shall be entered into within one month from the date the employee commences work. If an employer fails to enter into a written employment contract with an employee for more than one month but less than one year as of the date on which the employment commences, it shall pay the employee twice his/her salary for each month of that period and rectify the situation by subsequently entering into a written employment contract with the employee. If the employee refuses to enter into the written contract with the employer, the employer shall issue a written notice to the employee to rescind the employment relationship, and pay severance to the employee in accordance with relevant provisions of the ECL.

 

C. Organizational Structure

As of March 15, 2016, we mainly operate our business through the following significant subsidiaries and consolidated affiliated entities:

 

    Beijing NQ Technology Co., Ltd., or Beijing Technology, our consolidated affiliated entity in the PRC;

 

    NQ Mobile (Beijing) Co., Ltd., or NQ Beijing, our wholly owned subsidiary in the PRC;

 

    FL Mobile Jiutian Technology Co., Ltd.*, or FL Mobile, a majority owned subsidiary of Xinjiang NQ in the PRC;

 

    NQ (Beijing) Co., Ltd., or NQ Tongzhou, our wholly owned subsidiary in the PRC;

 

    Beijing Fanyue Information Technology Co., Ltd., or Fanyue, a wholly owned subsidiary of FL Mobile in the PRC;

 

    Beijing Wanpu Century Co., Ltd., or Wanpu Century, a wholly owned subsidiary of FL Mobile in the PRC;

 

    NQ International Limited, our wholly owned subsidiary in Hong Kong;

 

    Beijing NQ Mobile Co., Ltd., or NQ Yizhuang, our wholly owned subsidiary in the PRC;

 

    Beijing Showself Technology Co., Ltd., or Showself, a majority owned subsidiary of Beijing Technology in the PRC;

 

    Xinjiang NQ Mobile Venture Capital Investment Co., Ltd., or Xinjiang NQ, a wholly owned subsidiary of Beijing Technology in the PRC.

 

*  Also previously translated as Feiliu Jiutian Technology Co., Ltd.

 

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LOGO

 

D. Property, Plants and Equipment

Our principal executive office and headquarter in Beijing is located on premises comprising approximately 6114 square meters at 11 Heping Li East Street, Dongcheng District, Beijing, China, which we lease from an unrelated third party. We plan to renew our lease when it expires. The premises are shared by NQ Beijing, Beijing Technology and some subsidiary companies. The lessor of the leased premises in Beijing has valid title to the property. We believe that our existing facilities are adequate for our current and foreseeable requirements.

We also lease an aggregate of approximately 9917 square meters of office space in Beijing, Tianjin, Shanghai, Shenzhen, Taipei, Hong Kong, Gyeonggi-do and Texas all from unrelated third parties.

We made capital expenditures of US$1.6 million, US$3.7 million and US$0.5 million for the years ended December 31, 2013, 2014 and 2015 respectively. Our capital expenditures were primarily used to purchase servers and other equipment, software and other intangible assets (such as the domain name www.nq.com) for our business. Our capital expenditures may increase in the near term as our business continues to grow.

See footnotes 8 and 9 to our financial statements for further information about our property and equipment and intangible assets.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

None.

 

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ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included elsewhere in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this annual report.

 

A. Operating Results

Overview

We are a leading global provider of mobile Internet services. We have been a pioneer in the consumer mobile security industry since 2005 and have since built a portfolio of offerings including mobile game publishing platforms, mobile advertising platforms, mobile entertainment applications and platforms, mobile security and productivity applications as well as other mobile applications. We currently offer a variety of products and services to consumers and enterprises.

Since our inception, we have focused on building a large and engaged user base. We monitor certain key operating metrics that we believe are important to our financial performance. As our business evolves and we continue to gain further insight into our growing business, we may change the method of calculating our key operating metrics to address uncertainties in these metrics or add new key operating metrics to reflect the changes in our business.

 

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We generate revenues primarily through (i) mobile value added services, which include mobile game publishing, mobile entertainment applications and platforms, and mobile security, productivity and other applications, (ii) mobile advertising and (iii) mobile enterprise mobility. Our total net revenues increased from US$196.7 million in 2013 to US$332.3 million in 2014 and US$406.7 million in 2015. We had a net loss of US$1.9 million, US$76.7 million and US$1.3 million in 2013, 2014 and 2015. Our adjusted net income attributable to NQ Mobile Inc., which is determined by adding back share-based compensation expenses to our net income attributable to NQ Mobile Inc. presented in accordance with U.S. GAAP, is another measure used by our management to evaluate our operating performance. We had adjusted net income attributable to NQ Mobile Inc. of US$53.5 million, US$7.1 million and US$15.3 million in 2013, 2014 and 2015, respectively.

We incur significant share-based compensation expenses in the course of our business as we have issued share-based awards in order to motivate and retain talent and pursuant to earn outs in certain of our acquisitions. We incurred US$55.4 million, US$83.8 million and US$16.6 million in share-based compensation expenses for the fiscal year ended December 31, 2013, 2014 and 2015, respectively. The granting or acceleration of our share-based awards will materially and adversely affect our financial results in the periods over the vesting period of the newly granted options and restricted shares.

Our results of operations are affected by PRC laws, regulations and policies relating to value-added telecommunications services. Due to current legal restrictions on foreign ownership and investment in value-added telecommunications services in China, we rely on a series of contractual arrangements with Beijing Technology and its shareholders to conduct our business in China. We do not hold equity interests in Beijing Technology. As a result of these contractual arrangements, we are the primary beneficiary of Beijing Technology.

Factors Affecting Our Results of Operations.

Our results of operations are affected by, among others, the following factors:

The growth of the consumer mobile security, privacy and productivity industry

Our business and prospects depend on the continued development of the mobile security, privacy and productivity industry in China and abroad. The mobile security, privacy and productivity industry has begun to experience substantial growth in recent years in terms of number of users and revenues. The growth of the mobile security, privacy and productivity industry is affected by numerous factors, such as users’ general communication experience, technological innovations, development of smartphones and other mobile devices, development of mobile Internet and Internet-based mobile telecommunication services, regulatory changes, and the macroeconomic environment.

 

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The growth of the mobile game industry

We generate mobile game revenues from operating free-to-play mobile games that monetize through the sale of in-game virtual items. The number of mobile gamers has been increasing significantly over the past two years with the continuous increasing market penetration of mobile Internet and affordable smart devices. Based on CNNIC data, more and more gamers are migrating from PC to mobile phones as mobile devices enable gamers to better utilize their fragmented time in everyday life. The growth of mobile game industry depends on factors including the penetration of mobile Internet, affordability of smart devices, ever-evolving mobile game content and quality of mobile game operators.

The growth of the mobile entertainment industry

We generate mobile entertainment revenues from operating a variety of applications and services that interest consumers including Showself Live Video, our live mobile social video platform, Showself Desktop and Lockscreen, our programmable and interactive wallpaper and desktop lockscreens, and Showself Music Radar, our audio-based search application that enables consumers to search and find music and songs based on singing or humming input. This is a highly fragmented and competitive market and our ability to deliver quality applications that engage the users and compel them to purchase in-app items, pay for premium download or to deliver enough traffic to generate mobile advertising occurrences is the key.

The growth of the mobile advertising industry

We generate advertising revenues on CPA and CPT basis. Mobile advertising industry in China is still at the early stage of development and the revenue is mainly contributed by application-related marketing, downloads and in-application advertisements. The growth of this industry depends on factors including the penetration of mobile Internet, affordability and functionalities of mobile devices, advertising budget shifting to mobile platforms and effectiveness of mobile advertising.

The growth of enterprise mobility industry

In December 2015, we completed the divestment of NationSky and therefore going forward the growth of the enterprise mobility segment will be primarily driven by our Trustek business. Trustek is primarily engaged in providing enterprise mobility solutions and services, including hardware supplies, system management, application development, business intelligence and maintenance services. As employees and knowledge workers increasingly use bring-your-own-device (BYOD) smart mobile devices for both business and personal use, managing work productivity and keeping corporate owned information and sensitive employee data protected have become significant concerns for businesses and employees. Enterprise mobility is a relatively new and fast-growing industry in China and around the world and we believe factors such as IT consumerization, BYOD adoption and availability of smart mobile devices at affordable prices are the key drivers for the growth of enterprise mobility across different industry sectors.

Foreign Exchange Risks

We are exposed to foreign exchange risk arising from various currency exposures. See “Item 11. Quantitative and Qualitative Disclosure About Market Risk.”

 

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Discussion of Selected Statements of Comprehensive Income Items

Net Revenues

We recognize revenues net of value added tax business tax and related surcharges. We derive our net revenues primarily from (i) mobile value added services, which include mobile game publishing, mobile entertainment applications and platforms, and mobile security, productivity and other applications, (ii) mobile advertising and (iii) mobile enterprise mobility. We generate mobile game publishing revenues from operating free-to-play mobile games that monetize through sales of in-game virtual items. We generate mobile entertainment applications and platform revenues primarily from our live mobile social video platform where mobile users can interact with hosts and monetize through the sale of in-app virtual items and games. For our consumer mobile security services, we focus on mobile security, privacy protection and productivity services and provide for free the basic functions of such services, such as the anti-malware scanning, anti-spam, contact back-up and restore functions. We charge our users a subscription fee for subscribing to our premium services, such as access to continual updates of our virus library and advanced privacy protection services, on a monthly, quarterly, semi-annual or annual basis. We generate advertising revenues on CPA and CPT basis through our mobile security applications, mobile games, advertising network platform and offline channels. For our enterprise users, we derive enterprise mobility product revenues from sales of mobile hardware and enterprise mobility service revenues from the offering of managed mobility services. In addition, we derive a portion of our net revenues from other sources, such as secured download and technology development services to third parties. In December 2015 we completed the divestment of NationSky and will have less revenues from this segment going forward compared to recent periods.

Due to the expansion of our business and diversification of our revenue streams, we re-classified our revenues into the following categories beginning in 2013: mobile value added services (including mobile game publishing, mobile entertainment applications and platforms, and consumer mobile security, productivity and applications.), enterprise mobility, advertising services and other services. As a result, we re-classified in the consolidated results of operations table, and the presentation of the revenue categories for the years ended December 31, 2013, 2014 and 2015 in this annual report are in conformity with these new revenue categories.

Mobile game publishing revenues are derived from third-party developed mobile games and self-developed mobile games. We enter into exclusive or joint operation agreements with game developers for licensed mobile game applications. Game players can download the free-to-play games and pay to acquire virtual currency which can be redeemed in the games for in-game virtual items. Pursuant to agreements signed between us and game developers, revenues from the sales of virtual currency to be used for the purchase of virtual items are shared between us and the game developers based on a pre-agreed ratio for each game. We also generate mobile games revenues from offering virtual items in self-developed mobile games and collect license fees of our self-developed mobile games. Within the storefronts, game players can download our free-to-play games and pay to acquire virtual currency which can be redeemed in the games for in-game virtual items.

Mobile Entertainment Applications and Platforms consists primarily from our live mobile social video platform - Showself, revenues are mainly derived from the sale of virtual currency which can be used to purchase virtual presents and items in the Rooms. All the Rooms can be accessed for free. Our operating entities primarily cooperate with independent third-party distributors to sell our virtual currency through the annual distribution agreements with these distributors. Pursuant to the distribution agreements with these distributors, each distributor is responsible for sales of virtual currency for one or more of our communities through developing and engaging sales agents who directly sell the virtual currency to users. We have discretion to determine the price of the virtual currency sold to sales agents or users. In addition, we take overall responsibility of the content or performances provided by hosts in our community. Consequently, we recognize revenue on a gross basis pursuant to ASC 605-45.

We collect net revenues from consumer mobile security services primarily through three payment channels. First, we cooperate with wireless carriers, either directly or through mobile payment service providers, to provide services to users. In this payment channel, wireless carriers charge a fixed percentage of the total user payment as a fee primarily for billing, collection and customer support services relating to the end users. We recognize net revenues excluding the fees retained by wireless carriers. If we cooperate with wireless carriers through mobile payment service providers, we pay a fee to the mobile payment service providers and the amounts attributed to mobile payment service providers are recognized as cost of revenues. Second, we sell prepaid cards to customers of our consumer mobile security services through independent distributors and amortize such net proceeds from the distributors as net revenues on a straight-line basis over the subscription period. Third, users can subscribe for our consumer mobile security services directly through our website and make payments through third-party payment processors. We recognize the proceeds collected through third-party payment processors as revenues on a gross basis and the amounts attributed to third-party payment processors are recognized as cost of revenues.

Advertising revenues are derived from the advertisement placement services on our platform. Advertising fees are generally charged to advertisers on a cost per action (“CPA”) basis. The desired actions to be performed include but are not limited to activation, download, click, registration or opt-ins, which are determined by the advertisers. The revenues are generally recognized when the end users activate the applications, register accounts or deliver their opt-ins. We also provide advertisement placements on our websites and interest-based communities. We enter into pay-for-time (“CPT”) contracts with advertisers, under which the fixed price and advertising services are established upfront and charged ratably over the contractual period of display.

 

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Enterprise mobility revenues are derived primarily from hardware sales to enterprise customers for their provision of mobility solutions, technology and software development, and commission income shared with mobile network operators. We recognize the hardware procurement revenue once customers acknowledge the receipt of the hardware delivered and title and risk of loss have been transferred. Mobility solution revenue in connection with agreements for standard proprietary software is recognized upon delivery of the software, provided that collection is considered probable and the fee is fixed or determinable. Revenues from technology and software development are recognized when services are completed. Commission income is derived from bringing enterprise customers to the mobile network operators and is determined based on fixed percentages, agreed with the mobile operators, of actual charges to the enterprise customers. We recognize the commission incomes in the month in which the service is provided to the enterprise customers.

The following table sets forth the principal components of our net revenues in both domestic and overseas markets by amount and as a percentage of our total net revenues for the periods indicated.

 

    For the Year Ended December 31,  
    2013     2014     2015  
    Domestic     Overseas     Domestic     Overseas     Domestic     Overseas  
    US$     %     US$     %     US$     %     US$     %     US$     %     US$     %  
    (in thousands of dollars, except for percentages)  

Service Revenues (1)

                       

Mobile value added services

    51,954        36.3        51,565        96.4        67,052        23.1        39,051        92.2        104,336        28.3        35,252        92.3   

Enterprise mobility

    14,174        9.9        —          —          16,035        5.5        —          —          27,416        7.5        —          —     

Advertising services

    36,623        25.6        —          —          72,825        25.1        78        0.2        69,379        18.8        2,342        6.1   

Other services

    1,617        1.1        1,942        3.6        1,422        0.5        3,219        7.6        4,730        1.3        622        1.6   

Product Revenues

                       

Enterprise mobility

    38,827        27.1        —          —          132,642        45.8        —          —          162,614        44.1        —          —     

Total net revenues

    143,195        100.0        53,507        100.0        289,976        100.0        42,348        100.0        368,475        100.0        38,216        100.0   

 

(1) Due to the expansion of our business and diversification of our revenue streams, we re-classified our revenues into the following categories in 2013: mobile value added services (including consumer mobile security, mobile games, and live mobile social video platform), enterprise mobility, advertising services and other services. As a result, we re-classified in the above table, within this annual report, the presentation of the revenue categories for the years ended December 31, 2013, 2014 and 2015 in conformity with these new revenue categories.

Net revenues from mobile value added services, which included mobile game publishing, mobile entertainment applications and platforms and consumer mobile security and productivity applications increased from 2013 to 2015. The increase in mobile value added service revenues was primarily due to the increase in mobile game revenues and the inclusion of live mobile social video platform revenues, partially offset by the decrease in consumer mobile security revenues. The increase in mobile game revenues was primarily the result of the continuing expansion of FL Mobile’s business in both domestic and overseas markets. The inclusion of live mobile social video platform revenues is the result of the consolidation of Showself. The decrease in consumer mobile security revenues was primarily due to moving our focus away from premium security subscription-based revenues and focusing more on other consumer mobile applications and services.

 

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Net revenues from advertising services increased from 2013 to 2015, due primarily to (i) the acquisitions of Fanyue, Best Partners and Tianya in 2013; and (ii) our launch of the offer wall in March 2013, through which we generated advertising revenues when users download third-party sponsored applications and games from the offer wall.

We recorded net revenues from enterprise mobility products and services of US$53.0million, US$148.7 million and US$190.0 million in 2013, 2014 and 2015, respectively. Our net revenues from enterprise mobility products and services were generated primarily from Trustek and NationSky.

Cost of Revenues

Cost of revenues primarily consists of: (i) payments to third parties in connection with user acquisition, (ii) salaries and benefits for employees that provide customer services and other support directly related to our products and services, (iii) payments paid to or retained by mobile payment service providers and third-party payment processors, (iv) revenues shared with third-party content providers for entertainment applications and platforms, advertising services and mobile games, and (v) hardware procurement costs.

We acquire users primarily through viral marketing, or word-of-mouth marketing, pre-installation and online download. We provide online downloads of our products and services via various third-party websites, including online advertising networks, Internet portals and mobile application stores. We pay such third parties a fee for each registered user account acquired through them. Payments to these third parties increased from 2013 to 2015 as we acquired more users through them during these periods. We also pay fees to handset manufacturers to pre-install our applications on their handsets. As we further expand our global user base and grow our revenue, we expect payments to third parties in connection with user acquisition to continue to increase.

Salaries and benefits for employees that provide customer services and other support directly related to our products and services increased from 2013 to 2015, primarily reflecting the expansion of customer services and product support teams.

We cooperate with wireless carriers, either directly or through mobile payment service providers, to provide services to users. If we cooperate with wireless carriers through mobile payment service providers, we pay a fee to the mobile payment service providers and the amounts attributed to mobile payment service providers are recognized as cost of revenues.

We entered into arrangements with certain content providers, under which we display advertisements in their applications. To the extent we are obligated to share our revenues with such content providers, we recognize the shared revenues as our cost of revenues over the terms of the arrangements. We also entered into exclusive operation agreements with mobile game developers. We share our revenues with the mobile game developers and recognize the shared revenues as cost of revenues.

Our hardware procurement costs include the majority of the cost of revenues incurred by Trustek and Nationsky which operates at a much lower gross margin than our mobile value added services and advertising services. These costs should decrease as we completed the divestiture of NationSky in December 2015, which comprised the majority of the enterprise mobility financial performance historically.

Cost of revenues also includes an allocation of our share-based compensation expenses. See “— Critical Accounting Policies — Share-based compensation.”

 

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Operating Expenses

Our operating expenses consist of (i) selling and marketing expenses, (ii) general and administrative expenses, and (iii) research and development expenses. We expect our operating expenses to continue to increase as our business grows. The following table sets forth the components of our operating expenses by amount and as a percentage of total operating expenses for the periods indicated.

 

     For the Years ended December 31,  
     2013      2014      2015  
     US$      %      US$      %      US$      %  
     (in thousands of dollars, except for percentages)  

Selling and marketing expenses

     25,810         21.5         29,962         16.1         26,752         22.1   

General and administrative expenses

     77,026         64.0         131,001         70.2         65,458         54.0   

Research and development expenses

     17,437         14.5         25,665         13.7         29,020         23.9   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total operation expenses

     120,273         100.0         186,628         100.0         121,230         100.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Selling and Marketing Expenses. Selling and marketing expenses consist primarily of marketing and promotional expenses and salaries, benefits and commissions for our sales and marketing personnel.

General and Administrative Expenses. General and administrative expenses consist primarily of salaries and benefits, including share-based compensation, for our general and administrative personnel. We expect our general and administrative expenses to continue to increase in the future as our business continues to grow and we hire additional executives, officers, and employees and we incur increased costs related to complying with our compliance and reporting obligations under the U.S. securities laws as a public company.

Research and Development Expenses. Research and development expenses consist primarily of salaries and benefits for research and development personnel. We expect our research and development expenses to increase as we intend to hire more research and development personnel to increase performance levels of existing products and services and develop new products and services.

Operating expenses also include an allocation of our share-based compensation charges. See “— Critical Accounting Policies — Share-based compensation.”

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with US GAAP. The preparation of these financial statements requires us to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience 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 those 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 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 believe that our accounting policies with respect to revenue recognition, segment reporting, goodwill, impairment of long-lived assets, allowance for doubtful accounts, share-based compensation, income taxes, equity investments, convertible debts, and mezzanine equity represent critical accounting policies that reflect the more significant judgments and estimates used in the preparation of our consolidated financial statements.

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

 

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Revenue Recognition

We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred and/or service has been performed, the price is fixed or determinable and collection is reasonably assured. Revenue is recorded net of business tax, value added tax and related surcharges.

Revenues presented in the consolidated statements of comprehensive income (loss) include revenues from mobile value added services that are comprised of consumer mobile security, mobile games and live mobile social video platform, advertising services, enterprise mobility and other services.

Mobile Value Added Service Revenues

 

  (i) Consumer mobile security revenues

Consumer mobile security revenues are derived principally from providing premium mobile security and productivity services to end users. The basic functions of security and productivity services, including anti-virus, anti-malware, anti-spam, privacy protection, data backup and recovery are free of charge. The customers are charged for updating the anti-virus database on a pay-per-use basis or paying a fee to subscribe to the premium security and productivity services including continuous update of anti-virus database, continuous update of the semantics of anti-spam, and advanced privacy protection on a monthly, quarterly, semi-annually or annually basis. We recognize revenue for premium services considered to be software-related (e.g., mobile security services) in accordance with industry specific accounting guidance for software and software-related transactions. For premium services where the customer does not take possession of fully-functioning software (e.g., mobile productivity services), we recognize revenue pursuant to ASC 605, Revenue Recognition. Provided collectability is probable, revenue is recognized over the usage period which is the same for software-related services and services where software is incidental to the provision of the services. Basic functions and customer support are provided to end users free of charge, whether they subscribe to our services or not. Customer arrangements may include premium mobile security and productivity services which are multiple elements. Revenue on arrangements that include multiple elements is allocated to each element based on the relative fair value of each element. Fair value is generally determined by vendor-specific-objective-evidence, or VSOE. For all the periods presented, the usage period for the elements in arrangements that include multiple elements is the same. No allocation was performed as there is no impact from the allocation on revenue recognized.

Revenue for pay-per-use services is recognized on a per-use basis when the update is made. Proceeds from sale of subscription services are deferred when received and revenue for the subscription services is recognized on a straight-line basis over the estimated service period provided all revenue recognition criteria have been met.

The payment channels include primarily wireless carriers, service providers, independent distributors of prepaid cards, and third-party payment processors.

 

  (ii) Mobile game revenues

Mobile game revenues are derived principally from game operations for both third-party developed mobile games and self-developed mobile games and game licensing of self-developed mobile games to other third-party game operators.

Mobile game operations. We generate mobile games revenues from operating and publishing mobile games developed by third parties and itself. We enter into exclusive or joint operation agreements with developers for licensed mobile game applications. We distribute the games on Apple’s App Store, Android platforms, FL Mobile’s platforms and other channels (collectively, “Platforms”). Game players can download the free-to-play games and pay to acquire virtual currency which can be redeemed in the game for in-game virtual items.

We sell both consumable and durable virtual goods in games. Consumable goods are items that are used up one-time, while durable goods are items accessible to the user over an extended period of time. We recognize revenue from the sales of consumable goods when the goods are used up. We recognize revenue from the sales of durable goods ratably over the estimated average playing period of paying users.

 

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We estimate the playing periods of paying users based on available data obtained since September 2012. On a quarterly basis, we determine the estimated average playing period for paying players on a game by game basis, beginning at the time of a payer’s first purchase in that game and ending on a date when that paying player is no longer playing the game. We then calculate the average of the time periods from the first purchase date to the date the last player is expected to cease playing the game for each game player to determine the total average playing period for that game.

We determine that a paying player will cease playing a game once the Inactive Period has occurred. We define the Inactive Period as the time period after which if a paying player has not logged onto a game, the possibility that he/she will continue to play the game in the future is very low. To determine the Inactive Period, we regularly analyze the paying players’ activities on our games to determine when the paying players stop playing the games. For the players who have not logged onto a game for 50 days as of the period end, we deem them inactive players. For the players who have not logged onto a game for less than 50 days as of the period end, we deem that they will cease to play the game after 90 days from the last date when they logged onto the game before the period end.

Currently estimated average playing periods of the mobile games are three months, based on current available game player information. We regularly reassess these estimates and may revise such estimates in the future as additional game data becomes available and if and when future data indicates a change in playing patterns or behaviors.

Pursuant to agreements signed between us, game developers and the Platforms, revenues from the sale of game currency to be used for the purchase of virtual items are shared between us, game developers and the Platforms for third-party developed games, based on a pre-agreed ratio for each game.

The determination of whether to record these revenues using gross or net method is based on an assessment of various factors. The primary factors are whether we are acting as the principal in offering services to the game players or as an agent in the transaction, and the specific requirements of each agreement.

For third-party developed games under exclusive operation agreements and self-developed games, we recognize revenue based on the gross amount billed to customers (i.e., inclusive of the amount retained by the Platforms and amounts paid to game developers under revenue-sharing arrangements if any), because we are able to determine pricing for the virtual items sold and are the primary obligor to the customer. The amount paid to Platforms and game developers are recorded as cost of revenue.

For third-party developed games under joint operation agreements, the game developer is considered the primary obligor to the customers and has latitude in establishing price. We account for such sales on a net basis by recognizing the commission it retains from each sale (i.e., revenue net of the amount retained by the Platforms and amounts paid to game developers under revenue-sharing arrangements).

To determine whether Platforms play a role of primary obligor or agents, we has considered ASC 605-45-45 and concluded that Platforms are agents in the sale of in-game virtual items to the customers because it 1) is not responsible for the fulfillment of in-game virtual items and does not take overall responsibility of the services provided to the customers, 2) does not have pricing latitude and only receives a fixed commission, 3) does not have inventory risk, 4) does not change the virtual items sold or determine specifications of the game or the virtual items sold, and 5) does not have credit risk. In the case of self-developed games and third-party developed games under exclusive operation by us, Platforms are our agents. In the case of third-party developed games under joint operation, Platforms are the agents of the game developers.

Mobile game licensing. We license our self-developed games to other third-party game operators and generally receive revenue in forms of initial license fees, non-refundable minimum guarantee, monthly revenue-based fees under revenue-sharing arrangement or a combination. The initial license fee is generally a fixed amount and recognized ratably over the term of the license. The non-refundable minimum guarantee is generally a fixed amount and recognized once the fees are collected. The revenue-based fees under revenue-sharing arrangement are generally equal to a fixed percentage of the revenues generated by the game operators from the sale of virtual items and are recognized when the game operators provide us with the monthly billing confirmation.

 

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  (iii) Live mobile social video platform

We operate live mobile social video communities, including Showself Live Video and Lehai Live Video. The community contains thousands of real time video rooms (“Room”) with user-created content provided by hosts and online users, and broadcasted to the ‘Rooms’ viewers. We are responsible for providing a technological infrastructure to enable the hosts, online users and viewers to interact through live online social video platforms.

All the Rooms can be accessed for free. We mainly derive the revenue from sales of virtual currency which can be used to purchase virtual presents in the Rooms. Our operating entities primarily cooperate with independent third-party distributors to sell our virtual currency through the annual distribution agreements with these distributors. Pursuant to the distribution agreements with these distributors, each distributor is responsible for sales of virtual currency for one or more of our communities through developing and engaging sales agents who directly sell the virtual currency to users.

We have discretion to determine the price of the virtual currency sold to sales agents or users. In addition, we take overall responsibility of the content or performances provided by hosts in our community. Consequently, we recognize revenue on a gross basis pursuant to ASC 605-45.

We also utilize third-party payment collection channels, which charge us the payment handling cost, for users to purchase the virtual currency directly from it. The payment handling costs are recorded in cost of revenues. Upon sales of virtual currency, we typically have an implied obligation to provide the services which enable the virtual currency to be used on our platform. We recognize revenue ratably over the estimated average playing period of paying users.

We estimate the playing periods of paying users based on available data obtained since we launched the platform in April 2014 and another platform in October, 2015. On a quarterly basis, we determine the estimated average playing period for paying players, beginning at the time of a payer’s first purchase on our platform and ending on a date when that paying player is no longer active. We then calculate the average of the time periods from the first purchase date to the date the player is expected to cease playing on our platform to determine the total average playing period. We recognized revenue directly for payment from users, which used for instant consumable virtual good related to Room’s hosts. For payment used for virtual goods that are durable to be consumed and those consumed by end users, the group recognized deferred revenue and amortizes the amount over the estimated average playing period of paying users.

We determine that a paying player has ceased playing on our platform once the player reached an “Inactive Period”. We define the Inactive Period as the length of time after which if a paying player has not logged into the community, the possibility that he/she will continue to play on our platform in the future is very low. To determine the Inactive Period, we regularly analyze paying players’ activities in the community. For the players who have not logged on our platform for 50 days as of the period end, we deem them inactive players. Currently estimated average playing periods are within three months, based on current available paying users’ information. We regularly reassess these estimates and may revise such estimates in the future as additional data becomes available and if and when future data indicates a change in playing patterns or behaviors.

Advertising Revenues

Advertising revenues are derived principally from promotion of third-parties’ applications, games or services over a particular period of time, through a variety of patterns, which are classified into online advertising services and offline advertising services.

 

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  (i) Online advertising revenues

We promote third-parties’ games and applications through NQ security applications, interest-based online community applications and mobile games in a variety of forms including but not limited to offer walls, banners, buttons, text-links and content integration and referrals. Advertising fees are generally charged to advertisers on a CPA basis. The desired actions to be performed include but are not limited to activation, download, click, registration or inquiry, which are determined by the advertisers. The revenues are generally recognized when the end users activate the applications, register accounts or deliver their opt-ins.

We also provide advertising services by embedding the advertisement in applications developed by third-party content providers. We sign agreements with advertisers and content providers separately. The determination of whether to record these revenues using gross or net method is based on an assessment of various factors. The primary factors are whether we are acting as the principal in offering services to advertisers or as an agent in the transaction, and the specific requirements of each agreement. After considering our obligations and risk, latitude in establishing price, determination of service specifications and etc., we conclude that we are the primary obligor in the contracts with advertisers. The fees are charged to advertisers on the cost-per-activation basis. The revenues are recognized by us on a gross basis pursuant to ASC 605-45, without net of payment to content providers which are recognized as costs of revenues.

Moreover, we provide advertisement placements on our websites and interest-based communities. We enter into CPT contracts with advertisers, under which the fixed price and advertising services are established upfront and charged ratably over the contractual period of display.

 

  (ii) Offline pre-installation revenues

We provide with the pre-installation services to promote various applications in mobile phones. The revenues are recognized when the end users activate the applications or could be active users within certain periods, pursuant to the contracts.

Enterprise Mobility Revenues

Enterprise mobility revenues are derived principally from hardware sales to enterprise users, technology and software development for provision of mobility solution, and commission income shared from mobile network operators, all of which are provided on a stand-alone basis in the years of 2014 and 2015.

The revenue from sale of hardware is recognized upon the time of acceptance. Hardware is considered delivered to customers once customers acknowledge the receipt of the hardware delivered and title and risk of loss have been transferred. For most of our hardware sales, these criteria are met at the time customers sign the delivery notes.

We recognize the revenue from technology and software development in connection with provision of mobility solution upon the delivery and acceptance by customers of the standard proprietary software, which involves significant production, modification, or customization. These software arrangements generally include the right to post contract customer support (“PCS”). We recognize the technology and software development revenues immediately after we deliver the software since PCS is assessed insignificant after considering the facts of (i) no additional charges are occurred for PCS; (ii) all PCS were normally for a period of 6 months to 1 year; (iii) the estimated cost for such services is insignificant based on our historical records; and (iv) we did not offer upgrades or enhancements to the software during PCS period and these services are expected to continue to be infrequent. We adopted completed-contract method to account for revenues from technology and software development, given the substantive acceptance terms in arrangements and short duration of development.

Commission income derived from bringing enterprise users to the mobile network operators and is determined based on fixed percentages of actual charges to the enterprise users as agreed with the mobile operators. Commission incomes are recognized in the month in which the service is provided to the enterprise users. For the amount of revenues to be recognized, we firstly estimate the amount of service fee and recognize revenue based on the fixed commission rates as stipulated on the contract that multiply the estimated customer charges. When we later receive the statements of actual charge issued by the mobile network operators, we record a true-up adjustment. Based on the historical experience, there had not been any material adjustments incurred.

 

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Other Service Revenues

Other service revenues are derived primarily from providing technical services and training services. We recognize such revenues when the performance of our obligation is completed.

Segment Reporting

Operating segments are defined as components of an enterprise engaging in business activities about which separate financial information is available that is evaluated regularly by our chief operating decision-maker (“CODM”), Chairman of the Board and Chief Executive Officer, in deciding how to allocate resources and assess performance.

Our organizational structure is based on a number of factors that the CODM uses to evaluate, view and run our company’s business operations, which include, but are not limited to, customer base, homogeneity of products and technology. Our operating segments are based on its organizational structure and information reviewed by our CODM to evaluate the operating segment results.

Before 2012, we principally engaged in consumer mobile security and other services and operated and managed this business as a single segment. In 2012, we expanded our business by the acquisition of NationSky in enterprise mobility services and the acquisition of FL Mobile and its subsidiary, Red, in mobile games and advertising services. In 2013, 2014 and 2015, we enhanced our business in enterprise mobility services and traffic services by a series of acquisitions, and generate revenue from the operations of such businesses. See Note 4 of our financial statements– “Business Combination” for more details.

We have determined that the business segments that constitute its primary reportable segments are consumer and enterprise. The consumer segment primarily consists of mobile value added services, which includes mobile security services, mobile games and live mobile social video platform, advertising services and other services. The enterprise segment mainly consists of technology and software development services and hardware sales aggregated under enterprise mobility revenues.

We generate our revenues from customers in the PRC and overseas. Net revenues from customers in the PRC were US$143.2 million, US$290.0 million and US$368.5 million in 2013, 2014 and 2015, respectively. Net revenues from our overseas customers were US$53.5 million, US$42.3 million and US$38.2 million in 2013, 2014 and 2015, respectively.

Substantially all our long-lived assets are located in the PRC.

Goodwill

Goodwill is the excess of the consideration transferred over the fair value of the acquired assets and assumed liabilities in a business combination.

We test goodwill for impairment at the reporting unit level on an annual basis as of November 1, and between annual tests when an event occurs or circumstances change that indicate that the assets might be impaired. Commencing in September 2011, in accordance with the FASB revised guidance on “Testing of Goodwill for Impairment,” a company first has the option to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we decide, as a result of the qualitative assessment, that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is mandatory. Otherwise, no further testing is required. The quantitative impairment test consists of a two-step goodwill impairment test. The first step compares the fair value of each reporting unit to its carrying amount. If the fair value of each reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and the second step will not be required. If the carrying amount of a reporting unit exceeds its fair value, the second step compares the implied fair value of goodwill to the carrying value of a reporting unit’s goodwill. The implied fair value of goodwill is determined in a manner similar to accounting for a business combination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. This allocation process is only performed for purposes of evaluating goodwill impairment and does not result in an entry to adjust the value of any assets or liabilities. An impairment loss is recognized for any excess in the carrying value of goodwill over the implied fair value of goodwill.

 

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Application of a goodwill impairment test requires significant management judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. The judgment in estimating the fair value of reporting units includes estimating future cash flows, determining appropriate discount rates and making other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit during the impairment test period.

Impairment of Long-Lived Assets

The carrying amounts of long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is evaluated by a comparison of the carrying amount of assets to future undiscounted net cash flows expected to be generated by the assets. Such assets are considered to be impaired if the sum of the expected undiscounted cash flow is less than carrying amount of the assets. The impairment to be recognized is measured by the amount by which the carrying amounts of the assets exceed the fair value of the assets.

Allowance for Doubtful Accounts

An allowance for doubtful accounts is recorded in the period in which a loss is determined to be probable. We review the receivable balances on a periodic basis and make specific allowances based on an assessment of specific evidence indicating doubtful collection, historical experience, account balance aging and prevailing economic conditions. If any of our intermediaries with significant outstanding receivable balances were to become insolvent or unable to make payments in a timely manner, or refuse to pay us, we would have to make further provisions or write off the relevant amounts if the potential for recovery is considered remote.

Share-Based Compensation

We grant options and restricted shares to our selected employees, directors and non-employee consultants. Awards granted to employees with service conditions attached are measured at the grant date fair value and are recognized as an expense using graded vesting method, net of estimated forfeitures, over the requisite service period, which is generally the vesting period. The estimate of forfeitures will be adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of share-based compensation expense to be recognized in future periods.

Awards granted to employees with performance conditions attached are measured at fair value on the grant date and are recognized as compensation expenses in the period and thereafter when the performance goal becomes probable to achieve.

Awards granted to employees with market conditions attached are measured at fair value on the grant date and are recognized as the compensation expenses over the estimated requisite service period, regardless of whether the market condition has been satisfied if the requisite service period is fulfilled.

Awards granted to non-employees are measured at fair value at the earlier of the commitment date or the date the services are completed, and are recognized using graded vesting method over the period the service is provided.

 

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Binomial option-pricing models are adopted to measure the value of awards at each grant date or measurement date. The determination of fair value is affected by the share price as well as assumptions relating to a number of complex and subjective variables, including but not limited to the expected share price volatility, actual and projected employee and non-employee share option exercise behavior, risk-free interest rates and expected dividends. The use of the option-pricing model requires extensive actual employee and non-employee exercise behavior data for the relative probability estimation purpose, and a number of complex assumptions.

Income Tax

Current income tax is provided on the basis of income for financial reporting purpose, adjusted for income and expense items which are not assessable or deductible for income tax purpose, in accordance with the regulations of the relevant tax jurisdictions. Deferred income tax is accounted for using the liability approach which requires the recognition of income tax payable or refundable for the current year and deferred income tax liabilities and assets for the future tax consequences of events that have been recognized in our financial statements or tax returns. Deferred income tax is determined based on the differences between the financial reporting and tax basis of assets and liabilities and is measured using the currently enacted tax rates and laws. The effect on deferred income tax assets and liabilities of a change in income tax rates is recognized in the consolidated statements of comprehensive income in the period when such changes are enacted. A valuation allowance is provided to reduce the carrying amounts of deferred income tax assets if it is considered more likely than not that a portion or all of the deferred income tax assets will not be realized.

We adopt a more likely than not threshold and a two-step approach for the tax position measurement and financial statement recognition. Under the two-step approach, the first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained, including resolution of related appeals or litigation process, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement.

We currently have deferred tax assets resulting from net operating loss carryforwards and deductible temporary differences, all of which are available to reduce future tax payable in our significant tax jurisdictions. The largest component of our deferred tax assets is operating loss carryforwards generated by our PRC subsidiaries and VIE due to their historical operating losses. In assessing whether such deferred tax assets can be realized in the future, we need to make judgments and estimates on the ability of each of our PRC subsidiaries and VIE to generate taxable income in the future years. To the extent that we believe it is more likely than not that some portion or the entire amount of deferred tax assets will not be realized, we established a total valuation allowance to offset the deferred tax assets. As of December 31, 2013, 2014 and 2015, we recognized a valuation allowance of US$4.4 million, US$7.9 million and US$6.9 million against deferred tax assets, respectively. If we subsequently determine that all or a portion of the carryforwards are more like than not to be realized, the valuation allowance will be released, which will result in a tax benefit in our consolidated statements of comprehensive income.

Equity Investments

Our equity investments are comprised of cost method investments and equity method investments.

Cost method investments

In accordance with ASC subtopic 325-20 (“ASC 325-20”), Investments-Other: Cost Method Investments, we carry the investment at cost and only adjusts for other-than-temporary declines in fair value and distributions of earnings. We regularly evaluate the impairment of the cost method investments based on performance and financial position of the investee as well as other evidence of market value. Such evaluation includes, but is not limited to, reviewing the investee’s cash position, recent financing, projected and historical financial performance, cash flow forecasts and financing needs.

 

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Equity method investments

In accordance with ASC subtopic 323-10 (“ASC 323-10”), Investments-Equity Method and Joint Ventures: Overall. Under the equity method, we initially record our investment at cost and the difference between the cost of the equity investee and the amount of the underlying equity in the net assets of the equity investee is recognized as equity method goodwill, which is included in the equity method investment on the consolidated balance sheets. We subsequently adjust the carrying amount of the investment to recognize our proportionate share of each equity investee’s net income or loss into consolidated statements of comprehensive income after the date of investment. We will discontinue applying the equity method if an investment (and additional financial supports to the investee, if any) has been reduced to zero.

Sales of equity interests of an investee by us is accounted for as gains or losses equal to the difference at the time of sale between selling price and carrying amount of the equity interests sold.

Impairment for equity investments

We assess our equity investments for other-than-temporary impairment by considering factors including, but not limited to, current economic and market conditions, operating performance of the companies, including current earnings trends and undiscounted cash flows, and other company-specific information. The fair value determination, particularly for investments in privately-held companies, requires significant judgment to determine appropriate estimates and assumptions. Changes in these estimates and assumptions could affect the calculation of the fair value of the investments and determination of whether any identified impairment is other-than-temporary. Other-than-temporary impairment loss is recognized in the consolidated statements of comprehensive income equal to the excess of the investment’s carrying value over its fair value at the balance sheet date of the reporting period for which the assessment is made. The fair value would then become the new cost basis of such investment.

Convertible Debts

In accordance with ASC subtopic 470-20, the convertible debts are initially carried at the principal amount of the convertible debts. Related debts issuance cost, are subsequently amortized using effective interest method as adjustments to interest expense from the debt issuance date to its first redemption date. Convertible debts are classified as a current liability if they are or will be callable by us or puttable by the debt holders within one year from the balance sheet date, even though liquidation may not be expected within that period.

Mezzanine Equity

Mezzanine Equity consists of non-controlling interests in FL Mobile Inc. and a put option pursuant to which the non-controlling shareholders will have the right to put their equity interests in FL Mobile Inc. to us at a pre-determined price if FL Mobile Inc. does not complete a qualified listing. The put option will expire within three months after the first anniversary of the closing date. Since the occurrence of the put is not solely within the control of our company, we classify the non-controlling interest as mezzanine equity instead of permanent equity in our consolidated financial statements.

In accordance with ASC subtopic 480-10, we calculate, on an accumulative basis from the acquisition date, (i) the amount of accretion that would increase the balance of non-controlling interest to its estimated redemption value over the period from the date of the issuance to the earliest redemption date of the non-controlling interest and (ii) the amount of net profit attributable to non-controlling shareholders of FL Mobile Inc. based on their ownership percentage. The carrying value of the non-controlling interest as mezzanine equity will be adjusted by an accumulative amount equal to the higher of (i) and (ii).

 

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Results of Operations

The following table sets forth a summary of our consolidated results of operations as a percentage of net revenue for the periods indicated. This information should be read together with our consolidated financial statements and related notes included elsewhere in this annual report. The results of operations in any period are not necessarily indicative of the results that may be expected for any future period.

 

     For the Years ended December 31,  
     2013     2014     2015  
     US$     %     US$     %     US$     %  
     (in thousands of dollars, except for percentages)  

Net Revenues(1)

            

Service Revenues (1)

            

Mobile value added services

     103,519        52.6        106,103        31.9        139,588        34.3   

Advertising services

     36,623        18.6        72,903        21.9        71,721        17.6   

Enterprise mobility

     14,174        7.2        16,035        4.9        27,416        6.8   

Other services

     3,559        1.8        4,641        1.4        5,352        1.3   

Product Revenues

            

Enterprise mobility

     38,827        19.8        132,642        39.9        162,614        40.0   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenues

     196,702        100.0        332,324        100.0        406,691        100.0   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenues

            

Cost of services

     (43,557     (22.1     (98,235     (29.6     (158,446     (39.0

Cost of products sold

     (37,371     (19.0     (128,416     (38.6     (160,906     (39.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenues (2)

     (80,928     (41.1     (226,651     (68.2     (319,352     (78.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     115,774        58.9        105,673        31.8        87,339        21.5   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

            

Selling and marketing expenses (2)

     (25,810     (13.1     (29,962     (9.0     (26,752     (6.6

General and administrative expenses (2)

     (77,026     (39.2     (131,001     (39.4     (65,458     (16.1

Research and development expenses (2)

     (17,437     (8.9     (25,665     (7.8     (29,020     (7.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     (120,273     (61.1     (186,628     (56.2     (121,230     (29.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income/(Loss) from operations

     (4,499     (2.3     (80,955     (24.4     (33,891     (8.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income/(expense), net

     411        0.2        (5,360     (1.6     (4,662     (1.1

Realized gain on available-for-sale investments

     5        0.0        65        0.0        1,435        0.4   

Realized gain on disposal of a subsidiary

     —          —          —          —          56,211        13.8   

Impairment loss

     —          —          (5,967     (1.8     (15,452     (3.8

Foreign exchange gain/(loss), net

     1,784        0.9        (391     (0.1     (1,693     (0.4

Gain on change of interest in an associate

     —         —          —          —          —          —     

Other income, net

     2,083        1.1        19,514        5.9        6,778        1.7   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income/(Loss) before income taxes

     (216     (0.1     (73,094     (22.0     8,726        2.1   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income tax expense

     (1,117     (0.6     (5,518     (1.7     (9,243     (2.3

Share of profit from an associate

     —          —          —          —          —          —     

Net income/(loss)

     (1,333     (0.7     (78,612     (23.7     (517     (0.1

 

(1) Due to the expansion of our business and diversification of our revenue streams, we re-classified our revenues into the following categories in 2013: mobile value added services (including consumer mobile security mobile games and live mobile social video platform), enterprise mobility, advertising services and other services. As a result, we re-classified in the above table, within this annual report, the presentation of the revenue categories for the years ended December 31, 2013, 2014 and 2015 in conformity with these new revenue categories.

 

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(2) Share-based compensation expense included in:

 

     For the Years ended December 31,  
     2013      2014      2015  
     US$      %      US$      %      US$     %  
     (in thousands of dollars, except for percentages)  

Cost of revenues

     370         0.2         263         0.1         164        0.0   

Selling and marketing expenses

     2,310         1.2         1,430         0.4         683        0.2   

General and administrative expenses

     50,708         25.8         81,129         24.4         16,077        4.0   

Research and development expenses

     2,016         1.0         1,022         0.3         (366     (0.1

Year Ended December 31, 2015 Compared to Year Ended December 31, 2014

Net Revenues Our total net revenues increased by 22.4% from US$332.3 million in 2014 to US$406.7 million in 2015, primarily due to the increase in net revenues from growth in our enterprise mobility products and services segment as well as growth in our mobile valued added services segment.

 

    Net revenues from mobile value added services, which included mobile game publishing revenues, revenues from live mobile social video platforms, and consumer mobile security and productivity revenues, increased by 31.6% from US$106.1 million in 2014 to US$139.6 million in 2015. This increase was primarily the result of the growth in mobile gaming revenues and live mobile social video platform revenues. The growth in mobile game revenues was driven by the continued expansion of FL Mobile’s business in both domestic and overseas markets. The strong growth in our live mobile social video platform revenues was due to the strong growth at our Showself platforms.

 

    Net revenues from advertising services decreased by 1.6% from US$72.9 million in 2014 to US$71.7 million in 2015, primarily due to slower smartphone sales and shipments which impacted our advertising network revenues for the fiscal year.

 

    Net revenues from enterprise mobility products and services increased by 27.8% from US$148.7 million in 2014 to US$190.0 million in 2015, which included net revenues from enterprise mobility products of US$162.6 million, and net revenues from enterprise mobility services of US$27.4 million primarily due to the strong growth of NationSky and Trustek.

 

    Net revenues from other services increased by 15.3% from US$4.6 million in 2014 to US$5.4 million in 2015. Revenues from other services are generated primarily by providing technical services to third parties. As this business is driven by individual projects, revenues from other services fluctuate considerably from period to period.

 

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Cost of Revenues Our total cost of revenues increased by 40.9% from US$226.7 million in 2014 to US$319.4 million in 2015. This increase was primarily due to: (i) an increase in hardware procurement costs (ii) an increase in user acquisition cost and (iii) an increase in revenue sharing costs incurred mainly for our mobile game business and live mobile social video platform business.

Gross Profit and Margin As a result of the foregoing, our gross profit decreased by 17.3% from US$105.7 million in 2014 to US$87.3 million in 2015. Our gross margin decreased from 31.8% in 2014 to 21.5% in 2015. This decrease was primarily due to the impact from the enterprise mobility business, which has much lower gross margin than other portions of our business. The other primary reason for the decline in gross profit and gross margin is the free charge of mobile security services in domestic markets and higher customer acquisition costs and revenue sharing costs, incurred mainly for our mobile game business and live mobile social video platform business.

Operating Expenses Our total operating expenses decreased by 35% from US$186.6 million in 2014 to US$121.2 million in 2015.

Selling and Marketing Expenses. Our selling and marketing expenses decreased by 10.7% from US$30.0 million in 2014 to US$26.8 million in 2015. This decrease was primarily due to the decrease in promotional activities within our consumer mobile security businesses and a reduction in expenditiures within the consumer mobile security businesses. Due to the fact that the Company has been moving its focus away from premium mobile security services. The selling and marketing expenses related to our enterprise business were US$7.1 million in 2015, increased from US$4.7 million in 2014. The increase was mainly due to the increase in staff costs, traveling and other expenses.

General and Administrative Expenses. Our general and administrative expenses decreased by 50.0% from US$131.0 million in 2014 to US$65.5 million in 2015. The decrease was primarily due to lower share based compensation expenses due to less performance-based share options granted in relation to the Company’s acquisitions in 2015 compared with that in 2014.

Research and Development Expenses. Our research and development expenses increased by 13.1% from US$25.7 million in 2014 to US$29.0 million in 2015. This increase was primarily due to the hiring of more research and development personnel, which led to the increase in staff costs.

Loss from Operations. As a result of the foregoing, we had a loss from operations of US$33.9 million in 2015, compared to a loss from operations of US$81.0 million in 2014.

Income Tax Expense. Our income tax expense increased by 67.3% from US$5.5 million in 2014 to US$9.2 million in 2015. The increase was primarily due to the increased tax liability associated with the gain from the disposal of the NationSky business.

Net loss attributable to NQ Mobile Inc. As a result of the foregoing, we had a net loss of US$1.3 million in 2015, compared to a net loss of US$76.7 million in 2014.

Year Ended December 31, 2014 Compared to Year Ended December 31, 2013

Net Revenues Our total net revenues increased by 68.9% from US$196.7 million in 2013 to US$332.3 million in 2014, primarily due to the increase in net revenues from mobile valued added services and, to a lesser extent, to an increase in net revenues from enterprise mobility products and services and advertising services.

Net revenues from mobile value added services, which included consumer mobile security revenues mobile games revenues, and revenues from live mobile social video platform, increased by 2.5% from US$103.5 million in 2013 to US$106.1 million in 2014. This increase was primarily due to the growth of our premium services in the areas of mobile games and live mobile social video platform. The consolidation of mobile games revenue from FL Mobile after its acquisition in November 2012 also contributed to the increase in net revenues from mobile value added services in 2013.

 

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Net revenues from advertising services increased by 99.1% from US$36.6 million in 2013 to US$72.9 million in 2014, primarily due to increased monetization through advertising and promotional revenue in the form of third party application referrals through our mobile security services, mobile games, advertising network platforms and offline channels.

Net revenues from enterprise mobility products and services increased by 180.5% from US$53.0 million in 2013 to US$148.7 million in 2014, which included net revenues from enterprise mobility products of US$132.6 million, and net revenues from enterprise mobility services of US$16.1 million primarily due to the increase in the number of our enterprise customers acquired through NationSky and Trustek.

Net revenues from other services increased by 30.4% from US$3.6 million in 2013 to US$4.6 million in 2014. Revenues from other services are generated primarily by providing technical services to third parties. As this business is driven by individual projects, revenues from other services fluctuate considerably from period to period.

Cost of Revenues Our total cost of revenues increased by 180.1% from US$80.9 million in 2013 to US$226.7 million in 2014. This increase was primarily due to: (i) an increase in hardware procurement costs from US$37.4 million in 2013 to US$128.5 million in 2014 following our acquisitions of NationSky in May 2012 and Trustek in January 2014; (ii) an increase in user acquisition cost from US$19.7 million in 2013 to US$26.8 million in 2014, primarily as payments to handset manufacturers and distributors for pre-installation and to third-party websites increased as we acquired more registered user accounts and active user accounts through these channels; (iii) amortization of intangible assets resulted from the acquisition activities; and (iv) an increase in staff cost from US$5.3 million in 2013 to US$11.7 million in 2014, mainly in the form of increased salary and headcount as our overall business continues to expand. Our cost of services increased by 125.5% from US$43.6 million in 2013 to US$98.2 million in 2014. Our cost of products sold increased by 243.6% from US$37.4 million in 2013 to US$128.5 million in 2014. Our cost of products sold is primarily due to hardware procurement cost for NationSky and Trustek’s enterprise mobility business.

Gross Profit and Margin As a result of the foregoing, our gross profit decreased by 8.7% from US$115.8 million in 2013 to US$105.7 million in 2014. Our gross margin decreased from 58.9% in 2013 to 31.8% in 2014. This decrease was primarily due to the impact from the enterprise mobility business, which has much lower gross margin than other portions of our business. Excluding the impact from the enterprise mobility business, our gross profit in 2014 was US$91.5 million, representing a 10.6% decreased from US$102.3 million in 2013. The gross margin of the enterprise mobility business in 2014 was 9.5%. Our gross margin excluding the enterprise mobility business was 49.9% in 2014.

Operating Expenses Our total operating expenses increased by 55.2% from US$120.3 million in 2013 to US$186.6 million in 2014.

Selling and Marketing Expenses. Our selling and marketing expenses increased by 16.1% from US$25.8 million in 2013 to US$30.0 million in 2014. This increase was primarily due to (i) an increase in travelling and entertainment spending from US$1.5 million in 2013 to US$2.6 million in 2014, due to business expansion; and (ii) an increase in staff costs, including salaries, benefits and commissions to our sales and marketing personnel, from US$6.9 million in 2013 to US$11.5 million in 2014, as a result of the increased employee headcount resulting from our acquisition activities. The selling and marketing expenses related to our enterprise business were US$4.7 million in 2014, increased from US$2.7 million in 2013. The increase was mainly due to the increase in staff costs, traveling and other expenses.

General and Administrative Expenses. Our general and administrative expenses increased by 70.1% from US$77.0 million in 2013 to US$131.0 million in 2014. The increase was primarily due to (i) a significant increase in share-based compensation expenses for our general and administrative personnel from US$50.7 million in 2013 to US$81.1 million in 2014, primarily attributable to the grant of restricted shares in connection with our acquisition activities and to our senior executives and employees in 2014; (ii) an increase in staff cost from US$8.2 million in 2013 to US$14.7 million in 2014, resulting mostly from salary increases and the hiring of additional senior executives; and (iii) an increase in legal and professional fees from US$7.2 million in 2013 to US$14.0 million in 2014, largely in connection with our acquisition activities and our reactions to the short seller allegations. The general and administrative expenses related to our enterprise business were US$4.5 million in 2014, increased from US$2.0 million in 2013. The increase was mainly due to the increase in staff costs and other expenses.

 

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Research and Development Expenses. Our research and development expenses increased by 47.2% from US$17.4 million in 2013 to US$25.7 million in 2014. This increase was primarily due to the hiring of more research and development personnel, which led to (i) an increase in staff cost from US$11.7 million in 2013 to US$17.3 million in 2014; and (ii) an increase in joint R&D from US$0.3 million in 2013 to US$2.7 million in 2014. The research and development expenses related to our enterprise business were US$7.8 million in 2014, increased from US$2.4 million in 2013. The increase was mainly due to the increase in staff costs.

Loss from Operations. As a result of the foregoing, we had a loss from operations of US$81.0 million in 2014, compared to a loss from operations of US$4.5 million in 2013.

Income Tax Expense. Our income tax expense increased by 394.0% from US$1.1 million in 2013 to US$5.5 million in 2014. The increase was primarily due to the increase in the income of our subsidiaries and consolidated affiliated entities in the PRC, offset by the tax benefits from our deferred tax assets.

Net loss attributable to NQ Mobile Inc. As a result of the foregoing, we had a net loss of US$76.7 million in 2014, compared to a net income of US$1.9 million in 2013.

Discussion of Segment Operations

In our management’s view, we operate through two operating segments: consumer and enterprise. Both are reportable segments.

Net revenues from our consumer segment accounted for 53.3% of our total net revenues in the year ended December 31, 2015. Net revenues from our enterprise segment accounted for 46.7% of our total net revenues in the year ended December 31, 2015. We recognize revenues from consumer mobile security services as we deliver the services and revenues from consumer mobile games when the game players consume the virtual items. We recognize revenues from enterprise mobility products when users acknowledge the receipt of the hardware and software delivered and title and risk of loss have been transferred to the users.

Cost of revenues for our consumer segment primarily consists of user acquisition costs, payments to mobile payment service providers, revenues shared with third-party content providers and related staff cost. Cost of revenues for our enterprise segment primarily consists of hardware procurement cost for our enterprise mobility business and related staff cost.

Operating expenses for our consumer segment primarily consist of expenses for selling and marketing activities for our mobile value added services and advertising services, general and administrative expenses for the compensation and benefits of administrative staff of consumer segment and professional and consulting fees, and expenses for research and development of related technologies. Operating expenses for our enterprise segment primarily consist of expenses for selling and marketing activities for our mobile enterprise services, general and administrative expenses for compensation and benefits of administrative staff of enterprise segment, communication expense and depreciation and amortization of property and equipment used in the general and administrative activities of our enterprise segment, and expenses for research and development of related technologies.

 

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The following tables list our net income by reportable segments for the years ended December 31, 2015, 2014 and 2013.

 

     For the Year ended December 31, 2015  
     Consumer      Enterprise      Consolidated  
     (in thousands of US$)  

Net Revenues

        

Service revenues

        

Mobile value added services

     139,588         —           139,588   

Advertising services

     71,721         —           71,721   

Enterprise mobility

     —           27,416         27,416   

Other services

     5,352         —           5,352   

Product revenues

        

Enterprise mobility

     —           162,614         162,614   
  

 

 

    

 

 

    

 

 

 

Total Net Revenues

     216,661         190,030         406,691   
  

 

 

    

 

 

    

 

 

 

Cost of revenues

     (147,544      (171,808      (319,352
  

 

 

    

 

 

    

 

 

 

Gross profit

     69,117         18,222         87,339   
  

 

 

    

 

 

    

 

 

 

Operating expenses

        

Sales and marketing expenses

     (19,698      (7,054      (26,752

General and administrative expenses

     (60,843      (4,615      (65,458

Research and development expenses

     (16,031      (12,989      (29,020
  

 

 

    

 

 

    

 

 

 

Total operating expenses

     (96,572      (24,658      (121,230
  

 

 

    

 

 

    

 

 

 

Loss from operations

     (27,455      (6,436      (33,891
  

 

 

    

 

 

    

 

 

 

Interest income/(expense), net

     (4,001      (661      (4,662

Realized gain on disposal of a subsidiary

     56,211         —           56,211   

Realized gain on available-for-sale investments

     1,435         —           1,435   

Impairment loss

     (12,913      (2,539      (15,452

Foreign currency exchange gain/(loss), net

     (1,693      —           (1,693

Other income/(expense), net

     3,776         3,002         6,778   

Profit/(loss) before income taxes

     15,360         (6,634      8,726   
  

 

 

    

 

 

    

 

 

 

Income tax expense

     (9,072      (171      (9,243
  

 

 

    

 

 

    

 

 

 

Net income/(loss)

     6,288         (6,805      (517
  

 

 

    

 

 

    

 

 

 

 

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     For the Year ended December 31, 2014  
     Consumer      Enterprise      Consolidated  
     (in thousands of US$)  

Net Revenues

        

Service revenues

        

Mobile value added services

     106,103         —          106,103   

Advertising services

     72,903         —          72,903   

Enterprise mobility

     —          16,035         16,035   

Other services

     4,641         —          4,641   

Product revenues

        

Enterprise mobility

     —          132,642         132,642   
  

 

 

    

 

 

    

 

 

 

Total Net Revenues

     183,647         148,677         332,324   
  

 

 

    

 

 

    

 

 

 

Cost of revenues

     (92,172      (134,479      (226,651
  

 

 

    

 

 

    

 

 

 

Gross profit

     91,475         14,198         105,673   
  

 

 

    

 

 

    

 

 

 

Operating expenses

        

Selling and marketing expenses

     (25,307      (4,655      (29,962

General and administrative expenses

     (126,491      (4,510      (131,001

Research and development expenses

     (17,905      (7,760      (25,665
  

 

 

    

 

 

    

 

 

 

Total operating expenses

     (169,703      (16,925      (186,628
  

 

 

    

 

 

    

 

 

 

(Loss) from operations

     (78,228      (2,727      (80,955
  

 

 

    

 

 

    

 

 

 

Interest (expense)/income

     (5,382      22         (5,360

Realized gain on available-for-sale investments

     65         —          65   

Investment impairment

     (5,967      —          (5,967

Foreign currency exchange (loss)/gain, net

     (391      —          (391

Other income/(expense), net

     18,389         1,125         19,514   
  

 

 

    

 

 

    

 

 

 

(Loss)/Income before income taxes

     (71,514      (1,580      (73,094
  

 

 

    

 

 

    

 

 

 

Income tax (expense)/benefit

     (5,766      248         (5,518
  

 

 

    

 

 

    

 

 

 

Net loss

     (77,280      (1,332      (78,612
  

 

 

    

 

 

    

 

 

 

 

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     For the Year ended December 31, 2013  
     Consumer      Enterprise      Consolidated  
     (in thousands of US$)  

Net Revenues

        

Service revenues

        

Mobile value added services

     103,519         —          103,519   

Advertising services

     36,623         —          36,623   

Enterprise mobility

     —          14,174         14,174   

Other services

     3,559         —          3,559   

Product revenues

        

Enterprise mobility

     —           38,827         38,827   
  

 

 

    

 

 

    

 

 

 

Total Net Revenues

     143,701         53,001         196,702   
  

 

 

    

 

 

    

 

 

 

Cost of revenues

     (41,430      (39,498      (80,928
  

 

 

    

 

 

    

 

 

 

Gross profit

     102,271         13,503         115,774   
  

 

 

    

 

 

    

 

 

 

Operating expenses

        

Sales and marketing expenses

     (23,143      (2,667      (25,810

General and administrative expenses

     (74,966      (2,060      (77,026

Research and development expenses

     (15,063      (2,374      (17,437
  

 

 

    

 

 

    

 

 

 

Total operating expenses

     (113,172      (7,101      (120,273
  

 

 

    

 

 

    

 

 

 

(Loss)/Income from operations

     (10,901      6,402         (4,499
  

 

 

    

 

 

    

 

 

 

Interest income

     393         18         411   

Realized gain on available-for-sale investments

     5         —          5   

Foreign currency exchange gain/(loss), net

     1,784         —          1,784   

Other income/(expense), net

     2,073         10         2,083   
  

 

 

    

 

 

    

 

 

 

(Loss)/Income before income taxes

     (6,646      6,430         (216
  

 

 

    

 

 

    

 

 

 

Income tax expense

     (555      (562      (1,117
  

 

 

    

 

 

    

 

 

 

Net (loss)/income

     (7,201      5,868         (1,333
  

 

 

    

 

 

    

 

 

 

 

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Inflation

Since our inception, inflation in China has not materially impacted our results of operations. According to the National Bureau of Statistics of China, the year-over-year percent changes in the consumer price index for December 2013, 2014 and 2015 were increases of 2.5% and 1.5% and 3%, respectively. Although we have not been materially affected by inflation in the past, we may be materially affected if China experiences higher rates of inflation in the future.

Recent Accounting Pronouncements

In May 2014, the FASB issued Topic 606, “Revenue from Contracts with Customers”. This topic clarifies the principles for recognizing revenue and develops a common revenue standard for U.S. GAAP and IFRS. Simultaneously, this topic supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the Codification. The core principle of the guidance requires an entity 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. To achieve that core principle, an entity should apply the five steps: 1) identify the contract(s) 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; 5) recognize revenue when (or as) the entity satisfies a performance obligation. The amendments are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. This amendments shall be applied retrospectively either to each prior reporting periods or with the cumulative effect of initially applying this amendments recognized at the date of initial application. In August of 2015, the FASB issued Accounting Standards Update (“ASU”) 2015-14, Revenue from Contracts with Customer (Topic 606): Deferral of the Effective Date. This ASU was fairly straight forward and simple as it defers the effective date of ASU 2014-09, Revenue from Contracts with Customers, for all entities. With the issuance of ASU 2015-14, public business entities should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Group is in process of evaluating the cumulative effect on the consolidated financial statements of adopting this guidance so as to transit to the new revenue recognition guidance in 2018.

In June 2014, the FASB issued guidance on “Stock Compensation – Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period”. The amendments clarify that a performance target that affects vesting and that could be achieved after the requisite service period should be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. No matter when the performance target becomes probable of being achieved, the compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The amendments are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The Group had evaluated that there is no impact on the consolidated financial statements of adopting this guidance.

In April 2015, the FASB issued Accounting Standards Update (ASU) No. 2015-03, Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. It requires companies to present debt issuance costs the same way they currently present debt discounts, as a direct deduction from the carrying value of that debt liability. ASU 2015-03 does not impact the recognition and measurement guidance for debt issuance costs. For public businesses, ASU No. 2015-03 will be effective for fiscal years starting after December 15, 2015, including any interim periods within those years. Early adoption of ASU No. 2015-03 will be allowed for financial statements that have yet to be issued. The amendments of ASU No. 2015-03 must be applied retrospectively, where the balance sheet of each presented individual period is adjusted to indicate the period-specific impact of using the new guidance. During the transition phase, a business must adhere to the appropriate disclosures for an adjustment in an accounting principle. Such disclosures include why the change in accounting principle is occurring, the method of transition, a explanation of the previous period’s information that was retrospectively adjusted, and how the change impacts the financial statement line items (i.e., debt issuance cost asset and the debt liability).The Group had evaluated that there is no impact on the consolidated financial statements of adopting this guidance.

In July 2015, the FASB issued No. ASU No. 2015-11, Simplifying the Measurement of Inventory. This ASU changes the measurement principle for inventories valued under the FIFO or weighted-average methods from the lower of cost or market to the lower of cost and net realizable value. Net realizable value is defined by the FASB as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. This ASU does not change the measurement principles for inventories valued under the LIFO method. The amendments in this Update are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Group is in process of evaluating the cumulative effect on the consolidated financial statements of adopting this guidance so as to transit to the new guidance in the year of 2017.

 

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In September 2015, the FASB issued ASU No. 2015-16, Simplifying the Accounting for Measurement-Period Adjustments, which eliminates the requirement for acquirers in a business combination to account for measurement-period adjustments retrospectively. Instead, acquirers must recognize measurement-period adjustments during the period in which they determine the amounts, including the effect on earnings of any amounts that would have been recorded in previous periods if the accounting had been completed at the acquisition date. This update is effective for interim and annual periods beginning after December 15, 2015, with early adoption permitted. The implementation of this update is not expected to have any material impact on the Group’s consolidated financial statements.

In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. The update eliminates the requirement to classify deferred tax assets and liabilities as noncurrent or current within a classified statement of financial position. Current guidance requires entities to classify deferred taxes as noncurrent or current. Under ASU 2015-17, a reporting entity is required to classify deferred tax assets and liabilities as noncurrent in a classified statement of financial position. Current guidance requiring the offsetting of deferred tax assets and liabilities of a tax-paying component of an entity and presentation as a single noncurrent amount is not affected. The amendment applies to all entities that present a classified statement of financial position. The update is effective for public business entities issuing financial statements for the annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early application is permitted for financial statements as of the beginning of an interim or annual reporting period. Entities may apply the update prospectively to all deferred tax assets and liabilities and taxes, or retrospectively for all periods presented. If an entity applies the update prospectively, the entity shall disclose the nature and reason of the change in accounting principle and disclose that the prior periods were not retrospectively adjusted. If an entity adopts the update retrospectively, the entity shall disclose the nature and reason of the change in accounting principle and disclose the quantitative effects of the accounting change on prior periods. The Group had evaluated that there is no impact on the consolidated financial statements of adopting this guidance.

The FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-01 requires that a lessee recognize the assets and liabilities that arise from operating leases. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (i.e., January 1, 2019, for a calendar year entity). Early application is permitted for all public business entities and all nonpublic business entities upon issuance. The Group is in process of evaluating the cumulative effect on the consolidated financial statements of adopting this guidance so as to transit to the new revenue recognition guidance in 2019.

 

B. Liquidity and Capital Resources

To date, we have financed our operations primarily through private placements of preferred shares to investors, the proceeds of our initial public offering in May 2011, the proceeds of our convertible senior notes offering in October 2013, proceeds from our occasional divestment of subsidiary business and cash generated from operations. Except as disclosed in this annual report, we have no outstanding bank loans or financial guarantees or similar commitments to guarantee the payment obligations of third parties. We believe that our current cash and cash equivalents and our anticipated cash flows from operations will be sufficient to meet our anticipated working capital requirements and capital expenditures needs for the next 12 months.

In October 2013, we issued US$172.5 million in aggregate principle amount of 4.00% Convertible Senior Notes due October 15, 2018 (the “Notes”) at par. The Notes may be converted, under certain circumstances, based on an initial conversion rate of 39.0472 American depository shares (“ADSs”) per US$1,000 principal amount of the Notes (which represents an initial conversion price of US$25.61 per ADS).

In November 2015, we entered into an agreement with a former member of management of NationSky and an independent third party company to divest all of the equity interests of NationSky for a total cash consideration of RMB510 million. On December 30, 2015, we closed this transaction and received all the consideration.

As of December 31, 2015, we had US$118.6 million in cash and cash equivalents, and US$134.1 million in term deposits. Cash and cash equivalents represent cash on hand, demand deposits and other short-term highly liquid investments placed with banks that have original maturities of three months or less and are readily convertible to known amounts of cash. Term deposits are bank deposits with maturity terms of four to twelve months, which expect no risk of principal loss.

 

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

 

     For the Year ended December 31,  
     2013      2014      2015  
     (in thousands of dollars)  

Net cash provided by (used in) operating activities

     24,274         6,211         (11,970

Net cash used in investing activities

     (41,450      (21,017      (19,110

Net cash provided by/(used in) financing activities

     176,751         (13,306      1,427   

Effect of exchange rate changes on cash and cash equivalents

     1,281         1,378         (4,759
  

 

 

    

 

 

    

 

 

 

Net increase/(decrease) in cash and cash equivalents

     160,856         (26,734      (34,412

Cash and cash equivalents at the beginning of the year

     18,862         179,718         152,984   
  

 

 

    

 

 

    

 

 

 

Cash and cash equivalents at the end of the year

     179,718         152,984         118,572   
  

 

 

    

 

 

    

 

 

 

Current PRC regulations permit our subsidiary to pay dividends to us only out of its accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. Under PRC law, each of our wholly owned PRC subsidiaries and consolidated affiliated entities is required to set aside at least 10% of its after-tax profits each year, if any, to fund a statutory reserve until such reserve reaches 50% of each of their respective registered capital. Although the statutory reserves can be used, among other ways, to increase the registered capital and offset future losses in excess of retained earnings of the respective companies, the reserve funds are not distributable as cash dividends except in the event of liquidation. As a result of these PRC laws and regulations, our PRC subsidiaries and consolidated affiliated entities are restricted in their abilities to transfer net assets to us in the form of dividends, loans or advances. Total restricted net assets of our PRC subsidiaries and consolidated affiliated entities were US$79.0 million, US$93.5 million and US$89.6 million as of December 31, 2013, 2014 and 2015, respectively. Furthermore, cash transfers from our PRC subsidiaries to our subsidiaries outside of China are subject to PRC government control of currency conversion. Restrictions on the availability of foreign currency may affect the ability of our PRC subsidiaries and consolidated affiliated entities to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency denominated obligations. See “Item 3. Key Information — D. Risk Factors — Risks Related to Our Corporate Structure — We may rely principally on dividends and other distributions on equity paid by our PRC and HK subsidiaries to fund any cash and financing requirements we may have. Any limitation on the ability of our PRC and HK subsidiaries to pay dividends to us could have a material adverse effect on our ability to conduct our business” and “Risk Factors — Risks Related to Doing Business in China — Governmental control of currency conversion may limit our ability to utilize our revenues effectively and affect the value of your investment.”

According to the exclusive technical consulting services agreement between Beijing Technology and NQ Beijing, Beijing Technology pays to NQ Beijing quarterly service fees, the amount of which is determined unilaterally by NQ Beijing. The cash held by Beijing Technology and its subsidiaries can be transferred to NQ Beijing through this method.

Cash held by our PRC subsidiaries, within China can be transferred to their respective shareholders outside of China through dividend payments. Such transfer will incur cost in the form of PRC withholding tax of 10%, as disclosed in this annual report under “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China—Our global income and the dividends that we may receive from our PRC subsidiaries may be subject to PRC taxes under the PRC Enterprise Income Tax Law which would have a material adverse effect on our results of operations.”

 

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The following table sets forth a breakdown of our cash and cash equivalents located inside and outside the PRC, respectively, for the periods indicated:

 

     As of December 31,  
     2013      2014      2015  
     (in thousands of dollars)  

Cash and cash equivalents located outside of the PRC

     158,980         22,074         4,701   

Cash and cash equivalents located inside the PRC

     20,738         130,910         113,871   

Beijing Technology and its subsidiaries

     11,579         8,013         64,480   

Other entities consolidated by us

     9,159         122,897         49,391   
  

 

 

    

 

 

    

 

 

 

Cash and cash equivalents

     179,718         152,984         118,572   
  

 

 

    

 

 

    

 

 

 

The following table sets forth a breakdown of our term deposits located inside and outside the PRC, respectively, for the periods indicated:

 

     As of December 31,  
     2013      2014      2015  
     (in thousands of dollars)  

Term deposits located outside of the PRC

     —          —          —     

Term deposits located inside the PRC

     103,331         116,284         134,055   

Beijing Technology and its subsidiaries

     70,528         68,891         63,139   

Other entities consolidated by us

     32,803         47,393         70,916   
  

 

 

    

 

 

    

 

 

 

Term deposits

     103,331         116,284         134,055   
  

 

 

    

 

 

    

 

 

 

As an offshore holding company, we are permitted, under PRC laws and regulations, to provide funding from the proceeds of our overseas fund raising activities to our PRC subsidiaries only through loans or capital contributions, and to our PRC consolidated affiliated entities only through loans, subject to the satisfaction of the applicable government registration and approval requirements. As a result, uncertainties exist as to our ability to provide prompt financial support to our PRC subsidiaries or consolidated affiliated entities when needed. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Corporate Structure—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 making loans to our PRC subsidiaries and consolidated affiliated entities or making additional capital contributions to our PRC subsidiaries, which may materially and adversely affect our liquidity and our ability to fund and expand our business.” Notwithstanding the foregoing, our wholly-owned subsidiaries may use their own retained earnings to provide financial support to our consolidated affiliated entities in the PRC either through extended payment terms on amounts due to NQ Beijing from our consolidated affiliated entities, or via entrusted loans from our subsidiaries to consolidated affiliated entities, or direct loans to the nominee shareholders of consolidated affiliated entities, which would be contributed to the consolidated affiliated entities as capital injection.

Operating Activities

Net cash provided by or used in operating activities consisted primarily of our net income/loss adjusted by non-cash adjustments, such as share-based compensation charges, and adjusted by changes in operating assets and liabilities, such as accounts receivable.

Net cash used in operating activities amounted to US$12.0 million in 2015, as compared to US$6.2 million net cash provided by operating activities in 2014. Non-cash expenses consisting principally of share-based compensation of US$16.6 million, depreciation and amortization of US$15.5 million and realized gain from the disposal of Nationsky of US$56.2 million, an increase in accounts receivable of US$34.9 million and an increase in accounts payable of US$19.6 million. The decrease in share-based compensation expenses was mainly due to less performance-based share options granted in relation to the Company’s acquisitions in 2015 compared with that in 2014.

 

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Net cash provided by operating activities amounted to US$6.2 million in 2014, as compared to US$24.3 million in 2013. Non-cash expenses consisting principally of share-based compensation of US$83.8 million, depreciation and amortization of US$14.2 million and allowance for doubtful accounts of US$5.0 million were partially offset by other income from ADR depositary arrangement and unrealized gain on investment of US$12.4 million, an increase in accounts receivable of US$10.3 million and an increase in prepaid expenses and other current assets of US$5.1 million. The increase in share-based compensation was primarily due to the increase of acquisition related share-based compensation expenses and share-based compensation for our executives and employees.

Net cash provided by operating activities amounted to US$24.3 million in 2013, as compared to net loss of US$1.3 million. Non-cash expenses consisting principally of share-based compensation of US$55.4 million, depreciation and amortization of US$6.0 million and allowance for doubtful accounts of US$2.8 million were partially offset by an increase in accounts receivable of US$26.6 million and an increase in prepaid expenses and other current assets of US$14.6 million. The increase in share-based compensation was primarily due to the increase of acquisition related share-based compensation expenses and share-based compensation for our executives and employees.

Investing Activities

Net cash used in investing activities largely reflected placement and maturities of term deposits, cash paid for equity investment and for business acquisitions, bridge loans paid in connection with completed and ongoing investments, purchase of property and equipment and intangible assets and proceeds from disposals of available-for-sale investments.

Net cash used in investing activities amounted to US$19.1 million in 2015, primarily attributable to cash paid for equity investment of US$21.9 million, cash paid for business acquisitions of US$25.3 million, cash paid for acquisition of non-controlling shareholder interest US$16.7 million, partially offset by Cash received from disposal of subsidiaries US$ 77.2 million.

Net cash used in investing activities amounted to US$21.0 million in 2014, primarily attributable to cash paid for equity investment of US$3.4 million cash paid for business acquisitions of US$23.0 million, partially offset by cash received from the disposal of non-controlling shareholder interest US$21.6 million, as well as bridge loans collected of US$4.4 million.

Net cash used in investing activities amounted to US$41.5 million in 2013, primarily attributable to cash paid for equity investment of US$28.4 million, cash paid for business acquisitions of US$14.9 million, bridge loans made in connection with completed and ongoing investments of US$6.7 million, partially offset by bridge loans collected of 1.2 million, as well as proceeds from disposals of available-for-sale investments of 7.6 million.

Financing Activities

Net cash provided by financing activities amounted to US$1.4 million in 2015, primarily attributable to bank borrowings.

Net cash used in financing activities amounted to US$13.3 million in 2014, primarily attributable to repurchasing common stock of US$15.7 million, partially offset by proceeds from exercising of share options of US$2.4 million.

Net cash provided by financing activities amounted to US$176.8 million in 2013, primarily attributable to the net proceeds of US$166.4 million from the issuance of convertible senior note issued in 2013 and the net proceeds of US$11.6 million from issuance of common shares, partially offset by our repurchase of common shares of US$6.7 million as part of our Repurchase Plan. See “Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers” for the details of the Repurchase Plan.

 

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Capital Expenditures

We made capital expenditures of US$1.6 million, US$3.7 million and US$0.5 million for the years ended December 31, 2013, 2014 and 2015, respectively. Our capital expenditures were primarily used to purchase servers and other equipment, software and other intangible assets (such as the domain name www.nq.com) for our business. Our capital expenditures may increase in the near term as our business continues to grow.

 

C. Research and Development, Patents and Licenses, Etc.

See “Item 4. Information on the Company — B. Business Overview — Research and Development” for a description of the research and development aspect of our business and “Item 4. Information on the Company — B. Business Overview — Intellectual Property” for a description of the protection of our intellectual property.

Research and development expenses consist primarily of salaries and benefits for research and development personnel. We expect our research and development expenses to increase as we intend to hire more research and development personnel to increase performance levels of existing products and services and develop new products and services. We incurred US$17.4, US$25.7 million and US$29.0 million in research and development expenses in 2013, 2014 and 2015, respectively.

 

D. Trend Information

Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events since the beginning of our fiscal year 2015 that are reasonably likely to have a material effect on our net revenues, income from operations, profitability, liquidity or capital resources, or that would cause the disclosed financial information to be not necessarily indicative of future operating results or financial condition.

 

E. Off-Balance Sheet Arrangements

We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholders’ 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.

 

F. Tabular Disclosure of Contractual Obligations

The following table sets forth our contractual obligations as of December 31, 2015 by specified categories:

 

     Payment Due by Period  
Contractual Obligations    Total      Less than
1 year
     1-3 years      3-5 years      More than
5 years
 
     (in thousands of dollars)  

Operating Lease Obligations (1)

     7,346         3,898         3,419         29         —     

Long-term Debt Obligations (2)

     177,963         177,963         —           —           —     

Total

     185,309         181,861         3,419         29         —     

 

(1) Operating lease obligations are primarily related to the lease of office spaces in mainland China and the United States. The expiration dates for these leases ranged from 2016 to 2020 and are renewable upon negotiation.
(2) Long-term borrowing includes principle and interests that are derived from 4.00% senior convertible debts, presumed no conversion would occur.

Other than the obligations set forth above, we did not have any other long-term debt obligations, operating lease obligations, purchase obligations or other long-term liabilities as of December 31, 2015.

 

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G. Safe Harbor

See “Forward Looking Statements” on page 2 of this annual report.

 

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

 

A. Directors and Senior Management

The following table sets forth information regarding our directors and executive officers as of the date of this annual report. There are no family relationships among any of the directors or executive officers of our company.

 

Name

  

Age

  

Position/Title

Vincent Wenyong Shi, Ph.D

   38    Chairman and Chief Operating Officer

ZeminXu

   52    Director and Chief Executive Officer

Justin Chen

   45    Director and President

Jun Zhang

   51    Independent Director

William Tiewei Li

   52    Independent Director

Chun Ding

   44    Independent Director

Ethan Hu, Ph.D

   45    Independent Director

Roland Wu

   39    Chief Financial Officer

Matthew Mathison

   39    Vice President, Capital Markets

Vincent Wenyong Shi is a founder of our company. Dr. Shi has served as our chairman since December 2014, our director since January 2011, our chief operating officer since our inception in October 2005 and our acting chief financial officer from August 2014 to June 2015. He is responsible for the operations of our company, including management of business operations, channel development, online business development and customer support. Dr. Shi also served the chairman of the board of directors of Beijing Wangnuo Xingyun Technology Co., Ltd., Beijing Yuanxin Technology Co., Ltd. and another private company. Dr. Shi received a Ph.D and a master’s degree in geographic information system and a bachelor’s degree in computer science from Peking University.

Zemin Xu has served as our director and chief executive officer since December 2014 and our president from December 2010 through December 2014. Mr. Xu has served as a member of the audit committee, strategy and development committee, compensation committee and evaluation committee of Hengxin Mobile Business Co., Ltd., a company listed on the Shenzhen Stock Exchange, since January 2012. From January 2007 to November 2010, Mr. Xu was the vice president and the business development and strategic marketing general manager of Asia Info-linkage, Inc., which was a NASDAQ listed company. Prior to that, Mr. Xu worked at Internet Security One (China) Co., Ltd., where he served as the chief operating officer and the executive vice president in charge of day-to-day operations from March 2005 to November 2006. Before joining Internet Security One (China) Co., Ltd., Mr. Xu served multiple positions with business and management functions in the posts and telecommunications sector in Tianjin for over ten years. Mr. Xu received an MBA degree from the Business School of Nanyang Technological University in Singapore.

Justin Chen has served as our President and General Counsel since February 2016 and our director since July 2014. Mr. Chen is a California-licensed attorney and is a counsel at PacGate Law Group. Before joining PacGate Law Group, Mr. Chen was the chief executive officer of Starvax Inc., a biotechnology company based in Beijing, China from 2003 to 2005. Mr. Chen was an attorney at Intellectual Property Law Group, LLP in San Jose, California from 1998 to 2003. Mr. Chen received a juris doctor degree and a master’s degree in biochemistry from the University of Iowa and a bachelor’s degree from Peking University.

Jun Zhang has served as our director since June 2007. Mr. Zhang was appointed as our independent director in January 2011. Mr. Zhang has also served as the vice president of Beijing Beida Jade Bird Group and the president of Beijing Beida Jade Bird New Energy Technology Co., Limited since 2001, and the president of Chengdu Shengbang Information Technology Co., Limited since 2010. Mr. Zhang received a bachelor’s degree from Peking University.

 

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William Tiewei Li has served as our independent director since May 2012. From 1998, Mr. Li has worked for Beijing Zhongchuang Telecom Test Co., Ltd., or Beijing Zhongchuang, a company listed on Shanghai Stock Exchange as the vice president, general manager, financial director and assistant to the general manager. Prior to joining Beijing Zhongchuang, Mr. Li worked for World Capital Market (US) Investment Co., Ltd., or World Capital Market, from October 1997 to November 1998, during which he set up the Beijing representative office and served as the chief representative. Mr. Li joined World Capital Market from Jardin Fleming Securities Ltd. where he was mainly responsible for business related to B-shares and overseas listings from May 1996 to October 1997. Mr. Li holds a bachelor’s degree in engineering from Changchun University of Technology in China, a master’s degree in economics from Renmin University, and an MBA degree from the University of Edinburgh.

Chun Ding has served as our independent director since March 2015. Mr. Ding is the Managing Member of CRCM LLC, which is the general partner of CRCM L.P., an asset management firm founded by Mr. Ding in 2006. Mr. Ding is a Responsible Officer (RO) of CRCM Ltd., also an asset management firm and a subsidiary of CRCM L.P. Prior to founding CRCM, he worked at Farallon Capital Management from 1997. In July 2003, Mr. Ding became a Managing Member of Farallon Capital Management. Prior to business school, Mr. Ding worked as a financial analyst at Goldman Sachs. He graduated from Middlebury College in 1993 with a B.A. in Economics, where he was valedictorian of his class, and he received his Masters of Business Administration from Harvard Business School in 1997 where he was elected a Baker Scholar.

Ethan Hu has served as our independent director since February 2016. Dr. Hu has served as a director and the chief financial officer of Frankenman Medical Equipment Limited, a leading surgical device company in China, since 2014. From 2011 to 2014, Dr. Hu worked as a vice president of CITIC PE Investment Limited, a recognized private equity firm in China. Prior to that, Dr. Hu was a principal at Lilly Asian Ventures from 2007 to 2010 and an associate director of Novartis Oncology from 2004 to 2007. Dr. Hu received an MBA degree from the University of Chicago, a Ph.D. degree in molecular and cell biology from the University of Maryland and a bachelor’s degree from Peking University.

Roland Wu has served as our chief financial officer since June 2015 and was our director from December 2014 to February 2016. Mr. Wu has extensive experience and in-depth capital markets knowledge, having served in financial industry over the last fourteen years. He has served as Executive Director of Winshine Science Company Limited since 2014 and as independent director of T3 Mobile Inc. since 2014. In addition, Mr. Wu was Executive Director of Bestway International Holdings Limited from 2013 to 2014. Additionally, Mr. Wu served as a portfolio manager at Haitong International Asset Management Company from 2010 to 2013 and as an investment analyst at Baoying Fund Management Co., Ltd. from 2006 to 2009. Mr. Wu received an MBA from Nankai University and a Bachelor of Computer Science from Beijing Jiaotong University.

Matthew Mathison has served as our vice president of capital markets since July 2013. Before joining our company, Mr. Mathison served as president of WP Asset Management, a registered investment advisor in the U.S. and acted as general partner of Proconex Partners LLC from January 2012 through June 2013. Before that, he was president of Wedge Partners Corporation from 2004 to 2011, responsible for leading the sales efforts of the company’s technology-focused research and trading business and worked as an institutional sales representative at Goldman Sachs from 2000 to 2004. Mr. Mathison received a bachelor’s degree in finance from Brigham Young University’s Marriott School of Management.

Employment Agreements

We have entered into employment agreements with each of our executive officers. In general, we may terminate an executive officer’s employment for cause, at any time, without notice or remuneration, for certain acts of the officer, including, but not limited to, a conviction or plea of guilty to a felony, willful misconduct to our detriment or a failure to perform agreed duties. We may also terminate an executive officer’s employment without cause at any time. An executive officer may terminate his or her employment with us by 90-day prior written notice for certain reasons.

Our executive officers have also agreed not to engage in any activities that compete with us, or to directly or indirectly solicit the services of our employees, during the term of the employment. Each executive officer has agreed to hold in strict confidence any of our confidential information or trade secrets. Each executive officer also agrees to comply with all material applicable laws and regulations related to his or her responsibilities with respect to our company as well as all of our material corporate and business policies and procedures.

 

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B. Compensation of Directors and Executive Officers

For the fiscal year ended December 31, 2015, we paid an aggregate of approximately US$1.7 million in cash to our executive officers and directors. We also paid an aggregate of approximately US$0.07 million in cash compensation and granted 193,920 restricted shares to our non-executive directors in 2015. For the fiscal year ended December 31, 2015, our PRC subsidiaries made contributions equal to certain percentages of each employee’s salary for his or her pension insurance, medical insurance, housing fund, unemployment and other statutory benefits as required by law. We did not set aside or accrue any pension or other retirement benefits for our named executive officers and directors for the fiscal year ended December 31, 2015.

For share incentive grants to our officers and directors, see “— Share Incentive Plans.”

Share Incentive Plans

We have adopted two share incentive plans, the 2007 Global Share Plan and the 2011 Share Plan. The purpose of these two share incentive plans is to motivate, retain and attract certain officers, employees, directors and other eligible persons by linking their personal interests with those of our shareholders and with the success of our business.

The 2011 Share Plan

Under the 2011 Share Plan, as amended, the maximum aggregate number of Class A common shares which may be issued pursuant to all awards under the plan shall be 13,000,000 plus an annual increase on the first day of each fiscal year, beginning in 2012, equal to the total number of shares underlying the options or other awards granted in the preceding year that remain outstanding, or such lesser amount of Class A common shares as determined by the board. Thus, unless our board of directors determines to add a lesser amount of shares to the number of shares reserved under the 2011 Share Plan on or before the first day of each fiscal year, the maximum number of shares that can be issued in that year pursuant to all awards granted under the 2011 Share Plan is 13,000,000. As of March 15, 2016, 118,325 restricted shares and options to purchase 10,555,835 Class A common shares have been granted and were outstanding under the 2011 Share Plan. In addition, as of March 15, 2016, 442,740 restricted ADSs were also granted and outstanding under the 2011 Share Incentive Plan.

The following paragraphs summarize the terms of the 2011 Share Plan.

Types of Awards The following briefly describe the principal features of the various awards that may be granted under the 2011 Share Plan.

 

    Options. Options provide for the right to purchase a specified number of our Class A Common Shares at a specified price and usually will become exercisable at the discretion of our plan administrator in one or more installments after the grant date. The option exercise price may be paid, subject to the discretion of the plan administrator, in cash or check, in our Class A Common Shares which have been held by the option holder for such period of time as may be required to avoid adverse accounting consequences, in other property with value equal to the exercise price, through a broker-assisted cashless exercise, or by any combination of the foregoing.

 

    Restricted Shares. A restricted share award is the grant of our Class A Common Shares which are subject to certain restrictions and may be subject to risk of forfeiture. Unless otherwise determined by our plan administrator, a restricted share is nontransferable and may be forfeited or repurchased by us upon termination of employment or service during a restricted period. Our plan administrator may also impose other restrictions on the restricted shares, such as limitations on the right to vote or the right to receive dividends.

 

    Restricted Share Units. Restricted share units represent the right to receive our Class A Common Shares at a specified date in the future, subject to forfeiture of such right upon termination of employment or service during the applicable restriction period. If the restricted share units have not been forfeited, then subject to the discretion of the plan administrator, we shall pay the holder in the form of cash or unrestricted Class A common shares or a combination of both after the last day of the restriction period as specified in the award agreement.

 

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Plan Administration The plan administrator is our board or a committee of one or more members of our board.

Award Agreement Options, restricted shares, or restricted share units granted under the plan are evidenced by an award agreement that sets forth the terms, conditions, and limitations for each grant.

Option Exercise Price The exercise price subject to an option shall be determined by the plan administrator and set forth in the award agreement. The exercise price may be amended or adjusted in the absolute discretion of the plan administrator, the determination of which shall be final, binding and conclusive. To the extent not prohibited by applicable laws or the rules of any exchange on which our securities are listed, a downward adjustment of the exercise prices of options shall be effective without the approval of the shareholders or the approval of the affected participants.

Eligibility We may grant awards to our employees, directors, consultants, and advisers or those of any related entities.

Term of the Awards The term of each option grant shall be stated in the award agreement, provided that the term shall not exceed ten years from the grant date. As for the restricted shares and restricted share units, the plan administrator shall determine and specify the period of restriction in the award agreement.

Vesting Schedule In general, the plan administrator determines the vesting schedule, which is set forth in the award agreement.

Transfer Restrictions. Awards for options, restricted shares or restricted share units may not be transferred in any manner by the award holder and may be exercised only by such holders, subject to limited exceptions. Restricted shares and restricted share units may not be transferred during the period of restriction.

Termination of Employment or Service In the event that an award recipient ceases employment with us or ceases to provide services to us, any unvested options will automatically terminate and any vested options will generally terminate after a period of time following the termination of employment or service if the award recipient does not exercise the options during this period. Any restricted shares and restricted share units that are at the time of termination subject to restrictions will generally be forfeited and automatically transferred to and reacquired by us at no cost to us.

The 2007 Global Share Plan

On June 7, 2007, we adopted our 2007 Global Share Plan to motivate, retain and attract talent and promote the success of our business. We amended the 2007 Global Share Plan on December 15, 2007, April 26, 2010, December 15, 2010 and February 28, 2011. Our board of directors authorized the issuance and reservation of up to 44,415,442 common shares under the Plan. As of March 15, 2016, options to purchase 11,655,610 common shares have been granted and were outstanding under the 2007 Global Share Plan.

Types of Awards and Exercise Prices. Two types of awards may be granted under the 2007 Global Share Plan.

 

    Incentive Share Option. An incentive share option is a share option which by its term satisfies and is otherwise intended to satisfy the requirements of Section 422 of the Internal Revenue Code of 1986, as amended. The exercise price of an incentive share option shall be determined by the plan administrator in its sole discretion, provided that the exercise price shall not be less than 100% of its fair market value on the date of grant.

 

    Nonstatutory Share Option. A nonstatutory share option is a share option which by its term does not satisfy or is not intended to satisfy the requirements of Section 422 of the Internal Revenue Code of 1986, as amended. The exercise price of a nonqualified share option shall be determined by the plan administrator.

 

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Plan Administration. Our board of directors or a committee appointed by the board will administer the Plan. The administrator has the power, among other things, to determine the fair market value of shares underlying the options, to select the persons to whom the awards may be granted, to determine the number of awards granted, to determine the form of the award agreement, and to determine the terms and conditions of any award granted including, but not limited to, the exercise price, the purchase price, when the options may be exercised, when the relevant repurchase or redemption rights shall lapse, any vesting acceleration or waiver of forfeiture restrictions, and any restriction or limitation regarding any award or the shares relating thereto, based in each case on such factors as the administrator, in its sole discretion, shall determine. Subject to applicable laws, the administrator may delegate limited authority to specified offices of our company to execute on behalf of our company any instrument required to effect an award previously granted by the administrator.

Award Agreement. Incentive share options or nonstatutory share options granted under the 2007 Global Share Plan are evidenced by an award agreement that sets forth the terms and conditions for each grant, including the exercise price, the exercisable date and term of the option.

Eligibility. We may grant awards to employees, directors or consultants of our company.

Transfer Restriction. Awards for incentive share options and nonstatutory share options are subject to such forfeiture conditions, rights of repurchase or redemption, rights of first refusal and other transfer restrictions as the plan administrator may determine.

Term of Awards. The award agreement shall specify the term of each option; however, the term shall not exceed ten years from the grant date, or a shorter term may be required by the 2007 Global Share Plan.

Vesting Schedule. The plan administrator may determine the vesting schedule.

Amendment and Termination. The plan administrator may at any time amend, alter, suspend or terminate the 2007 Global Share Plan. Unless sooner terminated, the Plan shall continue in effect for a term of ten years.

The following table summarizes the outstanding options and restricted shares that our directors, executive officers and other individuals as a group beneficially owned as of March 15, 2016.

 

Name

   Class A
Common Shares
Underlying
Outstanding
Options/Restricted
Shares
    Class B
Common

Shares
Underlying
Outstanding
Options
    Exercise
Price
(US$/Share)
  Grant Date   Expiration
Date

Vincent Wenyong Shi

     —          6,000,000      1.52   February 28, 2011   (1)

Zemin Xu

     —               0.40   December 15, 2010   (1)
            —        N/A   July 8, 2014   N/A

Jun Zhang

            —        N/A   July 8, 2014   N/A

William Tiewei Li

            —        N/A   July 10, 2012   N/A
            —        N/A   July 8, 2014   N/A

Matthew Mathison

            —        1.67   July 1, 2013   (1)
            —        0.74   April 7, 2015   (1)

Other individuals as a group

     11,311,015        4,655,610      0.07-2.6

(2)

  August 8, 2007 –
January 30, 2015 (2)
  (1)

 

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* The aggregate number of common shares underlying the outstanding options held by the option grantee or restricted shares is less than 1% of our total outstanding shares.
(1) Each option will expire after ten years from the grant date or such shorter period as the board of directors may determine at the time of the grant.
(2) We granted stock options to other individuals under the 2007 Global Share Plan and the 2011 Share Plan on the following dates and at the following exercise prices: (i) on August 8, 2007, 4,260,000 options, on November 8, 2007, 1,420,000 options and on December 15, 2010, 5,500,000 options, each with an exercise price of $0.07 per share, (ii) on February 8, 2008, 3,779,500 options, on August 8, 2008, 3,323,500 options, on April 8, 2009, 4,649,500 options and on December 8, 2009, 1,059,000 options, each with an exercise price of $0.25 per share, (iii) on August 8, 2010, 5,123,500 options, on November 8, 2010, 235,500 options and on December 15, 2010, 2,604,117 options, each with an exercise price of $0.40 per share, (iv)on February 28, 2011, 2,020,000 options with an exercise price of $1.52 per share,(v) on March 15, 2011, 1,020,942 options with an exercise price of $1.52 per share, (vi) on June 13, 2011, 3,925,000 options with an exercise price of $0.80 per share, (vii) on November 2, 2011, 1,000,000 options with an exercise price of $0.91 per share, (vii) on December 22, 2011, 4,029,500 options with an exercise price of $0.95 per share, (viii) on July 10, 2012, 3,985,450 options with an exercise price of US$1.35 per share, (ix) on January 2, 2013, 6,037,000 options with an exercise price of US$1.18 per share, (x) on July 1, 2013, 1,065,000 options with an exercise price of US$1.67 per share, and (xi) on August 1, 2014, 62,500 options with an exercise price of US$1.31 per share. Among the total number of options granted to other individuals, 28,640,950 had been exercised, 8,036,250 had become expired or forfeited, and 250,000 had been cancelled, leaving a total number of 14,011,445 options outstanding as of March 15, 2016.

We granted restricted shares to other individuals under the 2007 Global Share Plan and the 2011 Share Plan on the following dates: (i) on May 5, 2011, 1,075,000 restricted shares, (ii) on July 10, 2012, 2,287,630 restricted shares, (iii) on July 27, 2012, 2,893,750 restricted shares, (iv) on January 2, 2013, 3,000,000 restricted shares, (v) on February 19, 2013, 189,105 restricted shares, (vi) on July 1, 2013, 1,710,000 restricted shares, (vii) on May 15, 2014, 250,000 restricted shares, (viii) on June 27, 2014, 1,500,000 restricted shares, (ix) on July 8, 2014, 1,525,000 restricted shares, (x) on January 30, 2015, 2,079,020 restricted shares, (xi) on April 8, 2015, 1,860,000 restricted shares, (xii) on April 29, 2015, 350,000 restricted shares, (xiii) on June 26, 2015, 50,000 restricted shares, (xiiii) on December 14, 2015, 2,351,845 restricted shares. Among the total number of restricted shares granted to other individuals, 16,031,689 had been vested, 2,597,293 had become expired or forfeited and 453,750 had been cancelled, leaving a total number of 1,955,180 restricted shares outstanding as of March 15, 2015.

 

C. Board Practices

Our board of directors currently consists of seven directors, including four independent directors. A director is not required to hold any shares in our company by way of qualification. A director may vote with respect to any contract, proposed contract or arrangement in which he is materially interested provided the nature of the interest is disclosed prior to voting. A director may exercise all the powers of our company to borrow money, mortgage its undertaking, property and uncalled capital, and issue debentures or other securities whenever money is borrowed or as security for any obligation of our company or of any third party. None of our non-executive directors has a service contract with us that provides for benefits upon termination of employment. See “Item 6. Directors, Senior Management and Employees — B. Compensation of Directors and Executive Officers” for a description of the employment agreements we have entered into with our senior executive officers.

Committees of the Board of Directors

We have established three committees under the board of directors: the audit committee, the compensation committee and the corporate governance and nominating committee. We have adopted a charter for each of these committees. Each committee’s members and functions are described below.

Audit Committee. Our audit committee consists of Dr. Ethan Hu, Mr. Jun Zhang, and Mr. William Tiewei Li. Dr. Ethan Hu is the chairman of our audit committee. Each of Dr. Hu, Mr. Zhang, and Mr. Li satisfies the “independence” requirements of Section 303A of the Corporate Governance Rules of the New York Stock Exchange and Rule 10A-3 under the Securities Exchange Act of 1934. The audit committee oversees our accounting and financial reporting processes and the audits of the financial statements of our company. The audit committee is responsible for the following, among others:

 

    selecting the independent registered public accounting firm and pre-approving all auditing and non-auditing services permitted to be performed by the independent registered public accounting firm;

 

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    reviewing with the independent registered public accounting firm any audit problems or difficulties and management’s response;

 

    reviewing and approving all proposed related party transactions, as defined in Item 404 of Regulation S-K under the Securities Act;

 

    discussing the annual audited financial statements with management and the independent registered public accounting firm;

 

    reviewing major issues as to the adequacy of our internal control and any special audit steps adopted in light of material control deficiencies; and

 

    meeting separately and periodically with management and the independent registered public accounting firm.

Compensation Committee. Our compensation committee consists of Mr. Jun Zhang, Dr. Ethan Hu and Mr. William Tiewei Li. Mr. Zhang is the chairman of our compensation committee. Each of Mr. Zhang, Dr. Hu and Mr. Li satisfies the “independence” requirements of the Corporate Governance Rules of the New York Stock Exchange. The compensation committee assists the board in reviewing and approving the compensation structure, including all forms of compensation, relating to our directors and executive officers. Our chief executive officers may not be present at any committee meeting during which his compensation is deliberated. The compensation committee is responsible for, the following, among others:

 

    reviewing and approving the total compensation package for our chief executive officers;

 

    reviewing and recommending to the board the compensation of our directors; and

 

    reviewing periodically and approving any long-term incentive compensation or equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans.

Corporate Governance and Nominating Committee. Our corporate governance and nominating committee consists of Mr. William Tiewei Li, Mr. Jun Zhang and Dr. Ethan Hu, and is chaired by Mr. William Tiewei Li. Each of Mr. Li, Mr. Zhang and Dr. Hu satisfies the “independence” requirements of the Corporate Governance Rules of the New York Stock Exchange. The corporate governance and nominating committee will assist the board of directors in identifying individuals qualified to become our directors and in determining the composition of the board and its committees. The corporate governance and nominating committee is responsible for the following actions, among others:

 

    identifying and recommending to the board nominees for election or re-election to the board, or for appointment to fill any vacancy;

 

    reviewing annually with the board the composition of the board in light of the characteristics of independence, age, skills, experience and availability of service to us;

 

    identifying and recommending to the board the directors to serve as members of the board’s committees;

 

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    advising the board periodically with respect to significant developments in the law and practice of corporate governance as well as our compliance with applicable laws and regulations, and making recommendations to the board on all matters of corporate governance and on any corrective action to be taken; and

 

    monitoring compliance with our code of business conduct and ethics, including reviewing the adequacy and effectiveness of our procedures to ensure proper compliance.

Duties of Directors

Under Cayman Islands law, our directors have a duty of loyalty to act honestly in good faith with a view to our best interests. Our directors also have a duty to exercise the skill they actually possess and such care and diligence that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our memorandum and articles of association. We have the right to seek damages if a duty owed by our directors is breached.

Terms of Directors and Officers

Our officers are elected by and serve at the discretion of the board of directors. Our directors are not subject to a term of office and hold office until such time as they resign or are removed from office by ordinary resolution of our company. A director will be removed from office automatically if, among other things, the director (i) becomes bankrupt or makes any arrangement or composition with his creditors; or (ii) becomes of unsound mind.

 

D. Employees

We had 1,233, 1,742 and 1,019 employees as of December 31, 2013, 2014 and 2015, respectively. The change of employee number in 2015 is maily due to the divestment of NationSky. The following table sets forth the number of our employees by function as of December 31, 2015.

 

Operating Division

   Number of Employees      Percentage of Total  

General and administration

     60         5.9%   

Research and development

     456         44.8%   

Operations

     213         20.9%   

Business development

     290         28.4%   
  

 

 

    

 

 

 

Total

     1,019         100.0%   
  

 

 

    

 

 

 

We invest significant resources in the recruitment, retention, training and development of our employees. We hire our employees through various channels, including word-of-mouth referrals, on-campus recruiting programs, professional headhunters and job search websites. At the time a new employee is hired, we offer introductory training during the probation period which typically lasts three months. We offer internal continuing education training programs for our employees on a variety of topics, including (i) general training on topics like time management and general business communication, (ii) training specific to each of their professional positions, such as training regarding sales strategies and project management, and (iii) management-level training, including training on employee motivation, delegation of authority and stress management. We also offer employees outside training opportunities on an as-needed basis.

Our success depends on our ability to attract, retain and motivate qualified personnel. We believe we offer our employees competitive compensation packages, and we have generally been able to attract and retain qualified personnel and maintain a stable core management team. Through a combination of short-term performance evaluation and long-term incentive arrangements, we intend to build a competent, loyal and highly motivated workforce.

Compensation for our full-time employees typically consists of base salary, additional pay determined in accordance with employee seniority and other subsidies. In addition, based on our results of operations, we may award discretionary bonuses to our employees. Our employees are also eligible for equity incentives. For more information on the terms of our share option plans, see “Item 6. Directors, Senior Management and Employees — B. Compensation of Directors and Executive Officers — Share Incentive Plans.”

 

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Substantially all of our employees are based in the PRC. In accordance with PRC laws, our full-time employees in China participate in various employee benefit plans including pension, medical benefit plans as well as various types of general social insurance required by the relevant PRC laws and regulations, including unemployment insurance, and commercial insurance covering certain worked-related injuries and complementary medical expenses for all of our employees.

We believe that we maintain a good working relationship with our employees and we have not experienced any business interruptions due to labor disputes. For a description of the employment agreement we signed with some members of our senior management, see “Item 6. Directors, Senior Management and Employees — B. Compensation of Directors and Executive Officers — Employment Agreements.”

 

E. Share Ownership

Class A Common Shares

As of March 15, 2016, we had 430,504,041 Class A common shares outstanding (excluding 12,084,305 Class A common shares represented by ADSs that we reserved for issuance upon the exercise of options or the vesting of restricted shares and 892,495 Class A common shares that we repurchased from open market but not cancelled). In addition, as of March 15, 2016, we have granted, and have outstanding, options to purchase 10,555,835 Class A common shares and 11,655,610 Class B common shares, 118,325 restricted shares and 442,740 restricted ADSs to our directors, executive officers, other employees and consultants. For information regarding the Share Incentive Plans, see “Item 6. Directors, Senior Management and Employees — B. Compensation of Directors and Executive Officers.”

Class B Common Shares

As of March 15, 2016, we had 50,352,971 Class B common shares outstanding.

The following table sets forth information with respect to the beneficial ownership of our common shares as of March 15, 2016, by:

 

    each of our directors and executive officers; and

 

    each person known to us to beneficially own more than 5% of our common shares.

Beneficial ownership is determined in accordance with the rules and regulations of the SEC. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, we have included shares that the person has the right to acquire within 60 days after March 15, 2016, the most recent practicable date, including through the exercise of any option, warrant or other right or the conversion of any other security. These shares, however, are not included in the computation of the percentage ownership of any other person.

 

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The calculations in the table below assume that there were 480,857,012 common shares outstanding as of March 15, 2016.

 

    Class A
Common Shares Beneficially
Owned
    Class B
Common Shares Beneficially
Owned
    Total
Common Shares Beneficially
Owned
    Total Voting
Power
 
    Number     (1)     Number     % (2)     Number (3)     % (4)     % (5)  

Directors and Executive Officers:**

             

Vincent Wenyong Shi (6)

    2,395,000        0.6        55,602,941        100.0        57,997,941        11.9        56.6   

Zemin Xu (7)

                                                

Justin Chen (8)

                  —         —                          

Jun Zhang (9)

                  —         —                          

William Tiewei Li (10)

                  —         —                          

Chun Ding (11)

    13,424,830        3.1        —         —         13,424,830        2.8        1.4   

Ethan Hu

    —          —          —          —          —          —          —     

Roland Wu(12)

                  —          —                          

Matthew Mathison (13)

                  —          —                          

All Directors and Executive Officers as a group

    18,904,313        4.4        56,602,941        100.0        75,507,254        15.5        58.6   

Principal Shareholders:

             

RPL Holdings Limited (14)

    —         —         50,352,941        100.0        50,352,941        10.5        53.9   

 

* Less than 1% of our total outstanding shares.
** Except for Messrs. Jun Zhang, William Tiewei Li, Ethan Hu, Matthew Mathison and Chun Ding, the business address of our directors and executive officers is c/o No. 4 Building, 11 Heping Li East Street, Dongcheng District, Beijing 100013, the People’s Republic of China. The business address of Mr. Matthew Mathison is 4514 Travis St, Dallas, Texas, 75205, United States of America. The business address of Mr. Jun Zhang is 1F, Jade Bird Building, 207 Chengfu Road, Haidian District, Beijing 100871, the People’s Republic of China. The business address of Mr. William Tiewei Li is C12/F, Beijing International Building, No. 18 Zhongguancun Nan Dajie, Haidian District, Beijing 100081, the People’s Republic of China. The business address of Mr. Chun Ding is One Maritime Plaza, Suite 1107, San Francisco, CA, 94111, United States of America. The business address of Dr. Ethan Hu is 108 S, Jinfen Rd, High-New District, Suzhou, Jiangsu, the People’s Republic of China.
(1) For each person and group included in this column, percentage ownership is calculated by dividing the number of Class A common shares beneficially owned by such person or group by the sum of the number of Class A common shares outstanding and the number of Class A common shares such person or group has the right to acquire, including upon exercise of options and vesting of restricted shares and restricted share units, within 60 days after March 15, 2016. The calculation in the table below is based on 430,504,041 Class A common shares outstanding as of March 15, 2016, which excludes 12,084,305 Class A common shares represented by ADSs that are reserved for future issuance upon the exercise of options or vesting of restricted shares or restricted share units and 892,495 Class A common shares that are repurchased by our company from open market but not cancelled, and the number of Class A common shares underlying the options held by such person or group that are exercisable, or restricted shares or restricted share units that will become vested, within 60 days after March 15, 2016.
(2) For each person and group included in this column, percentage ownership is calculated by dividing the number of Class B common shares beneficially owned by such person or group by the sum of the number of Class B common shares outstanding and the number of Class B common shares such person or group has the right to acquire upon exercise of options within 60 days after March 15, 2016. The calculation in the table is based on 50,352,971 Class B common shares outstanding as of March 15, 2016 and the number of Class B common shares underlying the options held by such person or group that are exercisable within 60 days of March 15, 2016.
(3) Represents the sum of Class A and Class B common shares beneficially owned by such person or group.
(4) For each person and group included in this column, percentage ownership is calculated by dividing the number of total common shares beneficially owned by such person or group by the sum of the number of common shares outstanding and the number of common shares such person or group has the right to acquire, including upon exercise of options and vesting of restricted shares and restricted share units, within 60 days after March 15, 2016.
(5) For each person or group included in this column, percentage of total voting power represents voting power based on both Class A and Class B common shares held by such person or group, and the common shares such person or group has the right to acquire upon exercise of the stock options or warrants within 60 days after March 15, 2016, with respect to all outstanding shares of our Class A and Class B common shares as a single class. Each holder of Class A common shares is entitled to one vote per Class A common share. Each holder of our Class B common shares is entitled to ten votes per Class B common share. Our Class B common shares are convertible at any time by the holder into Class A common shares on a share-for-share basis.

 

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(6) Represents (i) 2,395,000 Class A common shares in form of ADSs held by Dr. Vincent Wenyong Shi, (ii) 50,352,941 Class B common shares held by RPL Holdings Limited, a British Virgin Islands company which is wholly owned by a collective trust, of which Dr. Shi is a beneficiary, and (iii) 5,250,000 Class B common shares underlying the options that are exercisable within 60 days after March 15, 2016 by Dr. Shi.
(7) Represents the Class A common shares in the form of ADSs held by Mr. Zemin Xu and Class B common shares underlying the options that are exercisable within 60 days after March 15, 2016 by Mr. Xu.
(8) Represents the Class A common shares in the form of ADSs held by Mr. Justin Chen.
(9) Represents the Class A common shares in the form of ADSs held by Mr. Jun Zhang.
(10) Represents the Class A common shares in the form of ADSs and restricted Class A common shares that will become vested within 60 days after March 15, 2016 held by Mr. William Tiewei Li.
(11) Represents 25,000 Class A common shares in the form of ADSs held by Mr. Chun Ding and 13,399,830 Class A common shares in the form of ADSs beneficially owned by CRCM Institutional Master Fund (BVI), Ltd., a British Virgin Islands limited company. By virtue of Mr. Ding’s position as the managing member of the General Partner, CRCM LLC, a Delaware limited liability company, and the director of the Sub-Investment Adviser, ChinaRock Capital Management Limited, a Hong Kong company limited by shares, Mr. Ding may be deemed to have the shared power to vote or direct the vote of (and the shared power to dispose or direct the disposition and, therefore, Mr. Ding may be deemed to be the beneficial owner. Such shareholding information is based on the information contained in the Schedule 13D/A filed by CRCM Institutional master Fund (BVI), Ltd., CRCM LLC, CRCM LP, ChinaRock Capital management Limited and Mr. Chun Ding with the SEC on January 21, 2016. The business address of Mr. Chun Ding is One Maritime Plaza, Suite 1107, San Francisco, CA 94111, United States.
(12) Represents the Class A common shares in the form of ADSs held by Mr. Roland Wu.
(13) Represents the Class A common shares in the form of ADSs held by Mr. Matthew Mathison and Class A common shares underlying the options that are exercisable within 60 days after March 15, 2016 by Mr. Mathison.
(14) Represents 50,352,941 Class B common shares held by RPL Holdings Limited, a British Virgin Islands company which is wholly owned by RPL Global Limited and RPL Global Limited is wholly owned by a collective trust, of which Messrs. Lingyun Guo, Xu Zhou and Vincent Wenyong Shi are beneficiaries. The business address of RPL Holdings Limited is Portcullis TrustNet Chambers, P.O. Box 3444, Road Town, Tortola, British Virgin Islands.

As of March 15, 2016, 480,857,012 of our common shares were issued and outstanding, including 430,504,041 Class A common shares and 50,352,971 Class B common shares (excluding 12,084,305 Class A common shares represented by ADSs that we reserved for issuance upon the exercise of options or the vesting of restricted shares and 892,495 Class A common shares that we repurchased from open market but not cancelled). Based on a review of the register of members maintained by our Cayman Islands registrar, we believe that as of March 15, 2016, 419,592,625 Class A common shares and 7 Class B common shares representing approximately 87.3% of our total outstanding shares were held by two record holders in the United States, which includes 419,592,625 Class A common shares held of record by Deutsche Bank Trust Company Americas, the depositary of our ADS program (including 12,084,305 Class A common shares represented by ADSs that we reserved for issuance upon the exercise of options or the vesting of restricted shares and 892,495 Class A common shares that we repurchased from open market but not cancelled). The number of beneficial owners of our ADSs in the United States is likely to be much larger than the number of record holders of our common shares in the United States. None of our existing shareholders have different voting rights from other shareholders in the same class. See “Item 6. Directors, Senior Management and Employees — B. Compensation of Directors and Executive Officers — Employee Agreements” for a description of the employment agreements we have entered into with our senior executive officers.

Our common shares are divided into Class A common shares and Class B common shares. Holders of Class A common shares are entitled to one vote per share, while holders of Class B common shares are entitled to ten votes per share.

We are not aware of any arrangement that may, at a subsequent date, result in a change of control of our company.

 

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ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

 

A. Major Shareholders

Please refer to “Item 6. Directors, Senior Management and Employees — E. Share Ownership.”

 

B. Related Party Transactions

Contractual Arrangements

PRC laws and regulations currently limit foreign ownership of companies that provide value-added telecommunications services. To comply with PRC laws, we provide our products and services through our contractual arrangements with Beijing Technology and its shareholders.

The following is a summary of the material contracts among our subsidiary, NQ Beijing, our VIE Beijing Technology and its shareholders. We used to control and receive economic benefits from FL Mobile and Wanpu Century via similar contractual arrangements, which were both terminated. Wanpu Century was reorganized as a subsidiary of Xinjiang NQ and FL Mobile was reorganized as a majority owned subsidiary of Xinjiang NQ.

Agreements that Provide Us Effective Control over Beijing Technology

Business Operations Agreement. Pursuant to the business operations agreement dated as of June 5, 2007 and amended and restated as of June 6, 2012, and November 17, 2015, among NQ Beijing, Beijing Technology and the shareholders of Beijing Technology, Beijing Technology must appoint the persons designated by NQ Beijing to be its directors, general manager, chief financial officer and any other senior officers. Beijing Technology agrees to accept the proposal provided by NQ Beijing from time to time relating to employment, daily business and financial management. Without NQ Beijing or its representative’s prior written consent, Beijing Technology shall not conduct any transaction which may materially affect its assets, business, personnel, rights, liabilities or operations. In addition, the shareholders of Beijing Technology irrevocably appointed a person designed by NQ Beijing as their attorney-in-fact to vote on their behalf on all matters of Beijing Technology requiring shareholder approval, including matters relating to the transfer of any or all of their respective equity interests in Beijing Technology, and appointment of the directors, chief executive officer, chief financial officer, and other senior management members of Beijing Technology. They further agree to withdraw such appointment and appoint another person as their power-in-fact per NQ’s request in any time. The shareholders of Beijing Technology agree to transfer any dividends, bonus or any other benefits or interests, which they received as the shareholders of Beijing Technology, to NQ Beijing without any conditions. This agreement is effective until NQ Beijing ceases to exist. NQ Beijing may terminate the agreement at any time by providing 30-day’s advance written notice to Beijing Technology and to each of its shareholders. Neither Beijing Technology nor any of its shareholders may terminate this agreement prior to the expiration date.

Equity Interest Pledge Agreement. Pursuant to the equity interest pledge agreement dated as of August 6, 2007 and amended and re