- Prospectus filed pursuant to Rule 424(b)(4) (424B4)
30 Marzo 2011 - 6:04PM
Edgar (US Regulatory)
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TABLE OF CONTENTS
QIHOO 360 TECHNOLOGY CO. LTD. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Table of Contents
Filed pursuant to Rule 424(b)(4)
Registration No. 333-172816
PROSPECTUS
12,110,800 American Depositary Shares
Qihoo 360 Technology Co. Ltd.
Representing 18,166,200 Class A Ordinary Shares
This is our initial public offering. We are offering 12,110,800 American depositary shares, or ADSs. Every two ADSs represent three of our Class A ordinary
shares. No public market currently exists for our ordinary shares or ADSs.
We
have received approval for listing our ADSs on the New York Stock Exchange under the symbol "QIHU."
Investing in our ADSs involves a high degree of risk. See "Risk Factors" beginning on page 12.
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or
accuracy of this prospectus. Any representation to the contrary is a criminal offense.
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Per ADS
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Total
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Public Offering Price
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$
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14.50
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$
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175,606,600
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Underwriting Discounts and Commissions
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$
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1.015
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$
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12,292,462
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Proceeds, Before Expenses, to Us
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$
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13.485
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$
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163,314,138
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We
have granted the underwriters a 30-day option to purchase up to 1,816,620 additional ADSs from us at the initial public offering price less the underwriting
discounts and commissions.
Upon
the completion of this offering, 51,332,336 Class A ordinary shares and 121,881,034 Class B ordinary shares of our company will be issued and outstanding. Each
Class A ordinary share will be entitled to one vote and each Class B ordinary share will be entitled to five votes on all matters subject to shareholder vote. Accordingly, holders of our
Class A ordinary shares and Class B ordinary shares will hold 7.77% and 92.23% of our aggregate voting power, respectively.
Delivery
of our ADSs will be made on or about April 4, 2011.
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UBS Investment Bank
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Citi
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Stifel Nicolaus Weisel
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Cowen and Company
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The
date of this prospectus is March 29, 2011.
Table of Contents
Table of Contents
TABLE OF CONTENTS
You
should rely only on the information contained in this prospectus or in any related free writing prospectus that we have filed with the SEC. We have not authorized anyone to provide
you with information that is different. If anyone provides you with different or inconsistent information, you should not rely on it. This prospectus may only be used where it is legal to offer and
sell these securities. Unless otherwise indicated, the information in this document may only be accurate as of the date of this document.
We
have not taken any action to permit a public offering of the ADSs outside the United States. Persons outside the United States who come into possession of this
prospectus must inform themselves about and observe any restrictions relating to the offering of the ADSs and the distributions of this prospectus outside the United States.
Through
and including April 23, 2011 (the 25th day after the date of this prospectus), all dealers that effect transactions in these securities, whether or not
participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers' obligation to deliver a prospectus when acting as an underwriter and with respect to their
unsold allotments or subscriptions.
Table of Contents
PROSPECTUS SUMMARY
You should read the following summary together with the entire prospectus, including the more detailed
information regarding us, the ADSs being sold in this offering and our consolidated financial statements and related notes appearing elsewhere in this prospectus. You should consider carefully, among
other things, the matters discussed in the section entitled "Risk Factors." Unless otherwise indicated or the context otherwise requires, all references in this prospectus to "we," "us," "our," and
"our company" are to Qihoo 360 Technology Co. Ltd., its subsidiaries and consolidated entities, collectively. "China" or "PRC" refers to the People's Republic of China, excluding Taiwan, Hong
Kong and Macau; "shares" or "ordinary shares" refers to our ordinary shares, including Class A and Class B ordinary shares; "ADSs" refers to American depositary shares and every two ADSs
represent three Class A ordinary shares; "Renminbi" or "RMB" refers to the legal currency of China; and "$" or "U.S. dollars" refers to the legal currency of the
United States. We commissioned iResearch Consulting Group, or iResearch, and Horizon Research and Consulting Group, or Horizon, market research firms in China, to prepare reports for the
purpose of providing various industry and other information and illustrating our position in the Internet and mobile security products and services market in China. Information from these reports
appears in the "Prospectus Summary," "Industry," "Business" and other sections of this prospectus.
Overview
We are the No. 3 Internet company in China as measured by user base, according to a report we commissioned from iResearch. In
January 2011, we had 339 million monthly active Internet users, representing a user penetration rate of 85.8% in China, according to iResearch. Recognizing security as a fundamental need
of Internet and mobile users, we offer comprehensive high-quality Internet and mobile security products free of charge, providing users with secure access points to Internet activities. As
a result, we have amassed a large and loyal user base, which we monetize primarily through offering online advertising and Internet value-added services.
We
are also the No. 1 provider of Internet and mobile security products in China as measured by user base, according to iReseach. In January 2011, we had 328 million
monthly active Internet security product users, representing a user penetration rate of 83.9% in China, according to iResearch. Our core Internet and mobile security products
include:
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360 Safe Guard and 360 Anti-virus, the No. 1 and No. 2 Internet security products
in China, with 301 million and 248 million monthly active users in January 2011, respectively, according to iResearch;
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360 Mobile Safe, the No. 1 mobile security product in China, with a market share of 58.2% as measured by the
number of active users in January 2011, according to iResearch.
On
top of our core layer of Internet and mobile security product offerings, we have further developed various platform products to meet a full spectrum of security related needs of
Internet users and create trusted access points to Internet activities. Our platform products include:
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360 Safe Browser, the No. 2 web browser in China, only after Microsoft Internet Explorer, with 172 million
monthly active users and a user penetration rate of 44.1% in China in January 2011, according to iResearch;
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360 Personal Start-up Page, the default homepage of 360 Safe Browser and a key access point to popular and
preferred information and applications, with 98 million monthly active users in China in January 2011, according to iResearch;
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360 Application Store, a key access point to securely obtain and manage software and applications; and
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360 Safebox, a solution that protects users against thefts of personal account information.
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Leveraging
our large user base, we are developing open platforms on which third-party Internet product and service providers, such as web game developers, e-commerce websites
and software and application developers, offer their products and services. These open platforms allow us to effectively monetize our large user base through revenue sharing arrangements with third
parties. For example, our open platform for web games enables our users to access web games provided by over 30 web game developers using their 360 accounts, and our open platform for
group-buy provides users with daily updated deal information from over 200 group-buy websites. Our open platforms enable our users to securely access a wide variety of
products and services, which in turn enhances our users' experience and loyalty and further grows our user base.
Our
products and services are supported by our cloud-based security technology, which we believe is one of the most advanced and robust technologies in the Internet security industry.
Our cloud-based security technology enables us to continuously update and enhance our capabilities to detect Internet security threats on a real-time basis. By utilizing this cloud
architecture, we believe we are able to offer superior performance through reduced usage of user computing resources, particularly in comparison to traditional anti-virus software. As the
effectiveness of our cloud-based security technology increases with the size of our user cloud, growth of our user base enhances our malware detection capabilities, which in turn helps us to attract
even more users.
We
have been able to leverage our large user base and our strong brand recognition to grow our paying customer base. We generate revenues primarily through offering the following
services:
-
-
Online advertising.
We offer advertising services by
providing marketing opportunities on our websites and secure platform products to our advertising customers. We also offer search referral services to search engine companies.
-
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Internet value-added services.
We offer web games
developed by third parties, provide Internet security services such as remote technical support to paying customers and provide other Internet value-added services.
We
have grown significantly since we commenced operations in 2005. Our monthly active Internet users increased from 122 million in December 2008 to 231 million in
December 2009 and 339 million in January 2011. Our revenue was $16.9 million, $32.3 million and $57.7 million, respectively, in 2008, 2009 and 2010,
representing a CAGR of 84.8%. We first became profitable in 2009 and our net income increased by 102.7% from $4.2 million in 2009 to $8.5 million in 2010.
Industry Background
With rapidly increasing broadband penetration in China, Internet usage in China has been on the rise in recent years. According to
iResearch, the number of Internet users in China grew from 137 million in 2006 to 457 million in 2010, representing a CAGR of 35.2%, and is expected to grow to 667 million in
2013. Users are also increasingly conducting Internet activities through mobile devices, including mobile-banking, mobile-commerce, mobile-gaming and mobile social networking, among others. According
to iResearch, the number of mobile Internet users in China increased from 17 million in 2006 to 303 million in 2010, representing a CAGR of 105.3%, and is expected to grow further to
reach 658 million by the end of 2013.
Users'
growing reliance on the Internet and the increasing exchange of personal information and virtual assets over the Internet through various devices have created strong incentives
for hackers to develop malware to profit from exploiting these confidential data. According to iResearch, the largest number of malware samples collected by a single Internet security provider in
China increased dramatically from approximately 538,000 in 2006 to over 650 million in 2010. This has led to a strong and growing adoption of Internet and mobile security solution in
China. According to iResearch, the number of Internet security users in China reached 394 million in 2010, an increase from 89 million in
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2006,
representing a CAGR of 45.0%, and is expected to grow further to reach 559 million by 2013. The accumulated number of activated users of mobile security products is expected to grow from
27 million in 2009 to reach 254 million by 2012.
The
growing complexity of threats, and increasing focus on terminal-end processing performance, particularly for processor and power-constrained mobile devices, have resulted
in an increasing demand among users for a pan-security solution covering system protection, privacy protection, and performance optimization across devices. Traditional
anti-virus technologies are no longer sufficient in safeguarding users against the rapid proliferation and evolution of security threats, and cloud-based security technology has emerged as
a superior Internet security solution.
Strengths and Strategies
We believe the following strengths have contributed to our success and differentiate us from our
competitors:
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largest user base of Internet and mobile security products and services in China;
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innovative pan-security solutions creating secure Internet access points;
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strong monetization potential through open platforms;
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leading Internet and mobile security brand in China;
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leading cloud-based Internet technologies and strong R&D capabilities creating high entry barriers; and
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seasoned management team with extensive industry knowledge and proven execution capabilities.
Our
goal is to enhance our position as the largest Internet and mobile security product and service provider and a leading Internet company in China and ultimately become a leading
Internet company globally. To achieve our goal, we intend to:
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continue to expand product and service offerings to grow user base and promote brand recognition and loyalty;
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further monetize our large user base through open platforms;
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continue to focus on R&D to enhance cloud-based Internet and mobile security technologies;
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capitalize on the fast growing mobile Internet market;
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selectively pursue international business expansion; and
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strengthen existing and build new strategic alliances and selectively pursue investments and acquisitions.
Challenges and Risks
The successful execution of our strategies is subject to certain challenges and risks that may materially affect
us, including:
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our ability to continue to innovate and provide attractive products and services to attract and retain users;
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our ability to keep up with rapid changes in technologies and Internet-enabled devices;
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our ability to leverage our user base to attract customers for our revenue-generating services;
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our dependence on online advertising for a substantial portion of our revenues; and
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-
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our ability to compete effectively.
Please
see "Risk Factors" and other information included in this prospectus for a detailed discussion of these challenges and risks.
Corporate History and Structure
In 2005, Mr. Xiangdong Qi, our director and president, founded our business, which originally focused on user generated content
search and aggregation. Mr. Hongyi Zhou, our chairman and chief executive officer, joined us in August 2006, and together with Mr. Qi, reshaped our primary business. In
July 2006, we launched 360 Safe Guard, our first Internet security product that protects users against malware, and entered the Internet security market.
We
were incorporated in the Cayman Islands as an exempted limited liability company on June 9, 2005. On December 31, 2010, we changed our name from Qihoo Technology
Company Limited to Qihoo 360 Technology Co. Ltd., or Qihoo 360. We conduct our business operations in China through our wholly-owned subsidiaries and affiliated entities.
We formed a wholly-owned subsidiary, Qizhi Software (Beijing) Co., Ltd., or Qizhi Software, one of our primary operating entities, in China in December 2005.
In
November 2010, we formed three Hong Kong subsidiaries that we expect to become intermediate holding companies for our operations in China: Qiji International Development
Limited, or Qiji International, 360 International Development Co. Limited, or 360 International, and Qifei International Development Co. Limited, or Qifei International.
Qiji International, 360 International and Qifei International are all wholly-owned by Qihoo 360.
The
following diagram illustrates our corporate structure as of the date of this prospectus:
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Corporate Information
Our principal executive offices are located at Block 1, Area D, Huitong Times Plaza, No. 71 Jianguo Road, Chaoyang
District, Beijing 100025, People's Republic of China. Our telephone number is +86 10 5878 1000 and our fax number is +86 10 5878 1001. Our registered address in the Cayman Islands is located at the
offices of 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
Corporation Service Company, 1180 Avenue of the Americas, Suite 210, New York, New York 10036-8401.
Investors
should contact us for any inquiries through the address and telephone number of our principal executive offices. Our corporate website address is
www.360.cn
. The information contained on our website is
not a part of this prospectus.
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Table of Contents
The Offering
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ADSs offered by us
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12,110,800 ADSs.
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Concurrent Private Placement
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In conjunction with, and subject to, the closing of this offering, affiliates of certain of our existing shareholders, or the private placement investors, have agreed to purchase an aggregate
$50 million of our Class A ordinary shares in the form of restricted ADSs at the initial public offering price of $14.50 per ADS for this offering for an aggregate of 5,172,414 Class A ordinary shares. This investment is being
made pursuant to an offer exempt from registration with the SEC pursuant to Regulation S and Section 4(2) of the Securities Act. In connection with this investment, we have agreed to (i) pay a placement fee equal to 7% of the aggregate
purchase price for the investment to UBS AG and Citigroup Global Markets Inc. as the placement agents and (ii) grant these private placement investors the registration rights as described under "Description of Share
Capital Registration Rights in Connection with Concurrent Private Placement." See "UnderwritingConcurrent Private Placement."
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ADSs outstanding immediately after this offering
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12,110,800 ADSs, or 13,927,420 ADSs if the underwriters exercise their option to purchase additional ADSs in full, excluding 3,448,276 restricted ADSs sold in the concurrent private placement
which will be subject to resale restrictions and will not be immediately fungible with the ADSs sold in this offering.
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Ordinary shares outstanding immediately after this offering
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After giving effect to the concurrent private placement, 173,213,370 ordinary shares (or 175,938,300 ordinary shares if the underwriters exercise their overallotment option in full), consisting
of (i) 51,332,336 Class A ordinary shares (or 54,057,266 Class A ordinary shares if the underwriters exercise their over-allotment option in full), which includes 5,172,414 Class A ordinary shares issued in the form of restricted
ADSs in connection with the concurrent private placement, and (ii) 121,881,034 Class B ordinary shares.
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Holders of Class A ordinary shares and Class B ordinary shares have the same rights except for voting and conversion rights. In respect of matters requiring shareholders' vote, each Class A
ordinary share is entitled to one vote and each Class B ordinary share is entitled to five votes. Each Class B ordinary share is convertible into one Class A ordinary share at any time by the holder thereof. Class A ordinary
shares are not convertible into Class B ordinary shares under any circumstances. Upon any sale, pledge, transfer, assignment or disposition of Class B ordinary shares by a holder thereof to any person or entity that is not an affiliate of
such holder, such Class B ordinary shares shall be automatically and immediately converted into the equal number of Class A ordinary shares.
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ADSs
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Every two ADSs represent three Class A ordinary shares. The ADSs may be evidenced by American depositary receipts, or ADRs.
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The depositary will hold the Class A ordinary shares underlying the ADSs and you will have the rights of an ADS holder as provided in the deposit agreement among us, the depositary and holders of
ADSs from time to time.
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You may surrender your ADSs to the depositary to withdraw the Class A ordinary shares underlying your ADSs. The depositary will charge you a fee for such an exchange.
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We may amend or terminate the deposit agreement for any reason without your consent. If an amendment becomes effective, you will be bound by the deposit agreement as amended if you continue to hold
your ADSs.
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To better understand the terms of the ADSs, you should carefully read the section in this prospectus entitled "Description of American Depositary Shares." You should also read the deposit agreement,
which is an exhibit to the registration statement that includes this prospectus.
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Use of proceeds
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We estimate that we will receive net proceeds of approximately $206.5 million from this offering and from our concurrent private placement (or $231.0 million if the underwriters
exercise their option to purchase additional ADSs in full) based upon the initial public offering price of $14.50 per ADS, after deducting underwriting discounts and commissions. We intend to use the net proceeds from this offering for the
following purposes:
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approximately $61.9 million for
development of new Internet and mobile security products and services;
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approximately $61.9 million for
enhancement of our research and development capability to further develop technologies;
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approximately $31.0 million for
investment in and acquisition of technologies, products or businesses; and
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the balance for general corporate
purposes.
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New York Stock Exchange Trading Symbol
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QIHU
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Depositary
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The Bank of New York Mellon
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Lock-up
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Each of our directors, executive officers, existing shareholders and private placement investors has agreed, subject to some exceptions, not to transfer or dispose of, directly or indirectly, any of
our ordinary shares, in the form of ADSs or otherwise, or any securities convertible into or exchangeable or exercisable for our ordinary shares, in the form of ADSs or otherwise, for a period of 180 days after the date this
prospectus.
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The
number of ordinary shares outstanding after this offering:
-
-
is based on 149,874,756 shares outstanding as of the date of this prospectus, assuming the conversion of all outstanding
preferred shares into 78,314,016 ordinary shares upon the closing of this offering; and
-
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excludes 11,047,650 ordinary shares issuable upon the exercise of options to purchase ordinary shares outstanding as of
the date of this prospectus with exercise prices ranging from $1.50 to $6.0 per share and a weighted average exercise price of $3.87 per share.
Unless
otherwise indicated, all information in this prospectus assumes no exercise by the underwriters of their option to purchase up to 2,724,930 Class A ordinary shares in the
form of ADSs in this offering.
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SUMMARY CONSOLIDATED FINANCIAL INFORMATION AND OPERATING DATA
You should read the summary consolidated financial information and other data in conjunction with our financial statements, the related
notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this prospectus. Our summary consolidated statement of operations data for the
years ended December 31, 2008, 2009 and 2010 and summary consolidated balance sheet data as of December 31, 2009 and 2010 have been derived from our audited consolidated financial
statements included elsewhere in this prospectus. The summary consolidated balance sheet data as of December 31, 2008 have been derived from our audited financial statements not included in
this prospectus. Our consolidated financial statements have been prepared and presented in accordance with accounting principles generally accepted in the United States, or U.S. GAAP.
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Year Ended December 31,
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2008
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2009
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2010
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($ in thousands, except share and per share data)
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Statement of Operations Data:
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Revenues:
|
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|
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|
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Internet services
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5,795
|
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16,010
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53,790
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Sales of third party anti-virus software
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11,100
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16,292
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3,875
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Total revenues
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16,895
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32,302
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57,665
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Cost of revenues:
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|
|
|
|
|
|
|
|
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Internet services
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|
|
1,147
|
|
|
1,790
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|
|
5,566
|
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Sales of third party anti-virus software
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|
|
7,073
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|
|
6,600
|
|
|
1,185
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|
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|
|
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Total cost of revenues
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|
|
8,220
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|
|
8,390
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|
|
6,751
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|
|
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|
|
|
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|
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Subsidy income
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|
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|
|
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266
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|
Operating expenses:
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|
|
|
|
|
|
|
|
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Selling and marketing
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2,732
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|
|
6,256
|
|
|
12,603
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General and administrative
|
|
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1,645
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|
|
2,531
|
|
|
5,051
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Research and development
|
|
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7,283
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|
|
10,664
|
|
|
24,505
|
|
|
|
|
|
|
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Total operating expenses
|
|
|
11,660
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|
|
19,451
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|
|
42,159
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|
|
|
|
|
|
|
|
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(Loss) income from operations
|
|
|
(2,985
|
)
|
|
4,461
|
|
|
9,021
|
|
Interest income
|
|
|
616
|
|
|
281
|
|
|
415
|
|
Interest expense
|
|
|
(32
|
)
|
|
(169
|
)
|
|
(98
|
)
|
Other expense
|
|
|
(164
|
)
|
|
|
|
|
(60
|
)
|
Exchange (loss) gain
|
|
|
(360
|
)
|
|
28
|
|
|
(267
|
)
|
|
|
|
|
|
|
|
|
(Loss) income before income tax benefit (expense) and loss from equity method investment
|
|
|
(2,925
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)
|
|
4,601
|
|
|
9,011
|
|
Income tax benefit (expense)
|
|
|
179
|
|
|
(412
|
)
|
|
(463
|
)
|
Loss from equity method investment
|
|
|
|
|
|
|
|
|
(57
|
)
|
|
|
|
|
|
|
|
|
Net (loss) income
|
|
|
(2,746
|
)
|
|
4,189
|
|
|
8,491
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|
Less: Net loss attributable to noncontrolling interest
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|
|
|
|
|
|
|
|
17
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|
|
|
|
|
|
|
|
|
Net (loss) income attributable to Qihoo 360 Technology Co. Ltd.
|
|
|
(2,746
|
)
|
|
4,189
|
|
|
8,508
|
|
|
|
|
|
|
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Year Ended December 31,
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2008
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2009
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2010
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($ in thousands, except share and per share data)
|
|
Accretion of Series A convertible participating redeemable preferred shares
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|
815
|
|
|
815
|
|
|
815
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Accretion of Series B convertible participating redeemable preferred shares
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|
|
1,250
|
|
|
1,250
|
|
|
1,250
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|
Accretion of Series C convertible participating redeemable preferred share
|
|
|
|
|
|
|
|
|
978
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|
|
|
|
|
|
|
|
|
Net (loss) income attributable to ordinary shareholders of Qihoo 360 Technology Co. Ltd.
|
|
|
(4,811
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)
|
|
2,124
|
|
|
5,465
|
|
|
|
|
|
|
|
|
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Net (loss) income per ordinary sharebasic
|
|
|
(0.07
|
)
|
|
0.03
|
|
|
0.05
|
|
Net (loss) income per participating unvested sharebasic
|
|
|
(0.07
|
)
|
|
0.03
|
|
|
0.05
|
|
Net income per Series A convertible participating redeemable preferred sharebasic
|
|
|
0.02
|
|
|
0.03
|
|
|
0.06
|
|
Net income per Series B convertible participating redeemable preferred sharebasic
|
|
|
0.03
|
|
|
0.03
|
|
|
0.06
|
|
Net income per Series C convertible participating redeemable preferred sharebasic
|
|
|
N/A
|
|
|
N/A
|
|
|
0.13
|
|
|
|
|
|
|
|
|
|
Net (loss) income per ordinary sharediluted
|
|
|
(0.07
|
)
|
|
0.03
|
|
|
0.05
|
|
|
|
|
|
|
|
|
|
Weighted average shares used in calculating net income per ordinary sharebasic
|
|
|
48,969,589
|
|
|
51,780,932
|
|
|
55,568,041
|
|
Weighted average shares used in calculating net income per participating unvested sharebasic
|
|
|
16,370,371
|
|
|
13,559,028
|
|
|
15,782,530
|
|
Weighted average shares used in calculating net income per Series A convertible participating redeemable preferred sharebasic
|
|
|
32,603,760
|
|
|
32,603,760
|
|
|
32,603,760
|
|
Weighted average shares used in calculating net income per Series B convertible participating redeemable preferred sharebasic
|
|
|
37,878,789
|
|
|
37,878,789
|
|
|
37,878,789
|
|
Weighted average shares used in calculating net income per Series C convertible participating redeemable preferred sharebasic
|
|
|
|
|
|
|
|
|
7,659,818
|
|
Weighted average shares used in calculating net income per ordinary sharediluted
|
|
|
65,339,960
|
|
|
65,339,960
|
|
|
71,350,571
|
|
|
|
|
|
|
|
|
|
Share-based compensation expense included in:
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing
|
|
|
226
|
|
|
479
|
|
|
524
|
|
|
General and administrative
|
|
|
104
|
|
|
151
|
|
|
337
|
|
|
Research and development
|
|
|
923
|
|
|
1,294
|
|
|
3,145
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
1,253
|
|
|
1,924
|
|
|
4,006
|
|
|
|
|
|
|
|
|
|
10
Table of Contents
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
2008
|
|
2009
|
|
2010
|
|
2010
|
|
|
|
Actual
|
|
Actual
|
|
Actual
|
|
Pro Forma As
Adjusted
(1)
|
|
|
|
($ in thousands)
|
|
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
|
23,262
|
|
|
28,144
|
|
|
60,505
|
|
|
266,968
|
|
Total assets
|
|
|
33,943
|
|
|
49,589
|
|
|
87,808
|
|
|
294,271
|
|
Total current liabilities
|
|
|
1,987
|
|
|
8,489
|
|
|
13,924
|
|
|
13,924
|
|
Total liabilities
|
|
|
4,948
|
|
|
10,935
|
|
|
14,886
|
|
|
14,886
|
|
Total (deficit) equity
|
|
|
(16,175
|
)
|
|
(8,581
|
)
|
|
2,722
|
|
|
279,385
|
|
-
(1)
-
Pro forma
as adjusted to give effect to:
-
-
the automatic conversion of all of our outstanding Series A, Series B and Series C convertible
participating redeemable preferred shares into 78,314,016 ordinary shares upon the closing of this offering; and
-
-
the issuance and sale of 23,338,614 Class A ordinary shares in the form of ADSs by us in this offering and in our
concurrent private placement at the initial public offering price of $14.50 per ADS, after deducting estimated underwriting discounts, commissions and estimated offering expenses payable by us.
The
following table shows the monthly active users for our primary security products and platform products, both in an absolute number and as a percentage of the then total Internet
users in China as reported by iResearch:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Monthly Active Users of:
|
|
December 2008
|
|
December 2009
|
|
January 2011
|
|
|
|
(in millions, except percentages)
|
|
360 Safe Guard
|
|
|
116
|
|
|
60.9
|
%
|
|
216
|
|
|
72.8
|
%
|
|
301
|
|
|
76.9
|
%
|
360 Anti-Virus
|
|
|
2
|
|
|
0.9
|
%
|
|
87
|
|
|
29.3
|
%
|
|
248
|
|
|
63.5
|
%
|
360 Safe Browser
|
|
|
18
|
|
|
9.4
|
%
|
|
106
|
|
|
35.8
|
%
|
|
172
|
|
|
44.1
|
%
|
360 security products
|
|
|
119
|
|
|
62.8
|
%
|
|
225
|
|
|
75.9
|
%
|
|
328
|
|
|
83.9
|
%
|
11
Table of Contents
RISK FACTORS
You should carefully consider all of the information in this prospectus, including the risks and uncertainties
described below, before you decide to buy our ADSs. Any of the following risks could materially adversely affect our business, prospects, financial condition and results of operations. As a result,
the trading price of our ADSs could decline, and you could lose all or part of your investment.
Risks Related to Our Business
If we fail to continue to innovate and provide attractive products and services to attract and retain users, the effectiveness of our cloud-based security technology may be
adversely affected and we may lose customers for our revenue generating services.
Our success depends on our ability to continue to provide attractive products and services that enable users to have a secure and
high-quality Internet experience. In order to attract and retain users and compete against our competitors, we must continue to invest significant resources in research and development to
enhance our Internet security technology, improve our existing products and services, introduce additional high-quality products and services and enhance user experience. We may not be
able to expand our user base if our products and services do not meet the needs of our users or are not effectively or timely brought to market. If we are unable to anticipate user preferences or
industry changes, or if we are unable to modify our products and services on a timely basis, our user base may not increase at the expected rate, if at all, or even decrease. As our cloud-based
security technology increases with the size of our user cloud, growth of our user base enhances our malware detection capabilities. If we fail to innovate and provide attractive products and services
to attract and retain users, the effectiveness of our cloud-based security technology may be adversely affected. Users may not choose to use our Internet security products and services if our
technology is ineffective, and customers may not choose to use our online advertising and Internet value-added services if our user base does not grow. As Internet security technology continues to
develop, our competitors may be able to offer Internet security products and services that are, or are perceived to be, substantially similar to or better than our own. This may force us to expend
significant resources in order to remain competitive.
If we fail to keep up with rapid changes in technologies and Internet-enabled devices, our business may be adversely affected.
The Internet security industry is characterized by rapid technological changes. Our future success will depend on our ability to
respond to rapidly changing technologies, adapt our services to evolving industry standards and improve the performance and reliability of our products and services. Our failure to adapt to such
changes could harm our business. In addition, changes in Internet-enabled devices resulting from technological development may also adversely affect our business. For example, the number of people
accessing the Internet through devices other than personal computers, including mobile phones and other hand-held devices, has increased in recent years. In 2009, we began to offer mobile
security products and services in response to this market trend. However, if we are slow to develop products and services that are compatible with mobile devices, or if the products and services we
develop are not widely accepted and used by mobile device users, we may not be able to capture a significant share of this increasingly important market. In addition, the widespread adoption of new
Internet, networking or telecommunications technologies or other technological changes could require substantial expenditures to modify or adapt our products, services or infrastructure. If we fail to
keep up with rapid technological changes to remain competitive, our future success may be adversely affected.
12
Table of Contents
If we fail to leverage our user base to attract customers for our revenue-generating services, our results of operations and growth prospects could be harmed.
We generate revenues primarily through online advertising and Internet value-added services, such as the offering of web games and the
offering of remote technical support to our paying customers. The attractiveness of our online advertising and Internet value-added services largely depends on our ability to maintain and expand our
user base, which in turn requires us to continuously invest significant resources in providing Internet and mobile security products and services that retain and attract users. We plan to make
significant investments in developing and offering Internet security products and services. However, we cannot assure you that our investments will maintain or expand our user base or that our user
base will successfully attract customers for our revenue-generating services. If we fail to leverage our user base to promote sales to such users or attract paying customers, our business, results of
operations and growth prospects could be seriously harmed.
Legal proceedings or allegations of impropriety against us or our management could have a material adverse impact on our reputation, results of operation, financial
condition and liquidity.
From time to time, we have been, and may be in the future, subject to lawsuits or allegations brought by our competitors, individuals
or other entities against us or our management, including claims of unfair, unethical or otherwise inappropriate business practices. Certain key members of our management team have also been in the
past alleged to have committed wrong doings in their prior business affiliations. Any such lawsuit or allegation, with or without merit, or any perceived unfair, unethical or inappropriate business
practice by us or perceived wrong doing by any key member of our management team could harm our reputation and user base and distract our management from day-to-day operations of our company. We are
currently involved in several lawsuits in PRC courts where our competitors and an individual instituted proceedings or asserted counterclaims against us or we instituted proceedings or asserted
counterclaims against our competitors for unfair competition practices, defamation or breach of contract. See "BusinessLegal Proceedings." We cannot assure you that we or key members of
our management team will not be subject to lawsuits or allegations of similar nature in the future. Where we can make a reasonable estimate of the liability relating to pending litigation and
determine that an adverse liability resulting from such litigation is probable, we record a related contingent liability. As additional information becomes available, we assess the potential liability
and revise estimates as appropriate. In 2008, 2009 and 2010, we did not record any contingency liability relating to pending litigation. However, when we record or revise our estimates of the
contingent liability in the future, the amount of our estimates may be inaccurate due to the inherent uncertainties relating to litigation. In addition, the outcomes of actions we institute against
our competitors may not be successful or favorable to us. These litigations and allegations may also generate negative publicity that significantly harms our reputation, which may materially and
adversely affect our user base and the number of our paying customers. In addition to the related cost, managing and defending litigation and related indemnity obligations can significantly divert
management's and the board of directors' attention from operating our business. We may also need to pay damages or settle the litigation with a substantial amount of cash. All of these could have a
material adverse impact on our business, results of operation and cash flows.
We generate a substantial portion of our revenues from online advertising. If we fail to retain existing customers or attract new customers for our online advertising
services, our business, results of operations and growth prospects could be seriously harmed.
In the three years ended December 31, 2010, online advertising services accounted for 33.2%, 43.1% and 67.3% of our total
revenues, respectively. Our online advertising customers include, among others, third-party websites who pay us for displaying their links on our websites or our secure platform products and search
engines who pay us fees for directing searches from our 360 Safe Browser and
13
Table of Contents
360 Personal
Start-up Page. Our online advertising customers may not continue to do business with us if their investment does not generate sales leads and ultimately customers. If we fail to
retain existing
customers or attract new customers for our online advertising services, our business, results of operations and growth prospects could be seriously harmed.
Our dependence on a single customer for a substantial portion of our revenues may cause significant fluctuations or declines in our revenues.
Google Ireland Limited, or Google, was our largest customer in 2009 and 2010. Revenues from Google in 2009 and 2010 amounted to 11.2%
and 21.1% of our total revenues, respectively. We have entered into two one-year linking agreements with Google, under which we agree to direct search queries from the users of
360 Safe Browser and 360 Personal Start-up Page to Google for processing and Google agrees to pay us fees based on the referral traffic directed by us up to a pre-determined
limit. These linking agreements are renewable upon written agreement of both parties. Google has the right to terminate the two agreements without cause with a 30-day written notice. We
anticipate that our dependence on Google will continue for the foreseeable future. Consequently, any of the following events may cause material fluctuations or declines in
our revenues:
-
-
reduced, delayed or cancelled services required by Google;
-
-
Google's failure to pay for our services; and
-
-
Google's cessation of services in China.
In
addition, because we depend on Google for a substantial portion of our revenue, if Google ceases to do business with us for any reason, we may not be able to secure such alternative
source of revenues with similar terms in a timely manner, or at all, which may materially and adversely affect our business, results of operations and growth prospects.
We face significant competition and may suffer from a loss of users and customers as a result.
We face significant competition from Internet security product and service providers and PRC-based Internet companies. The
competitive standing of an Internet security market player in China largely depends on the technological reputation of its brand, the size of its user base, its technological expertise, the
effectiveness of its security software as well as its business model. We compete in the Internet security market with established anti-virus companies such as Beijing Kingsoft Security
Software Co., Ltd., or Kingsoft, and Beijing Rising Information Technology Co., Ltd., or Rising. According to iResearch, as of January 31, 2011, the Internet
security software developed by Kingsoft and Rising were used by 14.6% and 11.0% of the Internet users in China, respectively. We also compete with PRC-based Internet companies that offer
similar value-added and online advertising services as we do. Our primary competitor in this market is Tencent Holdings Limited, or Tencent, the largest instant messaging service provider in China. In
January 2011, Tencent's instant message software had a monthly active user penetration rate in China of 89.3%, while our 360 Safe Guard had a monthly active user penetration rate in China of
76.9% of Internet users in China, according to iResearch. See "BusinessCompetition" for description of our principal competitors in each of our product and services categories. Some of
our competitors have significantly greater financial resources than we do. They also have longer operating histories and more experience in attracting and retaining users and managing customers than
we do. They may use their experience and resources to compete with us in a variety of ways, including by competing more intensely for users and customers, investing more heavily in research and
development and making strategic acquisitions. If any of our competitors provides better Internet security products and services than we do, our user base and user traffic could decline significantly.
Any such decline could weaken our brand, result in loss of users and customers and have a material adverse effect on our results of operations.
14
Table of Contents
Furthermore,
in an increasingly competitive environment, our competitors may adopt business practices or take other actions that could be harmful to us, and we may have difficulties in
obtaining remedies against such actions. Any increase in competition could erode our market share, reduce our user base and customer base, and increase our marketing and research and development
expenditures, which could adversely materially affect our business, financial condition and operating results.
Our competitors may cause their products to be incompatible with ours, which may reduce our market share.
As two of the largest providers of user-end software in China, we and Tencent may from time to time compete for users. On
November 3, 2010, Tencent issued a letter to users of Tencent QQ, Tencent's popular instant message software, announcing its decision to disable the widely used Tencent QQ on computers
that had installed our security products, effectively requiring users to either stop using Tencent QQ or uninstall our Internet security products. As a result, a significant number of users
stopped using Tencent QQ, or our Internet security products, or both. Due to the large number of Internet users that were affected, this incident was extensively reported in the media and
attracted government scrutiny. On November 21, 2010, the Ministry of Industry and Information Technology, or the MIIT, ordered that Tencent and we end the dispute, apologize to affected users
and ensure the compatibility of products concerned. We lost some users in the first several days of this dispute before our user base quickly returned to its prior level. Although the MIIT required us
to ensure the compatibility of the relevant products, similar events may occur in the future, which may reduce our market share, negatively affect our brand and reputation and materially and adversely
affect our business, results of operations or financial condition.
If our expansion into new Internet businesses and overseas markets is not successful, our future results of operations and growth prospects may be materially and adversely
affected.
As part of our growth strategy, we enter into new Internet businesses from time to time by leveraging our expansive user base to
generate additional revenue streams. We may also expand into overseas markets through investment or strategic alliances with local market participants. Expansions into new businesses and new markets
may present operating and marketing challenges that are different from those that we currently encounter. For each new business or markets we enter into, we face competition from existing leading
providers in that business or market. If we cannot successfully address the new challenges and compete effectively against the existing leading players in the new businesses or markets, we may not be
able to develop a sufficiently large customer and user base, recover costs incurred for marketing new businesses or developing new markets, and eventually achieve profitability from these businesses
or markets, and our future results of operations and growth prospects may be materially and adversely affected.
Our business depends on a strong brand and reputation, and if we are not able to maintain and enhance our brand or reputation or if there is negative publicity against us,
our business and operating results may be harmed.
We believe that our "360" brand and our reputation have contributed significantly to the success of our business. We also believe that
maintaining and enhancing the "360" brand and our reputation are critical to increasing our number of users and customers. As our market becomes increasingly competitive, our success in maintaining
and enhancing our brand and reputation
will depend largely on our ability to remain as a leading provider of Internet and mobile security products and services in China, which may become more expensive and challenging.
Historically,
we have developed our user base primarily by word-of-mouth and incurred limited brand promotion expenses. We began enhancing marketing and brand
promotion efforts in early 2010. However, we cannot assure you that our marketing and brand promotion activities in the future will achieve the expected brand promotion effect. If we fail to maintain
and further promote the "360"
15
Table of Contents
brand
or our reputation, or if we incur excessive expenses in this effort, our business and results of operations may be materially and adversely affected. In addition, historically there has been
negative publicity about our company, our products and services and certain key members of our management team. We cannot assure you that there will not be additional negative publicity of the similar
nature in the future. Any such negative publicity, regardless of its veracity, could harm our brand image and reputation and in turn adversely affect our business and operating results.
The success of our Internet value-added services depends on our ability to accommodate user demand and source suitable third-party products and services.
We have derived, and expect to continue to derive, a substantial portion of our revenues from our Internet value-added services, such
as offering web games developed by third parties. The success of our Internet value-added services depends on our ability to respond adequately and timely to accommodate our users' demand for such
value-added services and source suitable third-party products and services on reasonable terms. If we are unable to continue to offer a variety of suitable value-added services that attract users and
generate revenue, our financial condition and operating results may be materially adversely affected.
If our products and services fail to detect malware or malicious websites or otherwise do not work properly, we may experience negative publicity, damage to our reputation,
legal liability, declined revenues and increased expenses.
Our users rely on our Internet security products and services for safe access to the Internet. New malware and malicious websites are
continuously being created and modified, and the detection technologies underlying our products and services may not detect all forms of malware or malicious websites that our users are exposed to.
Additionally, our users may experience errors, failures, or bugs in our products that are undetected by our pre-launch testing, especially when our products and services are first
introduced or when new updates are first released. Failure to detect malware or malicious websites or defects in our products may result in security
breaches, disruption or damage to our users' computers or networks and theft of confidential information or other negative consequences. Any such event may damage our brand reputation, decrease our
user and customer base, require large research and development and marketing expenditures to remedy and may otherwise significantly affect our business and results of operations.
Furthermore,
our Internet security products and services may falsely identify programs or websites as malicious or otherwise undesirable. Parties whose programs are incorrectly blocked
by our products or services, or whose websites are incorrectly identified as unsafe or malicious, may seek redress against us for labeling them as malicious and interfering with their businesses. In
addition, falsely identifying programs or websites as malicious may adversely affect our users' confidence and trust in our products and decrease our user base.
We may not be able to manage our expanding operations effectively.
We have significantly expanded our operations in recent years. Since our inception in 2005, we have expanded our product offering into
a comprehensive suite of Internet and mobile security products and services and have rapidly established a leading position in the Chinese Internet and mobile security service market. We expect this
expansion to continue as we grow our user and customer base and explore new opportunities. To manage the further expansion of our business and growth of our operations and personnel, we need to
continuously improve our operational and financial systems, procedures and controls, and expand, train, manage and maintain good relations with our growing employee base. In addition, we must maintain
and expand our relationships with other websites, Internet companies and third parties. Our current and future personnel, systems, procedures and
16
Table of Contents
controls
may not be adequate to support our expanding operations. If we fail to manage our expansion effectively, our business, results of operations and prospects may be materially and adversely
affected.
Our limited operating history makes it difficult to evaluate our future prospects and results of operations.
We have a limited operating history under our current business model upon which you can evaluate the viability and sustainability of
our business. Accordingly, you should consider our future prospects in light of the risks and uncertainties experienced by early stage companies in evolving industries such as the Internet security
industry in China. Some of these risks and uncertainties relate to our ability to:
-
-
maintain our leading position in the Internet security market in China;
-
-
continue to offer new and innovative products and services to attract and retain a larger user base;
-
-
attract additional customers and increase spending per customer;
-
-
increase awareness of our brand and continue to enhance user and customer loyalty;
-
-
respond to competitive market conditions;
-
-
respond to changes in our regulatory environment;
-
-
manage risks associated with intellectual property rights;
-
-
maintain effective control of our costs and expenses;
-
-
raise sufficient capital to sustain and expand our business;
-
-
attract, retain and motivate qualified personnel; and
-
-
upgrade our technology and infrastructure to support increased traffic and expanded offerings of products
and services.
If
we are unsuccessful in addressing any of these risks and uncertainties, our business may be materially and adversely affected.
Interruption or failure of our own information technology and communications systems or those of third-party service providers we rely upon could impair our ability to
effectively provide our products and services, which could damage our reputation and harm our operating results.
Our ability to provide our products and services depends on the continuing operation of our information technology and communications
systems. Any damage to or failure of our systems could affect the performance and reliability of our Internet security products and services and directly impact our users. Service interruptions may
damage our brand and reduce our user base if our products and services are perceived to be unreliable. Our systems are vulnerable to damage or interruption as a result of terrorist attacks, wars,
earthquakes, floods, fires, power loss, telecommunications failures, undetected errors or "bugs" in our software, computer viruses, interruptions in access to our websites and servers through the use
of "denial of service" or similar attacks, hacking or other attempts to harm our systems and similar events. Our servers, which are hosted at third-party Internet data centers, are vulnerable to
break-ins, sabotage and vandalism. Additionally, the occurrence of a closure of an Internet data center by any of our third-party providers without adequate notice could result in lengthy
service interruptions.
If
we experience frequent or persistent system failures affecting our products and services, whether due to interruptions and failures of our own information technology and
communications systems or those of third-party service providers we rely upon, our reputation and brand could be severely harmed.
17
Table of Contents
The
steps we take to improve the reliability of our systems will increase our cost and reduce our operating margin and may not be successful in reducing the frequency or duration of service
interruptions.
Our strategy of acquiring and investing in complementary businesses, assets and technologies may fail.
As part of our business strategy, we have acquired, and intend to continue to selectively acquire and invest in, businesses, assets and
technologies that complement our existing business. Acquisitions and investments involve uncertainties and risks, including:
-
-
potential ongoing financial obligations and unforeseen or hidden liabilities;
-
-
failure to achieve the intended objectives, benefits or revenue-enhancing opportunities;
-
-
costs and difficulties of integrating acquired businesses and managing a larger business;
-
-
costs and difficulties of integrating acquired technologies into our existing products and
services; and
-
-
diversion of resources and management attention.
Our
failure to address these risks successfully may have a material adverse effect on our financial condition and results of operations. Any such acquisition or investment may require a
significant amount of capital investment, which would decrease the amount of cash available for working capital or capital expenditures. In addition, if we use our equity securities to pay for
acquisitions, we may dilute the value of our ADSs and the underlying Class A ordinary shares. If we borrow funds to finance acquisitions, such debt instruments may contain restrictive covenants
that could, among other things, restrict us from distributing dividends. Such acquisitions may also generate significant amortization expenses related to intangible assets.
Our success depends on the continuing and collaborative efforts of our management team and other key personnel, and our business may be harmed if we lose
their services.
Our future success depends heavily upon the continuing services of our management team, in particular Mr. Hongyi Zhou, our
chairman and chief executive officer, and Mr. Xiangdong Qi, our director and president. If one or more of our executives or other key personnel are unable or unwilling to continue in their
present positions, we may not be able to replace them easily or at all, and our business may be disrupted and our financial condition and results of operations may be materially and adversely
affected. Competition for management and key personnel is intense, the pool of qualified candidates is limited, and 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 executives or other key personnel joins a competitor or forms a competing company, we may lose customers, distributors, know-how and key personnel. Each
of our executive officers and key employees has entered into an employment agreement with us that contains confidentiality provisions. If any disputes arise between any of our executives or key
personnel and us, we cannot assure you the extent to which any of these agreements may be enforced.
We rely on highly skilled personnel. If we are unable to retain or motivate them or hire additional qualified personnel, we may not be able to grow effectively.
Our performance and future success depend on the talents and efforts of highly skilled individuals. We will need to continue to
identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization. Competition in the Internet industry for qualified employees is intense. Our continued ability
to compete effectively depends on our ability to attract new employees and to retain and motivate our existing employees.
18
Table of Contents
As
competition in the Internet industry intensifies, it may be more difficult for us to hire, motivate and retain highly skilled personnel. If we do not succeed in attracting additional
highly skilled personnel or retaining or motivating our existing personnel, we may be unable to grow effectively.
We may not be able to prevent others from unauthorized use of our intellectual property or brands, which could harm our business and competitive position.
We rely on a combination of copyright, trademark and trade secret laws, as well as nondisclosure agreements and other methods to
protect our intellectual property rights and brands. We have registered our "Qihoo" brand in China and are applying to register our "360" brand with relevant government authorities. We may not be able
to successfully register the word "360" as a trademark because the relevant government authorities may not deem "360" as sufficiently distinctive. The protection of intellectual property rights and
brands in China may not be as effective as those in the United States or other countries. The steps we have taken may be inadequate to prevent the misappropriation of our technology or
unauthorized use of our brands. Reverse engineering, unauthorized copying or other misappropriation of our technologies could enable third parties to benefit from our technologies without compensating
us. Moreover, unauthorized use of our technology could enable our competitors to offer products and services that are comparable to or better than ours, which could harm our business and competitive
position. From time to time, we may have to enforce our intellectual property rights and brands through litigation. Such litigation may result in substantial costs and diversion of resources and
management attention.
Third parties may claim that we infringe their proprietary rights, which could cause us to incur significant legal expenses and prevent us from promoting our products
and services.
From time to time, we may receive claims that we have infringed the intellectual property rights of others. Such claims may be based on
our use of trademarks, logos, technologies or other intellectual properties. Any such claim, with or without merit, could result in costly litigation and distract our management from
day-to-day operations. If we fail to successfully defend such claims, we could be required to make unavailable or redesign our products and services, pay monetary amounts as
damages, enter into royalty or licensing arrangements, or satisfy indemnification obligations that we have with some of our users. Any royalty or licensing arrangements that we may seek in such
circumstances may not be available to us on commercially reasonable terms or at all. Also, if we acquire technology to include in our products from third parties, our exposure to infringement actions
may increase because we must rely upon these third parties to verify the origin and ownership of such technology.
Further,
we license and use technologies from third parties in our products and services. These third-party technology licenses may not continue to be available to us on acceptable terms
or at all, and may expose us to additional liability. This liability, or our inability to use any of this third-party software, could result in disruptions in our business that could materially and
adversely affect our operating results.
The successful operation of our business depends upon the performance and reliability of the Internet infrastructure in China and the safety of our network and
infrastructure.
Our business depends on the performance and reliability of the Internet infrastructure in China. Almost all access to the Internet is
maintained through state-owned telecommunication operators under the administrative control and regulatory supervision of the MIIT. A more sophisticated Internet infrastructure may not be developed in
China. We may not have access to alternative networks in the event of disruptions, failures or other problems with China's Internet infrastructure. In addition, the Internet infrastructure in China
may not support the demands associated with continued growth in Internet usage.
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Although
we believe we have sufficient controls in place to prevent intentional disruptions, we expect our network and infrastructure to be targets of attacks specifically designed to
impede the performance of our products and services, misappropriate proprietary information or harm our reputation. Because the techniques used by hackers to access or sabotage networks change
frequently and may not be recognized until launched against a target, we may be unable to anticipate these techniques. The theft, unauthorized use or publication of our trade secrets and other
confidential business information as a result of such an event could adversely affect our competitive position, brand reputation and user base, and our users and customers may assert claims against us
related to resulting losses arising from security breaches. Our business could be subject to significant disruption and our results of operations may be affected.
If we fail to establish an effective system of internal control, we may be unable to accurately and timely report our financial results or prevent fraud, and investor
confidence and the market price of our ADSs may be adversely impacted.
We will be subject to reporting obligations under U.S. securities laws. Section 404 of the Sarbanes-Oxley Act of 2002 and
related rules require a public company to include a management report on the company's internal control over financial reporting in its annual report, which contains management's assessment of the
effectiveness of the company's internal control over financial reporting. In addition, an independent registered public accounting firm must audit and report on the effectiveness of a public company's
internal control over financial reporting. These requirements will first apply to our annual report on Form 20-F for the fiscal year ending on December 31, 2012. Our
reporting obligations as a public company will place a significant strain on our management, operational and financial resources and systems for the foreseeable future.
Prior
to this offering, we have been a private company and have had limited accounting personnel and other resources with which to address our internal control over financial reporting.
We and our independent registered public accounting firm, in connection with the preparation and external audit of our consolidated financial statements as of and for the fiscal year ended
December 31, 2010, identified one material weakness and several control deficiencies in our internal control over financial reporting as of December 31, 2010. A "material weakness" is a
deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim
financial statements will not be prevented or detected on a timely basis.
The
material weakness identified primarily related to lack of sufficient accounting personnel with appropriate knowledge of U.S. GAAP. Neither we nor our independent registered
public accounting firm undertook a comprehensive assessment of our internal control for purposes of identifying and reporting material weaknesses and other control deficiencies in our internal control
over financial reporting as we and they will be required to do once we become a public company. In light of the material weakness and other control deficiencies that were identified as a result of the
limited procedures performed, we believe it is possible that, had we performed a formal assessment of our internal control over financial reporting or had our independent registered public accounting
firm performed an audit of our internal control over financial reporting, additional control deficiencies may have been identified.
We
have taken measures and plan to continue to take measures to remedy the identified weakness and deficiencies, including (i) hiring additional accounting personnel with
understanding of U.S. GAAP and experience with SEC reporting requirements, and (ii) providing external and internal training to our accounting personnel. However, the implementation of
these measures may not fully address this material weakness and other control deficiencies in our internal control over financial reporting, and we cannot conclude that they have been fully remedied.
Our failure to address the material weakness and other control deficiencies or our failure to discover and address any other control deficiencies
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could
result in inaccuracies in our financial statements and could also impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis.
As a result, our business, financial condition, results of operations and prospects, as well as the trading price of our ADSs, may be materially and adversely affected. Moreover, ineffective internal
control over financial reporting could significantly hinder our ability to prevent fraud.
We may need additional capital, and we may be unable to obtain such capital in a timely manner or on acceptable terms, or at all. Furthermore, our future capital needs may
require us to sell additional equity or debt securities that may dilute our shareholders or introduce covenants that may restrict our operations or our ability to pay dividends.
To grow our business and remain competitive, we may require additional capital. Our ability to obtain additional capital is subject to
a variety of uncertainties, including:
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our future financial condition, results of operations and cash flows;
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general market conditions for capital raising activities by companies offering Internet and mobile security products and
services; and
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economic, political and other conditions in China and internationally.
We
may be unable to obtain additional capital in a timely manner or on acceptable terms or at all. In addition, our future capital needs and other business reasons could require us to
sell additional equity or debt securities or obtain a credit facility. The sale of additional equity or equity-linked securities could dilute our shareholders. The incurrence of indebtedness would
result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations or our ability to pay dividends to our shareholders.
Our business, financial condition and results of operations may be adversely affected by the downturn in the global or Chinese economy.
The global financial markets have experienced significant disruptions since 2008 and the effect of the crisis persisted in 2009.
China's economy has also faced challenges. To the extent that there have been improvements in some areas, it is uncertain whether such recovery is sustainable. Since we derive substantially all of our
revenues from China, our business and prospects may be affected by economic conditions in China.
Moreover,
a slowdown in the global or Chinese economy or the recurrence of any financial disruptions may have a material and adverse impact on financings available to us. The weakness in
the economy could erode investors' confidence, which constitutes the basis of the equity markets. The recent financial turmoil affecting the financial markets and banking system may significantly
restrict our ability to obtain financing in the capital markets or from financial institutions on commercially reasonable terms, or at all. We are uncertain about the extent to which the recent global
financial and economic crisis and slowdown of the Chinese economy may impact our business in the long term. There is a risk that our business, results of operations and prospects would be materially
and adversely affected by the global economic downturn and the slowdown of the Chinese economy.
Risks Related to Our Corporate Structure
In order to comply with PRC laws and regulations limiting foreign ownership of Internet businesses, we conduct
our Internet businesses through our consolidated affiliated entities in China by means of contractual arrangements. If the PRC government determines that these contractual arrangements do not comply
with applicable regulations, our business could be materially and adversely affected.
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The
PRC government restricts foreign investment in Internet businesses. See "RegulationRegulations Related to Our BusinessTelecommunications Regulations."
Accordingly, we conduct our business activities primarily through our two consolidated variable interest entities, or VIEs, namely Beijing Qihu Technology Company Limited, or Beijing Qihu, and
Shanghai Qitai Network Technology Company Limited, or Shanghai Qitai. See "Corporate History and Structure." We bear the economic risks and derive the economic benefits of Beijing Qihu and Shanghai
Qitai as their primary beneficiary through contractual arrangements with them and their respective registered shareholders. We also entered into similar contractual arrangements with five other VIEs
that do not have significant business operations as of the date of this prospectus. For a description of these contractual arrangements, see "Corporate History and Structure."
Although
we believe we comply with current PRC regulations, the PRC government may not agree that these operating 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. If the PRC government determines that we do not comply with applicable law, it may revoke our
business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues, block our websites, require us to restructure our operations, impose
additional conditions or requirements with which we may not be able to comply, impose restrictions on our business operations
or on our customers, or take other regulatory or enforcement actions against us that could be harmful to our business.
Our contractual arrangements with our VIEs and their respective shareholders may not be as effective in providing control over the entity as direct ownership.
We rely on contractual arrangements with our VIEs and their shareholders for the operation of our Internet business in China. These
contractual arrangements may not be as effective in providing us with control over our VIEs as direct ownership in these entities. If our VIEs or their respective shareholders fail to perform their
respective obligations under these contractual arrangements, we may incur substantial costs and resources to enforce these arrangements, and rely on legal remedies available under applicable PRC laws,
including seeking specific performance or injunctive relief and claiming damages. In particular, if shareholders of a VIE refuse to transfer their equity interests in such VIEs to us or our designated
persons when we exercise the purchase option pursuant to these contractual arrangements, we may need to initiate legal actions to compel them to fulfill their contractual obligations.
If
the applicable PRC authorities invalidate our contractual arrangements for violation of PRC laws, rules and regulations, or any of our VIEs or their shareholders terminate the
contractual arrangements or fail to perform their obligations under these contractual arrangements, our Internet and online advertising businesses in China would be materially disrupted, and the value
of our ordinary shares would decrease substantially. Furthermore, if we fail to renew these contractual arrangements upon their expiration and the relevant foreign investment restrictions remain
effective, we would not be able to continue our Internet business.
In
addition, if any of our VIEs or all or part of its assets become subject to court injunctions or asset freezes or liens or rights of third-party creditors, we may be unable to
continue some or all of our businesses, which could materially and adversely affect our business, financial condition and results of operations. If any of our VIEs undergoes a voluntary or involuntary
liquidation proceeding, its shareholders or unrelated third-party creditors may claim rights to some or all of its assets. The occurrence of any of these events may hinder our ability to operate our
Internet business, which could in turn materially harm our business and our ability to generate revenues and cause the market price of our ordinary shares to decline significantly.
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Perfection of the pledges in our equity pledge agreements with our VIEs and their registered shareholders may be adversely affected due to failure to register these equity
pledge agreements.
Under our equity pledge agreements with our VIEs and their registered shareholders, these registered shareholders have pledged all of
their respective equity interests in the VIEs to us. The pledges under the equity pledge agreements were duly created by recording the pledges on the VIEs' registers of shareholders in accordance with
the then effective PRC Security Law and the Contract Law. The purpose of such pledges is to secure the performance of the VIEs' obligations under the various VIE agreements, including the business
operation agreements and technology development agreements. Under the then effective PRC laws and regulations, the pledge of equity in a limited liability company became effective upon recording of
the pledge on the company's register of members. However, according to the PRC Property Rights Law, which became effective on October 1, 2007, a pledge is not deemed to be validly created
without registration with the relevant local administration for industry and commerce. Three of our VIEs have completed the pledge registration. We are applying to register the equity pledges by the
shareholders of our other VIEs with the relevant offices of the administration for industry and commerce and expect to submit the complete applications by the end of May 2011. Although under PRC laws
and regulations, the administration for industry and commerce should register a pledge immediately upon receiving a complete application, the registration process could take longer in practice. If the
equity pledges are not successfully registered, they would not be deemed as validly created security interests under the PRC Property Rights Law. If our VIEs breached their obligations under the
agreements with us, there is a risk that we may not be able to successfully enforce the pledges if the equity pledge agreements have not been registered with the relevant administration for industry
and commerce.
The shareholders of our VIEs may have potential conflicts of interest with us, which may adversely affect our business.
The registered shareholders of our VIEs are our directors, officers or employees. Conflicts of interest may arise between these
shareholders' duties to us and our VIEs. If such conflicts arise, these shareholders may not act in our best interests and such conflicts of interest may not be resolved in our favor. In addition,
these shareholders may breach or cause our VIEs to breach or refuse to renew their existing contractual arrangements that allow us to exercise effective control over them and to receive economic
benefits from them. The laws of the Cayman Islands provide that directors of a company owe a fiduciary duty to the company, which requires them to act in good faith and in the best interests of the
company and not to use their positions for personal gain. If certain shareholders of our VIEs do not comply with their fiduciary duties to us as our designated directors, or if we cannot resolve any
conflicts of interest or disputes between us and such shareholders or any future beneficial owners of our VIEs, we would have to rely on legal proceedings to remedy the situation, which could result
in disruption of our business and substantial uncertainty as to the outcome of any such legal proceedings.
Our contractual arrangements with our VIEs and their respective shareholders may be subject to scrutiny by the PRC tax authorities and we could be required to pay additional
taxes, which could substantially reduce our consolidated net income and the value of your investment.
Arrangements and transactions among related parties may be subject to audits or challenges by the PRC tax authorities. We could face
material and adverse tax consequences if the PRC tax authorities determine that our contractual arrangements with VIEs are not arm's length transactions. If this were to occur, the tax authorities
could adjust our VIEs' income in the form of a transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in a reduction, for PRC tax purposes, of expense deductions
recorded by our VIEs, which could in turn increase their tax liabilities. The PRC tax authorities could also impose late payment fees and other penalties on our VIEs for under-paid taxes.
In addition, any challenge by the PRC tax authorities may limit the ability of our VIEs to receive any preferential tax treatments and other financial incentives. Our consolidated net income may be
materially and adversely affected if our VIEs' tax liabilities increase or if our VIEs are found to be subject to late payment fees or other penalties.
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Risks Related to Regulation of Our Services and Products
We may be adversely affected by complexity, uncertainties and changes in regulation of Internet and value-added telecommunications service companies.
The PRC government extensively regulates the Internet industry, including foreign ownership of, and the licensing and permit
requirements pertaining to, companies in the Internet industry. These Internet-related laws and regulations are relatively new and still evolving, and their interpretation and enforcement involve
significant uncertainty. As a result, it may be difficult in certain circumstances to determine what actions or omissions may be deemed to be violations of applicable laws and regulations. The
following illustrates some of the risks and uncertainties relating to PRC government regulation of the Internet industry:
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We only have contractual control over our websites. We do not own the websites due to the restriction of foreign
investment in businesses providing value-added telecommunication services in China, including online information services.
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There are uncertainties relating to the regulation of the Internet business in China, including licensing practices that
continue to evolve. This means that permits, licenses or operations at some of our companies may be subject to challenge, or we may not be able to obtain or renew certain permits or licenses. This may
significantly disrupt our business, require us to compromise enforceability of related contractual arrangements, or subject us to sanctions, requirements to increase capital or other conditions
or enforcement.
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New laws and regulations may be promulgated that will regulate Internet activities, including online advertising and
online payment. Other aspects of our online operations may be regulated in the future. If these new laws and regulations are promulgated, additional licenses may be required for our online 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.
As
a result of the complexity, uncertainties and constant changes in regulation in the Internet and value-added telecommunications companies, our business activities and growth may be
adversely affected if we do not respond to the changes in a timely manner or are found to be in violation of the applicable laws, regulations and policies as a result of a different position from ours
taken by the competent authority in the interpretation of such applicable laws, regulations and policies.
If we fail to obtain or maintain all required licenses, permits and approvals or if we are required to take actions that are time-consuming or costly, our
business operations may be materially and adversely affected.
We are required to obtain applicable licenses, permits and approvals from different regulatory authorities in order to conduct our
business. Over the last several years, various governmental authorities in the PRC have issued regulations regulating specific aspects of Internet content and services. Some of this legislation
requires operators to obtain licenses, permits or approvals that were previously not required. The government authorities may continue to pass new rules regulating the Internet sector. They may
require us to obtain additional licenses, permits or approvals so that we can continue to operate our existing businesses or otherwise prohibit our operation of the types of businesses to which the
new requirements apply. In addition, new regulations or new interpretations of existing regulations may increase our costs of doing business and prevent us from efficiently delivering services and
products over the Internet and through mobile operators and expose
us to potential penalties and fines. These regulations may also restrict our ability to expand our customer and user base or to provide services in additional geographic areas.
Applicable
PRC laws and regulations may deem online software download services as Internet publishing activities that require Internet publishing licenses. We currently do not hold an
Internet
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publishing
license for our online software download services. We expect to submit a complete application to relevant government authorities in April 2011. Although under PRC laws and regulations,
relevant government authorities should decide on an application for the internet publishing license within 60 days after receiving a complete application, the approval process may take longer
in practice and we may not be able to receive approval for the internet publishing license in a timely manner or at all. See "RegulationRegulation of Electronic Publications and Internet
Publishing." Failure to obtain such license may subject us to various penalties, including fines and suspension of our online software download services, which may materially and adversely affect our
business, financial condition and results of operations.
Our
security software must be examined and approved by the PRC Ministry of Public Security, or the MPS, before it may be made available to users. We believe that we have obtained the
applicable permits for offering 360 Safe Guard and 360 Anti-Virus for download. However, as the upgrades of our software become more frequent and such examination and
approval by the MPS may be time consuming, we may not be able to obtain such permits for all upgrades in a timely manner, which may subject us to various penalties and adversely affect our business
and results of operations.
In
addition, we provide promotion services for a third party's online lottery business on our platform. Under the Tentative Administrative Measures on Internet Lottery Sale promulgated
by the PRC Ministry of Finance on September 26, 2010, a license is required for conducting online lottery business. As these measures were newly released and no implementation rules are
available yet, our online lottery business partner currently does not hold such license. Although there is no explicit provision under the Lottery Measures that imposes penalties for conducting online
lottery business without a license, the online lottery business operated by such third party may be suspended by relevant governmental authorities. We have requested our online lottery business
partner to apply for such license as soon as the application procedures are available. We also plan to apply for such license for ourselves as a provider of platform for such lottery business if
required under newly issued rules or regulations or by relevant government authorities. If our online lottery business partner or we are subject to regulatory penalties for lack of such license, our
reputation may be harmed and our business may be adversely affected.
If any of our web games business activities is deemed to be in violation of law, we may have to cease or modify our web game operations, which could have a material and
adverse effect on our business and results of operations.
All web games currently offered by our platform are licensed by, and operated with, third-party game developers. Although we have
obtained licenses which we believe are sufficient for our web game offerings, the MIIT or other competent government authorities may interpret existing or promulgate and implement new laws,
regulations or policies that may require us to cease or modify our web games business in order to avoid violation of any PRC laws or regulations. Any such modification to our web games business may
result in disruption of our business, diversion of management attention and the incurrence of substantial costs. See also "RegulationRegulations Relating to Our BusinessWeb
Games and Virtual Currency." In addition, we have requested our web game business partners to obtain and maintain all necessary licenses. However, we cannot assure you that all of our business
partners have obtained or updated all necessary licenses, permits or registrations with relevant governmental authorities. If any of such business partners fails to do so, we may not continue to
operate the affected web games, which may adversely affect our business and results of operations.
Regulation and censorship of information disseminated over the Internet in China may adversely affect our business and subject us to liability for information displayed on
or linked to our websites.
The MIIT has published regulations that subject website operators to potential liability for content displayed on their websites and
the actions of users and others using their systems, including liability
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for
violations of PRC laws and regulations prohibiting the dissemination of content deemed to be socially destabilizing. The Ministry of Public Security has the authority to order any local Internet
service provider to block any Internet website at its sole discretion. From time to time, the Ministry of Public Security has stopped the dissemination over the Internet of information which it
believes to be socially destabilizing. The State Secrecy Bureau is also authorized to block any website it deems to be leaking state secrets or failing to meet the relevant regulations relating to the
protection of State secrets in the dissemination of online information. Furthermore, we are required to report any suspicious content to relevant governmental authorities, and to undergo computer
security inspections. If we fail to implement the relevant safeguards against security breaches, our websites may be shut down and our business and business licenses may be revoked.
Although
we attempt to monitor the content posted on our websites or transmitted through our services, we are not able to control or restrict the content generated or linked by the users
to other Internet content providers. If the PRC regulatory authorities find any content displayed on our websites
objectionable, they may require us to limit or eliminate the dissemination of such information on our websites. If third-party websites linked to or accessible through our websites operate unlawful
activities, PRC regulatory authorities may require us to report such unlawful activities to competent authorities and to remove the links to such websites, or they may suspend or shut down the
operation of such websites. PRC regulatory authorities may also temporarily block access to certain websites for a period of time for reasons beyond our control. Any of these actions may reduce our
user traffic and adversely affect our business. In addition, we may be subject to penalties for violations of those regulations arising from information displayed on or linked to our websites,
including a suspension or shutdown of our online operations.
Risks Related to Doing Business in China
Adverse changes in economic and political policies of the PRC government could negatively impact China's overall economic growth, which could materially adversely affect
our business.
We conduct substantially all of our operations in China. Accordingly, our business, financial condition, results of operations and
prospects depend significantly on economic developments in China. China's economy differs from the economies of most other countries in many respects, including the amount of government involvement in
the economy, the general level of economic development, growth rates and government control of foreign exchange and the allocation of resources. While the PRC economy has grown significantly over the
past few decades, this growth has remained uneven across different periods, regions and economic sectors.
The
PRC government also exercises significant control over China's economic growth by allocating resources, controlling the payment of foreign currency-denominated obligations, setting
monetary policy and providing preferential treatment to particular industries or companies. Between late 2003 and 2008, the PRC government implemented a number of measures, such as increasing the
People's Bank of China's statutory deposit reserve ratio and imposing commercial bank lending guidelines, which slowed the growth of credit. In 2008 and 2009, however, in response to the global
financial crisis, the PRC government loosened such requirements. Any actions and policies adopted by the PRC government could negatively impact the Chinese economy, which could materially adversely
affect our business.
We may rely on dividends and other distributions from our subsidiaries in China to fund our cash and financing requirements, and any limitation on the ability of our
subsidiaries to make payments to us could materially adversely affect our ability to conduct our business.
As an offshore holding company, we may rely principally on dividends from our subsidiaries in China for our cash requirements,
including to pay dividends or make other distributions to our shareholders or to service our debt we may incur and to pay our operating expenses. The payment of
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dividends
by entities organized in China is subject to limitations. In particular, the PRC regulations permit our subsidiaries to pay dividends to us only out of their accumulated profits, if any, as
determined in accordance with Chinese accounting standards and regulations. In addition, each of our subsidiaries in China is required to set aside a certain amount of its after-tax
profits each year, if any, to fund certain statutory reserves. These reserves are not distributable as cash dividends.
If
our subsidiaries in China incur debt on their own behalf, the instruments governing the debt may restrict their ability to pay dividends or make other distributions to us. Any
limitation on the ability of our subsidiaries to distribute dividends or other payments to us could materially adversely limit our ability to grow, make investments or acquisitions, pay dividends and
otherwise fund and conduct our business.
PRC regulation of loans to, and direct investments in, PRC entities by offshore holding companies may delay or prevent us from using the proceeds of this offering to make
loans or capital contributions to our PRC operating subsidiaries, which could materially adversely affect our liquidity and ability to fund and expand our business.
We may transfer funds to our PRC subsidiaries or finance our PRC subsidiaries by means of shareholder's loans or capital contributions
upon completion of this offering. Any loans to our PRC subsidiaries, which are foreign-invested enterprises, cannot exceed statutory limits based on the amount of our investments in such subsidiaries,
and shall be registered with the State Administration of Foreign Exchange, or SAFE, or its local counterparts. Furthermore, any capital contributions we make to our PRC subsidiaries shall be approved
by the Ministry of Commerce, or MOFCOM, or its local counterparts. We may not be able to obtain these government registrations or approvals on a timely basis, if at all. If we fail to receive such
registrations or approvals, our ability to provide loans or capital contributions to our PRC subsidiaries may be negatively affected, which could adversely affect our liquidity and our ability to fund
and expand our business.
In
addition, SAFE promulgated the Circular on the Relevant Operating Issues concerning Administration Improvement of Payment and Settlement of Foreign Currency Capital of
Foreign-invested Enterprises, or Circular 142, on August 29, 2008. Under Circular 142, registered capital of a foreign-invested company settled in RMB converted from foreign
currencies may only be used within the business scope approved by the applicable governmental authority and may not be used for equity investments in the PRC. In addition, foreign-invested companies
may not change how they use such capital without SAFE's approval, and may not in any case use such capital to repay RMB loans if they have not used the proceeds of such loans. Furthermore, SAFE
promulgated a circular on November 19, 2010, or Circular 59, which requires the authenticity of settlement of net proceeds from offshore offerings to be closely examined and the net
proceeds to be settled in the manner described in the offering documents. Circular 142 and Circular 59 may significantly limit our ability to transfer the net proceeds from this offering
to our PRC subsidiaries and convert the net proceeds into RMB, which may adversely affect our liquidity and our ability to fund and expand our business in the PRC.
Fluctuations in the value of the RMB may materially adversely affect your investment.
The value of the RMB against the U.S. dollar and other currencies may fluctuate. Exchange rates are affected by, among other
things, changes in political and economic conditions and the foreign exchange policy adopted by the PRC government. On July 21, 2005, the PRC government changed its policy of pegging the value
of the RMB to the U.S. dollar. Under the new policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of foreign currencies. Following the removal of the
U.S. dollar peg, the RMB appreciated more than 20% against the U.S. dollar over three years. From July 2008 until June 2010, however, the RMB has traded stably within a
narrow range against the U.S. dollar.
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There
remains significant international pressure on the PRC government to adopt a more flexible currency policy, which could result in a further and more significant appreciation of the
RMB against foreign currencies. On June 20, 2010, the People's Bank of China announced that the PRC government would reform the RMB exchange rate regime and increase the flexibility of the
exchange rate. We cannot predict how this new policy will impact the RMB exchange rate.
Our
revenues and costs are mostly denominated in the RMB, and a significant portion of our financial assets are also denominated in the RMB. Any significant fluctuations in the exchange
rate between the RMB and the U.S. dollar may materially adversely affect our cash flows, revenues, earnings and financial position, and the amount of and any dividends we may pay on our ADSs in
U.S. dollars. In addition, any fluctuations in the exchange rate between the RMB and the U.S. dollar could also result in foreign currency translation losses for financial reporting
purposes.
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 Renminbi into foreign currencies and, in certain cases, the remittance
of currency out of China. We receive substantially all of our revenues in Renminbi. Under our current corporate structure, our Cayman Islands holding company primarily relies on dividend payments from
our wholly-owned PRC subsidiary in China, Qizhi Software, to fund any cash and financing requirements we may have. See "Corporate History and Structure."
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, Qizhi Software may pay dividends in foreign currency to us
without pre-approval from SAFE. However, approval from or registration with competent government authorities is required where the Renminbi 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. With the prior approval from SAFE, cash generated from the operations of our PRC subsidiary may be used
to pay off debt they owe to entities outside China in a currency other than the Renminbi. The PRC government may 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.
Uncertainties in the Chinese legal system could materially adversely affect our business.
We conduct our business primarily through our subsidiaries and affiliated entities in China. Our operations in China are governed by
PRC laws and regulations. The PRC legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value.
In
1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general, and forms of foreign investment (including wholly
foreign-owned enterprises and joint ventures) in particular. These laws, regulations and legal requirements are relatively new and amended frequently, and their interpretation and enforcement often
raise uncertainties that could limit the reliability of the legal protections available to us. In addition, the PRC legal system is based in part on government policies and internal rules (some of
which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violations of these policies and rules until the violations have
occurred. Furthermore, any litigation in China may be protracted and result in substantial costs and diversion of resources and management's attention. We cannot predict future developments in the PRC
legal
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system.
We may be required to procure additional permits, authorizations and approvals for our operations, which we may not be able to obtain. Our inability to obtain such permits or authorizations
may materially adversely affect our business, financial condition and results of operations.
We may be required to obtain approval of the China Securities Regulatory Commission, or CSRC, before listing and trading our ADSs on the New York Stock Exchange.
Pursuant to the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the New M&A Rules, an
offshore special purpose vehicle formed for purposes of overseas listing and controlled directly or indirectly by PRC companies or individuals shall obtain CSRC approval prior to listing and trading
its securities on an overseas stock exchange. On December 14, 2006, the CSRC published procedures for special purpose vehicles to obtain approval of overseas listings. The procedures include
filing documents with the CSRC and take several months to complete. The application of this new PRC regulation remains unclear.
Our
PRC legal counsel, Commerce & Finance Law Offices, is of the opinion that prior CSRC approval for this offering is not required because (i) we and our PRC operating
subsidiary, Qizhi Software, were incorporated before the effective date of the New M&A Rules; (ii) our PRC subsidiary was not established through acquisition of any equity or assets of a
"PRC domestic company" as defined under the M&A rules; and (iii) the New M&A Rules do not explicitly classify contractual arrangements like those described in "Corporate History and
Structure" as a type of transactions that require such approval under the New M&A Rules. However, we cannot assure you that PRC government authorities, including the CSRC, will reach the same
conclusion as our PRC legal counsel. If the CSRC or other PRC government authorities determine that prior CSRC approval is required, this offering will be delayed until we obtain the approval from the
CSRC, which may take several months or longer. If a prior approval from the CSRC is required but not obtained, we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory
authorities.
These
regulatory authorities may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, delay or restrict the repatriation of the proceeds
from this offering
into the PRC, or take other actions that could materially adversely affect our business or the trading price of our ADSs. The CSRC or other PRC regulatory authorities may also require us, or make it
advisable for us, to halt this offering before settlement and delivery of the ADSs offered under this prospectus. Consequently, if you engage in market trading or other activities in anticipation of
and prior to settlement and delivery, you do so at the risk that settlement and delivery may not occur.
PRC regulations relating to the establishment of offshore SPVs by PRC residents may subject our PRC resident beneficial owners or our PRC subsidiaries to liability or
penalties, limit our ability to inject capital into our PRC subsidiaries, limit our PRC subsidiaries' ability to increase their registered capital or distribute profits to us, or may otherwise
adversely affect us.
SAFE has promulgated several regulations, including the Notice on Relevant Issues Concerning Foreign Exchange Control on Domestic
Residents' Corporate Financing and Roundtrip Investment Through Offshore Special Purpose Vehicles, or Circular 75, effective on November 1, 2005. These 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.
Under
these foreign exchange regulations, PRC residents who make or have previously made prior to the implementation of these foreign exchange regulations, direct or indirect investments
in special purpose vehicles, or SPVs, will be required to register those investments. In addition, any PRC resident who is a direct or indirect shareholder of an SPV is required to update the
previously filed registration
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with
the local branch of SAFE to reflect any material change. Moreover, the PRC subsidiaries of that SPV are required to urge the PRC resident shareholders to update their registration with the local
branch of SAFE. If any PRC shareholder fails to make the required registration or update the previously filed registration, the PRC subsidiaries of that SPV may be prohibited from distributing their
profits and the proceeds from any reduction in capital, share transfer or liquidation to their SPV parent, and the SPV may also be prohibited from injecting additional capital into its PRC
subsidiaries. Moreover, failure to comply with the various foreign exchange registration requirements described above could result in liabilities for such PRC subsidiaries under PRC laws for evasion
of applicable foreign exchange restrictions. Furthermore, the responsible persons and other persons in such PRC subsidiaries who are held directly liable for the violations may be subject to
administrative sanctions.
These
regulations apply to our shareholders who are PRC residents and may apply to any offshore acquisitions that we make in the future. We have notified holders of ordinary shares of
our company whom we know are PRC residents to register with the local SAFE branch and update their registrations as required under the SAFE regulations described above. We are aware that
Mr. Hongyi Zhou, our chairman and chief executive officer and principal shareholder and Mr. Xiangdong Qi, our director,
president and principal shareholder, both of whom are PRC residents, have registered with the relevant local SAFE branch. We, however, cannot provide any assurances that all of our shareholders who
are PRC residents will file all applicable registrations or update previously filed registrations as required by these SAFE regulations. If SAFE determines that any of our beneficial owners who are
PRC residents fails to comply with the above SAFE rules, our PRC subsidiaries could be subject to fines and legal penalties, and SAFE could restrict our cross-border investment activities and our
foreign exchange activities, including restricting our PRC subsidiaries' ability to distribute dividends to, or obtain loans denominated in foreign currencies from, our company, or prevent us from
making distributions or paying dividends. As a result, our business operations and our ability to make distributions to you could be materially and adversely affected.
Failure to comply with the registration requirements for employee share option plans may subject our PRC equity incentive plan participants or us to fines and other legal or
administrative sanctions.
In January 2007, SAFE issued implementing rules for the Administrative Measures of Foreign Exchange Matters for Individuals,
which, among other things, specified approval requirements for certain capital account transactions such as a PRC citizen's participation in the employee stock ownership plans or stock option plans of
an overseas publicly-listed company. In March 2007, SAFE promulgated the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock
Ownership Plan or Stock Option Plan of Overseas-Listed Company, or Circular 78.
Under
Circular 78, PRC citizens who participate in an employee stock option plan in an overseas publicly-listed company are required to register with SAFE or its local office and
complete certain other procedures. A PRC agent, which could be the PRC subsidiary of such overseas publicly-listed company, is required to retain a financial institution with stock brokerage
qualification at the listing place or a qualified institution relating to the exercise or sale of share options. For participants who had already participated in an employee stock option plan before
the date of Circular 78, their PRC employers or PRC agents are required to complete the relevant formalities within three months of the date of this Circular. We and our PRC employees who
receive stock option plan will be subject to these regulations when we are listed in the United States. If we or our PRC optionees fail to comply with these regulations, we or our PRC optionees
may be subject to fines and other legal or administrative sanctions.
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We may be subject to PRC taxation on our worldwide income.
Under the PRC Enterprise Income Tax Law, or the New EIT Law, and its implementation rules, both effective from January 1,
2008, an enterprise established outside of the PRC with "de facto management bodies" within the PRC is considered a resident enterprise and is subject to a 25% enterprise income tax on its global
income. The implementation rules define the term "de facto management bodies" as establishments that carry out substantial and overall management and control over the manufacturing and business
operations, personnel, accounting and properties of an enterprise. The State Administration of Taxation, or the SAT, issued the Notice Regarding the Determination of Chinese-Controlled Offshore
Incorporated Enterprises as PRC Tax Resident Enterprises on the Basis of De Facto Management Bodies, or Circular 82, which sets out certain specific criteria for determining whether the "de
facto management body" of a Chinese-controlled offshore incorporated enterprise is located in China.
While
we do not believe we are considered a resident enterprise or meet the criteria under Circular 82, we cannot ensure you that the SAT will not implement Circular 82
or amend the rules in the future to the effect that such rules will apply to us or our wholly-owned subsidiaries in Hong Kong. If the PRC authorities were to subsequently determine that we
should be treated as a resident enterprise, a 25% enterprise income tax will be imposed on our global income, which could significantly increase our tax burden and materially adversely affect our
financial condition and results of operations.
Dividends we receive from our PRC subsidiaries, dividends payable by us to our foreign investors and gain on the sale of our shares may become subject to PRC withholding
taxes under PRC tax laws.
Under the New EIT Law, dividends payable by a foreign-invested enterprise in China to its shareholders that are
"non-resident enterprises" are subject to a 10% withholding tax starting from January 1, 2008, unless such shareholders' jurisdiction of incorporation has a tax treaty with China
that provides for a different arrangement. As of the date of this prospectus, the Cayman Islands have not entered into any such tax treaties with the PRC. If we are considered a
"non-resident enterprise" under the New EIT Law, dividends paid to us by our PRC subsidiaries will be subject to this 10% withholding tax, which would reduce our net income and
adversely affect our operating results.
Similarly,
any gain realized on the transfer of ADSs or shares by shareholders that are "non-resident enterprises" is also subject to a 10% PRC withholding tax, if such gain
is regarded as income derived from sources within the PRC. If we are considered to be an "offshore-registered resident enterprise," the dividends we pay to our shareholders that are
"non-resident enterprises" with respect to our ADSs or shares would be treated as income derived from sources within the PRC and be subject to a 10% withholding tax. The gain that such
shareholders realize from the transfer of our ADSs or shares may also be treated as income
derived from sources within the PRC and be subject to PRC income tax if such shareholders are considered as "non-resident enterprises."
Pursuant
to the Notice on How to Understand and Determine the Beneficial Owners in Tax Agreement, a "beneficial owner" under China's tax treaties and tax arrangements shall engage in
substantive business activities. An agent or conduit company that is set up for the purpose of avoiding or reducing taxes or transferring or accumulating profits will not be regarded as a beneficial
owner and, therefore, will not qualify for treaty benefits. We cannot assure you that any dividends to be distributed by us to our non-PRC shareholders will be entitled to the benefits
under the relevant withholding arrangement set out in a tax treaty between such shareholders' jurisdiction of incorporation and China.
If
we are required under the New EIT Law to withhold PRC income tax on our dividends payable to our non-PRC enterprise ADS holders, or if gain from disposition of our
ordinary shares or ADSs will be subject to PRC taxes, your investment in our ADSs may be materially adversely affected.
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Any change in the preferential tax treatment we currently enjoy in the PRC may materially adversely impact our net income.
Pursuant to the New EIT Law, enterprises that previously enjoyed preferential treatments of low tax rates will be subject to the
new enterprise income tax rate of 25% after a five-year transitional period. Moreover, tax exemption or reduction with fixed terms enjoyed by enterprises including us will continue until
the expiry of the prescribed period. Our operating subsidiary, Qizhi Software, and our VIE, Beijing Qihu, receive preferential tax treatment in the PRC as "high and new technology enterprises." As a
result, subject to satisfaction of applicable criteria as confirmed by the competent authorities, Qizhi Software is entitled to an exemption from the 15% reduced EIT tax rate in 2008 and a 50%
reduction in the 15% reduced EIT tax rate in 2009 and 2010, and Beijing Qihu is entitled to a reduced EIT rate of 15% for 2009 and 2010. On April 21, 2010, the State Administration of Taxation
issued Circular 157, which seeks to provide additional guidance on the interaction of certain preferential tax rates under the transitional rules of the New EIT Law. Prior to
Circular 157, we understood that if a high and new technology enterprise was in a tax holiday period, where it was entitled to a 50% reduction in the tax rate, and it was also entitled to the
15% preferential tax rate, it would be entitled to pay tax at the rate of 7.5%. Circular 157 appears on its face to have the effect that such an entity is entitled to pay taxes at either the
lower of 15% or 50% of the standard PRC tax rate. Circular 157 is newly-issued and the tax authorities may differ in explaining the rules, and there might be a risk that the competent tax
authority may later decide that Qizhi Software will not be eligible for a 7.5% discounted tax rate and instead a 12.5% preferential tax rate may be applicable. Moreover, the PRC government could
eliminate any of these preferential tax treatments
before their scheduled expiration. Expiration, reduction or elimination of such preferential tax treatments will increase our income tax expenses and in turn decrease our net income.
New labor laws in the PRC may adversely affect our results of operations.
On June 29, 2007, the PRC government promulgated the Labor Contract Law of the PRC, or the New Labor Contract Law, which
became effective on January 1, 2008. The New Labor Contract Law imposes greater liabilities on employers and significantly impacts the cost of an employer's decision to reduce its
workforce. Furthermore, the New Contract Labor Law requires certain terminations to be based upon seniority and not the merits of employees. As a result, the New Labor Contract Law could
increase our operating expenses and limit our ability to significantly change or decrease our workforce.
Risks Related to Our ADSs and This Offering
There has been no public market for our ordinary shares or ADSs prior to this offering, and you may not be able to resell our ADSs at or above the price you paid, or
at all.
Prior to this initial public offering, there has been no public market for our ordinary shares or ADSs. We have received approval for
listing our ADSs on the New York Stock Exchange. Our ordinary shares will not be listed or quoted for trading on any exchange. If an active trading market for our ADSs does not develop after
this offering, the market price and liquidity of our ADSs will be materially adversely affected. The initial public offering price for our ADSs was determined by negotiations between us and the
underwriters and may bear little or no relationship to the market price for our ADSs after the initial public offering. An active trading market for our ADSs may not develop and the market price of
our ADSs may decline below the initial public.
The market price for our ADSs may be volatile.
The market price of our ADSs is likely to be highly volatile and subject to wide fluctuations in response to factors including
the following:
-
-
regulatory developments in our industry;
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-
-
actual or anticipated fluctuations in our quarterly results of operations;
-
-
changes in financial estimates by securities research analysts;
-
-
negative publicity, studies or reports;
-
-
changes in conditions of Internet and mobile security industry;
-
-
changes in performance and valuation of our peer or comparable companies;
-
-
announcements by us or our competitors of new services, acquisitions, strategic relationships, joint ventures or capital
commitments;
-
-
changes in our senior management;
-
-
fluctuations in the exchange rate between the Renminbi and the U.S. dollar; and
-
-
sales or anticipated sales of additional ordinary shares or ADSs.
In
addition, securities markets have experienced significant price and volume fluctuations unrelated to the operating results of any particular companies. These market fluctuations may
also materially adversely affect the market price of our ADSs.
We may be classified as a passive foreign investment company, which could result in adverse U.S. federal income tax consequences to U.S. holders of our ADSs or
ordinary shares.
Based on the current and anticipated value of our assets, including goodwill, and composition of our income and assets, we do not
expect to be a passive foreign investment company, or PFIC, for U.S. federal income tax purposes for our current taxable year ending December 31, 2011 or in the foreseeable future.
However, the application of the PFIC rules is subject to uncertainty in several respects, and we cannot assure you that we will not be a PFIC for any taxable year. A
non-U.S. corporation will be a PFIC for any taxable year if either (i) at least 75% of its gross income for such year is passive income or (ii) at least 50% of the
value of its assets (based on an average of the quarterly values of the assets) during such year is attributable to assets that produce passive income or are held for the production of
passive income.
We
must make a separate determination after the close of each taxable year as to whether we were a PFIC for that year. 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 and ordinary shares, fluctuations in the market price of the ADSs and ordinary shares may cause us to become a PFIC. In
addition, changes in the composition of our income or assets may cause us to become a PFIC. If we are a PFIC for any taxable year during which a U.S. holder holds an ADS or ordinary share,
certain adverse U.S. federal income tax consequences could apply to such U.S. holder. See "TaxationUnited States Federal Income TaxationPassive Foreign
Investment Company."
Because our initial public offering price is substantially higher than our net tangible book value per share, you will experience immediate and substantial dilution.
If you purchase ADSs in this offering, you will pay more for your ADSs than our existing shareholders paid for their Class A
ordinary shares on a per ADS basis. As a result, you will experience immediate and substantial dilution of approximately $12.16 per ADS, which equals the difference between the initial public offering
price of $14.50 per ADS, and our net tangible book value per ADS immediately upon the completion of this offering, assuming that the underwriters do not exercise their option to purchase additional
ADSs. See "Dilution."
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We may need additional capital, and the sale of additional ADSs or other equity securities could result in additional dilution to our shareholders.
We believe that our current cash and cash equivalents, anticipated cash flow from operations and the proceeds from this offering will
be sufficient to meet our anticipated cash needs for the foreseeable future. We may, however, require additional cash resources due to changed business conditions or other future developments,
including any investments or acquisitions we may decide to pursue. If these resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or
obtain a credit facility. The sale of additional equity securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service
obligations and could result in operating and financing covenants that would restrict our operations. It is uncertain whether financing will be available in amounts or on terms acceptable to us, if
at all.
Substantial future sales of our ADSs in the public market, or the perception that these sales could occur, could cause the price of our ADSs to decline.
Additional sales of our Class A ordinary shares in the public market after this offering, or the perception that these sales
could occur, could cause the market price of our ADSs to decline. Immediately upon completion of this offering and the concurrent private placement, we will have 173,213,370 ordinary shares
outstanding (or 175,938,300 ordinary shares if the underwriters exercise their over-allotment option in full), including 51,332,336 Class A ordinary shares (or 54,057,266 Class A
ordinary shares if the underwriters exercise their option to purchase additional ADSs in full) and 121,881,034 Class B ordinary shares. This number of outstanding Class A ordinary
shares also
includes 5,172,414 Class A ordinary shares in the form of restricted ADSs issued to the investors in our concurrent private placement, at the initial public offering price of $14.50
per ADS. See "UnderwritingConcurrent Private Placements." 173,213,370 ordinary shares outstanding after this offering will be available for sale upon the expiration of the
lock-up period, subject to volume and other restrictions applicable under Rule 144 under the Securities Act of 1933.
The
lock-up restrictions on each of our existing shareholders in this offering will expire 180 days after the date of this prospectus. Any or all of these shares can
be released prior to expiration of the lock-up period at the discretion of the representatives of the underwriters for this offering. To the extent shares are released before the
expiration of the lock-up period and these shares are sold into the market, the market price of our ADSs could decline.
In
addition, certain holders of our ordinary shares after the completion of this offering will have the right to cause us to register the sale of those shares under the Securities Act.
Registration of these shares under the Securities Act would result in these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the
registration. Sales of these registered shares in the public market could cause the price of our ADSs to decline.
Our memorandum and articles of association will contain anti-takeover provisions that could materially adversely affect the rights of holders of our ordinary
shares and ADSs.
We have adopted an amended and rested memorandum and articles of association that will become effective upon the closing of this
offering. Our amended and restated articles of association will contain provisions that could limit the ability of others to acquire control of our company or cause us to engage in
change-of-control transactions. These provisions could deprive our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by
discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. For example, our board of directors has the authority, without further action by our
shareholders, to issue preferred shares in one or more series and to fix their designations, powers, preferences, privileges and relative participating, optional or special rights and their
qualifications, limitations or restrictions. These preferred shares may include dividend rights, conversion rights, voting rights, terms of redemption and
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liquidation
preferences, any or all of which may provide rights and preferences that holders of our ordinary shares or ADSs do not have.
We
could issue preferred shares quickly on terms that could delay or prevent a change in control of our company or make removal of management more difficult. If we issue preferred
shares, the price of
our ADSs may fall and the voting and other rights of the holders of our ordinary shares and ADSs may be materially adversely affected.
Our dual-class ordinary share structure with different voting rights will limit your ability to influence corporate matters and could discourage others from
pursuing any change of control transactions that holders of our Class A ordinary shares and ADSs may view as beneficial.
In March 2011, we adopted a dual-class ordinary share structure that will become effective immediately upon the completion
of this offering. Our ordinary shares are divided into Class A ordinary shares and Class B ordinary shares. Holders of Class A ordinary shares will be entitled to one vote per
share, while holders of Class B ordinary shares will be entitled to five votes per share. We will issue Class A ordinary shares represented by our ADSs in this offering. Global Village
Associates Limited, or Global Village, a holder of our ordinary shares controlled by Mr. Hongyi Zhou, our chairman and chief executive officer, will hold 32,228,158 Class B ordinary
shares. Young Vision Company Limited, or Young Vision, a holder of our ordinary shares controlled by Mr. Xiangdong Qi, our director and president, will hold 18,633,343 Class B ordinary
shares. Highland Capital Partners VI Limited Partnership and its affiliates, or Highland, holders of our preferred shares, will hold 26,515,152 Class B ordinary shares. Sequoia Capital China
I, L.P. and its affiliates, or Sequoia, holders of our preferred shares, will hold 14,202,219 Class B ordinary shares. CDH Net Technology Limited, or CDH, a holder of our preferred
shares, will hold 10,572,556 Class B ordinary shares. Certain of our executive officers will hold an aggregate of 19,729,606 Class B ordinary shares. All the remaining ordinary shares
and preferred shares will convert into 27,993,722 Class A ordinary shares immediately upon the completion of this offering. We intend to maintain the dual-class ordinary share
structure after the closing of this offering. Each Class B ordinary share will be convertible into Class A ordinary share at any time by the holder thereof. Class A ordinary
shares will not be convertible to Class B ordinary shares under any circumstances. Upon any sale, pledge, transfer, assignment or disposition of Class B ordinary shares by a holder
thereof to any person or entity which is not an affiliate of such holder, such Class B ordinary shares shall be automatically and immediately converted into the equal number of Class A
ordinary shares.
Due
to the disparate voting powers attached to these two classes of shares, we anticipate that Mr. Hongyi Zhou, Mr. Xiangdong Qi, Highland, Sequoia, CDH and certain of our
executive officers will collectively own approximately 92.23% of the voting power of our outstanding ordinary shares after this offering and will 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. 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 our Class A ordinary shares and
ADSs may view as beneficial.
You may not have the same voting rights as the holders of our Class A ordinary shares and may not receive voting materials in time to be able to exercise your right
to vote.
Except as described in this prospectus and in the deposit agreement, holders of our ADSs will not be able to exercise voting rights
attaching to the Class A ordinary shares represented by our ADSs on an individual basis. Holders of our ADSs may instruct the depositary how to vote the Class A ordinary shares
underlying their ADSs, and the depositary will endeavor to carry out those instructions. However, you may not receive voting materials in time to instruct the depositary to vote, and you may not have
the opportunity to exercise a right to vote.
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You may not be able to participate in rights offerings and may experience dilution of your holdings as a result.
We may distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement for the ADSs, the
depositary will not offer those rights to ADS holders 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 with respect to all holders of ADSs.
We
are not obligated to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared
effective. In addition, we may not be able to take advantage of any exemptions from registration under the Securities Act. Accordingly, holders of our ADSs may be unable to participate in our rights
offerings and may experience dilution in their holdings as a result.
You may be subject to limitations on transfer of your ADSs.
Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from
time to time when it deems doing so expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs when our books
or the books of the depositary are closed, when we or the depositary deem it advisable to do so because of any requirement of law or of any government or governmental body, under any provision of the
deposit agreement or for any other reason.
We are a Cayman Islands company and, because judicial precedent regarding the rights of shareholders is more limited under Cayman Islands law than under U.S. law, you
may have less protection of your shareholder rights than you would under U.S. law.
Our corporate affairs are governed by our amended and restated memorandum and articles of association, the Cayman Islands Companies Law
and the common law of the Cayman Islands. The rights of shareholders to take action against the directors, the rights of minority shareholders to institute actions and the fiduciary responsibilities
of our directors to us 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, the latter of which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary
responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in the United States. In particular, the Cayman
Islands has a less developed body of securities law than the United States. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before the
federal courts of the United States. As a result, our public shareholders may encounter more difficulty in protecting their interests against actions taken by the management, the board of
directors or the controlling shareholders of our company than they would as shareholders of a public company incorporated in the United States.
You may have difficulty enforcing judgments obtained against us.
We are a Cayman Islands company, and we conduct substantially all of our operations in the PRC. Substantially all of our assets are
located outside of the United States. In addition, most of our directors and officers are nationals and residents of countries other than the United States. As a result, it may be
difficult for you to effect service of process upon our directors and officers in the United States. It may also be difficult for you to enforce judgments obtained in U.S. courts based
on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents of the United States and the substantial
majority of whose assets are located outside of the United States.
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In
addition, the courts of the Cayman Islands or the PRC may not recognize or enforce judgments of U.S. courts against us or our directors and officers predicated upon the civil
liability provisions of the securities laws of the United States or any state. Furthermore, Cayman Islands or PRC courts may not be competent to hear original actions brought in the Cayman
Islands or the PRC against us or our
directors and officers predicated upon the securities laws of the United States or any state. See "Enforceability of Civil Liabilities."
Our management will have considerable discretion in applying the net proceeds from this offering and may use the net proceeds in ways that do not improve our profitability
or increase our share price.
We intend to use the net proceeds of this offering for technology development and the development of new products and services,
investment in and acquisition of technologies, products or businesses, and general corporate purposes. However, our plans are made based on the business conditions as of the date of this prospectus
and we will have significant discretion in applying the net proceeds of this offering. Unforeseen events or changed business conditions could result in our applying the net proceeds of this offering
in a manner other than as described in this prospectus. You will not have the opportunity to assess whether we use the proceeds appropriately, and we may use the net proceeds in ways that do not
improve our operating results or increase the value of your investment.
We will incur additional costs as a result of becoming a public company, which could negatively impact our net income and liquidity.
Upon completion of this offering, we will become a public company in the United States. As a public company, we will incur
significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002 and rules and regulations implemented by the SEC and the
New York Stock Exchange require significantly heightened corporate governance practices for public companies. We expect that these rules and regulations will increase our legal, accounting and
financial compliance costs and will make many corporate activities more time-consuming and costly.
We
do not expect to incur materially greater costs as a result of becoming a public company than those incurred by similarly sized U.S. public companies. If we fail to comply with
these rules and regulations, we could become the subject of a governmental enforcement action, investors may lose confidence in us and the market price of our ADSs could decline.
We are a "foreign private issuer," and our disclosure obligations differ from those of U.S. domestic reporting companies. As a result, we may not provide you the same
information as U.S. domestic reporting companies or we may provide information at different times, which may make it more difficult for you to evaluate our performance and prospects.
We are a foreign private issuer and, as a result, we are not subject to the same requirements as U.S. domestic issuers. Under
the Exchange Act, we will be subject to reporting obligations that, to some extent, are more lenient and less frequent than those of U.S. domestic reporting companies. For example, we will not
be required to issue quarterly reports or proxy statements. We will not be required to disclose detailed individual executive compensation information. Furthermore, our directors and executive
officers will not be required to report equity holdings under Section 16 of the Exchange Act and will not be subject to the insider short-swing profit disclosure and recovery regime.
As
a foreign private issuer, we will also be exempt from the requirements of Regulation FD (Fair Disclosure) which, generally, are meant to ensure that select groups of investors
are not privy to specific information about an issuer before other investors. However, we will still be subject to the anti-fraud and anti-manipulation rules of the SEC, such
as Rule 10b-5 under the Exchange Act. Since many of the disclosure obligations imposed on us as a foreign private issuer differ from those imposed on U.S. domestic
reporting companies, you should not expect to receive the same information about us and at the same time as the information provided by U.S. domestic reporting companies.
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FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that relate to future events, including our future operating results and
conditions, our prospects and our future financial performance and condition. The forward-looking statements are contained principally in the sections entitled "Prospectus Summary," "Risk Factors,"
"Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Industry" and "Business." These statements involve known and unknown risks, uncertainties
and other factors, including those listed under "Risk Factors," which may cause our actual results, performance or achievements to materially differ from the future results, performance or
achievements expressed or implied by the forward-looking statements.
You
can identify forward-looking statements by forward-looking terminology, such as "may," "will," "expect," "anticipate," "aim," "estimate," "intend," "plan," "believe," "potential,"
"continue," "is/are likely to" or other similar expressions or the negative of these words or 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, among other things, statements relating to:
-
-
our growth strategies;
-
-
our future development, results of operations and financial condition;
-
-
our ability to continue to develop new and attractive technologies, products and services;
-
-
our ability to attract and retain users and customers;
-
-
the expected growth of the Internet and mobile security industries;
-
-
trends in the Internet and mobile security industries;
-
-
PRC governmental policies and regulations relating to the Internet and mobile security industries in China;
-
-
competition in the Internet and mobile security industries; and
-
-
general economic and business conditions in China.
The
forward-looking statements in this prospectus reflect our good faith beliefs as of the date of this prospectus. Except as required by law, we undertake no obligation to update or
revise any forward-looking statements, whether as a result of new information, future events or otherwise. You should read this prospectus and the documents that we have filed as exhibits to the
registration statement of which this prospectus is a part completely and with the understanding that our actual future results may be materially different from what we expect.
38
Table of Contents
USE OF PROCEEDS
We estimate that we will receive net proceeds of approximately $206.5 million from this offering and from our concurrent private
placement, or approximately $231.0 million if the underwriters exercise their option to purchase additional ADSs in full based upon the initial public offering price of $14.50 per ADS, after
deducting the estimated underwriting discounts and commissions and offering expenses payable by us.
We
intend to use the net proceeds of this offering for the following purposes:
-
-
approximately $61.9 million for development of new Internet and mobile security products and services;
-
-
approximately $61.9 million for enhancement of our research and development capabilities to further develop
technologies;
-
-
approximately $31.0 million for investment in and acquisition of technologies, products or businesses; and
-
-
the balance for general corporate purposes.
The
foregoing represents our current intentions based upon our current plans and business conditions. Accordingly, we will have significant discretion in applying the net proceeds of
this offering. Unforeseen events or changed business conditions could result in our applying the net proceeds of this offering in a manner other than as described in this prospectus. Pending use of
the net proceeds, we intend to invest our net proceeds in short-term, interest bearing and investment-grade obligations.
In
using the proceeds of this offering, as an offshore holding company, we are permitted, under PRC laws and regulations, to provide funding to our PRC subsidiaries only through loans or
capital contributions and to other entities only through loans. Subject to satisfaction of applicable government registration and approval requirements, we may extend inter-company loans to our PRC
subsidiaries or make additional capital contributions to our PRC subsidiaries to fund their capital expenditures or working capital. We cannot assure you that we will be able to obtain these
government registrations or approvals on a timely basis, if at all.
39
Table of Contents
DIVIDEND POLICY
We have never declared or paid any dividends on our ordinary shares. We do not anticipate paying any dividends in the foreseeable
future. We currently intend to retain future earnings, if any, to finance operations and expand our business.
As
an offshore holding company, we may rely on dividends from our subsidiaries in China for our cash requirements, including to pay dividends or make other distributions to our
shareholders. PRC regulations permit our subsidiaries to pay dividends to us only out of their accumulated profits, if any, as determined in accordance with Chinese accounting standards and
regulations. In addition, each of our subsidiaries in China is required to set aside a certain amount of its after-tax profits each year, if any, to fund certain statutory reserves. These
reserves are not distributable as cash dividends. Furthermore, if our subsidiaries in China incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability
to pay dividends or make other payments to us.
Our
board of directors has sole discretion whether to pay dividends. If our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future
operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that our directors may deem relevant.
Holders
of our ADSs will be entitled to receive dividends, if any, subject to the terms of the deposit agreement, to the same extent as the holders of our Class A ordinary shares.
Cash dividends will be paid to the depositary in U.S. dollars, and the depositary will distribute them to the holders of ADSs, after deducting its fees and expenses, according to the terms of
the deposit agreement. Other distributions, if any, will be paid by the depositary to the holders of ADSs in any means it deems legal, fair and practical. See "Description of American Depositary
SharesDividends and Other Distributions."
40
Table of Contents
CAPITALIZATION
The following table shows our capitalization as of December 31, 2010:
-
-
on an actual basis;
-
-
on a pro forma basis to reflect the automatic conversion of all of our outstanding Series A, Series B
and Series C convertible participating redeemable preferred shares into 78,314,016 ordinary shares immediately upon the completion of this offering at a conversion ratio of one
convertible participating redeemable preferred shares to one ordinary share as if the conversion had occurred as of December 31, 2010; and
-
-
on a pro forma as adjusted basis to reflect the automatic conversion of all of our outstanding Series A,
Series B and Series C convertible participating redeemable preferred shares into 78,314,016 ordinary shares immediately upon the completion of this offering at a conversion ratio
of one convertible participating redeemable preferred shares to one ordinary share, and the sale of 18,166,200 Class A ordinary shares in the form of ADSs by us in this offering and
5,172,414 Class A ordinary shares in the form of restricted ADSs in our concurrent private placement at the initial public offering price of $14.50 per ADS after deducting underwriting
discounts and commissions and estimated offering expenses payable by us.
You
should read this table in conjunction with our consolidated financial statements and related notes included in this prospectus and the information under "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2010
|
|
|
|
Actual
|
|
Pro Forma
|
|
Pro Forma
As Adjusted
|
|
|
|
($ in thousands)
|
|
Convertible Participating Redeemable Preferred Shares
|
|
|
|
|
|
|
|
|
|
|
Series A convertible participating redeemable preferred shares, par value $0.001 per share; 32,603,760 authorized; 32,603,760 issued and
outstanding; none outstanding on a pro forma or pro forma as adjusted basis
|
|
|
20,107
|
|
|
|
|
|
|
|
Series B convertible participating redeemable preferred shares, par value $0.001 per share; 37,878,789 authorized; 37,878,789 issued and
outstanding; none outstanding on a pro forma or pro forma as adjusted basis
|
|
|
29,193
|
|
|
|
|
|
|
|
Series C convertible participating redeemable preferred shares, par value $0.001 per share; 7,831,467 authorized; 7,831,467 issued and
outstanding; none outstanding on a pro forma or pro forma as adjusted basis
|
|
|
20,900
|
|
|
|
|
|
|
|
41
Table of Contents
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2010
|
|
|
|
Actual
|
|
Pro Forma
|
|
Pro Forma
As Adjusted
|
|
|
|
($ in thousands)
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
Ordinary shares, par value $0.001 per share, 156,631,180 authorized, 71,560,740 ordinary shares issued and outstanding on an actual basis,
149,874,756 ordinary shares outstanding on a pro forma basis and 173,213,370 ordinary shares outstanding on a pro forma as adjusted basis
|
|
|
72
|
|
|
150
|
|
|
174
|
|
Additional paid-in capital
|
|
|
12,568
|
|
|
82,690
|
|
|
289,129
|
|
Accumulated deficit
|
|
|
(13,606
|
)
|
|
(13,606
|
)
|
|
(13,606
|
)
|
Statutory reserves
|
|
|
164
|
|
|
164
|
|
|
164
|
|
Accumulated other comprehensive income
|
|
|
3,017
|
|
|
3,017
|
|
|
3,017
|
|
|
|
|
|
|
|
|
|
Total Qihoo 360 Technology Co. Ltd. shareholders' equity
|
|
|
2,215
|
|
|
72,415
|
|
|
278,878
|
|
|
|
|
|
|
|
|
|
Noncontrolling interest
|
|
|
507
|
|
|
507
|
|
|
507
|
|
|
|
|
|
|
|
|
|
Total equity
|
|
|
2,722
|
|
|
72,922
|
|
|
279,385
|
|
|
|
|
|
|
|
|
|
Total capitalization
|
|
|
72,922
|
|
|
72,922
|
|
|
279,385
|
|
|
|
|
|
|
|
|
|
This
table is based on 71,560,740 of our ordinary shares outstanding as of December 31, 2010 and excludes:
-
-
5,913,950 ordinary shares issuable upon the exercise of share options outstanding as of December 31, 2010
with exercise prices ranging from $1.50 to $2.80 per share and a weighted average exercise price of $2.61 per share; and
-
-
833,474 additional ordinary shares reserved for future grants under our share incentive plans.
42
Table of Contents
DILUTION
If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per
ADS and our net tangible book value per ADS after the offering. Dilution results from the conversion of our Series A, Series B and Series C convertible participating redeemable
preferred shares into ordinary shares and the fact that the initial offering price per Class A ordinary share is substantially greater than the book value per ordinary share attributable to
existing shareholders for our presently outstanding ordinary shares.
Our
net tangible book value at December 31, 2010 was $63.5 million, or $0.89 per ordinary share and $1.34 per ADS. Net tangible book value represents total consolidated
tangible assets less total consolidated liabilities. Our pro forma net tangible book value as of December 31, 2010 was $63.5 million, or $0.42 per ordinary share and $0.63 per
ADS. Pro forma net tangible book value adjusts net tangible book value to give effect to the automatic conversion of all of our Series A, Series B and Series C convertible
participating redeemable preferred shares into 78,314,016 ordinary shares immediately prior to the closing of this offering.
Without
taking into account any changes in net tangible book value after December 31, 2010 other than to give effect to (i) the automatic conversion of all of our
outstanding Series A, Series B and Series C convertible participating redeemable preferred shares into 78,314,016 ordinary shares immediately prior to the closing of this
offering, (ii) our sale of 12,110,800 ADSs in this offering at the initial public offering price of $14.50 per ADS and (iii) the issuance and sale of 5,172,414 Class A ordinary
shares in the form of restricted ADSs to the investors in our concurrent private placement, at the initial public offering price of $14.50 per ADS and after deducting the underwriting discounts and
commissions and estimated offering expenses and assuming no exercise of the underwriters' option to purchase additional ADSs and no other change to the number of ADS sold by us as set forth on the
cover page of this prospectus, our pro forma as adjusted net tangible book value as of December 31, 2010 would have been $269.9 million, or $1.56 per ordinary share and $2.34 per
ADS. This represents an immediate increase in pro forma net tangible book value of $1.14 per ordinary share, or $1.71 per ADS, to existing shareholders and an immediate dilution of $8.11 per
ordinary share, or $12.16 per ADS, to investors purchasing ADSs in this offering. The following table illustrates this per share dilution:
|
|
|
|
|
Initial public offering price per ordinary share
|
|
$
|
9.67
|
|
Net tangible book value per ordinary share as of December 31, 2010
|
|
$
|
0.89
|
|
Pro forma net tangible book value per ordinary share as of December 31, 2010
|
|
$
|
0.42
|
|
Increase in pro forma net tangible book value per ordinary share attributable to this offering and concurrent private placement
|
|
$
|
1.14
|
|
Pro forma as adjusted net tangible book value per ordinary share after giving effect to the conversion of our convertible participating redeemable
preferred shares, this offering and issuance of 5,172,414 Class A ordinary shares in the form of restricted ADSs in our concurrent private placement
|
|
$
|
1.56
|
|
Dilution per ordinary share to new investors
|
|
$
|
8.11
|
|
Dilution per ADS to new investors
|
|
$
|
12.16
|
|
The
following table summarizes, on a pro forma as adjusted basis as of December 31, 2010, the differences between existing shareholders and new investors (including those
in our concurrent private placement) with respect to the number of ordinary shares purchased from us, the total consideration paid and the average price per ordinary share and the average price per
ADS, each paid before deducting the underwriting discounts and commissions and our estimated offering expenses. The total
43
Table of Contents
number
of ordinary shares does not include the ordinary shares underlying the ADSs to be sold upon the exercise of the option granted to the underwriters to purchase additional ADSs from us.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares Purchased
|
|
Total Consideration
|
|
Average
Price Per
Ordinary
Share
|
|
|
|
|
|
Average
Price Per
ADS
|
|
|
|
Number
|
|
Percent
|
|
Amount
|
|
Percent
|
|
|
|
(in thousands of $, except per share and per ADS data)
|
|
Existing holders
(1)
|
|
|
149,874,756
|
|
|
86.5
|
%
|
$
|
62,746
|
|
|
21.8
|
%
|
$
|
0.42
|
|
$
|
0.63
|
|
New investors
|
|
|
23,338,614
|
|
|
13.5
|
|
|
225,607
|
|
|
78.2
|
|
|
9.67
|
|
|
14.50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
173,213,370
|
|
|
100.0
|
%
|
$
|
288,353
|
|
|
100.0
|
%
|
$
|
1.66
|
|
$
|
2.50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
(1)
-
Reflects
the automatic conversion of all of our outstanding Series A, Series B and Series C convertible participating redeemable
preferred shares into 78,314,016 ordinary shares upon the closing of this offering.
The
discussion and tables in this section assume no exercise of outstanding share options. As of December 31, 2010, there were share options outstanding to purchase a total of
5,913,950 ordinary shares, with a weighted average exercise price of $2.61 per ordinary share. To the extent that any of these share options are exercised, there will be further dilution to
new investors.
44
Table of Contents
ENFORCEABILITY OF CIVIL LIABILITIES
We are incorporated in the Cayman Islands as an exempted company with limited liability. We are incorporated in the Cayman Islands in
order to enjoy certain benefits associated with being a Cayman Islands exempted company, including:
-
-
political and economic stability;
-
-
an effective judicial system;
-
-
a favorable tax system;
-
-
the absence of exchange control or currency restrictions; and
-
-
the availability of professional and support services.
However,
certain disadvantages accompany incorporation in the Cayman Islands. These disadvantages include:
-
-
The Cayman Islands has a less developed body of securities laws compared to that of the United States and these
securities laws provide significantly less protection to investors; and
-
-
Cayman Islands companies may not have standing to sue before the federal courts of the United States.
Our
organizational documents do not contain provisions requiring that disputes, including those arising under the securities laws of the United States, between us, our officers,
directors and shareholders be arbitrated.
Almost
all of our assets are located in China. A majority of our directors and officers are nationals or residents of jurisdictions other than the United States and a substantial
portion of their assets are located outside the United States. As a result, it may be difficult for a shareholder to effect service of process within the United States upon these
persons, or to enforce against us or them judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the
United States or any state of the United States. We have appointed Corporation
Service Company as our agent upon whom process may be served in any action brought against us under the securities laws of the United States.
Maples
and Calder, our counsel as to the laws of the Cayman Islands, and Commerce & Finance Law Offices, our counsel as to Chinese law, have advised us respectively that there is
uncertainty as to whether the courts of the Cayman Islands or China respectively would:
-
-
recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated
upon the civil liability provisions of the securities laws of the United States or any state in the United States; or
-
-
entertain original actions brought in the Cayman Islands or China respectively against us or our directors or officers
predicated upon the securities laws of the United States or any state in the United States.
Maples
and Calder has further advised us that a final and conclusive judgment in a federal or state court of the United States under which a sum of money is payable, other than a
sum payable in respect of taxes, fines, penalties or similar charges, and which was neither obtained in a manner nor is of a kind enforcement of which is contrary to natural justice or the public
policy of the Cayman Islands, may be subject to enforcement proceedings as a debt in the courts of the Cayman Islands under the common law without any re-examination of the merits of the
underlying dispute. However, the Cayman Islands courts are unlikely to enforce a punitive judgment of a United States court predicated upon the
45
Table of Contents
liabilities
provision of the U.S. federal securities laws without retrial on the merits if such judgment gives rise to payments obligations that may be regarded as fines, penalties or similar
charges.
In
addition, Commerce & Finance Law Offices has advised us that under the PRC Civil Procedures Law, courts in China may recognize and enforce foreign judgments pursuant to treaties
between China and the country where the judgment is rendered or based on reciprocity arrangements for the recognition and enforcement of foreign judgments between jurisdictions. If there is no treaty
or reciprocity arrangement between China and a foreign jurisdiction where a judgment is rendered, according to the PRC Civil Procedures Law, parties may resolve matters relating to the recognition and
enforcement of a foreign judgment in China through diplomatic channels. China does not have any treaties or other arrangements that provide for the reciprocal recognition and enforcement of foreign
judgments with the United States or the Cayman Islands. As a result, it is generally difficult to recognize and enforce in China a judgment rendered by a court in either of these two
jurisdictions.
46
Table of Contents
EXCHANGE RATE INFORMATION
Our business is primarily conducted in China, and the financial records of our PRC subsidiaries are maintained in RMB, their functional
currency. However, we use the U.S. dollar as our reporting currency. The assets and liabilities of our PRC subsidiaries are translated from RMB into U.S. dollars at the exchange rates on
the balance sheet date, shareholders' equity is translated at the historical rates and the revenues and expenses are translated at the weighted average exchange rate for the period. The exchange rates
used are based on the noon buying rate in The City of New York for cable transfers of RMB as certified for customs purposes by the Federal Reserve Bank of New York.
For
your convenience, this prospectus also contains translations of certain amounts in RMB into U.S. dollars at the rate of RMB6.6000 to $1.00, the noon buying rate for
December 30, 2010, as set forth in the H.10 statistical release of the Federal Reserve Board.
We
make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any
particular rate, the rates stated below, or at all. The PRC government imposes controls over its foreign currency reserves in part through direct regulation of the conversion of Renminbi into foreign
exchange and through restrictions on foreign trade. The following table sets forth information concerning exchange rates between the RMB and the U.S. dollar for the periods indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noon Buying Rate
|
|
|
|
Period End
|
|
Average
(1)
|
|
Low
|
|
High
|
|
|
|
(RMB per $1.00)
|
|
2005
|
|
|
8.0702
|
|
|
8.1826
|
|
|
8.2765
|
|
|
8.0702
|
|
2006
|
|
|
7.8041
|
|
|
7.9579
|
|
|
8.0702
|
|
|
7.8041
|
|
2007
|
|
|
7.2946
|
|
|
7.5806
|
|
|
7.8127
|
|
|
7.2946
|
|
2008
|
|
|
6.8225
|
|
|
6.9193
|
|
|
7.2946
|
|
|
6.7800
|
|
2009
|
|
|
6.8259
|
|
|
6.8295
|
|
|
6.8470
|
|
|
6.8176
|
|
2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September
|
|
|
6.6905
|
|
|
6.7396
|
|
|
6.8102
|
|
|
6.6869
|
|
|
October
|
|
|
6.6705
|
|
|
6.6675
|
|
|
6.6912
|
|
|
6.6397
|
|
|
November
|
|
|
6.6670
|
|
|
6.6538
|
|
|
6.6892
|
|
|
6.6791
|
|
|
December
|
|
|
6.6000
|
|
|
6.6497
|
|
|
6.6745
|
|
|
6.6000
|
|
2011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January
|
|
|
6.6017
|
|
|
6.5843
|
|
|
6.6017
|
|
|
6.5809
|
|
|
February
|
|
|
6.5713
|
|
|
6.5761
|
|
|
6.5965
|
|
|
6.5520
|
|
|
March (through March 25)
|
|
|
6.5568
|
|
|
6.5660
|
|
|
6.5743
|
|
|
6.5510
|
|
Source: Federal Reserve Bank of New York and Federal Reserve Board
-
(1)
-
Annual
averages are calculated by using the average of the exchange rates on the last day of each month during the relevant year. Monthly averages are
calculated by using the average of the daily rates during the relevant month.
47
Table of Contents
SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OPERATING DATA
You should read the following selected consolidated financial information in conjunction with our financial statements, the related
notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this prospectus. Our selected consolidated statement of operations data for the
years ended December 31, 2008, 2009 and 2010 and selected consolidated balance sheet data as of December 31, 2009 and 2010 have been derived from our audited consolidated financial
statements included elsewhere in this prospectus. The selected consolidated balance sheet data as of December 31, 2008 have been derived from our audited financial statements not
included in this prospectus. Our consolidated financial statements have been prepared and presented in accordance with U.S. GAAP.
We
have omitted financial information as of and for the years ended December 31, 2006 and 2007 because such information is not available on a basis that is consistent with the
consolidated financial information included in this prospectus and cannot be prepared in accordance with U.S. GAAP without unreasonable effort or expense. Furthermore, we believe that the
omission of such financial information would not have a material impact on a reader's understanding of our financial results and condition and related trends.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2008
|
|
2009
|
|
2010
|
|
|
|
($ in thousands, except share and per share data)
|
|
Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
Internet services
|
|
|
5,795
|
|
|
16,010
|
|
|
53,790
|
|
|
Sales of third party anti-virus software
|
|
|
11,100
|
|
|
16,292
|
|
|
3,875
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
16,895
|
|
|
32,302
|
|
|
57,665
|
|
|
|
|
|
|
|
|
|
Cost of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
Internet services
|
|
|
1,147
|
|
|
1,790
|
|
|
5,566
|
|
|
Sales of third party anti-virus software
|
|
|
7,073
|
|
|
6,600
|
|
|
1,185
|
|
|
|
|
|
|
|
|
|
Total cost of revenues
|
|
|
8,220
|
|
|
8,390
|
|
|
6,751
|
|
|
|
|
|
|
|
|
|
Subsidy income
|
|
|
|
|
|
|
|
|
266
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing
|
|
|
2,732
|
|
|
6,256
|
|
|
12,603
|
|
|
General and administrative
|
|
|
1,645
|
|
|
2,531
|
|
|
5,051
|
|
|
Research and development
|
|
|
7,283
|
|
|
10,664
|
|
|
24,505
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
11,660
|
|
|
19,451
|
|
|
42,159
|
|
|
|
|
|
|
|
|
|
(Loss) income from operations
|
|
|
(2,985
|
)
|
|
4,461
|
|
|
9,021
|
|
Interest income
|
|
|
616
|
|
|
281
|
|
|
415
|
|
Interest expense
|
|
|
(32
|
)
|
|
(169
|
)
|
|
(98
|
)
|
Other expense
|
|
|
(164
|
)
|
|
|
|
|
(60
|
)
|
Exchange (loss) gain
|
|
|
(360
|
)
|
|
28
|
|
|
(267
|
)
|
|
|
|
|
|
|
|
|
(Loss) income before income tax benefit (expense) and loss from equity method investment
|
|
|
(2,925
|
)
|
|
4,601
|
|
|
9,011
|
|
Income tax benefit (expense)
|
|
|
179
|
|
|
(412
|
)
|
|
(463
|
)
|
Loss from equity method investment
|
|
|
|
|
|
|
|
|
(57
|
)
|
|
|
|
|
|
|
|
|
Net (loss) income
|
|
|
(2,746
|
)
|
|
4,189
|
|
|
8,491
|
|
Less: Net loss attributable to noncontrolling interest
|
|
|
|
|
|
|
|
|
17
|
|
|
|
|
|
|
|
|
|
Net (loss) income attributable to Qihoo 360 Technology Co. Ltd.
|
|
|
(2,746
|
)
|
|
4,189
|
|
|
8,508
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
48
Table of Contents
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2008
|
|
2009
|
|
2010
|
|
|
|
($ in thousands, except share and per share data)
|
|
Accretion of Series A convertible participating redeemable preferred shares
|
|
|
815
|
|
|
815
|
|
|
815
|
|
Accretion of Series B convertible participating redeemable preferred shares
|
|
|
1,250
|
|
|
1,250
|
|
|
1,250
|
|
Accretion of Series C convertible participating redeemable preferred share
|
|
|
|
|
|
|
|
|
978
|
|
|
|
|
|
|
|
|
|
Net (loss) income attributable to ordinary shareholders of Qihoo 360 Technology Co. Ltd.
|
|
|
(4,811
|
)
|
|
2,124
|
|
|
5,465
|
|
|
|
|
|
|
|
|
|
Net (loss) income per ordinary sharebasic
|
|
|
(0.07
|
)
|
|
0.03
|
|
|
0.05
|
|
Net (loss) income per participating unvested sharebasic
|
|
|
(0.07
|
)
|
|
0.03
|
|
|
0.05
|
|
Net income per Series A convertible participating redeemable preferred sharebasic
|
|
|
0.02
|
|
|
0.03
|
|
|
0.06
|
|
Net income per Series B convertible participating redeemable preferred sharebasic
|
|
|
0.03
|
|
|
0.03
|
|
|
0.06
|
|
Net income per Series C convertible participating redeemable preferred sharebasic
|
|
|
N/A
|
|
|
N/A
|
|
|
0.13
|
|
|
|
|
|
|
|
|
|
Net (loss) income per ordinary sharediluted
|
|
|
(0.07
|
)
|
|
0.03
|
|
|
0.05
|
|
|
|
|
|
|
|
|
|
Weighted average shares used in calculating net income per ordinary sharebasic
|
|
|
48,969,589
|
|
|
51,780,932
|
|
|
55,568,041
|
|
Weighted average shares used in calculating net income per participating unvested sharebasic
|
|
|
16,370,371
|
|
|
13,559,028
|
|
|
15,782,530
|
|
Weighted average shares used in calculating net income per Series A convertible participating redeemable preferred sharebasic
|
|
|
32,603,760
|
|
|
32,603,760
|
|
|
32,603,760
|
|
Weighted average shares used in calculating net income per Series B convertible participating redeemable preferred sharebasic
|
|
|
37,878,789
|
|
|
37,878,789
|
|
|
37,878,789
|
|
Weighted average shares used in calculating net income per Series C convertible participating redeemable preferred sharebasic
|
|
|
|
|
|
|
|
|
7,659,818
|
|
Weighted average shares used in calculating net income per ordinary sharediluted
|
|
|
65,339,960
|
|
|
65,339,960
|
|
|
71,350,571
|
|
|
|
|
|
|
|
|
|
Share-based compensation expense included in:
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing
|
|
|
226
|
|
|
479
|
|
|
524
|
|
|
General and administrative
|
|
|
104
|
|
|
151
|
|
|
337
|
|
|
Research and development
|
|
|
923
|
|
|
1,294
|
|
|
3,145
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
1,253
|
|
|
1,924
|
|
|
4,006
|
|
|
|
|
|
|
|
|
|
49
Table of Contents
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
2008
|
|
2009
|
|
2010
|
|
2010
|
|
|
|
Actual
|
|
Actual
|
|
Actual
|
|
Pro Forma As
Adjusted
(1)
|
|
|
|
($ in thousands)
|
|
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
|
23,262
|
|
|
28,144
|
|
|
60,505
|
|
|
266,968
|
|
Total assets
|
|
|
33,943
|
|
|
49,589
|
|
|
87,808
|
|
|
294,271
|
|
Total current liabilities
|
|
|
1,987
|
|
|
8,489
|
|
|
13,924
|
|
|
13,924
|
|
Total liabilities
|
|
|
4,948
|
|
|
10,935
|
|
|
14,886
|
|
|
14,886
|
|
Total (deficit) equity
|
|
|
(16,175
|
)
|
|
(8,581
|
)
|
|
2,722
|
|
|
279,385
|
|
-
(1)
-
Pro forma
as adjusted to give effect to:
-
-
the automatic conversion of all of our outstanding Series A, Series B and Series C convertible
participating redeemable preferred shares into 78,314,016 ordinary shares upon the closing of this offering; and
-
-
the issuance and sale of 23,338,614 Class A ordinary shares in the form of ADSs by us in this offering and in our
concurrent private placement at the initial public offering price of $14.50 per ADS, after deducting estimated underwriting discounts, commissions and estimated offering expenses payable by us.
The
following table shows the monthly active users for our primary security products and platform products, both in an absolute number and as a percentage of the then total Internet
users in China as reported by iResearch:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Monthly Active Users of:
|
|
December 2008
|
|
December 2009
|
|
January 2011
|
|
|
|
(in millions, except percentages)
|
|
360 Safe Guard
|
|
|
116
|
|
|
60.9
|
%
|
|
216
|
|
|
72.8
|
%
|
|
301
|
|
|
76.9
|
%
|
360 Anti-Virus
|
|
|
2
|
|
|
0.9
|
%
|
|
87
|
|
|
29.3
|
%
|
|
248
|
|
|
63.5
|
%
|
360 Safe Browser
|
|
|
18
|
|
|
9.4
|
%
|
|
106
|
|
|
35.8
|
%
|
|
172
|
|
|
44.1
|
%
|
360 security products
|
|
|
119
|
|
|
62.8
|
%
|
|
225
|
|
|
75.9
|
%
|
|
328
|
|
|
83.9
|
%
|
50
Table of Contents
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition and results of operations in
conjunction with the section entitled "Selected Consolidated Financial Information and Operating Data" and our consolidated financial statements and the related notes included elsewhere in this
prospectus. This discussion contains forward-looking statements about events 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 prospectus.
Overview
We are the No. 3 Internet company in China as measured by user base, according to a report we commissioned from iResearch. In
January 2011, we had 339 million monthly active Internet users, representing a user penetration rate of 85.8% in China, according to iResearch.
We
are also the No. 1 provider of Internet and mobile security products in China as measured by user base, according to iReseach. In January 2011, we had 328 million
monthly active Internet security product users, representing a user penetration rate of 83.9% in China, according to iResearch. We offer all of our Internet and mobile security products free of charge
and generate revenue primarily through offering the following services:
-
-
Online advertising.
We offer advertising services by
providing marketing opportunities on our websites and secure platform products to our advertising customers. We also offer search referral services to search engine companies.
-
-
Internet value-added services.
We offer web games
developed by third parties, provide Internet security services such as remote technical support to paying customers and provide other Internet value-added services.
-
-
Other services.
On an ad-hoc project basis, we
also offer IT outsourcing and systems integration services to enterprise customers. This is not our core business and its contribution to our revenues is insignificant.
In
addition, we also generate revenue through selling anti-virus software developed by third parties. We significantly decreased our sales of third-party anti-virus
software since the fourth quarter of 2009, as we began to offer 360 Anti-Virus to users free of charge.
We
charge customers advertising fees for providing links to their websites or online applications in prominent positions on our websites and secure platform products. We generally charge
our customers a fixed fee for an agreed contract period and occasionally also charge customers on a cost-per-sale or cost-per-action basis. Our
360 Safe Browser and its default home page, 360 Personal Start-up Page, also contain default search boxes that direct search traffic to search engines such as Google. These search engine
companies pay us a pre-determined fee for each search originated from 360 Safe Browser and 360 Personal Start-up Page.
We
began offering web games developed by third parties in 2009 under revenue sharing arrangements with the game developers. In 2010, we began to offer Internet security services such as
remote technical support to paying customers. When computer users encounter security issues, they can request our staff for live technical assistance and remote troubleshooting for a service fee on a
per-case basis. We also provide monthly and annual subscription for this service.
We
have grown significantly since we commenced operations in 2005. Our active monthly active Internet users increased from 122 million in December 2008 to
231 million in December 2009 and 339 million in January 2011. Our revenue was $16.9 million, $32.3 million and $57.7 million, respectively, in 2008,
2009 and 2010, representing a CAGR of 84.8%. We first became profitable in 2009 and our net income increased by 102.7% from $4.2 million in 2009 to $8.5 million in 2010.
51
Table of Contents
Factors Affecting Our Results of Operations
Our operating results are affected by prevailing general conditions in the PRC Internet industry, including China's economic
performance and the PRC regulatory environment governing the Internet industry. Our operating results may also be affected by our ability to compete effectively with other industry players and our
ability to control our operating costs and expenses. In addition, our operating results are affected by the following company-specific factors:
-
-
User base.
Our success in generating revenue, especially
from our online advertising and Internet value-added services, largely depends on our ability to maintain and increase the number of users of our security products and services. The size of our user
base drives the online traffic or transactions originated from our websites and secure platform products for which we get paid by our online advertising customers. The number of users visiting our
websites or using our secure platform products also represents the size of the addressable market for our Internet value-added services and the potential for generating additional sources of revenues.
In order to attract and retain users, we must continue to invest significant resources to provide comprehensive and effective security products and services.
-
-
Pricing and revenue sharing.
We generally charge our
advertising customers a fixed fee for an agreed contract period and occasionally also charge on a cost-per-sale or cost-per-action basis. We charge
search engines a pre-determined fee for each search originated from our websites and platform products. In both cases, we have been able to increase our fee rates as our advertising platform becomes
more effective as measured by the increase in Internet traffic or transactions that we are able to originate. However, our ability to increase fee rates is limited by the competitive landscape and
subject to acceptance by our customers. As our web games and software distribution business are based on revenue sharing arrangements with third-party developers, our revenue depends in part on our
percentage share of the revenues we generate. We are able to negotiate a more favorable percentage share if we can generate the revenue and sales that are attractive for these developers to continue
to cooperate with us.
-
-
Revenue mix.
Our revenues and costs of revenues are
affected by changes in our revenue mix. In 2008 and 2009, we generated a substantial portion of our revenues from sales of third-party anti-virus software. In the second half of 2009, we started
offering 360 Anti-Virus to users free of charge as we adopted the business model of offering free Internet and mobile security products to build up a large and loyal user base and generating
revenues through providing Internet services, including online advertising and Internet value-added services. In the fourth quarter of 2009, we significantly decreased sales of third-party
anti-virus software and focused on providing Internet services. As a result, revenues from sales of third-party anti-virus software as a percentage of total revenues decreased
from 50.4% in 2009 to 6.7% in 2010, while revenues from Internet services as a percentage of our revenues increased from 49.6% in 2009 to 93.3% in 2010. Largely because the cost of conducting Internet
services is lower compared to the cost of sales of third-party anti-virus software, our cost of revenues decreased from $8.4 million in 2009 to $6.8 million in 2010. As we
further expand our business, our revenue mix may continue to change, which may affect our results of operations for future periods.
-
-
Research and development.
In order to attract and retain
users, we have invested significant resources in research and development to enhance our Internet security technology and improve our products and services and enhance user experience. In 2008, 2009
and 2010, our research and development expenses were $7.3 million, $10.7 million and $24.5 million, respectively, representing 43.1%, 33.0% and 42.5% of our revenues in the
corresponding period. We expect our research and development expenses will continue to increase as we endeavor to develop attractive products and services that enable users to enjoy a more secure and
higher quality Internet experience.
52
Table of Contents
Financial Overview
Revenues
Our revenues increased by 91.2% from $16.9 million in 2008 to $32.3 million in 2009, and by 78.5% from
$32.3 million in 2009 to $57.7 million in 2010. The following table sets forth our revenues by source both in absolute amounts and as percentages of total revenues for the periods
indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2008
|
|
%
|
|
2009
|
|
%
|
|
2010
|
|
%
|
|
|
|
($ in thousands, except percentages)
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Internet services
|
|
|
5,795
|
|
|
34.3
|
%
|
|
16,010
|
|
|
49.6
|
%
|
|
53,790
|
|
|
93.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Online advertising
|
|
|
5,606
|
|
|
33.2
|
|
|
13,928
|
|
|
43.1
|
|
|
38,826
|
|
|
67.3
|
|
|
Internet value-added services
|
|
|
|
|
|
|
|
|
2,050
|
|
|
6.4
|
|
|
14,774
|
|
|
25.7
|
|
|
Other services
|
|
|
189
|
|
|
1.1
|
|
|
32
|
|
|
0.1
|
|
|
190
|
|
|
0.3
|
|
Sales of third-party anti-virus software
|
|
|
11,100
|
|
|
65.7
|
|
|
16,292
|
|
|
50.4
|
|
|
3,875
|
|
|
6.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16,895
|
|
|
100.0
|
%
|
|
32,302
|
|
|
100.0
|
%
|
|
57,665
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from Internet Services
Our revenues from Internet services comprise revenues from online advertising, revenues from Internet value-added services and revenues
from other services.
Online Advertising.
Customers of our online advertising business primarily consist of third-party websites who place links on our
websites (such as
360 Personal Start-up Page) and secure platform products and search engines who pay us fees for directing search traffic from our websites and secure platform products.
We
generally charge our advertising customers a fixed fee for an agreed contract period. We also charge many online shopping websites on a cost-per-sale basis,
i.e., a certain percentage of the amount of each sales transaction that we originate. In addition, we charge employment solution websites on a cost-per-action basis,
i.e., a fixed fee for each action taken by users directed by us on these websites.
For
search engines, we charge a pre-determined fee for each search that we originate, up to a pre-determined limit in certain cases. Our fee may be renegotiated
if the number of referred searches exceeds the agreed limit. Our agreements with the search engines usually have a term of one year and are renewable upon both parties' written agreement.
In
2008, we also derived revenues from designing and placing customized online advertisements to promote the brand of our customers and charged them fees on a
project-by-project basis. We gradually phased out this service in the second half of 2009.
Internet Value-added Services.
Our Internet value-added services include offering web games developed by third parties, offering
Internet security
services such as remote technical support to paying customers and providing other Internet value-added services.
We
select and offer popular web games developed by third-party game developers on our game platform. Our game portfolio includes role-playing, strategy, sports and simulation
games. Users can play these games directly on our game platform without downloading separate software. We offered over 25 games, with a combined player base of 14.7 million as of
December 31, 2010. We share revenues from game operations with game developers according to the terms of our cooperation agreements.
In
2010, we started offering Internet security services, such as providing remote technical support under our "Helpton" brand. When users encounter security issues, they can request our
staff to provide live technical assistance and remote troubleshooting for a service fee on a per-case basis. We also provide monthly and annual subscriptions for this service.
53
Table of Contents
Other services.
We also generate an insignificant amount of revenue from other ad-hoc services, such as IT outsourcing and system
integration
services to enterprise customers.
Revenues from Sales of Third-party Anti-virus Software
We purchase software from third-party anti-virus software developers for online resale to customers.
Cost of Revenues and Operating Expenses
The following table sets forth the cost of revenues and operating expenses, both in absolute amounts and as percentages of total
revenues for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2008
|
|
%
|
|
2009
|
|
%
|
|
2010
|
|
%
|
|
|
|
($ in thousands, except percentages)
|
|
Revenues
|
|
|
16,895
|
|
|
100.0
|
%
|
|
32,302
|
|
|
100.0
|
%
|
|
57,665
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Internet services
|
|
|
1,147
|
|
|
6.8
|
|
|
1,790
|
|
|
5.5
|
|
|
5,566
|
|
|
9.7
|
|
|
Sales of third-party anti-virus software
|
|
|
7,073
|
|
|
41.9
|
|
|
6,600
|
|
|
20.5
|
|
|
1,185
|
|
|
2.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenues
|
|
|
8,220
|
|
|
48.7
|
|
|
8,390
|
|
|
26.0
|
|
|
6,751
|
|
|
11.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing
|
|
|
2,732
|
|
|
16.2
|
|
|
6,256
|
|
|
19.4
|
|
|
12,603
|
|
|
21.8
|
|
|
General and administrative
|
|
|
1,645
|
|
|
9.7
|
|
|
2,531
|
|
|
7.8
|
|
|
5,051
|
|
|
8.8
|
|
|
Research and development
|
|
|
7,283
|
|
|
43.1
|
|
|
10,664
|
|
|
33.0
|
|
|
24,505
|
|
|
42.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
11,660
|
|
|
69.0
|
%
|
|
19,451
|
|
|
60.2
|
%
|
|
42,159
|
|
|
73.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Revenues
Cost of revenues consists of cost of Internet services and cost of sales of third-party anti-virus software.
Cost
of Internet services primarily consist of business tax and surcharges, payment collection costs and other costs. Our Internet services are subject to PRC business tax and related
surcharges on our revenue. We expect our business tax and surcharges will continue to increase in line with increases in our revenues. Payment collection costs in connection with Internet services
represents the fees that we pay to providers of mobile payment and online banking services for processing payments from our
customers. Other costs incurred in connection with Internet services primarily comprise cost of designing and placing brand-promoting advertisements for our enterprise customers and costs related to
our remote technical support service such as staff salary, equipment depreciation and office rental.
Cost
of sales of third-party anti-virus software primarily consists value added tax surcharges, payment collection costs and cost of purchasing third-party
anti-virus software. Payment collection costs in connection with sales of third-party anti-virus software represent the fees that we pay to providers of mobile payment and
online banking services for processing payments from software purchasers. We also incur costs of purchasing third-party anti-virus software that we resell.
Operating Expenses
Our selling and marketing expenses primarily consist of salaries and benefits, including share-based compensation expenses, for our
sales and marketing personnel and advertising and promotion expenses. We expect to incur higher selling and marketing expenses as we intensify our efforts to build our brand and promote our products
and services.
Our
general and administrative expenses primarily consist of salaries and benefits, including share-based compensation expenses, for our administrative personnel and fees that we pay to
legal, accounting and other professional service providers. We expect to incur higher general and
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Table of Contents
administrative
expenses as we expand our operations, incur expenses relating to this offering and become a U.S.-listed public company.
Our
research and development expenses relate to the development and enhancement of our Internet security products using our cloud-based security technology through (1) constantly
updating our server cloud with a massive amount of malware information that our user cloud provides through information newly retrieved from and submitted by users, (2) detecting the nature and
classification of malware on a real-time basis, (3) constantly developing new anti-malware countermeasures against newly detected malware, and (4) deploying the
enhanced technology in our server cloud on a real-time basis. Our research and development expenses primarily consist of salaries and benefits, including share-based compensation expenses,
of our research and development personnel, costs of bandwidth and utilities, license and technical service fees, and depreciation of equipment and amortization of acquired intangible assets. We expect
research and development expenses to continue to increase as we continue to develop and innovate security products and develop technologies related to the Internet, such as browser and mobile
technologies.
The
table below shows the effect of the share-based compensation expenses on our operating expense line items for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2008
|
|
2009
|
|
2010
|
|
|
|
($ in thousands)
|
|
Share-based compensation expense included in:
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing
|
|
|
226
|
|
|
479
|
|
|
524
|
|
|
General and administrative
|
|
|
104
|
|
|
151
|
|
|
337
|
|
|
Research and development
|
|
|
923
|
|
|
1,294
|
|
|
3,145
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
1,253
|
|
|
1,924
|
|
|
4,006
|
|
|
|
|
|
|
|
|
|
We
expect to continue to grant share options and nonvested shares under our share incentive plans and incur further share-based compensation expenses in future periods.
Acquisitions
In September 2009, we acquired the Internet business derived from The World Browser from Beijing Shengjing Wanwei
Technology Co., Ltd., or Shengjing Wanwei, a China-based software developer, for $2.2 million in cash and 2,125,176 of our ordinary shares. We also granted nonvested shares to
certain key employees of Shengjing Wanwei to retain their services. We integrated the core technology of The World Browser into 360 Safe Browser. Shengjing Wanwei's software development team is
primarily responsible for improving and updating our browser technologies and functions.
Critical Accounting Policies
The preparation of our consolidated financial statements and related notes requires us to make judgments, estimates and assumptions
that affect the reported amounts of assets, liabilities, net sales and expenses, and related disclosure of contingent assets and liabilities. We have based our estimates on historical experience and
various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that
are not readily apparent from other sources. Our management has discussed the development, selection and disclosure of these estimates with our board of directors. Actual results may differ from these
estimates under different assumptions or conditions.
An
accounting policy is considered to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate
is made, and if different 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.
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Table of Contents
We
believe that the following critical accounting policies are the most sensitive and require more significant estimates and assumptions used in the preparation of our consolidated
financial statements. You should read the following descriptions of critical accounting policies, judgments and estimates in conjunction with our consolidated financial statements and other
disclosures included in this prospectus.
Revenue Recognition
We generate revenue primarily through providing Internet services, consisting primarily of online advertising and Internet value-added
services, and sales of third-party anti-virus software.
We
consider revenue to be realizable and earned when all of the following criteria exist:
-
-
persuasive evidence of a sales arrangement exists;
-
-
delivery has occurred or services have been rendered;
-
-
the price is fixed or determinable; and
-
-
collectability is reasonably assured.
Internet Services
Internet services revenue includes online advertising, Internet value-added services and other services.
We provide links to third-party websites or online applications on our websites and secure platform products (such as
360 Personal Start-up Page). We generally charge our customers a fixed fee for an agreed contract period and occasionally also charge on a cost-per-sale or
cost-per-action basis. For the fixed-fee advertising contracts, we recognize revenue ratably over the period the advertising is provided. For contracts that are charged on a
cost-per-sale or cost-per-action basis, the revenue is estimated based on our internal data, which is subsequently confirmed with our customers.
We
also direct search traffic to search engines such as Google through our default search boxes on our 360 Safe Browser and its default home page, 360 Personal Start-up
Page. We receive a pre-determined fee from search engine companies based on the number of searches originated from 360 Safe Browser and 360 Personal Start-up Page, subject to a
pre-determined limit. Our fees may be renegotiated if the number of referred searches exceeds the agreed limit. We estimate the revenue based on our monthly traffic data, which is
subsequently confirmed with our search engine customers.
We
occasionally engage in barter transactions to allow certain third parties to bundle our security products with their software products, or to grant third parties the right to provide
links to our free security products on their websites in exchange for more downloads of our security products. We recognize revenues and expenses at fair value from a barter transaction only if the
fair value of the services exchanged in the transaction is determinable based on the entity's own historical practice of receiving cash, marketable securities, or other consideration that is readily
convertible to a known amount of cash for similar services from customers unrelated to the counterparty in the barter transaction. For the years ended December 31, 2008, 2009 and 2010, we
engaged in certain barter transactions for which the fair value was not determinable and therefore no revenues or expenses derived from these barter transactions were recognized.
Our Internet value-added services include offering web games developed by third parties, offering Internet security services, such as
remote technical support to paying customers, and providing other Internet value-added services.
Web Games.
We offer web games developed by third parties and generate revenue from selling in-game items online. All of the
web games are developed by third-party game developers and can be accessed and played by end users on our website without downloading separate software. We collect
56
Table of Contents
payments
for the sold items from end users and remit certain percentages of the proceeds to the game developers. We recognize revenue from these sales primarily on a net basis since we act as an agent
in the transactions.
Remote Technical Support.
We provide technical support to customers with respect to a broad range of security issues through remote access
to customers' computers. We generally charge fees on a per-case basis for this service and also provide monthly and annual subscriptions. For service charged on a per-case basis, we recognize revenue
when the service is provided, while for the monthly and annual subscriptions, we recognize revenue ratably over the life of the subscription.
Sales of Third-party Anti-virus Software
We purchase software from third-party software developers for online resale to customers. We recognize revenue when the activation code
of the software is delivered. We evaluate our software sale contracts to determine whether to recognize the revenues on a gross basis or net of costs of obtaining the associated software. The
determination is based upon an assessment as to whether we act as a principal or agent when providing the sales. Most of the software revenues are accounted for on a gross basis since we act as a
principal in the sales.
Goodwill and Intangible Assets with Indefinite Lives
Goodwill represents the cost of an acquired business in excess of the fair value of identifiable tangible and intangible net assets
purchased. We generally seek the assistance of independent valuation firm in determining the fair value of the identifiable tangible and intangible net assets of the acquired business.
There
are several methods that can be used to determine the fair value of assets acquired and liabilities assumed. For intangible assets, we typically use the income method. This method
starts with a forecast of all of the expected future net cash flows associated with a particular intangible asset. These cash
flows are then adjusted to present value by applying an appropriate discount rate that reflects the risk factors associated with the cash flow streams. Some of the more significant estimates and
assumptions inherent in the income method or other methods include the amount and timing of projected future cash flows, the discount rate selected to measure the risks inherent in the future cash
flows and the assessment of the asset's economic life cycle and the competitive trends impacting the asset, including consideration of any technical, legal, regulatory or economic barriers to entry.
Determining the useful life of an intangible asset also requires judgment, as different types of intangible assets will have different useful lives and certain assets may even be considered to have
indefinite useful lives.
Goodwill
is tested for impairment at the latest on December 31 of each year. Impairment is tested using a two-step process. The first step compares the fair value of
each reporting unit to its carrying amount, including goodwill. We currently have one reporting unit.
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. An impairment loss is recognized for any excess in the
carrying value of goodwill over the implied fair value of goodwill. Estimating fair value is performed by utilizing various valuation techniques, with the primary technique being the discounted cash
flow method.
During
the years ended December 31, 2008, 2009 and 2010, we did not realize any impairment loss on goodwill.
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Table of Contents
An
intangible asset that is not subject to amortization is tested for impairment at least annually or more frequently if events or changes in circumstances indicate that the asset might
be impaired. Such impairment test consists of the fair values of assets with their carrying value amounts and an impairment loss is recognized if and when the carrying amounts exceed the fair values.
The estimates of fair values of intangible assets not subject to amortization are determined using various discounted cash flow valuation methodologies. Significant assumptions are inherent in this
process, including estimates of discount rates and market price. Discount rate assumptions are based on an assessment of the risk inherent in the respective intangible assets. Market prices are based
on potential purchase quotes from third party.
Our
management performs impairment assessment on intangible assets with indefinite lives on December 31 of each year or when events or changes in circumstances indicate that the
assets might be impaired. Our management used the discounted cash flow method to estimate the fair value of intangible assets with indefinite lives. During the years ended December 31, 2008,
2009 and 2010, we recognized an impairment loss of nil, $256,000 and nil, respectively, on our intangible assets with indefinite lives.
Our
management assessed that there was no impairment on goodwill based on the following analysis:
|
|
|
|
|
|
|
As of December 31, 2010
|
|
|
|
($ in thousands, except percentage)
|
|
Estimated fair value of our company
|
|
|
767,586
|
|
Carrying value of our company
|
|
|
72,922
|
|
Percentage by which the fair value exceed the carrying value
|
|
|
953
|
%
|
Intangible Assets with Definite Lives
We generally seek the assistance of an independent valuation firm to determine the fair value of the identifiable tangible and
intangible net assets of an acquired business.
We
can use several methods to determine the fair value of assets acquired and liabilities assumed. For intangible assets, we typically use the income method. This method starts with a
forecast of the expected future net cash flows. We then discount these cash flows to present value by applying an appropriate discount rate that reflects the risk factors associated with the cash
flow streams.
Estimates
and assumptions used in the income method or other methods include the amount and timing of projected future cash flows, the discount rate selected to measure the risks of
future cash flows, the asset's life cycle and the competitive trends impacting the asset, including any technical, legal, regulatory or economic barriers to entry. Determining the useful life of an
intangible asset also requires judgment, as different types of intangible assets have different useful lives.
We
amortize intangible assets with determinable useful lives on a straight-line basis.
We
evaluate intangible assets with determinable useful lives for recoverability whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable.
We measure recoverability of long-lived assets to be held and used as part of a cash generating unit by comparing the carrying amount of an asset to the future undiscounted net cash flows
expected to be generated by the asset. If we believe the assets are impaired, the impairment will equal the amount by which the carrying value of the assets exceeds the fair value of
the assets.
Estimates
of fair value involve a complex series of judgments about future events and uncertainties and rely heavily on estimates and assumptions. Our judgments in determining an
estimate of fair value can materially impact our results of operations. We base these valuations on information available as of the impairment review date and on expectations and assumptions that
management deems reasonable. Any changes in key assumptions, including unanticipated events and circumstances, may affect the accuracy or validity of such estimates and could potentially result in
impairment charges.
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Table of Contents
Legal and Other Contingencies
The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss
contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be
reasonably estimated. Disclosure of a contingency is required if there is at least a reasonable possibility that a loss has been incurred. In determining whether a loss should be accrued, we evaluate,
among other factors, the probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our financial
statements.
Based
on the information currently available, we were unable to make a reasonable estimate of any liability because of the uncertainty related to the outcome and the amount or range of
loss. Accordingly, we did not accrue any provision for these contingencies as of December 31, 2009 and 2010.
Income Taxes
In preparing our consolidated financial statements, we must estimate our income taxes in each of the jurisdictions in which we operate.
We estimate our actual tax exposure and assess temporary differences resulting from different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and
liabilities, which we include in our consolidated balance sheet. We must then assess the likelihood that we will recover our deferred tax assets from future taxable income. If we believe that recovery
is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance, we must include an expense within the tax provision in our
statement of operations.
Management
must exercise significant judgment to determine our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net
deferred tax assets. We base the valuation allowance on our estimates of taxable income in each jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable.
If actual results differ from these estimates or we adjust these estimates in future periods, we may need to establish an additional valuation allowance, which could materially impact our financial
position and results of operations.
U.S. GAAP
requires that the impact of an uncertain income tax position on the income tax return is recognized at the largest amount that is more likely than not to be sustained
upon audit by the relevant tax authority. If we ultimately determine that the payment of these liabilities will be unnecessary, we reverse the liability and recognize a tax benefit during that period.
Conversely, we record additional tax charges in a period in which we determine that a recorded tax liability is less than we expect the ultimate assessment to be. We did not recognize any significant
unrecognized tax benefits during the periods presented in this prospectus.
On
April 21, 2010, the State Administration of Taxation issued Circular 157 Further Clarification on Implementation of Preferential EIT Rate during Transition Periods
(Circular 157). Circular 157 seeks to provide additional guidance on the interaction of certain preferential tax rates under the transitional rules of the Enterprise Income Tax Law, or
the New EIT Law. Prior to Circular 157, we interpreted the law to mean that if a high and new technology enterprise was in a tax holiday period, including "2-year exemption
plus 3-year half rate", "5-year exemption plus 5-year half rate" and other tax exemptions and reductions, where it was entitled to a 50% reduction in the tax rate
and was also entitled to a 15% rate of tax due to high and new technology enterprise status under the New EIT Law, then it was entitled to pay tax at the rate of 7.5%. Circular 157
appears to have the effect that such an entity is entitled to pay tax at either the lower of 15% or 50% of the standard PRC tax rate (i.e. currently 25%). Circular 157 is unclear as to
whether its effect is retrospective, but our understanding is that the State Administration of Taxation has recently taken the position that the Circular applies only to tax years commencing from
January 1, 2010. In addition, we have received
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Table of Contents
verbal
confirmation from the relevant local tax authorities that entities that qualify for the "3-year exemption plus 3-year half rate" tax holiday as high and new technology
enterprises and which are registered in Experimental Area for Developing New-Technology Industries of Beijing, notwithstanding Circular 157, will continue to pay tax at the rate of
7.5%. As a consequence, we do not expect the circular 157 has material impact to our current tax position.
Uncertainties
exist with respect to the application of the New EIT Law to our operations, specifically with respect to our tax residency status. The New EIT Law specifies
that legal entities organized outside of the PRC will be considered residents for PRC income tax purposes if their "de facto management bodies" are located within the PRC. The New EIT Law's
implementation rules define the term "de facto management bodies" as "establishments that carry out substantial and overall management and control over the manufacturing and business operations,
personnel, accounting, properties, etc. of an enterprise."
Because
of the uncertainties resulted from limited PRC tax guidance on the issue, it is uncertain whether our legal entities organized outside of the PRC constitute residents under the
New EIT Law. If one or more of our legal entities organized outside of the PRC were characterized as PRC tax residents, the impact would adversely affect our results of operations. See "Risk
FactorsRisk Related to Doing Business in ChinaDividends we receive from our PRC subsidiaries, dividends payable by us to our foreign investors and gain on the sale of our
shares may become subject to PRC withholding taxes under PRC tax laws."
Fair value of our common shares
We are a private company with no quoted market prices for our ordinary shares. We have therefore needed to make estimates of the fair
value of our ordinary shares at various dates for the purpose of:
-
-
determining the fair value of our shares at the date of acquisition when we have acquired another entity and the
consideration given includes our ordinary shares and nonvested shares.
-
-
determining the fair value of our ordinary shares at the date of the grant of a stock based compensation award to our
employees and non-employees as one of the inputs into determining the grant date fair value of the award.
-
-
determining the fair value of our ordinary dates at the date of issuance of convertible instruments in the determination
of the intrinsic value of the beneficial conversion feature, if any.
The
following table sets forth the fair value of our ordinary share estimated since January 1, 2008.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Date
|
|
Class of Shares
|
|
Fair
Value
|
|
Purpose of Valuation
|
|
DLOM
|
|
Discount
Rate
|
|
March 31, 2008
|
|
Ordinary Shares
|
|
US$
|
0.56
|
|
Grant of nonvested shares
|
|
|
34
|
%
|
|
28
|
%
|
December 31, 2008
|
|
Ordinary Shares
|
|
US$
|
0.83
|
|
Grant of nonvested shares
|
|
|
34
|
%
|
|
26
|
%
|
June 30, 2009
|
|
Ordinary Shares
|
|
US$
|
1.09
|
|
Grant of share options
|
|
|
34
|
%
|
|
24
|
%
|
September 30, 2009
|
|
Ordinary Shares
|
|
US$
|
1.50
|
|
Issuance of ordinary shares for the acquisition of The World Browser
|
|
|
32
|
%
|
|
21
|
%
|
October 29, 2009
|
|
Ordinary Shares
|
|
US$
|
1.53
|
|
Issuance of ordinary shares in connection with an acquisition
|
|
|
32
|
%
|
|
21
|
%
|
December 10, 2009
|
|
Ordinary Shares
|
|
US$
|
1.60
|
|
Issuance of ordinary shares in connection with an acquisition
|
|
|
30
|
%
|
|
21
|
%
|
January 8, 2010
|
|
Ordinary Shares
|
|
US$
|
1.86
|
|
Issuance of Series C preferred shares
|
|
|
29
|
%
|
|
20
|
%
|
June 30, 2010
|
|
Ordinary Shares
|
|
US$
|
2.58
|
|
Grant of share options
|
|
|
16
|
%
|
|
20
|
%
|
January 1, 2011
|
|
Ordinary Shares
|
|
US$
|
5.01
|
|
Grant of share options and nonvested shares
|
|
|
8
|
%
|
|
18
|
%
|
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Table of Contents
In determining the fair value of our ordinary shares in each of the grant date, we relied in part on a valuation report retrospectively prepared by an independent
valuer based on data we provided. The valuation report provided us with guidelines in determining the fair value, but the determination was made by our management. We obtained a retrospective
valuation instead of a contemporaneous valuation by an unrelated valuation specialist because, before January 2011, our financial and limited human resources were principally focused on our new
product development efforts. We applied the income approach/ discounted cash flow, or DCF, analysis based on our projected cash flow using management's best estimate as of the valuation date. The
determination of the fair value of our ordinary shares requires complex and subjective judgments to be made regarding our projected financial and operating results, our unique business risks, the
liquidity of our shares and our operating history and prospects at the time of valuation.
The
major assumptions used in calculating the fair value of ordinary shares include:
Weighted average cost of capital
, or
WACC
:
The
following table sets forth the WACC on each date indicated:
|
|
|
|
|
Date
|
|
WACC
|
|
March 31, 2008
|
|
|
28%
|
|
December 31, 2008
|
|
|
26%
|
|
June 30, 2009
|
|
|
24%
|
|
September 30, 2009
|
|
|
21%
|
|
October 29, 2009
|
|
|
21%
|
|
December 10, 2009
|
|
|
21%
|
|
January 8, 2010
|
|
|
20%
|
|
June 30, 2010
|
|
|
20%
|
|
January 1, 2011
|
|
|
18%
|
|
The
WACCs were determined based on a consideration of the factors including risk-free rate, comparative industry risk, equity risk premium, company size and
non systematic risk factors. The decrease in WACCs from March 2008 to January 2011 was due to the combined results of the following factors:
-
-
The continuous growth of our business and company size. As our size increased, small company risk premium, which is a
component of our WACC, decreased from 5.81% as of March 2008 to 4.5% as of January 2011.
-
-
A longer track record for forecasting. According to the guideline prescribed by the AICPA Audit and Accounting Practice
Aid, "Valuation of Privately Held Company Equity Securities Issued as Compensation," or the Practice Aid, when an enterprise has established a solid financial history, the reliability of forecasted
results is generally higher than those made at an earlier stage, and therefore the perceived risks of investing in the enterprise are generally lower than in an earlier stage. Therefore, the estimated
WACC, which reflects the perceived risks of and a market participant's expected rate of return for investing in our securities, also declined gradually from March 2008 to January 2011 as our
company progressed through the earlier stages of development and towards this offering.
-
-
Completion of the acquisition of realization of synergistic effects through the acquisitions of The World Browser, and two
other businesses in 2009. The acquisitions strengthened our technology and security service capabilities, expanded our service offerings and hence lowered the uncertainties associated with achieving
our business plan and financial forecast.
-
-
Additional financing obtained through the issuance of preferred shares. We issued our Series C preferred shares in
January 2010. This financing not only improved our capital resources, but also indicated that the uncertainty and risk perceived by investors in our business plan and our company were further
reduced.
Comparable
companies: In deriving the WACCs, which are used as the discount rates under the income approach, five publicly traded companies in China Internet and security software
industry were selected for reference as our guideline companies.
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Table of Contents
Discount
for lack of marketability, or DLOM: DLOM was quantified by the Black-Scholes option pricing model. Under this option-pricing method, the cost of the put option, which can hedge
the price change before the privately held shares can be sold, was considered as a basis to determine the DLOM. This option pricing method is one of the methods commonly used in estimating DLOM as it
can take into consideration factors like timing of a liquidity event (e.g., an IPO) and estimated volatility of our shares. The further the valuation date is from an expected liquidity event,
the higher the put option value and thus, the higher the implied DLOM. DLOMs of range from 8% to 34% were used in our valuations between March 31, 2008 and January 1, 2011.
The lower DLOM is used for the valuation, the higher is the determined fair value of the ordinary shares. Because of the proximity of the expected time of the offering, DLOM decreased from 34% for the
valuation as of March 31, 2008 to 8% for the valuation as of January 1, 2011.
The
income approach involves applying appropriate discount rates to estimated cash flows that are based on earnings forecasts. Our revenues and earnings growth rates, as well as major
milestones that we have achieved, contributed significantly to the increase in the fair value of our ordinary shares from 2008 to January 2011. However, these fair values are inherently
uncertain and highly subjective. The assumptions used in deriving the fair values are consistent with our business plan. These assumptions include: no material changes in the existing political, legal
and economic conditions in China; our ability to retain competent management, key personnel and staff to support our ongoing operations; and no material deviation in market conditions from economic
forecasts. These assumptions are inherently uncertain. The risk associated with achieving our forecasts were assessed in selecting the appropriate discount rates, which ranged from 18% to 28%.
Option-pricing
method was used to allocate enterprise value to preferred and ordinary shares, taking into account the guidance prescribed by the AICPA Audit and Accounting Practice Aid,
"Valuation of Privately-Held Company Equity Securities Issued as Compensation," or the Practice Aid. The method treats common stock and preferred stock as call options on the enterprise's
value, with exercise prices based on the liquidation preference of the preferred stock.
The
option-pricing method involves making estimates of the anticipated timing of a potential liquidity event, such as a sale of our company or an initial public offering, and estimates
of the volatility of our equity securities. The anticipated timing is based on the plans of our board of directors and management. Estimating the volatility of the share price of a privately held
company is complex because there is no readily available market for the shares. We estimated the volatility of our shares to range from 40% to 70% based on the historical volatilities of comparable
publicly traded companies engaged in similar lines of business. Had we used different estimates of volatility, the allocations between preferred and ordinary shares would have been different.
The
determined fair value of the ordinary shares increased from $0.56 per share as of March 31, 2008 to $0.83 per share as of December 31, 2008. We believe that the
increase in the fair value of ordinary shares in this period was primarily attributable to the following factors:
-
-
The overall economic growth in our principal geographic markets led to an increased market demand for our Internet and
security technology services;
-
-
In spite of the global financial crisis, we achieved a better financial performance in 2008 than our previous estimate
because of significant revenue growth from sale of anti-virus software. In view of the above, when preparing financial forecast as of December 2008, we revised the projection upward
and lowered the discount rate from 28% as of March 31, 2008 to 26% as of December 31, 2008 to reflect the increase of our confidence in achieving higher revenue growth rate and
profitability in the future.
The
determined fair value of the ordinary shares increased from $0.83 per share as of December 31, 2008 to $1.09 per share as of June 30, 2009. We believe that the increase
in the fair value of ordinary shares in this period was primarily attributable to the following factors:
-
-
We experienced continual improvement in our financial results and recorded net income for the first time in our history in
the first half of 2009. Achieving profitability was considered a
62
Table of Contents
milestone
event of our company. Such milestone reduced market participant's perceived risks and hence the required rate of return for investing in our equity securities. Also, we expected to continue
to improve our financial results. Therefore, we lowered the discount rate from 26% as of December 31, 2008 to 24% as of June 30, 2009;
-
-
In general, the global financial markets recovered in the first half of 2009. Market sentiment towards China-based
publicly-traded companies improved during that period, which resulted in an overall appreciation in the market value of their shares. For example, the Hang Seng China Enterprises Index that tracks the
performance of various China-based stocks on the Hong Kong Stock Exchange generally increased during the first half of 2009 and closed at 7,891.80 on December 31, 2008 and
10,962.6 on June 30, 2009. The NASDAQ China Index also generally increased in the first half of 2009 and closed at 114.65 on December 31, 2008 and 148.21 on
June 30, 2009.
The
determined fair value of the ordinary shares increased from $1.09 per share as of June 30, 2009 to $1.50 per share as of September 30, 2009, to $1.53 per share as of
October 29, 2009 and to $1.60 per share as of December 10, 2009. We believe that the increase in the fair value of ordinary shares in this period was primarily attributable to the
following factor:
-
-
We completed the acquisition of The World Browser and two other businesses on September 30, 2009,
October 29, 2009 and December 10, 2009 respectively. The acquisitions strengthened our technology security service capabilities, expanded our service offering and hence lowered the
uncertainties associated with achieving our business plan and financial forecast. Therefore, we lowered discount rate from 24% for valuation as of June 30, 2009 to 21% for the valuation as of
September 30, 2009, October 29, 2009 and December 10, 2009.
The
determined fair value of the ordinary shares increased from $1.60 per share as of December 10, 2009 to $1.86 per share as of January 8, 2010. We believe that the
increase in the fair value of ordinary shares in this period was primarily attributable to the following factor:
-
-
We completed the Series C financing for a total amount of $20 million. The new round of financing not only
provided us with more capital resources for business expansion, but also indicated a decrease in investor's perceived risks of achieving our business plans and therefore the perceived risks of
investing in our securities. As a result, we lowered the discount rate from 21% as of December 10, 2009 to 20% as of January 8, 2010.
The
determined fair value of the ordinary shares significantly increased from $1.86 per share as of January 8, 2010 to $2.58 per share as of June 30, 2010. We believe the
increase in the fair value of ordinary shares in this period was primarily attributable to the following factors:
-
-
Our financial and operating performance continued to improve in the first half of 2010. According to iResearch, from
January to July 2010, the number of users of our products and services, such as 360 Safe Guard, 360 Anti-Virus and 360 Safe Browser increased by approximately 19.7%, 89.5%
and 58.8% respectively. Our management anticipated that the increase in number of users would improve our revenue growth potential and revised the financial forecast upward accordingly.
-
-
During this period, we started planning and the preparation of this offering, resulting in a decrease of expected time
leading to a liquidity event. The proximity in time of this offering to the date of the valuation increased the liquidity of our shares and hence lowered DLOM from 29% as of January 2010 to 16%
as of June 2010.
The
determined fair value of the ordinary shares significantly increased from $2.58 per share as of June 30, 2010 to $5.01 per share as of January 1, 2011. We believe the
increase in the fair value of ordinary shares in this period was primarily attributable to the following factors:
-
-
We achieved a better financial performance in full year 2010 than our previous estimate as the result of significant,
unexpected revenue growth from online advertising and web games while exercising strict control over our cost and expenses. When preparing our financial forecasts as of June 30, 2010, we
estimated that our operating income margin in 2010 would be 13%. Our
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Table of Contents
actual
operating margin in 2010 reached 16%. Our operating income in 2010 also exceeded our previous estimates by 25%. In view of the above, when preparing our financial forecasts as of
December 2010, we increased our estimates for our net income from our previous estimates made as of June 30, 2010. We believe this factor contributed approximately 55% of the
increase in the fair value of our ordinary shares during this period.
-
-
Taking into account the improvement of our business performance and indications of the success of our business plan, the
company-specific risk factor used in estimating a market participant's required rate of return for investing in our shares was reduced by 3%, reflecting the decrease in the perceived risk in achieving
our financial forecasts. Therefore, the overall discount rate was lowered from 20% as of June 31, 2010 to 18% as of December 31, 2010. We believe this factor contributed
approximately 30% of the increase in the fair value of our ordinary shares during this period.
-
-
In connection with our financial forecasts as of December 2010, we estimated our initial public offering date to be
in the first quarter of 2011, resulting in a decrease of expected time leading to a liquidity event. The proximity in time of this offering to the date of the valuation increased the liquidity of our
shares and hence lowered DLOM from 16% as of June 2010 to 8% as of December 2010. We believe this factor contributed approximately 15% of the increase in the fair value of our ordinary
shares during this period.
The
increase in the fair value of our ordinary shares from June 30, 2010 to January 1, 2011 was in line with the overall appreciation in the market value of the shares of China-based
publicly-traded companies, as a result of the improved market sentiment towards those companies and the recovery of the global financial market during 2010. For instance, the NASDAQ China Index
generally increased in 2010 and closed at 166.47 on June 30, 2010 and 195.23 on December 31, 2010. The market capitalization of our closest China-based comparables on
average increased by 43% during such period.
The
determined fair value of the ordinary shares increased from $5.01 per share as of January 1, 2011 to $9.67 per share, based on the initial public offering price of $14.50 per
ADS. We believe the increase in fair value was primarily attributable to the following factors:
-
-
We have achieved significant business development since January 2011, which we believe contributed approximately
70% to 85% of the increase in the fair value of our ordinary shares.
-
o
-
360 Safe
Browser and 360 Personal Start-up Page, two of our key platform products, achieved stronger growth in their active user
base than what had been expected for the January 2011 valuation. In connection with the January 2011 valuation, we forecast that the daily active users of 360 Safe Browser would
increase 42% from the end of December 2010 to 52 million in December 2011. 360 Safe Browser's daily active users reached 56 million as of March 10, 2011,
exceeding our original year-end target in less than three months. In connection with the January 2011 valuation, we forecast that the daily active users of 360 Personal
Start-up Page would increase 55% from the end of December 2010 to 45 million at the end of 2011. As of March 10, 2011, 360 Personal Start-up Page's
daily active users reached 40 million in less than three months, which suggests that we had underestimated the success of this product at the time of the January 2011 valuation. We
expect that the increase in the active user base of these two platform products will generate more revenue and net income in 2011 and future periods.
-
o
-
Furthermore,
in late February 2011, we formulated our open platform strategy to further monetize our large user base to grow revenue. Under this new
strategy, we accelerated the development of our web game open platform, increasing the web games offered to 46 in the first quarter of 2011, an increase of 84% from year end 2010 and
significantly exceeding prior expectations. In February 2011, we also launched our group-buy open platform, and attracted over 200 group-buy websites to our
platform within the first 10 days. The launch of our group-buy platform was not in our January 2011 business plan. Under the open platform strategy, we also accelerated the
launch of our Desktop PC App store to early March from
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Table of Contents
the
originally scheduled year end 2011. Since its launch on March 1, 2011, the Desktop PC App store has offered more than 400 applications developed by over 40 third-party application developers. The
launch of the Desktop PC App store was not in our January 2011 business plan. We believe that the Desktop PC App store will provide substantial monetization opportunities to further grow
our revenue.
-
-
The initial public offering will create a public market for our ordinary shares, and eliminate the 8% DLOM that was used
in the January 2011 valuation. Upon the completion of this offering, the conversion of our preferred shares and the corresponding elimination of liquidation and other preferences will also contribute
to the increase in the value of our ordinary shares. Furthermore, the completion of this offering will provide us with additional capital and give us greater access to the capital markets when needed.
Upon the completion of this offering, we will be able to raise funds through public offerings for purposes such as the acquisitions of businesses. Our publicly listed securities also serve as an
attractive currency in pursuing acquisitions opportunities. In addition, such equity currency will be an attractive form of compensation given the liquidity of the shares issued. Equity compensation
arrangements allow an enterprise to conserve cash and increase loyalty and motivation of our employee, which are critical to the success of our business. In anticipation of a successful initial public
offering, we expect to further enhance our brand awareness and raise our profile to secure additional business and investment opportunities. We believe this factor contributed approximately 15% to 30%
of the increase in the fair value of our ordinary shares during this period.
The
increase in the fair value of our ordinary shares since January 1, 2011 was in line with the overall appreciation in the market value of the shares of China-based publicly-traded
companies, as a result of the further improved market sentiment towards those companies since January 2011. For instance, the NASDAQ China Index increased by 8.4% from December 31, 2010 to
March 15, 2011. The average market capitalization of the five largest China-based Internet companies by market capitalization increased by 22.5% during the same period.
Furthermore,
in accordance with paragraph 113 of the Practice Aid, we believe that the ultimate initial public offering price itself is generally not likely to be a reasonable estimate
of the fair value of our ordinary shares as of various dates before this offering as increases in enterprise value may be attributed partly to (i) changes in the amount and relative timing of
future net cash flows (estimated and actual) as the enterprise successfully executes its business plan and responds to risks and opportunities in the market, and (ii) a reduction in the risk
associated with achieving projected results.
Share-based Compensation
Our share-based payment transactions are measured based on the grant date fair value of the equity instrument we issued and recognized
as compensation expense over the requisite service period, with a corresponding impact reflected in additional paid-in capital.
The
following table sets forth certain information regarding the share options granted.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Grant Date
|
|
No. of Options
Granted
|
|
Exercise Price
Per Option
|
|
Weighted Average
Fair Value Per
Option at the
Grant Dates
|
|
Intrinsic
Value Per
Option at the
Grant Dates
|
|
Type of
Valuation
|
June 30, 2009
|
|
|
911,950
|
|
$
|
1.50
|
|
$
|
0.56
|
|
|
nil
|
|
Retrospective
|
January 1, 2010
|
|
|
110,000
|
|
$
|
2.20
|
|
$
|
1.01
|
|
|
nil
|
|
Retrospective
|
July 1, 2010
|
|
|
5,039,000
|
|
$
|
2.80
|
|
$
|
1.40
|
|
|
nil
|
|
Retrospective
|
January 1, 2011
|
|
|
3,786,200
|
|
$
|
5.20
|
|
$
|
2.64
|
|
|
nil
|
|
Retrospective
|
We
also granted options to purchase 700,000 ordinary shares on February 14, 2011 with the exercise price of $5.20 per share and options to purchase
704,500 ordinary shares on March 3, 2011 with the exercise price of $6.00 per share. We have not yet valued these option grants as they were made after the latest balance sheet date for
the financial statements included elsewhere in this prospectus.
65
Table of Contents
At
the time of the grants, the exercise price was determined by CEO with inputs by management based on various objective and subjective factors.
The
fair values of our option awards were estimated on the date of grant using the Black-Scholes and binomial option pricing model using the following assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009
|
|
January
2010
|
|
July
2010
|
|
January
2011
|
|
Weighted average risk-free interest rate
|
|
|
3.96
|
%
|
|
3.73
|
%
|
|
3.31
|
%
|
|
2.91
|
%
|
Weighted average expected term (number of years)
|
|
|
5.20
|
|
|
5.30
|
|
|
5.15
|
|
|
5.40
|
|
Weighted average expected volatility
|
|
|
64.87
|
%
|
|
63.64
|
%
|
|
62.70
|
%
|
|
57.7
|
%
|
Weighted average expected dividend yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
risk-free rate for periods within the expected life of the option is based on the implied yield rates of U.S. dollar denominated bond issued by the
Chinese government as of the valuation dates. The expected life of options represents the period of time the granted options are expected to be outstanding. As we did not grant options prior to
June 2009 and no options have been exercised, no sufficient historical exercising pattern could be followed in estimating the expected life. Therefore, the expected life is estimated based on a
consideration of factors including contractual term, vesting period and empirical study on early exercise behavior of employee share options. Our employees who received our stocks options are assumed
to exhibit similar behavior. As we expected to grow our business with internally generated cash, we did not expect to pay dividends in the foreseeable future.
Because
we do not maintain an internal market for our shares, the expected volatility was based on the historical volatilities of comparable publicly traded companies engaged in similar
lines of business.
Taxation
Cayman Islands
We are incorporated in the Cayman Islands. Under current law, we are not subject to income or capital gains tax. In addition, dividend
payments are not subject to withholding tax in the Cayman Islands.
Hong Kong
Our wholly-owned subsidiaries in Hong Kong, 360 International, Qifei International and Qiji International, are subject to the
uniform tax rate of 16.5% in Hong Kong for the year ended December 31, 2010. Under the Hong Kong tax laws, 360 International, Qifei International and Qiji International are exempted from
the Hong Kong income tax on their foreign-derived income and there are no withholding taxes in Hong Kong on remittance of dividends.
PRC
Prior to the effective date of the New EIT Law on January 1, 2008, domestic enterprises in China were generally subject
to an enterprise income tax at a statutory rate of 33% unless they qualified for certain preferential treatment. Effective as of January 1, 2008, the New EIT Law applies a uniform
enterprise income tax rate of 25% to all domestic enterprises and foreign-invested enterprises and defines new tax incentives for qualifying entities.
Pursuant
to the New EIT Law, enterprises that previously enjoyed preferential treatments of low tax rates will be subject to the new enterprise income tax rate of 25% after a
five-year transitional period. Moreover, tax exemption or reduction with fixed terms enjoyed by enterprises including us will continue until the expiration of the prescribed period. Our
operating subsidiary, Qizhi Software, receives preferential tax treatment in the PRC as "high and new technology enterprises." As a result, subject to satisfaction of applicable criteria as confirmed
by the competent authority, it is entitled to an exemption from the 15% reduced EIT tax rate in 2008 and a 50% reduction in the 15% reduced EIT tax rate in 2009 and 2010.
In
addition, the New EIT Law treats enterprises established outside of China with "de facto management bodies" within the PRC as a PRC resident enterprise for tax purposes. The
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Table of Contents
implementation
rules define the term "de facto management bodies" as establishments that carry out substantial and overall management and control over the manufacturing and business operations,
personnel, accounting and properties of an enterprise. The State Administration of Taxation, or the SAT, issued the Notice Regarding the Determination of Chinese-Controlled Offshore Incorporated
Enterprises as PRC Tax Resident Enterprises on the Basis of De Facto Management Bodies, or Circular 82, which sets out certain specific criteria for determining whether the "de facto management
body" of a Chinese-controlled offshore incorporated enterprise is located in China. We do not believe that we should be treated as a "resident enterprise" for PRC tax purposes. However, if considered
a "PRC resident enterprise" for tax purposes, we would be subject to the PRC enterprise income tax at a rate of 25% on our worldwide income. We will continue to monitor our tax status. See "Risk
FactorsRisks Related to Doing Business in ChinaWe may be subject to PRC taxation on our worldwide income."
Pursuant
to the New EIT law and its implementation rules, dividends payable to foreign investors are subject to a 10% withholding tax. Pursuant to the grandfathering arrangement,
dividends receivable from our PRC subsidiaries in respect of their undistributed profits prior to December 31, 2007 are exempt from withholding tax. Under the taxation arrangement between the
PRC and Hong Kong, a qualified Hong Kong tax resident which is the "beneficial owner" and directly holds 25% or more of the equity interest in a PRC-resident enterprise is entitled to a
reduced withholding tax rate of 5%.
Internal Control Over Financial Reporting
We and our independent registered public accounting firm, in connection with the preparation and external audit of our consolidated
financial statements as of and for the fiscal year ended December 31, 2010, identified one material weakness and several control deficiencies in our internal control over financial reporting as
of December 31, 2010. A "material weakness" is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a
reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis.
The
material weakness identified primarily related to lack of sufficient accounting personnel with appropriate knowledge of U.S. GAAP. Neither we nor our independent registered
public accounting firm undertook a comprehensive assessment of our internal control for purposes of identifying and reporting material weaknesses and other control deficiencies in our internal control
over financial reporting as we and they will be required to do once we become a public company. In light of the material weakness and other control deficiencies that were identified as a result of the
limited procedures performed, we believe it is possible that, had we performed a formal assessment of our internal control over financial reporting or had our independent registered public accounting
firm performed an audit of our internal control over financial reporting, additional control deficiencies may have been identified.
Following
the identification of the material weakness and other control deficiencies, we have taken measures and plan to continue to take measures to remedy the weakness and
deficiencies, including (1) hiring additional accounting personnel with understanding of U.S. GAAP and experience with SEC reporting requirements, and (2) providing external and
internal training to our accounting personnel. However, the implementation of these measures may not fully address this material weakness and other control deficiencies in our internal control over
financial reporting, and we cannot conclude that they have been fully remedied. We are not able to estimate with reasonable certainty the costs that we will need to incur to implement these and other
measures designed to improve our internal control over financial reporting. See "Risk FactorsRisks Related to Our BusinessIf we fail to establish 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 ADSs may be adversely impacted."
67
Table of Contents
Our Selected Quarterly Results of Operations
The following table presents our selected unaudited consolidated quarterly results of operations for the eight quarters in the period
from January 1, 2009 to December 31, 2010. This information should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this
prospectus. We have prepared the unaudited condensed consolidated quarterly financial information for the quarters presented below on the same basis as our audited consolidated financial statements.
The unaudited condensed consolidated financial information includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our
financial position and operating results for the quarters presented. Our limited
operating history makes it difficult to predict future operating results. The historical quarterly results presented below are not necessarily indicative of the results that may be expected for any
future quarters or periods.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
2009
|
|
June 30,
2009
|
|
September 30,
2009
|
|
December 31,
2009
|
|
March 31,
2010
|
|
June 30,
2010
|
|
September 30,
2010
|
|
December 31,
2010
|
|
|
|
($ in thousands, except share and per share data)
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Internet services
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Online advertising
|
|
|
2,033
|
|
|
2,800
|
|
|
3,467
|
|
|
5,628
|
|
|
5,504
|
|
|
8,476
|
|
|
10,718
|
|
|
14,128
|
|
|
Internet value-added services
|
|
|
|
|
|
335
|
|
|
536
|
|
|
1,179
|
|
|
2,319
|
|
|
3,141
|
|
|
4,072
|
|
|
5,242
|
|
|
Other services
|
|
|
|
|
|
|
|
|
8
|
|
|
24
|
|
|
36
|
|
|
35
|
|
|
91
|
|
|
28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
2,033
|
|
|
3,135
|
|
|
4,011
|
|
|
6,831
|
|
|
7,859
|
|
|
11,652
|
|
|
14,881
|
|
|
19,398
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales of third party anti-virus software
|
|
|
2,986
|
|
|
4,119
|
|
|
6,008
|
|
|
3,179
|
|
|
1,836
|
|
|
1,043
|
|
|
576
|
|
|
420
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
5,019
|
|
|
7,254
|
|
|
10,019
|
|
|
10,010
|
|
|
9,695
|
|
|
12,695
|
|
|
15,457
|
|
|
19,818
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Internet services
|
|
|
352
|
|
|
390
|
|
|
471
|
|
|
577
|
|
|
687
|
|
|
1,156
|
|
|
1,606
|
|
|
2,117
|
|
|
Sales of third party anti-virus software
|
|
|
1,421
|
|
|
1,670
|
|
|
2,178
|
|
|
1,331
|
|
|
546
|
|
|
334
|
|
|
176
|
|
|
129
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenues
|
|
|
1,773
|
|
|
2,060
|
|
|
2,649
|
|
|
1,908
|
|
|
1,233
|
|
|
1,490
|
|
|
1,782
|
|
|
2,246
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subsidy income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
49
|
|
|
57
|
|
|
71
|
|
|
89
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing
|
|
|
936
|
|
|
883
|
|
|
1,008
|
|
|
3,429
|
|
|
4,410
|
|
|
2,620
|
|
|
2,770
|
|
|
2,803
|
|
|
General and administrative
|
|
|
390
|
|
|
385
|
|
|
634
|
|
|
1,122
|
|
|
726
|
|
|
893
|
|
|
1,186
|
|
|
2,246
|
|
|
Research and development
|
|
|
1,860
|
|
|
2,274
|
|
|
2,625
|
|
|
3,905
|
|
|
4,873
|
|
|
5,366
|
|
|
6,058
|
|
|
8,208
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
3,186
|
|
|
3,542
|
|
|
4,267
|
|
|
8,456
|
|
|
10,009
|
|
|
8,879
|
|
|
10,014
|
|
|
13,257
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
60
|
|
|
1,652
|
|
|
3,103
|
|
|
(354
|
)
|
|
(1,498
|
)
|
|
2,383
|
|
|
3,732
|
|
|
4,404
|
|
Interest income
|
|
|
85
|
|
|
56
|
|
|
70
|
|
|
70
|
|
|
92
|
|
|
103
|
|
|
113
|
|
|
107
|
|
Interest expense
|
|
|
(32
|
)
|
|
(31
|
)
|
|
(30
|
)
|
|
(76
|
)
|
|
(28
|
)
|
|
(26
|
)
|
|
(22
|
)
|
|
(22
|
)
|
Other expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(52
|
)
|
|
|
|
|
(8
|
)
|
Exchange (loss) gain
|
|
|
(60
|
)
|
|
60
|
|
|
56
|
|
|
(28
|
)
|
|
(112
|
)
|
|
(164
|
)
|
|
116
|
|
|
(107
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income tax (expense) benefit and loss from equity method investment
|
|
|
53
|
|
|
1,737
|
|
|
3,199
|
|
|
(388
|
)
|
|
(1,546
|
)
|
|
2,244
|
|
|
3,939
|
|
|
4,374
|
|
Income tax (expense) benefit
|
|
|
(5
|
)
|
|
(155
|
)
|
|
(286
|
)
|
|
34
|
|
|
49
|
|
|
(72
|
)
|
|
(125
|
)
|
|
(315
|
)
|
Loss from equity method investment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(57
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
48
|
|
|
1,582
|
|
|
2,913
|
|
|
(354
|
)
|
|
(1,497
|
)
|
|
2,172
|
|
|
3,814
|
|
|
4,002
|
|
Less: Net loss attribute to noncontrolling interest
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to Qihoo 360 Technology Co. Ltd.
|
|
|
48
|
|
|
1,582
|
|
|
2,913
|
|
|
(354
|
)
|
|
(1,497
|
)
|
|
2,172
|
|
|
3,814
|
|
|
4,019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
68
Table of Contents
Our quarterly revenues generally increased in the eight quarters ended December 31, 2010, although our revenues were flat in the third and
fourth quarters of 2009 and decreased slightly in the first
quarter of 2010. Revenues from Internet services, our core business, has grown steadily over the eight quarters ended December 31, 2010. The general increase in our quarterly revenues was
primarily attributable to our expanded user base, which increased the user traffic and transactions originated from our platform products, as well as the increase in our revenue derived from offering
web games developed by third parties. Our revenues were flat in the third and fourth quarters of 2009 and decreased slightly in the first quarter of 2010 because we started offering 360
Anti-Virus to users free of charge in the second half of 2009 as we adopted the business model of offering free Internet and mobile security products to build up user base and generating
revenues through provide Internet services. Our quarterly cost of revenues decreased from the third quarter of 2009 to the first quarter of 2010 largely because the cost of conducting Internet
services is lower compared to the cost of sales of third-party anti-virus software. Our selling and marketing expenses increased significantly in the two quarters ended March 31,
2010 from the prior quarters, primarily due to the increase in our advertising and promotion expenses in connection with promotions for our free security products and other brand promotion activities.
The significantly high general and administrative expenses in the fourth quarter of 2009 was primarily the result of an impairment charge in connection with a domain name acquisition. Our general and
administrative expenses increased significantly from the third quarter of 2010 to the fourth quarter of 2010 primarily due to an increase in our professional fees incurred for legal proceedings and
other administrative activities. Our quarterly research and development expenses increased in line with the expansion of our business. Our quarterly revenues and operating results may continue to
experience fluctuations in the future due to various factors. See "Risk FactorsRisks Related to Our Business."
69
Table of Contents
Results of Operations
The following table sets forth a summary of our consolidated results of operations, both in absolute amounts and as percentages of
total revenues, for the periods indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2008
|
|
Percentage
of
Revenues
|
|
2009
|
|
Percentage
of
Revenues
|
|
2010
|
|
Percentage
of
Revenues
|
|
|
|
($ in thousands, except percentages)
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Internet services
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Online advertising
|
|
|
5,606
|
|
|
33.2%
|
|
|
13,928
|
|
|
43.1%
|
|
|
38,826
|
|
|
67.3%
|
|
|
Internet value-added services
|
|
|
|
|
|
|
|
|
2,050
|
|
|
6.4%
|
|
|
14,774
|
|
|
25.7%
|
|
|
Other services
|
|
|
189
|
|
|
1.1%
|
|
|
32
|
|
|
0.1%
|
|
|
190
|
|
|
0.3%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
5,795
|
|
|
34.3%
|
|
|
16,010
|
|
|
49.6%
|
|
|
53,790
|
|
|
93.3%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales of third party anti-virus software
|
|
|
11,100
|
|
|
65.7%
|
|
|
16,292
|
|
|
50.4%
|
|
|
3,875
|
|
|
6.7%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
16,895
|
|
|
100.0%
|
|
|
32,302
|
|
|
100.0%
|
|
|
57,665
|
|
|
100.0%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Internet services
|
|
|
1,147
|
|
|
6.8%
|
|
|
1,790
|
|
|
5.5%
|
|
|
5,566
|
|
|
9.7%
|
|
|
Sales of third party anti-virus software
|
|
|
7,073
|
|
|
41.9%
|
|
|
6,600
|
|
|
20.5%
|
|
|
1,185
|
|
|
2.0%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenues
|
|
|
8,220
|
|
|
48.7%
|
|
|
8,390
|
|
|
26.0%
|
|
|
6,751
|
|
|
11.7%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subsidy income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
266
|
|
|
0.4%
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing
|
|
|
2,732
|
|
|
16.2%
|
|
|
6,256
|
|
|
19.4%
|
|
|
12,603
|
|
|
21.8%
|
|
|
General and administrative
|
|
|
1,645
|
|
|
9.7%
|
|
|
2,531
|
|
|
7.8%
|
|
|
5,051
|
|
|
8.8%
|
|
|
Research and development
|
|
|
7,283
|
|
|
43.1%
|
|
|
10,664
|
|
|
33.0%
|
|
|
24,505
|
|
|
42.5%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
11,660
|
|
|
69.0%
|
|
|
19,451
|
|
|
60.2%
|
|
|
42,159
|
|
|
73.1%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income from operations
|
|
|
(2,985
|
)
|
|
(17.7%
|
)
|
|
4,461
|
|
|
13.8%
|
|
|
9,021
|
|
|
15.6%
|
|
Interest income
|
|
|
616
|
|
|
3.7%
|
|
|
281
|
|
|
0.8%
|
|
|
415
|
|
|
0.8%
|
|
Interest expense
|
|
|
(32
|
)
|
|
(0.2%
|
)
|
|
(169
|
)
|
|
(0.5%
|
)
|
|
(98
|
)
|
|
(0.2%
|
)
|
Other expense
|
|
|
(164
|
)
|
|
(1.0%
|
)
|
|
|
|
|
0.0%
|
|
|
(60
|
)
|
|
(0.1%
|
)
|
Exchange (loss) gain
|
|
|
(360
|
)
|
|
(2.1%
|
)
|
|
28
|
|
|
0.1%
|
|
|
(267
|
)
|
|
(0.5%
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income before income tax benefit (expense) and loss from equity method investment
|
|
|
(2,925
|
)
|
|
(17.3%
|
)
|
|
4,601
|
|
|
14.2%
|
|
|
9,011
|
|
|
15.6%
|
|
Income tax benefit (expense)
|
|
|
179
|
|
|
1.0%
|
|
|
(412
|
)
|
|
(1.2%
|
)
|
|
(463
|
)
|
|
(0.8%
|
)
|
Loss from equity method investment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(57
|
)
|
|
(0.1%
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income
|
|
|
(2,746
|
)
|
|
(16.3%
|
)
|
|
4,189
|
|
|
(13.0%
|
)
|
|
8,491
|
|
|
14.7%
|
|
Less: Net loss attributable to noncontrolling interest
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17
|
|
|
0.1%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income attributable to Qihoo 360 Technology Co. Ltd.
|
|
|
(2,746
|
)
|
|
(16.3%
|
)
|
|
4,189
|
|
|
13.0%
|
|
|
8,508
|
|
|
14.8%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
Revenues
Revenues increased by $25.4 million, or 78.5%, from $32.3 million in 2009 to $57.7 million in 2010, primarily as a
result of a substantial increase in our revenues from Internet services, which was in turn primarily attributable to (i) an increase in our revenues from online advertising, and (ii) an
increase in our revenues from Internet value-added services. This increase was partially offset by a decrease in revenues from sales of third-party anti-virus software.
Revenues
from online advertising increased by $24.9 million, or 178.8%, from $13.9 million in 2009 to $38.8 million in 2010. This increase was primarily due to a
substantial increase in our revenues from
70
Table of Contents
third-party
websites who placed links on 360 Personal Start-up Page, the default home page of our 360 Safe Browser that we launched at the end of 2009, and increased revenues
from Google. The increase in our revenues from third-party websites was due primarily to our expanded user base, which increased the user traffic and transactions originated from our websites and
secure platform
products. Our increased revenues from Google in 2010 were due primarily to (i) increased number of searches directed from our websites, (ii) our expanded cooperation with Google, who
entered into another linking agreement with us in the fourth quarter of 2009 for a search box on our newly launched 360 Personal Start-up Page.
Revenues
from Internet value-added services increased by $12.7 million from $2.1 million in 2009 to $14.8 million in 2010. This increase was primarily due to
(i) a substantial increase in our revenues from web games, (ii) additional revenues contributed by Internet security services, primarily remote technical support, that we started
offering in 2010, and (iii) an increase in our revenues from other Internet value-added services.
Revenues
from sales of third-party anti-virus software decreased by $12.4 million, or 76.2%, from $16.3 million in 2009 to $3.9 million in 2010,
primarily because we started offering 360 Anti-Virus to users free of charge in the fourth quarter of 2009.
Cost of Revenues
Our cost of revenues decreased by $1.6 million, or 19.5%, from $8.4 million in 2009 to $6.8 million in 2010,
primarily due to a decrease in cost of sales of third-party anti-virus software, which was partially offset by an increase in cost of Internet services.
Cost
of sales of third-party anti-virus software decreased by $5.4 million, or 82.0%, from $6.6 million in 2009 to $1.2 million in 2010. This decrease
was primarily attributable to (i) a decrease in payment collection cost, and (ii) a decrease in cost of purchasing third-party anti-virus software, both of which was the
result of our decreased sales of third-party anti-virus software.
Cost
of Internet services increased by $3.8 million, or 210.9%, from $1.8 million in 2009 to $5.6 million in 2010, primarily due to a $3.0 million increase in
the business tax and surcharges we paid in connection with our Internet services in line with our revenue growth.
Operating Expenses
Selling and Marketing Expenses.
Selling and marketing expenses increased by $6.3 million, or 101.5%, from $6.3 million in
2009 to
$12.6 million in 2010. This increase was primarily due to (i) an increase of $5.4 million in our advertising and promotion expenses relating to increased brand promotion
activities and promotion of our new security products in 2010, and (ii) an increase of $839,000 in the salaries and benefits as a result of increased headcount of sales and marketing personnel.
General and Administrative Expenses.
General and administrative expenses increased by $2.6 million, or 99.6%, from
$2.5 million in 2009
to $5.1 million in 2010. This increase was primarily due to (i) an increase of $1.1 million in the salaries and benefits for our general and administrative personnel as a result
of increased headcount and (ii) an increase of $1.2 million in professional fees incurred for legal proceedings and other administrative activities.
Research and Development Expenses.
Research and development expenses increased by $13.8 million, or 129.8%, from
$10.7 million in 2009
to $24.5 million in 2010. This increase was primarily due to (i) an increase of $6.5 million in the salaries and benefits for our research and development personnel as we hired
additional employees in 2010 to develop our security products, (ii) an increase of $3.6 million in bandwidth cost, as we leased additional bandwidth to develop and innovate security
products and services, and (iii) an increase of $1.9 million in share-based
71
Table of Contents
compensation
associated with additional nonvested shares granted to our key research and development employees.
Income Tax Expense
Income tax expenses increased from $412,000 in 2009 to $463,000 in 2010, because our taxable income in 2010 was higher than that in
2009, which was partially offset by the lower tax rate in 2010 due to our preferential tax treatment.
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Revenues
Revenues increased by $15.4 million, or 91.2%, from $16.9 million in 2008 to $32.3 million in 2009, primarily due
to an increase in the revenues from Internet services and an increase in the revenues from sales of third-party anti-virus software.
The
increase in revenues from Internet services was in turn primarily attributable to an increase in our revenues from online advertising and the additional revenues generated from
Internet value-added services, primarily the operation of web games, in 2009.
Revenues
from our online advertising business increased by $8.3 million, or 148.4%, from $5.6 million in 2008 to $13.9 million in 2009, primarily due to an increase
in the revenues generated from major search engines such as Baidu.com and Google.com. We derived more revenues from search engines in 2009 due primarily to the increased number of searches originated
from our websites, which was attributable to our expanded user base. In addition, we began deriving additional revenues from placing links for third-party websites on our 360 Personal
Start-up Page at the end of 2009.
Revenues
from Internet value-added services business increased by $2.1 million, from nil in 2008 to $2.1 million in 2009, primarily because we began generating revenues
from web games.
Revenues
from sales of third-party anti-virus software increased by $5.2 million, or 46.8%, from $11.1 million in 2008 to $16.3 million in 2009,
primarily attributable to our expanded user base and the increasing awareness among users of our platforms as reliable sources of security products.
Cost of Revenues
Cost of revenues slightly increased by $0.2 million, or 2.1%, from $8.2 million in 2008 to $8.4 million in 2009,
primarily due to an increase in cost of Internet services, which was partially offset by a decrease in cost of sales of third-party anti-virus software.
Cost
of Internet services increased by $0.7 million, or 56.1%, from $1.1 million in 2008 to $1.8 million in 2009, primarily due to a $0.6 million increase in
the business tax and related surcharges we paid in connection with our Internet services in line with our revenue growth.
Cost
of sales of third party anti-virus software decreased by $0.5 million, or 6.7%, from $7.1 million in 2008 to $6.6 million in 2009. This decrease was
primarily attributable a decrease in cost of purchasing third-party anti-virus software, primarily due to the more favorable pricing terms that we achieved in sourcing new
third-party software as a result of our expanded user base. The decrease was partially offset by an increase in payment collection cost in line with our revenue growth.
Operating Expenses
Selling and Marketing Expenses.
Selling and marketing expenses increased by $3.6 million, or 129.0%, from $2.7 million in 2008
to
$6.3 million in 2009. This increase was primarily due to (i) an increase of $2.9 million in our advertising and promotion expenses in connection with promotions for our free
security products, and (ii) an increase of $301,000 in the salaries and benefits paid to our selling and marketing personnel.
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General and Administrative Expenses.
General and administrative expenses increased by $886,000, or 53.9%, from $1.6 million in
2008 to
$2.5 million in 2009. This increase was primarily due to (i) an increase in the salaries and benefits for our general and administrative personnel as a result of increased headcount, and
(ii) an impairment charge in connection with a domain name acquired in 2009.
Research and Development Expenses.
Research and development expenses increased by $3.4 million, or 46.4%, from $7.3 million in
2008 to
$10.7 million in 2009. This increase was primarily due to (i) an increase of $2.1 million in the salaries and benefits paid to our research and development personnel as a result
of increased headcount, (ii) an increase in bandwidth costs as we leased additional bandwidth to develop and innovate security products and services, and (iii) an increase in share-based
compensation expenses associated with additional share options and nonvested shares granted to our key research and development employees. The foregoing increases were partially offset by a decrease
of $455,000 in the depreciation cost of our equipment in 2009.
Income Tax Benefit (Expense)
We recorded an income tax benefit of $179,000 in 2008 because we recorded a net loss before tax of $2.9 million in 2008. We
recorded an income tax expense of $412,000 in 2009, as we started to generate profit in 2009.
Liquidity and Capital Resources
As of December 31, 2010, our principal sources of liquidity have been proceeds from our cash flows from operations and financing
activities. As of December 31, 2010, we had no outstanding debt. Our cash and cash equivalents primarily consist of cash on hand and term deposits.
We
are a holding company and conduct our operations primarily through our subsidiaries and VIEs in China. As a result, our ability to pay dividends depends upon dividends paid by our
subsidiaries, which in turn depend upon earnings of our VIEs transferred to our subsidiaries in the form of payments under the technology support and management consulting agreements. If our
subsidiaries or any newly formed subsidiaries incur debt on their own behalf, the instruments governing their debt may restrict their ability to pay dividends to us. In addition, our subsidiaries are
permitted to pay dividends to us only out of their retained earnings, if any, as determined in accordance with accounting standards and regulations applicable to such subsidiaries. As of
December 31, 2010, our PRC subsidiaries and VIEs
had aggregate undistributed earnings of approximately $5.2 million that were available for distribution. These undistributed earnings are considered to be indefinitely reinvested, and will be
subject to PRC dividend withholding taxes upon distribution.
Under
PRC law, each of our PRC subsidiaries must 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 its registered capital. Each of our PRC subsidiaries with foreign investments must also set aside a portion of its after-tax profits to fund an employee welfare fund at the discretion
of the board. 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,
companies may not distribute the reserve funds as cash dividends except upon a liquidation of these subsidiaries. In addition, dividend payments from our PRC subsidiaries could be delayed as we may
only distribute such dividends upon completion of annual audits of the subsidiaries.
Furthermore,
cash transfers from our PRC subsidiaries to our subsidiaries outside of China are subject to PRC government control of currency conversion. Qizhi Software needs to obtain
the approval from or registration with the relevant government authorities if it plans to convert cash denominated in Renminbi into U.S. dollars and remit it to our subsidiaries outside of
China. See "Risk FactorsRisks Related to Doing Business in ChinaGovernmental control of currency conversion may limit our ability to utilize our revenues effectively and
affect the value of your investment."
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We
believe that our current levels of cash and cash flows from operations and financing activities will be sufficient to meet our anticipated cash needs for at least the next
twelve months. However, we may need additional cash resources in the future if we experience changed business conditions or other developments. We may also need additional cash resources in the
future if we find and wish to pursue opportunities for investment, acquisition, strategic cooperation or other similar actions. If we ever determine that our cash requirements exceed our amounts of
cash and cash equivalents on hand, we may seek to issue debt or equity securities or obtain additional credit facility. Any issuance of equity securities could cause dilution for our shareholders. Any
incurrence of indebtedness could increase our debt service obligations and cause us to be subject to restrictive operating and finance covenants. It is possible that, when we need additional cash
resources, financing will only be available to us in amounts or on terms that would not be acceptable to us or financing will not be available at all.
The
following table sets forth a summary of our cash flows for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2008
|
|
2009
|
|
2010
|
|
|
|
($ in thousands)
|
|
Net cash (used in) provided by operating activities
|
|
|
(661
|
)
|
|
9,040
|
|
|
20,125
|
|
Net cash used in investing activities
|
|
|
(33
|
)
|
|
(4,208
|
)
|
|
(9,053
|
)
|
Net cash provided by financing activities
|
|
|
|
|
|
|
|
|
20,253
|
|
Effect of exchange rates on cash and cash equivalents
|
|
|
714
|
|
|
50
|
|
|
1,036
|
|
Net increase in cash and cash equivalents
|
|
|
20
|
|
|
4,882
|
|
|
32,361
|
|
Cash and cash equivalents at the beginning of the year/period
|
|
|
23,242
|
|
|
23,262
|
|
|
28,144
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at the end of the year/period
|
|
|
23,262
|
|
|
28,144
|
|
|
60,505
|
|
|
|
|
|
|
|
|
|
Operating Activities
Net cash provided by operating activities increased to $20.1 million in 2010 from $9.0 million in 2009. Although our
growing business generated substantial net cash inflow as our revenues increased by $25.4 million from $32.3 million in 2009 to $57.7 million in 2010, the cash paid for cost of
revenues and operating expenses also increased by $20.4 million from $18.2 million in 2009 to $38.6 million in 2010.
Net
cash provided by operating activities amounted to $9.0 million in 2009 while net cash used in operating activities amounted to $661,000 in 2008. Our growing business generated
significantly more net cash inflow in 2009 compared to 2008 as we increased revenue by $15.4 million from $16.9 million in 2008 to $32.3 million in 2009. However, our cash paid
for cost of revenues and operating expenses also increased by $1.7 million from $16.5 million in 2008 to $18.2 million in 2009.
Investing Activities
Net cash used in investing activities amounted to $9.1 million in 2010, primarily due to the cash outflows for
(1) payment for the purchase of property and equipment of $2.8 million in connection with our operation expansion, and (2) cash considerations in the amount of $2.6 million
paid in a series of acquisitions.
Net
cash used in investing activities amounted to $4.2 million in 2009, primarily due to the cash outflows for (1) cash considerations in the amount of $1.7 million
paid in a series of acquisitions, (2) payment for the purchase of intangible assets of $1.2 million, mostly in connection with our purchase of certain intellectual properties, and
(3) payment for the purchase of property and equipment of $0.8 million in connection with our operation expansion.
Net
cash used in investing activities amounted to $33,000 in 2008, primarily due to the cash outflow of $168,000 for our purchase of property and equipment and the cash outflow of
$76,000 for
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our
purchase of the assets in connection with our operation expansion. This cash outflow was partially offset by a cash inflow from our receipt of proceeds of $211,000 from a business disposal.
Financing Activities
Net cash provided by financing activities amounted to $20.3 million in 2010, primarily due to our receipt of proceeds from the
issuance of Series C convertible participating redeemable preferred shares.
Capital Expenditures
We incur capital expenditures primarily for purchases of servers and intangible assets. Our capital expenditures were $168,000 in 2008,
$2.0 million in 2009, and $4.3 million in 2010. We expect to incur approximately $9.0 million in capital expenditures for 2011. We expect to fund capital expenditures by cash
generated from operating and financing activities, including the net proceeds from this offering.
Contractual Obligations
The following table sets forth our contractual obligations as of December 31, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payment Due by Period
|
|
Contractual Obligations
|
|
Total
|
|
Less
than
1 Year
|
|
1 - 3
Years
|
|
3 - 5
Years
|
|
More
than
5 Years
|
|
Other
|
|
|
|
($ in thousands)
|
|
Operating lease obligations
|
|
|
2,161
|
|
|
1,505
|
|
|
656
|
|
|
|
|
|
|
|
|
|
|
Long-term payable
(1)
|
|
|
1,975
|
|
|
1,525
|
|
|
450
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
4,136
|
|
|
3,030
|
|
|
1,106
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
(1)
-
Long-term
payable represents payment obligations under the agreement with a third party that allows us to offer its anti-virus software.
From time to time, we are subject to legal proceedings and claims in the ordinary course of business. For contingency liability of pending
litigation, see "Risk FactorsRisks Related to Our BusinessPending or future litigation could have a material adverse impact on our results of operation, financial condition
and liquidity."
Off-Balance Sheet Arrangements
We have not entered, and do not expect to enter, into any off-balance sheet arrangements. We also have not entered into any
financial guarantees or other commitments to guarantee the payment obligations of third parties. In addition, we have not entered into any derivative contracts indexed to equity interests and
classified as shareholders' equity. 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 it or that engages in leasing, hedging or
research and development services with it.
Inflation
Inflation in China has not materially impacted our results of operations. However, China has recently experienced a significant
increase in inflation levels, which may materially impact our results of operations. According to the National Bureau of Statistics of China, the change of
consumer price index in China was 5.9% in 2008. While the consumer price index in China decreased by 0.7% in 2009, the consumer price index in China increased by 3.3% year-over-year for the year ended
December 31, 2010.
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Quantitative and Qualitative Disclosure About Market Risk
Interest Rate Risk
Our exposure to interest rate risk primarily relates to the interest income generated by cash in bank deposits. We have not used any
derivative financial instruments to manage our interest risk exposure. Interest earning instruments carry a degree of interest rate risk. We have not been exposed to material risks due to changes in
interest rates. An increase in interest rates, however, may raise the cost of any debt we incur in the future. In addition, our future interest income may be lower than expected due to changes in
market interest rates.
With
respect to cash and cash equivalents as of December 31, 2009, a 1.0% decrease in interest rates would have decreased our interest income for the year then ended from $281,000
to $89,000. In addition, with respect to cash and cash equivalents as of December 31, 2010, a 1.0% decrease in interest rates would have decreased our interest income for the year then ended
from $415,000 to $118,000.
Foreign Exchange Risk
Substantially all of our revenues and most of our expenses are denominated in RMB. Our exposure to foreign exchange risk primarily
relates to cash and cash equivalents denominated in U.S. dollars as a result of our past issuances of preferred shares through private placement transactions and proceeds from this offering. We
do not believe that we currently
have any significant direct foreign exchange risk and have not hedged exposures denominated in foreign currencies or any other derivative financial instruments. Although we believe our exposure to
foreign exchange risks is limited, the value of your investment in our ADSs will be affected by the foreign exchange rate between U.S. dollars and RMB because the value of our business is
effectively denominated in RMB, while the ADSs will be traded in U.S. dollars.
The
value of the RMB against the U.S. dollar and other currencies may fluctuate depending on many factors, including changes in China's political and economic conditions. The
conversion of RMB into foreign currencies, including U.S. dollars, has been based on rates set by the People's Bank of China. On July 21, 2005, the PRC government changed its policy of
pegging the value of the RMB to the U.S. dollar. Under the revised policy, the RMB may fluctuate within a narrow and managed band against a basket of foreign currencies. Following the removal
of the U.S. dollar peg, the RMB appreciated more than 20% against the U.S. dollar over three years. From July 2008 until December 2010, however, the RMB traded stably within a
narrow range against the U.S. dollar.
There
remains significant international pressure on the PRC government to adopt a more flexible currency policy, which could result in a further and more significant appreciation of the
RMB against foreign currencies. On June 20, 2010, the People's Bank of China announced that the PRC government would reform the RMB exchange rate regime and increase the flexibility of the
exchange rate. We cannot predict how this new policy will impact the RMB exchange rate.
To
the extent that we need to convert U.S. dollars we receive from this offering into RMB for our operations, appreciation of the RMB against the U.S. dollar would
adversely affect the RMB amount we receive from the conversion. Assuming we were to convert the net proceeds received in this offering into RMB, a 1.0% increase in the value of the RMB against the
U.S. dollar would decrease the amount of RMB we receive by RMB13.5 million. Our U.S. dollar denominated cash balance was $10.5 million, $7.9 million and
$24.4 million as of December 31, 2008, 2009 and 2010, respectively. A 1.0% increase in the value of the RMB against the U.S. dollar would have decreased this U.S. dollar
denominated cash balance by RMB715,000, RMB539,000 and RMB1.6 million as of December 31, 2008, 2009 and 2010, respectively.
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Recent Accounting Pronouncements
In October 2009, the FASB issued an authoritative pronouncement regarding the revenue arrangements with multiple deliverables. The new
guidance eliminates the
residual method of revenue recognition and allows the use of management's best estimate of selling price for individual elements of an arrangement when vendor specific objective evidence (VSOE),
vendor objective evidence (VOE) or third-party evidence (TPE) is unavailable. Prospective application of this new guidance is permitted for revenue arrangements entered into or materially modified in
fiscal years beginning on or after June 15, 2010, with earlier application permitted. Alternatively, an entity can elect to adopt this guidance on a retrospective basis. We do not expect the
adoptions of this pronouncement to have a significant impact on its financial condition or results of operations.
In
October 2009, the FASB issued authoritative guidance which amends the scope of existing software revenue recognition accounting. Tangible products containing software components and
non-software components that function together to deliver the product's essential functionality would be scoped out of the accounting guidance on software and accounted for based on other
appropriate revenue recognition guidance. Prospective application of this new guidance is permitted for revenue arrangements entered into or materially modified in fiscal years beginning on or after
June 15, 2010, with earlier application permitted. Alternatively, an entity can elect to adopt this new guidance on a retrospective basis. This guidance must be adopted in the same period that
the company adopts the amended accounting for arrangements with multiple deliverables described in the preceding paragraph. We are in the process of evaluating the effect of adoption of this
pronouncement.
On
January 21, 2010, the FASB issued authoritative guidance to improve disclosures about fair value measurements. This guidance amends previous guidance on fair value measurements
to add new requirements for disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3
measurement on a gross basis rather than as a net basis as currently required. This guidance also clarifies existing fair value disclosures about the level of disaggregation and about inputs and
valuation techniques used to measure fair value. This guidance is effective for annual and interim periods beginning after December 15, 2009, except for the requirement to provide the
Level 3 activities of purchases, sales, issuances, and settlements on a gross basis, which will be effective for annual and interim periods beginning after December 15, 2010. Early
application is permitted and in the period of initial adoption, entities are not required to provide the amended disclosures for any previous periods presented for comparative purposes. We do not
expect the adoption of this pronouncement will have a significant effect on its consolidated financial position or results of operations.
In
April 2010, the FASB issued an authoritative pronouncement regarding the milestone method of revenue recognition. The scope of this pronouncement is limited to arrangements that
include milestones relating to research or development deliverables. The pronouncement specifies guidance that must be met for a vendor to recognize consideration that is contingent upon achievement
of a substantive milestone in its entirety in the period in which the milestone is achieved. The guidance applies to milestones in arrangements within the scope of this pronouncement regardless of
whether the arrangement is determined to have single or multiple deliverables or units of accounting. The pronouncement will be effective for fiscal years, and interim periods within those years,
beginning on or after June 15, 2010. Early application is permitted. Companies can apply this guidance prospectively to milestones achieved after adoption. However, retrospective application to
all prior periods is also permitted. We do not expect the adoptions of this pronouncement will have a significant impact on its financial condition or results of operations.
In
December 2010, the FASB issued an authoritative pronouncement on when to perform Step 2 of the goodwill impairment test for reporting units with zero or negative carrying amounts. The
amendments in this update modify Step 1 so that for those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill
impairment
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Table of Contents
exists.
In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment
may exist. The qualitative factors are consistent with existing guidance, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or
circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. For public entities, the guidance is effective for impairment tests performed
during entities' fiscal years (and interim periods within those years) that begin after December 15, 2010. Early adoption will not be permitted. For nonpublic entities, the guidance is
effective for impairment tests performed during entities' fiscal years (and interim periods within those years) that begin after December 15, 2011. Early application for nonpublic entities is
permitted; nonpublic entities that elect early application will use the same effective date as that for public entities. We do not expect the adoption of this pronouncement will have a significant
effect on its consolidated financial position or results of operations.
In
December 2010, the FASB issued an authoritative pronouncement on disclosure of supplementary pro forma information for business combinations. The objective of this guidance is to
address diversity in practice regarding the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. The amendments in this update specify that if a
public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current
year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and
amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments affect any public
entity as defined by Topic 805 that enters into business combinations that are material on an individual or aggregate basis. The amendments will be effective for business combinations consummated in
periods beginning after December 15, 2010, and should be applied prospectively as of the date of adoption. Early adoption is permitted. We do not expect the adoption of this pronouncement will
have a significant effect on its consolidated financial position or results of operations.
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Table of Contents
CORPORATE HISTORY AND STRUCTURE
Our History and Development
In 2005, Mr. Xiangdong Qi, our director and president, founded our business, which originally focused on user generated content
search and aggregation. Mr. Hongyi Zhou, our chairman and chief executive officer, joined us in August 2006, and together with Mr. Qi, reshaped our primary business. In
July 2006, we launched 360 Safe Guard, our first Internet security product that protects users against malware, and entered into the Internet security market.
We
were incorporated in the Cayman Islands as an exempted limited liability company on June 9, 2005. On December 31, 2010, we changed our name from Qihoo Technology Company
Limited to Qihoo 360 Technology Co. Ltd. We conduct our business operations in China through our wholly-owned subsidiaries
and affiliated entities. We formed a wholly-owned subsidiary, Qizhi Software, one of our primary operating entities, in China in December 2005.
In
November 2010, we formed three Hong Kong subsidiaries that we expect to become intermediate holding companies for our operations in China: Qiji International,
360 International and Qifei International, which are all wholly-owned by Qihoo 360.
The
following diagram illustrates our corporate structure as of the date of this prospectus.
Contractual Arrangements Among Qizhi Software, the VIEs and the Respective Shareholders of the VIEs
Qizhi Software, our PRC operating subsidiary, is a wholly foreign-owned enterprise and is subject to PRC legal restrictions on foreign
ownership in the telecommunications sector. See "RegulationsRegulations Relating to Our Business." Accordingly, we conduct our business activities primarily through two VIEs, namely
Beijing Qihu and Shanghai Qitai. The registered shareholders of Beijing Qihu and Shanghai Qitai are our directors, officers or key employees, who directly or indirectly hold our shares, including
Mr. Hongyi Zhou, our chairman of the board and the chief executive officer and Mr. Xiangdong Qi, our director and president. Through contractual arrangements with Beijing Qihu
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Table of Contents
and
Shanghai Qitai and their respective registered shareholders, we bear the economic risks and receive the economic benefits of Beijing Qihu and Shanghai Qitai as their primary beneficiary. The
financial results of Beijing Qihu and Shanghai Qitai are consolidated into our financial statements despite the lack of our equity interest in them. We believe the consolidation is necessary to fairly
present the financial position and results of operations of our company, because of the existence of a parent-subsidiary relationship through contractual arrangements. Qizhi Software has entered into
contractual arrangements with Beijing Qihu, Shanghai Qitai and their respective registered shareholders, which enable us to:
-
-
exercise effective control over Beijing Qihu and Shanghai Qitai;
-
-
receive substantially all of the economic benefits from Beijing Qihu and Shanghai Qitai as if we were their sole
shareholder; and
-
-
have an exclusive option to purchase all of the equity interests in Beijing Qihu and Shanghai Qitai when and to the extent
permitted by PRC law.
Qizhi
Software has also entered into similar contractual arrangements with five other VIEs that do not have significant business operations.
Qizhi Software entered into equity disposition agreements with Beijing Qihu, Shanghai Qitai and their respective registered
shareholders, who irrevocably granted Qizhi Software or its designated person exclusive options to purchase, when and to the extent permitted under PRC law, all of the equity interests in Beijing Qihu
and Shanghai Qitai. The exercise price for the options to purchase all of the equity interests in Beijing Qihu and Shanghai Qitai is the minimum amount of consideration permissible under the then
applicable PRC law. The agreements have an initial term of ten years and are renewable at Qizhi Software's sole discretion. These equity disposition agreements provide, among other things, that
without Qizhi Software's prior written consent:
-
-
the registered shareholders of each VIE may not transfer, encumber, grant security interest in, or otherwise dispose of in
any way any equity interests in their respective VIEs;
-
-
Beijing Qihu and Shanghai Qitai may not sell, transfer, mortgage or otherwise dispose of in any way their respective
assets, business or income, nor may they create any security interest therein (other than created in the ordinary course of their respective business);
-
-
no shareholders resolution should be passed to increase or reduce the registered capital of each VIE or otherwise alter
the capital structure of such VIE;
-
-
the articles of association of each VIE should not be supplemented, altered or modified in any way;
-
-
Beijing Qihu and Shanghai Qitai may not declare or pay any dividends to their respective registered shareholders;
-
-
Beijing Qihu and Shanghai Qitai may not merge with any third parties, or purchase or transfer any assets or businesses
from or to any third parties;
-
-
Beijing Qihu and Shanghai Qitai may not engage in any transactions that may cause substantially adverse effects on their
respective assets, obligations, operations, share capital and other rights;
-
-
Beijing Qihu and Shanghai Qitai may not incur any indebtedness, except where transactions were entered into in the
ordinary course of business; and
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-
-
the registered shareholders of the VIEs will apply the proceeds from the disposition of the shares of their respective
VIEs to repay the loans extended by Qihoo 360 under the loan agreements described below.
Under loan agreements between Qihoo 360 and the registered shareholders of Beijing Qihu and Shanghai Qitai, as the case may be,
Qihoo 360 extended loans of (i) an aggregate principal amount of RMB80 million ($12.0 million) to the registered shareholders of Beijing Qihu and (ii) an aggregate
principal amount of RMB1 million ($151,515) to the registered shareholders of Shanghai Qitai. The registered shareholders obtained the loans to fund the initial registered capital of and
contribute additional registered capital to Beijing Qihu and Shanghai Qitai, as the case may be. Each loan agreement has a term of ten years and is renewable for another ten-year term upon
the parties' agreement.
Under Qizhi Software's equity pledge agreements with Beijing Qihu, Shanghai Qitai and their respective registered shareholders, the
registered shareholders of Beijing Qihu and Shanghai Qitai pledged all of their respective equity interests in Beijing Qihu and Shanghai Qitai to Qizhi Software to secure the performance of the
registered shareholders', Beijing Qihu's and Shanghai Qitai's obligations under the various VIE agreements, including the business operation agreements and the technology development agreements
described below. If Beijing Qihu, Shanghai Qitai or any of their respective registered shareholders breaches any of their respective contractual obligations under these agreements, Qizhi Software, as
pledgee, will be entitled to certain rights, including the right to sell the pledged equity interests. The registered shareholders of Beijing Qihu and Shanghai Qitai agreed not to transfer, sell,
pledge, dispose of or otherwise create any new encumbrance on their respective equity interests in Beijing Qihu and Shanghai Qitai, as the case may be, without Qizhi Software's prior written consent.
Unless terminated at Qizhi Software's sole discretion, each equity pledge agreement has a term of ten years and will be automatically renewed upon the expiration of the
ten-year term.
Under the business operation agreements among Qizhi Software, Beijing Qihu and Shanghai Qitai, as the case may be, and the respective
registered shareholders of Beijing Qihu and Shanghai Qitai, the registered shareholders of Beijing Qihu and Shanghai Qitai may not enter into any transaction that could materially affect the assets,
liabilities, interests or operations of Beijing Qihu and Shanghai Qitai, as the case may be, without Qizhi Software's prior written consent. In addition, directors, chairman, general managers,
financial controllers or other senior managers of Beijing Qihu and Shanghai Qitai, as the case may be, must be Qizhi Software's nominees appointed by
the registered shareholders of Beijing Qihu and Shanghai Qitai. Each business operation agreement has a term of ten years and is renewable at Qizhi Software's sole discretion.
Under a technology development agreement dated May 1, 2008 between Qizhi Software and Beijing Qihu, Qizhi Software agreed to
provide Beijing Qihu with technology development and support services related to Beijing Qihu's advertising business. Beijing Qihu agreed to pay RMB8.5 million ($1.3 million) in 2008 and
30% of Beijing Qihu's revenues from its advertising business annually from 2009 to 2012 to Qizhi Software. This agreement has a term of five years. In September 2010, Beijing Qihu and
Qizhi Software signed a supplementary agreement, which amended the percentage of Beijing Qihu's revenues that Qizhi Software would receive from 30% to 20%, effective September 1, 2010.
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Under
a technology development agreement dated October 20, 2008 between Qizhi Software and Beijing Qihu, Qizhi Software agreed to provide Beijing Qihu with technology development
and support services related to Beijing Qihu's network digital products business. Beijing Qihu agreed to pay an aggregate amount of RMB9.5 million ($1.4 million) to Qizhi Software for
the entire term of the agreement. This agreement has a term of four years.
Under
a technology development agreement dated March 15, 2009 between Qizhi Software and Beijing Qihu, Qizhi Software agreed to provide Beijing Qihu with technology development
and support services related to Beijing Qihu's online shopping business. Beijing Qihu agreed to pay to Qizhi Software RMB4.5 million ($0.7 million) within 30 days from the date of
the agreement, RMB4.5 million ($0.7 million) within 60 days after the date of the agreement and 35% of the revenues generated from the online shopping business for the period
between June 2009 and December 2012. Unless earlier terminated, this agreement has a term of four years. In June 2010, Beijing Qihu and Qizhi Software signed a
supplementary agreement, which amended the percentage of Beijing Qihu's revenues from the online shopping business that Qizhi Software would receive from 35% to 20%, effective June 1, 2010. In
addition, Beijing Qihu and Qizhi Software agreed that no revenue needed to be paid by Beijing Qihu to Qizhi Software in September and October 2010.
Under
an exclusive technology consulting and services agreement dated September 2, 2009 between Qizhi Software and Shanghai Qitai, Qizhi Software agreed to provide Shanghai Qitai
with exclusive consulting services relating to Internet information technology and software development technology. In
return for Qizhi Software's services, Shanghai Qitai agreed to pay a monthly fee to Qizhi Software based on the number of page views generated. This agreement has a term of ten years.
Each registered shareholder of Beijing Qihu and Shanghai Qitai has executed a power of attorney to appoint Qizhi Software to be his or
her attorneys, and irrevocably authorize Qizhi Software to vote on his or her behalf on all of the matters concerning Beijing Qihu and Shanghai Qitai, as the case may be, that may require
shareholders' approval.
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OUR INDUSTRY
INTERNET AND MOBILE USAGE IN CHINA
Internet Usage in China
The number of Internet users in China has grown rapidly in recent years as the Internet emerges as a popular and powerful medium for
information, communication and
commerce in China. According to iResearch, the number of Internet users in China grew from 137 million in 2006 to 457 million in 2010, representing a CAGR of 35.2%. Over the same period,
the Internet penetration rate increased from 10.8% to 31.9%, according to the Economist Intelligence Unit, a research and analysis firm, or EIU. Although China has the largest Internet market in the
world in terms of number of users, China's Internet penetration is still low as compared to developed countries such as the United States and Japan, whose penetration rates were 84.5% and 80.8%
in 2010, respectively, according to EIU. The number of Internet users in China is expected to continue growing at a CAGR of 13.4% to reach 667 million by 2013 from 457 million in 2010.
The following chart sets forth the number of Internet users in China for the years indicated.
Number of Internet Users in China (2006-2013E)
Source: iResearch
Mobile Usage in China
China is the largest mobile market in the world, with 859 million mobile subscribers as of the end of 2010, according to
iResearch. However, China's mobile penetration rate, at 67.0% as of the end of 2010, is still relatively low as compared to that of developed countries such as the United States and Japan,
which was at 94.8% and 94.1% in 2010 respectively, according to EIU. Further economic growth is expected to drive the growth of mobile subscribers in China at a CAGR of 6.6% to reach 1 billion
by the end of 2013, according to iResearch.
A
prominent trend in China's mobile market is the rise of mobile Internet access. Users are increasingly conducting various Internet activities through mobile devices, including
mobile-banking, mobile-commerce, mobile-gaming, and mobile social networking. According to iResearch, the number of mobile Internet users increased from 17 million in 2006 to 303 million
in 2010, representing a CAGR of 105.3%. Over the same period, the mobile Internet penetration rate increased from 3.7% to 35.3%. As the number of mobile users in China continues to grow, along with
the increasing adoption of mobile Internet, the number of mobile Internet users in China is expected to grow further to reach 658 million by the end of 2013, representing a CAGR
of 29.5%. The following table sets forth the
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number
of mobile users, the number of mobile Internet users and the mobile penetration rate in China for the years indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
2007
|
|
2008
|
|
2009
|
|
2010
|
|
2011E
|
|
2012E
|
|
2013E
|
|
Mobile users (millions)
|
|
|
461
|
|
|
547
|
|
|
641
|
|
|
747
|
|
|
859
|
|
|
911
|
|
|
974
|
|
|
1,040
|
|
Mobile Internet users (millions)
|
|
|
17
|
|
|
50
|
|
|
118
|
|
|
233
|
|
|
303
|
|
|
415
|
|
|
522
|
|
|
658
|
|
Mobile Internet penetration rate
|
|
|
3.7%
|
|
|
9.1%
|
|
|
18.4%
|
|
|
31.2%
|
|
|
35.3%
|
|
|
45.6%
|
|
|
53.6%
|
|
|
63.3%
|
|
Emergence of Cloud Computing
With growing fixed-line and wireless broadband availability and penetration in China, the Internet services landscape has
begun to favor cloud-based technology. While cloud-based services are still in a relatively early stage of development in China, rapid adoption in more developed markets provides a template for how
China's Internet services landscape may develop. In more developed markets, cloud-based services have created new market opportunities and gained significant market share in existing segments by
offering users significant advantages over traditional technologies. The main advantage is the enhanced utility through centralized data management and processing, which results in lower processing
and power requirements at user terminals, and lower up-front investment and ongoing maintenance cost for users. In addition, cloud-based technology provides the convenience of cross-device
user experience and functionality, as well as real-time updating. However, centralizing key data and processing presents more concentrated security risk. Users must rely on providers of
cloud-computing services to ensure the security of their data and processes. Security is becoming increasingly crucial in the emerging cloud environment.
INTERNET AND MOBILE SECURITY ADOPTION IN CHINA
Internet Security Adoption in China
Internet security has become a major concern for Internet users as the scale and nature of security threats continue to evolve. In the
past, computer viruses primarily sought to disrupt the proper functioning of computer hardware or systems. However, as more personal information and virtual assets are now processed through or stored
on the Internet, Internet hacking has shifted from being motivated by hackers gaining notoriety to profiting from accessing and exploiting such confidential data. As a result, Internet attacks have
increased exponentially in both number and severity. According to iResearch, the largest number of malware samples collected by a single Internet security provider in China increased from
approximately 538,000 in 2006 to over 650 million in 2010.
In
addition, Internet security threats are also becoming increasingly covert and difficult to detect and defend against. Hackers are utilizing application content to disguise attacks to
effectively bypass many security software, such as through building fraudulent online banking and e-commerce phishing websites and other malicious websites. Such "content" level attacks
are especially vicious for Chinese Internet users as compared to users in other more mature markets, as China has a large and relatively nascent Internet population with relatively low disposable
income, who tend to download free software programs and are especially susceptible to threats disguised as harmless programs. According to China Internet Network Information Center, or the CNNIC, as
of December 2010, 45.8% of Internet users in China experienced malware attacks, and 21.8% of users experienced theft of personal account information. Traditional anti-virus applications
alone are no longer sufficient to safeguard users against the rapid proliferation of security threats. This has led to an increasing demand among Internet users for fully-integrated solutions covering
system protection, privacy protection and performance optimization, which we define as pan-security solutions.
According
to iResearch, the number of Internet security users reached 394 million in 2010, an increase from 89 million in 2006. The number of Internet security users is
expected to reach
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559 million
by 2013, representing a CAGR of 12.4%. The following chart sets forth the number of Internet security product users in China for the years indicated.
China Internet Security Product Users (2006-2013E)
Source: iResearch
Mobile Internet Security Adoption in China
With the world's largest number of mobile users, China's mobile industry presents another attractive market for hackers. Users' growing
adoption of mobile Internet activities such as mobile-banking, mobile-commerce, mobile gaming, and mobile social networking has further created opportunities for hackers to access users' private
information and to make fraudulent account charges, putting personal identity and assets at risk. According to iResearch, 972 different types of mobile malware were identified in 2009, an
increase from 125 types in 2006. The number of types of mobile malware identified is expected to more than double from 2009 to reach 2,146 in 2010.
As
a result of the explosive growth in mobile security threats, the accumulated number of mobile security product activated users is expected to grow from 27 million in 2009 to
reach 254 million by 2012, representing a CAGR of 111.1%, according to iResearch. The following chart sets forth the accumulated number of China mobile security product activated users
for the years indicated.
Accumulated Number of China Mobile Security Product Activated Users (2009-2012E)
Source: iResearch
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Emergence of Cloud-based Security Technology
The rapid growth and increasing complexity of Internet security threats require security software to be updated frequently. Traditional
anti-virus software uses "signatures" to identify threats, and as a result, its signature database must grow synchronously with the increasing number of threats. Given traditional
anti-virus software stores signature databases on the terminal-end (on users' computers), it consumes the limited computing resources at the user terminal, thereby
decreasing system speed and performance. In addition, malware is now able to evolve far more quickly than traditional anti-virus software can adapt through periodic signature database
updates. As a result, cloud-based security technology has emerged as an effective and superior Internet security solution, offering significant and sustained performance advantages for users.
Cloud-based
security technology maintains and utilizes a database of "blacklisted" known malware and "whitelisted" verified safe program files stored on central servers in the cloud
instead of on the users' computers. Fingerprints of program files are then compared against the database in the cloud, which is constantly updated by new information retrieved and submitted by users,
collectively forming the "user cloud." The technology also uses behavior analysis to identify unknown threats and improve threat-detection ability. Cloud-based security technology has several main
advantages over traditional anti-virus technologies. It provides real-time responses to new malware by minimizing lag time from initial discovery to full protection,
significantly enhances malware detection capabilities through a massive database, and frees computer resources by eliminating the need for a large database to be stored on the user-end terminal. In
addition, cloud-based security technology grows in effectiveness with the size of the user cloud. According to iResearch, Qihoo 360 has China's largest centralized cloud-based security solution
with 151 million daily active users in January 2011.
MARKETS FOR KEY INTERNET SERVICES
With rapidly increasing broadband penetration in China, combined with the proliferation of Internet-enabled mobile devices, Internet
usage in China has been growing rapidly in recent years. Users' growing reliance on the Internet and the increasing exchange of private personal information over the Internet across devices, have
created strong incentives for hackers to develop threats at multiple exposure points. The prevalence of malware and malicious websites have significantly impaired user experience and caused financial
losses, damaging both the reputation and profitability of software developers and Internet website operators. This has led to strong demand for security in the Internet and mobile markets in China,
especially across main Internet services markets including the Internet search market, the online gaming market, as well as the e-commerce market. At the same time, this presents
attractive opportunities for the development of secure Internet platform products to access these markets.
Online Advertising Market in China
China's online advertising market is expected to grow as the Internet gains acceptance as an increasingly effective advertising medium.
According to iResearch, the online advertising market in China grew from RMB6.1 billion in 2006 to reach RMB32.1 billion in 2010, representing a CAGR of 51.7%. Advertisers are
increasingly recognizing the benefits of online advertising and utilizing it as an important component of their overall marketing strategy in China, leading to an increase in online advertising as a
percentage of total advertising spend in China from 3.9% in 2006 to 10.1% in 2009, according to iResearch. As Internet advertising methods in China become more and more sophisticated and targeted, the
online advertising market is expected to continue to grow rapidly, and extract an increasing share of total market advertising dollars. According to iResearch, the online advertising market revenue in
China is expected to grow further from
RMB32.1 billion to reach RMB94.9 billion by 2013, representing a CAGR of 43.5%. The following chart sets forth the online advertising market revenue in China for the years
indicated.
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China Online Advertising Market Revenue (2006-2013E)
Source: iResearch
Internet Search Market in China
China's Internet search market has evolved rapidly in recent years as an increasing number of users seek information, products and
services via the Internet. According to iResearch, there were 239 billion web search queries in China in 2010. According to iResearch, total revenues generated by the Internet search
advertising market is expected to grow from RMB11.0 billion in 2010 to reach RMB38.4 billion in 2013, representing a CAGR of 51.8%. The following chart sets forth the search
advertising market revenue in China for the years indicated.
China Internet Search Advertising Market Revenue (2006-2013E)
Source: iResearch
Internet
search has enabled users to access a much wider range of websites, which has increased users' risk of exposure to malicious or phishing websites.
Online Gaming Market in China
Within the PRC Internet market, online gaming has been one of the fastest growing segments. According to iResearch, China's online
gaming market generated RMB32.7 billion of revenue in 2010, and is expected to grow to RMB43.5 billion in 2013. Massive multi-player online role-playing games, or MMORPGs
currently dominate online gaming. However, the greater accessibility of web games has contributed to the strong growth of China's web gaming market. According to iResearch, China's web gaming market
revenue increased from RMB100 million in 2007 to RMB990 million in 2009,
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representing
a CAGR of 214.6%, and is expected to further increase to RMB3 billion in 2013, representing a CAGR of 31.9%. The following chart sets forth the web gaming market revenue in
China for the years indicated.
China Web Gaming Market Revenue (2007-2013E)
Source: iResearch
One
key problem in the online gaming market in China is the proliferation of trojan horses that steal account information. According to a survey conducted by iResearch in
January 2010, account information theft was listed as the number one reason for players to abandon a game.
E-commerce Market in China
E-commerce has gained favor with PRC consumers as income levels rise and shopping behaviors change. With the rapid increase
in Internet penetration, the number of Internet shoppers in China grew by 48.6% from 108 million as of December 2009 to 161 million as of December 2010, according to CNNIC.
The overall e-commerce transaction value in China increased at a CAGR of 28.7% from RMB2.9 trillion in 2008 to RMB4.8 trillion in 2010, according to iResearch. This is
expected to grow further to reach RMB13.9 trillion by 2013, representing a CAGR of 42.5%. The explosive growth of e-commerce has also resulted in the widespread acceptance of online
payment systems, which has further increased the demand for Internet security services. According to CNNIC, the usage rates of Internet online shopping, online payment platforms and online banking
were 35.1%, 30.0%, and 30.5% as of December 2010, an increase from 28.1%, 24.5%, and 24.5% as of December 2009, respectively. More than ever, monetary transactions are carried out across
the Internet and exposed to the increasing threats of hackers. The following chart sets forth the overall e-commerce transaction value in China for the years indicated.
Overall E-commerce Transaction Value in China (2008-2013E)
Source: iResearch
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BUSINESS
Overview
We are the No. 3 Internet company in China as measured by user base, according to a report we commissioned from iResearch. In
January 2011, we had 339 million monthly active Internet users, representing a user penetration rate of 85.8% in China, according to iResearch. Recognizing security as a fundamental need
of Internet and mobile users, we offer comprehensive high-quality Internet and mobile security products free of charge, providing users with secure access points to Internet activities. As
a result, we have amassed a large and loyal user base, which we monetize primarily through offering online advertising and Internet value-added services.
We
are also the No. 1 provider of Internet and mobile security products in China as measured by user base, according to iReseach. In January 2011, we had 328 million
monthly active Internet security product users, representing a user penetration rate of 83.9% in China, according to iResearch. Our core Internet and mobile security products
include:
-
-
360 Safe Guard and 360 Anti-virus, the No. 1 and No. 2 Internet security products
in China, with 301 million and 248 million monthly active users in January 2011, respectively, according to iResearch;
-
-
360 Mobile Safe, the No. 1 mobile security product in China, with a market share of 58.2% as measured by the
number of active users in January 2011, according to iResearch.
On
top of our core layer of Internet and mobile security product offerings, we have further developed various platform products to meet a full spectrum security related needs of Internet
users and create trusted access points to Internet activities. Our platform products include:
-
-
360 Safe Browser, the No. 2 web browser in China, only after Microsoft Internet Explorer, with 172 million
monthly active users and a user penetration rate of 44.1% in China in January 2011, according to iResearch;
-
-
360 Personal Start-up Page, the default homepage of 360 Safe Browser and a key access point to popular
and preferred information and applications, with 98 million monthly active users in China in January 2011, according to iResearch;
-
-
360 Application Store, a key access point to securely obtain and manage software and applications; and
-
-
360 Safebox, a solution that protects users against thefts of personal account information.
Leveraging
our large user base, we are developing open platforms on which third-party Internet product and service providers, such as web game developers, e-commerce websites
and software and application developers, offer their products and services. These open platforms allow us to effectively monetize our large user base through revenue sharing arrangements with third
parties. For example, our open platform for web games enables our users to access web games provided by over 30 web game developers using their 360 accounts, and our open platform for
group-buy provides users with daily updated deal information from over 200 group-buy websites. Our open platforms enable our users to securely access a wide variety of
products and services, which in turn enhances our users' experience and loyalty and further grows our user base.
Our
products and services are supported by our cloud-based security technology, which we believe is one of the most advanced and robust technologies in the Internet security industry.
Our cloud-based security technology enables us to continuously update and enhance our capabilities to detect Internet security threats on a real-time basis. By utilizing this cloud
architecture, we believe we are able to offer superior performance through reduced usage of user computing resources, particularly in comparison to traditional anti-virus software. As the
effectiveness of our cloud-based security technology increases
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with
the size of our user cloud, growth of our user base enhances our malware detection capabilities, which in turn helps us to attract even more users.
We
have been able to leverage our large user base and our strong brand recognition to grow our paying customer base. We generate revenues primarily through offering the following
services:
-
-
Online advertising.
We offer advertising services by
providing marketing opportunities on our websites and secure platform products to our advertising customers. We also offer search referral services to search engine companies.
-
-
Internet value-added services.
We offer web games
developed by third parties, provide Internet security services such as remote technical support to paying customers and provide other Internet value-added services.
We
have grown significantly since we commenced operations in 2005. Our monthly active Internet users increased from 122 million in December 2008 to 231 million in
December 2009 and 339 million in
January 2011. Our revenue was $16.9 million, $32.3 million and $57.7 million, respectively, in 2008, 2009 and 2010, representing a CAGR of 84.8%. We first became profitable
in 2009 and our net income increased by 102.7% from $4.2 million in 2009 to $8.5 million in 2010.
Our Strengths
We believe the following strengths have contributed to our success and differentiate us from our competitors.
Largest user base of Internet and mobile security products and services in China
We believe that security is a fundamental need of all Internet and mobile users. Since 2006, we have rapidly established a leading
position in China's Internet and mobile security market. According to iResearch, we have amassed 328 million monthly active users of Internet security products as of January 2011,
representing an Internet user penetration rate of 83.9% and making us the No. 1 provider of Internet security products and a top three Internet company in China. According to iResearch, all of
our core Internet and mobile security products held leading market shares in their respective markets in China:
-
-
360 Safe Guard, a one-stop solution for Internet security and system performance optimization, had
301 million monthly active users and a user penetration rate of 76.9% in January 2011, which ranked first among all Internet security products in China;
-
-
360 Anti-Virus, a powerful multi-engine anti-virus product, had 248 million monthly
active users and a user penetration rate of 63.5% in January 2011, which ranked second among all Internet security products in China, after 360 Safe Guard; and
-
-
360 Mobile Safe, a leading mobile security product, had the largest market share of 58.2% in China as measured by
the number of active users in January 2011.
In
addition to our core Internet and mobile security products, 360 Safe Browser, one of our platform products, had 172 million monthly active users and a user penetration
rate of 44.1% in January 2011, which ranked second among all web browsers in China, only after Microsoft Internet Explorer, according to iResearch.
Given
the generally mutually exclusive nature of Internet and mobile security offerings among different providers and requirements for ongoing upgrades and support, switching costs for
Internet and mobile security users are relatively high. As such, we believe our large user base presents a significant entry barrier to our competitors.
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Innovative pan-security solutions creating secure Internet access points
Internet connectivity has become essential to many users' everyday activities. More and more users are exchanging and accessing
sensitive information over the Internet on a regular basis through various devices and are exposed to the increasing and ever-present security threats. Traditional anti-virus
applications alone are no longer sufficient in meeting users' intensifying security needs.
To
address these needs, we have repositioned the scope of our Internet security products and services from traditional standalone anti-virus applications to a
pan-security solution covering every step of a user's computer-using process, from system protection, privacy protection, to performance optimization. We continuously expand and improve
our portfolio of user-friendly and integrated Internet and mobile security products and services to address new security threats and the everyday computing needs of users who are
increasingly "always online" via PCs or mobile devices. In addition, our pan-security protection offerings are built on cloud architecture, enabling us to maintain accurate identification
of and rapid responsiveness to new threats. By providing a new standard of user security and computing experience and delivering consistent and ongoing product innovation, we have been able to
establish a large and loyal user base and strong market perception of trust in our "360" brand.
On
top of our core layer of Internet and mobile security product offerings, we have further developed various platform products to meet a full spectrum of Internet users' security
related needs, creating trusted access points to Internet activities. Our 360 Safe Browser serves as a key access point to the
Internet by ensuring a safe and fast browsing experience; our 360 Personal Start-up Page enables users to securely access popular and preferred information and applications; and our
360 Application Store serves as users' key access point to securely obtain and manage software and applications. By establishing trusted access points to facilitate safe browsing, searching,
downloading and other forms of online interaction, we have provided our users with an enriched and secure Internet experience. In addition, our ability to provide security products and services to
meet the fundamental needs of Internet users allows us to stay close to these users, to whom we can introduce new products and services effectively with minimal costs.
Strong monetization potential through open platforms
Our large and loyal user base lays a solid foundation for our open platform model, which allows third-party Internet product and
service providers, such as web game developers, e-commerce websites and software and application developers, to offer their products and services on our open platforms. Our open platforms
provide third-party Internet product and service providers with access to our massive user base in China, and we monetize our user base through revenue sharing arrangements with those third parties.
In addition, through our cooperation with third-party Internet product and service providers, we are able to further enhance user experience by extending secure access to a broader base of product and
service offerings accessible through our open platforms at low cost, which in turn enhances our users' loyalty, grows our user base and attracts even more third-party providers to our open platforms.
Our recently launched open platforms for web games and group-buy have already attracted over 30 web game developers and over 200 group-buy websites, respectively.
We believe open platforms with the trusted "360" security brand enable us to further monetize our large user base and will become a key driver for our future revenue growth.
Leading Internet and mobile security brand in China
With our comprehensive and strong pan-security product portfolio, we have established our "360" brand as a leading brand
associated with Internet and mobile security. The widespread market recognition of our brand has developed mainly through word-of-mouth among our users and customers. According
to a report we commissioned from Horizon, "360" ranked No. 1 in terms of brand awareness in the Internet security industry in the fourth quarter of 2010. In addition, we have also won
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many
noteworthy awards, including the "2010 China Central Television (CCTV) China Brand of the Year" award by CCTV.com, "The Most Trustworthy China Internet Anti-Virus Software in 2010"
award by the China IT CEO and CIO Annual Conference, the "Top 10 Most Valuable Internet
Product" award by the 2010 China Internet Conference and the "Choice of Internet Users" award by PConline.com.cn in 2010.
The
awareness of our "360" brand, which we believe has increasingly become associated with Internet and mobile security in China, enhances our ability to attract more users to our
products and services. For example, we began to offer 360 Safe Browser in April 2008 and have rapidly attracted a large number of users by leveraging our strong brand. In
January 2011, our 360 Safe Browser had 172 million monthly active users, according to iResearch. With our leading Internet and mobile security brand and the largest Internet and
mobile security user base in China, we believe we are well-positioned to extend our business offerings to other Internet services where security has become an increasing concern.
Leading cloud-based Internet technologies and strong R&D capabilities creating high entry barriers
Our security system is built upon advanced technologies combining input and processing from our central servers and user computers or
mobile devices, creating centralized cloud-based security solutions with the largest user cloud in China of over 150 million daily active users in January 2011, according to iResearch.
This has formed a large-scale "user cloud," enabling us to access and collect substantially greater and more thorough security threat samples and information than our competitors.
In
addition, we possess one of the strongest server-side cloud computing technology platform in the Internet and mobile security industry, with the combined strengths of our large-scale
parallel computing technology, our mass data storage technology, our high performance enquiry and search engine technology, our Qihoo Virtual Machine Learning, or QVM, an artificial intelligence-based
malware detection technology, and our 360 Host-based Intrusion Prevention System, or HIPS, a proactive defense technology. These technologies help ensure effective and efficient
identification and analysis of security threats by our cloud-based security system for our users.
Key
operational indicators of our cloud-based security system are:
-
-
a daily average of over 15 billion cloud security user queries in January 2011;
-
-
a daily average of over 5 million new file samples collected with a total size of about 1.8 terabytes in
January 2011;
-
-
automatic scanning and analysis on our server cloud of a daily average of over 40 million suspicious file samples
with a total size of over 12 terabytes in January 2011; and
-
-
a whitelist database covering over 14 million safe program files and a blacklist database covering over 700 malware
samples as of January 31, 2011.
With
the largest cloud-based security system and user base in China, we possess a comprehensive malware sample collection capability providing swift response time in security threat
detection, which helps solidify our user base and brand recognition in the market. This network effect advantage, in combination with our strong R&D capabilities founded upon one of the largest team
of experienced engineers in the industry in China, represent a high entry barrier to our competitors.
Seasoned management team with extensive industry knowledge and proven execution capabilities
We have a seasoned management team with strong operational experience and extensive industry expertise. Led by Mr. Hongyi Zhou
and Mr. Xiangdong Qi, our co-founders, our management team combines extensive knowledge of and experience in China's Internet and mobile security industries with a deep
understanding of the PRC market, business environment and regulatory regime. Mr. Zhou has
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over
10 years of experience in China's Internet industry, and is one of the most recognized CEOs in the Chinese Internet community. Mr. Qi has over 10 years of experience in
China's Internet industry and previously led Yahoo! China's operations and marketing. In addition, our management team has a strong track record in identifying and integrating complementary business
we have acquired in the past. We believe that our seasoned management team has contributed significantly to our past success and will continue to lead our future growth.
Our Strategies
Our goal is to enhance our position as a leading Internet company in China and ultimately become a leading Internet company globally.
To achieve our goal, we intend to:
Continue to expand product and service offerings to grow user base and promote brand recognition and loyalty
We seek to continue to broaden and deepen our product and service offerings while adhering to a user-centric philosophy. We
will continue to offer free Internet and mobile security products and will continue to enhance the security, functionality and service quality of our platform products to enrich our users' experience
and enhance their loyalty to our brand.
In
addition to expanding our product and service offerings, we plan to actively promote our "360" brand via various marketing campaigns through different channels, including the
Internet and television and partnerships with other Internet service providers to further increase our reach to users and enhance our brand image.
Further monetize our large user base through open platforms
We intend to grow revenues through our open platforms by leveraging our large and growing user base. We strive to improve and expand
our open platforms and enhance user experience by attracting more third party Internet product and service providers and broadening product and service offerings on our open platforms, which we
believe will attract more users and create additional monetization opportunities.
Furthermore,
we intend to continue to develop new businesses that will enable us to achieve synergies across different products and services and further diversify our revenue sources,
while delivering an enriched and secure user experience.
Continue to focus on R&D to enhance cloud-based Internet and mobile security technologies
We are committed to investments in R&D to maintain our competitive advantage in cloud-based Internet and mobile security technology as
well as to improve and develop Internet products and services to enhance user experience. Specifically, we plan to:
-
-
further enhance our proprietary QVM technology's efficiency in accurately identifying and collecting unknown security
threats;
-
-
further automate and enhance our system's ability to identify and process unknown or suspicious files on a large scale on
our server cloud and user end;
-
-
further improve our existing products to provide our users with faster and safer Internet access; and
-
-
develop new Internet products and services.
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Capitalize on the fast growing mobile Internet market
Users' increasing reliance on mobile devices for their everyday activities and increasing use of mobile Internet through smart phones
and tablet PCs exposes them to a rapidly
growing range of mobile security threats, which presents a large market opportunity for security software and service providers.
We
intend to capitalize on this opportunity by expanding our portfolio of mobile security products and services. Currently, our mobile security products offer malware removing and spam
text message and phone call filtering services. According to iResearch, in January 2011, our mobile security products collectively had the largest market share of 64.0% in China as measured by
the number of active users. We intend to leverage our early mover advantage and our strong brand recognition in the Internet security market to further solidify our leading position in the mobile
security market and expand into the mobile Internet market.
Selectively pursue international business expansion
We intend to gradually expand our business into selected geographies through investments into and partnerships with local Internet
security service providers in those markets. We will initially target countries with large Internet and mobile user bases, growing demand for Internet and mobile products and services and other
characteristics similar to Chinese Internet market. We believe such markets would present immense growth potential for our Internet and mobile security products and our paid value-added services. We
will leverage our technologies, extensive malware database and multi-platform expertise to quickly achieve success in our target markets.
Strengthen existing and build new strategic alliances and selectively pursue investments and acquisitions
We intend to strengthen existing relationships and build new relationships with our customers and partners through joint marketing,
co-branding and joint development initiatives. Currently, we closely cooperate online game developers and many other leading Internet software developers. We believe we are well positioned
to leverage our strong network of strategic alliances and our competitive advantages in China's Internet and mobile security markets to further strengthen our market leading position and enhance
existing revenue streams and develop new revenue streams.
In
addition to developing new services and enhancing service capabilities internally, we will continue to evaluate and selectively pursue strategic acquisition and investment
opportunities to complement our existing products and services and develop new revenue streams when these opportunities arise. We have successfully completed a number of acquisitions in the past to
expand our product offerings. For example, The World Browser, which we acquired and successfully integrated in 2009, provided us with the necessary infrastructure to expand into the web browser
market, which eventually contributed to
the success of our 360 Safe Browser product. Also, the acquisition of MCleaner in 2009 provided us with a strong foundation to develop our cloud-based mobile security platform. We plan to
continue to seek such strategic opportunities in a prudent manner.
Products and Services
Core Security Products
Our two core Internet security products are 360 Safe Guard and 360 Anti-Virus.
360 Safe
Guard is our flagship Internet security product and a one-stop solution for Internet security and system optimization. 360 Anti-Virus is an
anti-virus application that uses multiple scan engines to protect our users' computers against all kinds of malware, including traditional viruses, and may operate without Internet connection. These
applications protect our users' computers against trojan horses, viruses, worms, adware and other forms of malware.
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These
two core Internet security products collectively provide users with robust and efficient protection against malware and malicious websites, protect users' privacy by preventing
unauthorized access to and control of their computer system and optimize overall computer performance by removing unnecessary processes and unused junk files, automatically detecting and fixing
vulnerabilities in operating system and third-party applications, and providing other security and performance optimizing services.
In
January 2011, according to iResearch, 360 Safe Guard ranked first among all Internet security products in China with 301 million monthly active users and a user
penetration rate of 76.9% in China, and 360 Anti-Virus ranked second only to 360 Safe Guard among all Internet security products in China and first among all
anti-virus products in China, with 248 million monthly active users and a user penetration rate of 63.5% in China.
360 Safe
Guard and 360 Anti-Virus both comprise multiple integrated security products. The main components of 360 Safe Guard and
360 Anti-Virus include:
Cloud-based anti-malware.
We believe that our cloud-based anti-malware is one of the most advanced and robust technologies in the
Internet security industry. It relies on a large user base to provide information used to detect malware. Our centralized server cloud collects data, such as samples of malware, from our user base.
These samples are sent to our cloud-based analytic systems for automatic real-time detection of new malware and updating of the blacklist and whitelist on a real-time basis.
During
on-demand scans on and real-time protection of the user's computer or mobile device, our cloud-based anti-malware submits the unique digital fingerprints of files and
web pages from a user's computer to our cloud query engines for malware detection. Our cloud query engines compare these fingerprints against our server-side blacklist and whitelist for
matches before sending match results to the client side. Any file that matches our blacklist is immediately removed, quarantined or dealt with based on the user's instructions, while a
non-match to our whitelist is presumed to be suspicious and further analyzed by our other technologies.
Our
cloud-based anti-malware has the following advantages over traditional Internet security products:
-
-
it ensures minimal lag time between initial discovery of new malware on a single user's computer or mobile device and
protection of all users from that malware, thus providing real-time response to new threats and robust protection to our users;
-
-
our large user base provides large amounts of data from which we can detect many forms of newly created and variant
malware, which significantly enhances our malware detection capabilities; and
-
-
it eliminates the need for a traditional signature database stored on a user's computer, freeing up computer resources
otherwise required by traditional Internet security products.
The
effectiveness of cloud-based anti-malware depends primarily on the size of the user cloud and the amount of information that it provides. With over 300 million
users reporting new and potential threats, our user community contributes to its own protection.
360 HIPS.
360 HIPS adopts proactive defense technology and achieves real-time protection against malware by monitoring the
behaviors of a program rather than its programming code signature or digital fingerprint and using predetermined rules to decide whether the program is malicious. It provides multiple levels of
protection, such as monitoring file usage, processes, web browsing and removable media and preventing malware from intruding our users' computers. In addition, 360 HIPS provides
application-level protection to users against hijacking of desktop shortcuts and web browsers. Proactive defense technology takes advantage of the collective intelligence and processing power of our
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cloud-based
security system to accurately and efficiently identify and prevent malware and is particularly effective against unknown new malware.
360 Automatic Vulnerability Detection and Fix.
Since most trojan horses attack a computer through its vulnerabilities,
360 Automatic
Vulnerability Detection and Fix assesses the security status of a computer and automatically identifies, downloads and installs suitable vulnerability patches. It is a user-friendly tool
for users to manage and safeguard the operating system and applications on their computers.
360 WebShield.
360 WebShield is an application for secure Internet browsing. Using a blacklist of malicious websites compiled
through
our user cloud and our server side detection system, 360 WebShield effectively blocks websites that may contain automatically downloaded malware or phishing or fraudulent content and warn users
against these websites. 360 WebShield also filters advertisements, restores browser settings from and protects browser settings against unauthorized modification, scans downloaded files and
maintains a clean and stable browsing environment.
360 Privacy Protector.
360 Privacy Protector protects users' personal information and data stored on the hard drive of their
computers.
By identifying the files accessed by software programs running on a user's computer and allowing the user to decide whether to grant access, it protects our users' private files, including chat
records and online banking information, against unauthorized access. In addition,
with 360 Privacy Protector, our users can monitor the status of webcams on their computers to prevent peeping, utilize a strengthened and encrypted virtual drive to store their private and
sensitive files with minimized risks of data loss or leakage and clear unwanted access history or records.
Quick PC Health Check.
Quick PC Health Check is a user-friendly tool to quickly monitor, diagnose and rate the security status and
performance of a user's computer. It also provides a user-friendly "one-click fix" to solve identified security risks, shorten the startup time and optimize system performance.
Our
core mobile security product is 360 Mobile Safe. Launched in November 2009, 360 Mobile Safe is a security program for the Google Android, Apple iOS and Nokia
Symbian smartphone operating systems. It scans for malware using our cloud-based security technology, blocks spam text messages, filters incoming phone calls based on user-input blacklists
and whitelists, optimizes phone performance and speed and encrypts data for privacy protection in the event that the phone is lost or stolen. In January 2011, according to iResearch,
360 Mobile Safe had the largest market share of 58.2% in China as measured by the number of active users.
Platform Products
360 Safe Browser.
We have offered 360 Safe Browser, a platform product that allows our users to browse the Internet safely and
securely, since April 2008. According to iResearch, in January 2011, with 172 million monthly active users and a monthly active user penetration rate of 44.1% in China,
360 Safe Browser ranked second among web browsers in China, only after Microsoft Internet Explorer.
360 Safe
Browser seamlessly incorporates dual browser cores of Microsoft's Trident, which improves the compatibility of our browser with web pages such as online banking and
online video sites, and Webkit, which increases the speed of opening web pages. 360 Safe Browser also allows users to visit and access the contents of malicious sites safely by integrating
360 WebShield and using sandbox technology we licensed from a third party. Sandbox technology is a virtual environment where malicious actions can be performed without actual consequence to the
user's computer. 360 Safe Browser can automatically block malicious websites, identify them among search results and scan files downloaded through the browser. 360 Safe Browser also
offers a "private browsing" option to allow users to surf the Internet anonymously without leaving historical access records. Furthermore, certain functions of 360 Safe Browser allow users to
use Internet applications and services in a faster and
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smoother
fashion, which we believe leads to greater user loyalty to this product. For example, its microblog update reminder function enables users to better utilize social networking applications. In
addition, with the identification attribute, 360 Safe Browser's online bookmark folders allow users to store their bookmarks on our central server in the cloud and visit their bookmarks at any
time in any location with their 360 accounts.
360 Personal Start-up Page.
Launched in 2009, 360 Personal Start-up Page serves as user's start-up
page aggregating popular and preferred information and applications. As the default home page of our 360 Safe Browser, 360 Personal Start-up Page allows users to access and
utilize popular applications without leaving our site. It also enables users to customize their individual 360 Personal Start-up Page by storing their favorite websites and
applications to meet their different website navigation and application preferences. According to iResearch, 360 Personal Start-up Page had 98 million monthly active users in
January 2011.
360 Application Store.
360 Application Store allows users to search and obtain various software and applications through a
secure and
user-friendly platform. We have established strong relationships with software and application developers to enrich the software and application offerings in 360 Application Store.
360 Safebox.
360 Safebox is a solution that protects users against theft by malware of account and log-in information for
online
gaming, instant messaging, online banking, online shopping and other applications. We are working with online game developers to offer customized account protection solutions for specific games based
on 360 Safebox.
Online Advertising
We utilize our extensive user traffic to offer online advertising services, including online marketing services and search referral
services.
We
offer online marketing services by providing links to our advertising customers' websites or online applications in prominent positions on our websites or our secure platform
products. We generally charge our customers a fixed fee for an agreed contract period and occasionally also charge on a cost-per-sale or cost-per-action
basis.
We
also offer search referral services to search engine companies. Our 360 Safe Browser and its default home page, 360 Personal Start-up Page, contain default search boxes
that direct search traffic to search engines such as Google.com. These search engine companies pay us a pre-determined fee for each search originated from 360 Safe Browser and
360 Personal Start-up Page.
Internet Value-added Services
We offer Internet value-added services, including the operation of web games developed by third-parties, remote technical support,
cloud-based services leveraging our industry-leading cloud architecture and other Internet value-added services.
We
operate third-party developed web games on our game platform. We provide gamers seamless gameplay while minimizing exposure to malware intrusion. Our game portfolio includes
role-playing, strategy, sports and simulation games. Users can play these games directly on our game platform without downloading separate software. We offered over 20 games, which
had a combined player base of 12.7 million as of December 31, 2010. We share revenues from game operations with game developers pursuant to the terms of our cooperation agreements.
We
also offer remote technical support. When users encounter security issues, they can request our staff to provide live technical assistance and remote troubleshooting for a service fee
on a per-case basis. We expect to expand the scope of this service to cover our users' general computing needs. We
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also
provide monthly and annual subscriptions for this service. We began offering this service under our "Helpton" brand in 2010.
In
addition, we intend to develop various cloud-based services. Such cloud-based services include online secure data storage, allowing users to automatically back up important data to
our secure servers for storage and restoration in the event that such data is lost. We expect to leverage our leading presence in the Internet security industry, as well as our industry leading cloud
architecture to offer various other cloud-based services.
Our Technology
Cloud-based Technologies
We have developed leading cloud-based security technology, cloud computing technology and cloud storage technology.
Our
cloud-based security technology is composed of three parts: a cloud-based database of blacklisted and whitelisted program files, the automatic scanning and analysis of potential
malware and malicious websites and 360 security software installed on users' computers. It compares the unique digital fingerprint of a program file to a blacklist of confirmed malware and
malicious websites and whitelist of confirmed safe program files stored on our central servers. The blacklist and whitelist are updated by information retrieved from and submitted by our user cloud on
a real-time basis. In January 2011, we scanned and analyzed an average of over 40 million suspicious file samples per day. Our blacklist contains over 700 million
malware samples, and our whitelist contains over 14 million safe program files.
We
believe our cloud computing technology is one of the most advanced proprietary server-side cloud computing technologies in the Internet and mobile security industry. It
combines the strengths of our large-scale parallel computing technology, our mass data storage technology, our high performance inquiry and search engine technology and our QVM malware detection
technology.
Our
cloud storage system is based on our unique segmentation redundancy technology, which enables us to restore a file with limited redundant data and greatly improves the storage
reliability and security for our users' data. We possess know-how to customize servers to store greater amounts of data with lower power consumption. In addition, we have developed software for users
to implement our cloud storage and data backup and restore technology, which supports automatic incremental backup of users' designated files while ensuring the safety and confidentiality of
such files.
Dual-core Browser
360 Safe Browser integrates Trident, the core browser technology of Microsoft's Internet Explorer and Webkit, the
open-source core browser technology of Google Chrome, and automatically switches between these two core technologies seamlessly to provide our users with an optimized browsing experience.
Webkit increases the speed of opening web pages, while Trident improves the compatibility of 360 Safe Browser with online banking and video display web pages. We have also developed
technologies to minimize the memory usage of 360 Safe Browser to prevent decreases in performance after long periods of use, and isolate individual web page crashes to prevent browser deadlocks
when visiting certain pages. 360 Safe Browser also incorporates multiple security features, including the Microsoft DEP/NX exploit protection mechanism, anonymous browsing and the functions of
360 WebShield and sandbox technology.
Qihoo Search Engine Technology
Qihoo search engine technology consists of our proprietary search engine technologies, including a scalable spider system for
crawling web pages, a scalable parallel computing platform for processing and analyzing web pages, a massive data storage platform, a high-performance indexing system and a
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high-performance
query engine technology. Our search engine primarily focuses on online community content. It has indexed more than 10 billion web pages and captures
20 million new web pages on a daily basis. Core components of Qihoo search engine technology are used in our
cloud-based security system to augment our ability to screen massive amounts of program files and Internet content and quickly identify threats.
Mobile Security Technology
Our mobile security technology scans for malware using our cloud-based technologies, blocks spam text messages, filters incoming
phone calls based on user-input blacklists and whitelists and intelligent algorithms, monitors network accessing processes, optimizes phone performance and encrypts data for privacy
protection in the event that the phone is lost or stolen. It supports the Google Android, Apple iOS and Nokia Symbian smartphone operating systems.
QVM
QVM is our proprietary technology that detects malware through an artificial-intelligence algorithm capable of machine learning to
recognize new forms of malware. QVM technology offers a robust model for recognizing malware characteristics using the massive amount of data that we have compiled on confirmed malware in our
blacklist and verified safe programs files in our whitelist. This model is used as a basis for a detection algorithm which is automatically enhanced and updated with new malware samples submitted by
our users to our servers.
Program
files that do not appear in our blacklist and whitelist are scanned using QVM, and any "hits" returned by this technology are presumed to be malicious and removed or quarantined.
As malware is constantly being created or morphing, QVM has the advantage of being able to detect threats that have not been previously identified. According to PC Security Labs, an independent
security product test organization, QVM has a detection rate of 74.9% for unknown new malware, which surpasses most heuristic detection technologies.
360 HIPS
360 HIPS adopts a proactive defense technology that focuses on monitoring behaviors and actions performed by malware rather than
its programming code signature or digital fingerprint. Generally, even if malware evades detection by our cloud-based security and QVM technologies, it must still perform certain actions to achieve
its creator's intentions, such as modifying system settings and accessing confidential information. 360 HIPS proactive defense technology monitors
a computer's running processes during procedures such as web browsing, downloading, software installation and data transmission and assesses these actions based on a pre-determined algorithm. If a
process is deemed to be dangerous, the user is notified and information relating to that process is transmitted to our central servers for further processing. This proactive defense technology takes
advantage of the collective intelligence and processing power of our cloud architecture to accurately and efficiently determine whether an action performed by a program is malicious.
Malicious Web Page Detection Technology
Our proprietary automated detection system for malicious web pages is a core component of our cloud-based security system. It
automatically tests and recognizes malicious websites with an accuracy rate of over 99%. This detection system uses a collection of techniques, including simulated vulnerability environments, search
spiders, collections of suspicious websites compiled by our user base and monitoring of browser processes and actions. We have also collected large amounts of data on phishing and fraudulent websites
and used this information and machine-learning technology to develop an artificially intelligent algorithm for recognition of phishing and fraudulent websites.
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System Rescue and Recovery Technology
Our system rescue and recovery technology, along with our cloud-based security system, allows for the recovery of damaged systems with
crucial files that have been modified by malware or user error. It is able to restore the damaged system with optimal settings and correct system files retrieved from our whitelist database on our
server cloud. This technology also specifically aims to detect and remove sophisticated trojan horses.
System Performance Optimizing and Power Saving Technologies
Our system performance optimization technology assists our users to optimize the system settings and improve the system performance of
their computers. It manages hard drive, desktop, documents, Internet browsing and security settings to reduce system start-up time and increase operating speed. It also cleans the
registry, recycle bin, Internet access history and system patch files, improves hard drive performance through testing and defragmentation and automatically updates and backs up system files.
Our
hardware diagnosis and power saving technology effectively diagnoses hardware status, saves power, prevents hardware malfunctions and prolongs the battery life of a computer by
closely monitoring its power consumption and the temperature of its key components. This technology can be used on desktop, notebook and other personal computers.
Research and Development
To maintain and enhance our leadership position in the Internet security industry, we will continue to invest in research and
development to enhance and increase our security product offerings. Our primary research and development goals are to improve and strengthen our core cloud-based security and other detection
technologies, expand their applications to a wider range of products and enhance user experience. We also aim to focus our research and development efforts on expanding our other Internet-based
product offerings. Unlike the traditional research and development efforts of other software developers, our research and development focuses on updating our security cloud on a real-time
basis. This significantly enhances our effectiveness in detecting and removing malware to protect users against malware attacks, and distinguishes our products from traditional
anti-malware software.
As
of December 31, 2010, our research and development team consisted of 722 development and technical staff members, approximately 59% of whom held bachelor's or more
advanced degrees.
Our
internally developed technologies include our cloud-based security system, QVM, 360 HIPS and other technologies. See "Our Technology."
Our
research and development expenses primarily consist of salaries and benefits, including share-based compensation expenses, of our research and development personnel, costs of
bandwidth and utilities, license and technical service fees, and depreciation of equipment and amortization of acquired
intangible assets. Research and development expenditures represented 43.1%, 33.0% and 42.5% of total revenues for each of the three years ended December 31, 2010, respectively.
Network Infrastructure
Our network infrastructure is administered by our operations department, which handles hardware, system and network operation and
maintenance. Our systems are designed for scalability and reliability to support growth in our user base. We lease bandwidth from telecommunication operators such as China Telecom, China Unicom and
China Mobile to connect to the national Internet backbone. We believe that our current network facilities and broadband capacity provide us with sufficient capacity to carry out our current
operations.
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While
we believe that our network infrastructure and maintenance will likely prevent network interruption resulting from attacks by hackers, there remains a possibility that such attacks
could result in delays or interruptions on our network. For a further discussion, see the section entitled "Risk FactorsRisks Related to Our BusinessInterruption or failure
of our own information technology and communications systems or those of third-party service providers we rely upon could impair our ability to effectively provide our products and services, which
could affect our reputation and harm our operating results."
Customers
Our customers primarily comprise customers for our online advertising services, such as search engines who pay us for directing search
traffic and third-party websites who pay us for displaying their links on our websites or platform products.
In
2008, 2009 and 2010, we had 60, 139 and 210 customers for our online advertising services. Our largest customer accounted for approximately 5.8%, 11.2% and 21.1% of our total
revenues for each of the three years ended December 31, 2010, respectively. Our five largest customers accounted for approximately 16.9%, 27.8% and 35.1% of our total revenues for each of the
three years ended December 31, 2010, respectively.
Google
was our largest customer in 2009 and 2010. We entered into two one-year linking agreements with Google on December 1, 2008 and October 1, 2009,
respectively. Under these linking agreements, we agreed to direct search queries from the users of our 360 Safe Browser and 360 Personal Start-up Page to Google for processing and Google agreed
to pay us fees based on the user traffic directed by us up to a pre-determined limit. Google agreed to make payments to us by the end of each calendar month following the calendar month in
which the search queries are sent to Google. We may terminate the linking agreements by giving a 30-day written notice to Google, if the number of queries for a month exceeds the
pre-determined limit and Google does not raise such limit. Google has the right to terminate the two agreements without cause with a 30-day written notice. These two linking
agreements, as amended, are valid through March 31, 2011 and September 30, 2011, respectively, and are subject to renewal upon written agreement of both parties. We anticipate that our
dependence on Google will continue for the foreseeable future. See "Risk FactorsRisks Related to Our BusinessOur dependence on a single customer for a substantial portion of
our revenues may cause significant fluctuations or declines in our revenues."
Suppliers
Our suppliers are primarily providers of servers, network equipment and bandwidth that we need to maintain our network infrastructure
and operations. Our suppliers of Internet data centers, or IDC, host our servers in 63 cities across 24 provinces in China. Our primary IDC suppliers include China Telecom, China
Unicom and China Mobile. Our largest supplier accounted for approximately 27.3%, 17.3% and 9.4% of our total purchases for each of the three years ended December 31, 2010, respectively. Our
five largest suppliers accounted for approximately 61.7%, 47.4% and 34.5% of our total purchases for each of the three years ended December 31, 2010, respectively.
Under
our agreements with IDC service providers, we lease server racks and bandwidth and the providers guarantee that the error rate, which is defined as accumulated failure time per
month, will not exceed a very limited duration per calendar month. The agreements typically last for one year, some of which are automatically renewable for additional one-year terms
unless terminated by either party.
We
also purchase servers, office computers and other fixed assets for our operations, primarily from PRC suppliers.
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Sales and Marketing
We have historically relied primarily on "word-of-mouth" from our large user base as a sales and marketing tool
for our products and services. Trust and reliance by over 320 million users is a key driver for the growth of our business, as potential new users hearing positive feedback from their friends
and colleagues are more likely to try our products and services, which in turn enhances our "360" brand. Our public relations strategy is focused on events related to our products and services, such
as the launch of a new product or service, the update of existing products and services and awards and certifications we received for our products and services.
Since
2010, we have conducted advertising campaigns to reach a large number of potential users and customers. We expect to continue to control our sales and marketing expenses in the
future by focusing on advertisements that we believe will provide significant benefits to our brand recognition.
Intellectual Property
We rely on a combination of patent, copyright, trademark, software registration, non-competition and trade secret laws and
agreements with our employees to establish and protect our intellectual property rights. All of our employees enter into agreements requiring them to keep confidential all proprietary and other
information relating to our customers, methods, technologies, business practices and trade secrets. These agreements also stipulate that all software, inventions, trade secrets, works of authorship,
developments and other processes, whether or not patentable or copyrightable, made by them during their employment are our property. Despite our precautions, it may be possible for third parties to
obtain and use our intellectual property without our authorization. Furthermore, the validity, enforceability and scope of protection of intellectual property rights in the Internet and
telecommunications-related industries are uncertain and still evolving. Infringement and misappropriation of our intellectual property could materially harm our business. See "Legal
Proceedings."
As
of the date of this prospectus, we had over 60 registered trademarks in China and held copyrights to over 70 software programs covering almost all of our products. As of
the date of this prospectus, we had over 40 pending patent applications and five patents pending transfer from third parties.
We
have registered the domain name "
360.cn
" with China Internet Network Information Center. In addition to these domain names, we have
registered over 50 domain names with various domain name registration services as of December 31, 2010.
We
currently license malware scanning engines and signature libraries and other security technologies from third parties, such as BitDefender SRL.
Competition
We primarily compete with Internet security product and service providers and PRC-based Internet companies.
The
Internet security market in China is competitive among existing industry players, but contains high barriers to entry which make it difficult for new entrants to succeed, including:
-
-
Brand
. The technological reputation of a brand is
particularly important in the Internet security market, as users need to completely trust and rely on a service provider's security software. To compete with the well-established brand of existing
industry players, new entrants must commit significant resources to marketing and promotion.
-
-
User base
. Cloud-based security technology has come to the
forefront of the Internet security industry in recent years, and requires a large user cloud to be effective. It is difficult for new entrants with small user clouds that cannot detect malware
effectively to attract users.
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-
-
Technology
. Cloud-based security technology requires a
significant amount of technological expertise, infrastructure and resources. New entrants face significant lag time in developing their own technologies and establishing the infrastructure necessary
to operate.
-
-
Software
. Internet security software is generally mutually
exclusive, meaning that an Internet user generally uses security software from a single software provider. It is difficult for new entrants to the market to capture users from existing and established
brands.
-
-
Business model
. We have established our broad user base
through providing high quality pan-security products free of charge and generate revenues by leveraging that user base. New entrants into the Internet security market do not have the user base or the
brand recognition to follow this business model successfully.
We
compete for users in the Internet security market with established anti-virus companies such as Kingsoft and Rising. According to iResearch, in January 2011, the
Internet security software developed by Kingsoft and Rising had monthly active user penetration rates in China of 14.6% and 11.0%, respectively. We believe that our technological know-how,
large user base and established reputation in the Internet security market provide us with significant competitive advantages.
We
also compete with PRC-based Internet companies that offer similar value-added and online advertising services as we do. Our primary competitor in this market is Tencent,
the largest Internet value-added services provider in China. In January 2011, Tencent's QQ instant messaging software had a monthly active user penetration rate in China of 89.3%, while
our 360 Safe Guard had a monthly active user penetration rate in China of 76.9%, according to iResearch.
Employees
We had 275 and 488 employees as of December 31, 2008 and 2009, respectively. As of December 31, 2010, we had
860 employees, 62% of whom possessed at least a bachelor's degree. The following table sets forth the number of our full-time employees by area of responsibility as of
December 31, 2010:
|
|
|
|
|
|
|
|
Number of Employees
|
|
Administrative
|
|
|
50
|
|
Research and Development
|
|
|
722
|
|
Sales and Marketing
|
|
|
88
|
|
|
|
|
|
|
Total
|
|
|
860
|
|
|
|
|
|
We
pay most of our employees a base salary and performance-based bonuses, and we provide welfare and other benefits required by law. We also pay commissions to our sales personnel. Our
employees are not covered by a collective bargaining agreement. We believe that our compensation and benefits packages are competitive within our industry. We have not had any labor disputes that
materially interfered with our operations, and we believe that our employee relations are good.
Facilities
Our principal executive offices are located at Block 1, Area D, Huitong Times Plaza, No. 71 Jianguo Road, Chaoyang District,
Beijing, China, where we lease approximately
5,200 square meters of office space. We also lease additional office space in Beijing and other cities in China.
Legal Proceedings
We are subject to legal proceedings and claims in the ordinary course of business from time to time.
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In
February 2010, we brought an unfair competitive practices claim against Beijing Yijin Yuhui Technology Investment Co., Ltd. and Beijing Rising Information
Technology Co., Ltd. (together, "Rising") in the Xicheng District People's Court of Beijing, alleging that Rising misled users with statements that 360 Safe Guard poses security risks to
users' systems and seeking retraction of the statements and approximately RMB9.8 million ($1.5 million) in damages. This case is pending.
In
May 2010, Kingsoft brought an unfair competitive practices claim against us in the First Intermediate People's Court of Beijing, alleging that we misled users with statements
that Kingsoft's anti-virus software products pose security risks to users' systems and seeking retraction of the statements and approximately RMB20.0 million ($3.0 million)
in damages. This case is pending. In addition, in May 2010, Kingsoft brought a reputation infringement claim against our chairman, Hongyi Zhou, in the Haidian District People's Court of
Beijing, alleging that Mr. Zhou made defamatory statements against its business reputation and seeking retraction of the statements and approximately RMB12.0 million
($1.8 million) in damages. In March 2011, the Haidian District People's Court of Beijing entered into a judgment in favor of Kingsoft and ordered Mr. Zhou to (i) cease the
infringement and delete the relevant articles on his microblogs, (ii) post apologies to Kingsoft for seven days on his three designated microblogs, and (iii) pay an aggregate of
RMB80,000 ($12,121) in damages and fees to Kingsoft. In November 2010, we brought an unfair competitive practices claim against Kingsoft in the First Intermediate People's Court of
Beijing, alleging that Kingsoft made defamatory statements against us and that Kingsoft's software interferes with the use of 360 Safe Guard. We sought retraction of the relevant statements and
approximately RMB5.0 million ($0.8 million) in damages. This case is pending.
In
May 2010, we brought a breach of contract claim against Baidu Shidai Network Technology (Beijing) Co., Ltd., or Baidu Shidai, in the First Intermediate People's
Court of Beijing, alleging that Baidu Shidai owed us search referral commissions for the search box placed on our 360 Safe Browser and seeking approximately RMB50.4 million
($7.6 million) in damages, losses and interest. This case is pending. In September 2010, Baidu Shidai brought a counter-claim against us in the First Intermediate
People's Court of Beijing, alleging that we charged improper search referral commissions for the search box placed on the 360 Safe Browser and seeking damages of approximately RMB 10.5 million
($1.6 million). This case is pending. In August 2010, Baidu Shidai and Beijing Baidu Wangxun Science and Technology Co., Ltd. (collectively, "Baidu") brought an unfair competitive
practices claim against us in the Second Intermediate People's Court of Beijing, alleging that our Internet security products improperly advise removal of Baidu's products and seeking approximately
RMB10.2 million ($1.5 million) in damages and cessation of the unfair competitive practices. In December 2010, the Second Intermediate People's Court of Beijing entered into a judgment
in favor of Baidu and ordered us to (i) cease the unfair competitive practices, (ii) post an announcement on our website for 72 hours about our unfair competitive practices
against Baidu, and (iii) pay an aggregate of RMB385,000 ($58,333) in damages to Baidu.
In
October 2010, Tencent Technology (Shenzhen) Company Limited and Shenzhen Tencent Computer Systems Company Limited brought an unfair competitive practices claim against us in
the Chaoyang District People's Court of Beijing, alleging that we misled users with statements that Tencent's QQ instant messaging program invades users' privacy and seeking retraction of the
statements and RMB4.0 million ($0.6 million) in damages. This case is pending. In November 2010, we brought a defamation claim against Tencent Technology (Shenzhen) Company
Limited in the Xicheng District People's Court of Beijing, alleging that Tencent made defamatory statements on its website against us and seeking retraction of the statements and RMB1.0 ($0.2)
in nominal damages. This case is pending.
Other
than the aforementioned lawsuits, we are also a party to several legal proceedings and claims in China that we believe are immaterial.
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MANAGEMENT
Directors and Executive Officers
The following table sets forth information about our directors and executive officers as of the date of this prospectus. The business
address of all of our directors and executive officers is Block 1, Area D, Huitong Times Plaza, No.71 JianGuo Road, ChaoYang District, Beijing, People's Republic of China.
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Name
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Age
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Position
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Hongyi Zhou
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40
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Chairman of the board and chief executive officer
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Xiangdong Qi
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46
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Director and president
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Shu Cao
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35
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Director and chief engineer
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Neil Nanpeng Shen
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42
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Director
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Gongquan Wang
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|
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49
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Director
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Hong Chuan Thor
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39
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Director
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Ming Huang
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47
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Director
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Shujun Li
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39
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Director
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William Mark Evans
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53
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Director
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Alex Zuoli Xu
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|
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42
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Chief financial officer
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Jue Yao
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37
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Vice president of finance
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Xiaohong Shi
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40
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Vice president of technology
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Hongyi Zhou
is a co-founder of our company and has served as our chairman and chief executive officer since
August 2006. Mr. Zhou has over ten years of managerial and operational experience in China's Internet industry. Prior to founding our company, Mr. Zhou was a partner at IDG
Ventures Capital since September 2005, a global network of venture capital funds, where he assisted small- to medium-sized software companies in sourcing funding to support their growth.
Mr. Zhou was the chief executive officer of Yahoo! China from January 2004 to August 2005. In 1998, Mr. Zhou founded www.3721.com, a company engaged in Internet search and
online marketing business in China, and served as its chairman and chief executive officer until www.3721.com was acquired by Yahoo! China in January 2004. Mr. Zhou received his
bachelor's degree in computer software in 1992 and his master's degree in system engineering in 1995 from Xi'an Jiaotong University, China.
Xiangdong Qi
is a co-founder of our company and has served as our director and president since our inception. Prior to
founding our company, Mr. Qi served as a vice president of Yahoo! China from January 2004 to August 2005, where he was responsible for Yahoo! China's operations and marketing.
From August 2003 to January 2004, Mr. Qi was the general manager of www.3721.com, responsible for its overall operations and strategic planning. Mr. Qi worked at Xinhua
News Agency from 1986 to March 2004. Mr. Qi received his bachelor's degree in wireless communications from Changchun College of Posts and Telecommunications in China in 1986 and his MBA
degree from Beijing University of Science and Technology in China in 2007.
Shu Cao
has been our director since 2006 and served as our chief engineer since October 2005. Prior to joining us, Mr. Cao
served as the chief engineer of Yahoo! China from November 2003 to September 2005 and was responsible for system operation and maintenance. Mr. Cao has extensive experiences in
software engineering, information technology infrastructure and system operation. Mr. Cao was the co-founder of www.3721.com and served as its head of operations from
January 1999 to August 2003. Mr. Cao received his bachelor's degree in computer science from Zhejiang University in China in 1998.
Neil Nanpeng Shen
has been our director since 2006. Mr. Shen is the founding managing partner of Sequoia Capital China.
Mr. Shen co-founded Ctrip.com International Ltd., a NASDAQ-listed company and the largest travel service provider in China, and served as its chief financial officer from
2000 to October 2005 and as its president from August 2003 to October 2005. He also co-founded Home Inns
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and
Hotels Management Inc., a NASDAQ-listed company and leading economy hotel chain in China. Prior to founding Ctrip and Home Inns, Mr. Shen had worked for over eight years in the
investment banking industry in New York and Hong Kong. Currently, Mr. Shen is a co-chairman of Home Inns, a director of Ctrip, a director of E-House (China)
Holdings Limited, a NYSE-listed real estate services company in China, a director of China Real Estate Information Corporation, a NASDAQ-listed real estate information service company in
China, a director of Feihe International Inc., a NYSE-listed milk powder producer and distributor in China, a director of China Nuokang Bio-Pharmaceutical Inc., a
NASDAQ-listed biopharmaceutical company in China, a director of Le Gaga Holdings Co., Ltd., a NASDAQ-listed vegetable producer in China, chairman of Mecox Lane Limited, a Nasdaq listed
e-commerce company in China and a director of Peak Sport Products Co., Limited, a Hong Kong Stock Exchange listed sports products company in China. He is also an independent director of Focus
Media Holding Limited, a NASDAQ-listed media advertising company based in China and a director of a number of privately owned companies based in China. Mr. Shen received his bachelor's degree
from Shanghai Jiaotong University, China in 1988 and his master's degree from the School of Management at Yale University in 1992.
Gongquan Wang
has been our director since 2006. Mr. Wang built and managed CDH Venture Partners from its inception in 2005. Prior
to that, he was a general partner with IDG Technology Venture Investment, Inc. from 1999 to 2005, where he was responsible for overseeing the operational management of the portfolio companies
of the firm's various funds and also had an investment role. In 1991, he co-founded Vantone Industry Group, one of China's leading real estate developers, which he managed from 1991 to
1995, serving in various capacities, including president, vice chairman of the board, honorary chairman of the board, and managing director. Mr. Wang is also a director of CDG Holdings Limited,
Xueda Education Group, CDH Venture GP I Company Limited and CDH Venture GP II Company Limited, and was previously a director of ChinaEDU Corporation, China Civilink, China Finance
Online Co., Ltd. and 3721.com. Mr. Wang received a bachelor's degree from Jilin University of Technology in China.
Hong Chuan Thor
has been our director since February 2011. Since 2007, Mr. Thor has served as a managing director of Highland
Capital Partners (Shanghai) Investment Consulting Co., Ltd., a subsidiary of Highland Capital Partners, a venture capital firm. From 2005 to 2007, Mr. Thor was a venture partner
at Highland Capital Partners in the United States. Prior to that time, Mr. Thor was a partner at JAFCO America Ventures, a venture capital firm in the United States, from 1999 to 2005, and
served as a senior investment professional of JAFCO Co., Ltd, a venture capital firm in Japan, from 1995 to 1999. Mr. Thor received his bachelor's degree in commercial science from Meiji
University in Japan.
Ming Huang
became our director upon the declaration of effectiveness of the registration statement of which this prospectus forms a
part. He has been a professor of finance at the Johnson Graduate School of Management at Cornell University since July 2005 and a professor of finance at China-European International Business School
since July 2010. Professor Huang also served as a professor of finance at Cheung Kong Graduate School of Business in China from July 2008 to June 2010 and Dean of the School of Finance at Shanghai
University of Finance and Economics from April 2006 to March 2009. Prior to 2005, he was an associate professor of finance at the Graduate School of Business at Stanford University from September 2002
to June 2005 and an associate dean and visiting professor of finance at Cheung Kong Graduate School of Business from July 2004 to June 2005. Professor Huang's academic research primarily focuses on
behavioral finance, credit risk and derivatives. In recent years, his research has focused on Chinese capital market and public companies. Professor Huang also serves as an independent director at
Yingli Green Energy Holding Company Limited, a company listed on the NYSE, since August 2008. Professor Huang received his bachelor's degree in physics from Beijing University, his doctorate degree in
theoretical physics from Cornell University and his doctorate degree in finance from Stanford University.
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Shujun Li
became our director upon the declaration of effectiveness of the registration statement of which this prospectus forms a
part. He has been the managing partner of Trustbridge Partners III, L.P., a Cayman Islands exempted limited partnership since 2008. Mr. Li served as the chief financial officer and
several other senior management roles at Shanda Interactive Entertainment Limited, a NASDAQ-listed company from March 2002 to June 2006. Prior to that, Mr. Li served as a fund manager
responsible for the establishment of Zhongrong Fund Management Company from January 2001 to October 2001 and a senior manager at the international business department of China Southern
Securities Co., Ltd. from August 1997 to December 2000. He received his bachelor's degree from Hebei Normal University in China in 1994 and his master degree in economics from Nankai
University in China in 1998.
William Mark Evans
became our director upon the declaration of effectiveness of the registration statement of which this prospectus
forms a part. Mr. Evans has been a general partner of Balderton Capital, a U.K. based venture capital firm, since September 2002 and currently serves as a director of a number of private
companies. From April 2004 to October 2006, Mr. Evans served as the chairman of the audit committee of the board of directors of Shanda Interactive Entertainment Inc., a NASDAQ-listed
company. Prior to that, Mr. Evans held a variety of senior management positions at Goldman Sachs, including chairman of Goldman Sachs Asia from 1993 to 1997. Mr. Evans received his
bachelor's degree in economics from Queen's University in Canada in 1981 and his MLitt degree in economics from the University of Oxford in 1985.
Alex Zuoli Xu
has been our chief financial officer since February 2011. Mr. Xu has extensive experiences in investment research and
business management. Prior to joining us, Mr. Xu was a managing director at Cowen & Company, LLC, an investment banking service provider, where he led the firm's investment
research in China on Chinese companies listed in the United States. From March 2010 to August 2010, he served as the chief financial officer of Yeecare Holdings, a private health care product
distributor in
China, and from May 2008 to March 2010, as the chief strategy officer of China Finance Online Co., Ltd., a Chinese Nasdaq-listed online financial information/service company. Prior to
that, Mr. Xu was a senior VP at Brean Murray, Carret & Co, a research-driven investment and merchant bank, covering U.S.-listed Chinese companies. He was part of a top-ranked
research team at Banc of America Securities, LLC from 2003 to 2007, and was an equity research associate at UBS from 2002 to 2003. Mr. Xu received his bachelor's degree in applied
physics from Beijing University of Posts and Telecommunications in 1990 and an M.B.A. from Cornell University in 2002. Mr. Xu is a CFA charterholder.
Jue Yao
has been our vice president of finance since 2008. Ms. Yao served as our financial director from 2006 to 2008. Prior to
joining us in 2006, Ms. Yao held various positions at Sohu.com Inc. from 1999 to 2006, including financial director, where she was responsible for its strategic planning, budgeting and
finance of wireless value-added and gaming business units. From 1996 to 1999, Ms. Yao was a senior auditor at KPMG. Ms. Yao graduated from University of International Business and
Economics in China with a bachelor's degree in international accounting in 1996. She is a chartered accountant in China.
Xiaohong Shi
has been our vice president of technology since 2006. From January 2004 to August 2005, Mr. Shi was the chief
technology officer of Yahoo! China, where he was responsible for technology research and development. From 1999 to 2003, Mr. Shi was the chief technology officer of www.3721.com, a company
engaged in Internet search and online marketing business in China. From November 1998 to August 1999, Mr. Shi was a project manager at Founder Group, a leading Chinese information technology
company. Mr. Shi received his Ph.D. and master's degrees in computer science from Xi'an Jiaotong University in 1998 and 1995, respectively.
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Board of Directors
Our board of directors currently consists of six directors. A director is not required to hold any shares to qualify for appointment. A
director may vote with respect to any contract, proposed contract or arrangement in which he is materially interested as long as he or she has made a declaration of the nature of such interest. Our
board of directors may exercise all the powers of the company to borrow money, to mortgage or charge its undertaking, property and uncalled capital, or any part thereof, and to issue debentures,
debenture stock or other securities whether outright or as security for any debt, liability or obligation of our company or of any third party.
Indemnification Agreements
We have entered into indemnification agreements with each of our directors to indemnify them against certain liabilities and expenses
arising from their being a director. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers or persons controlling us pursuant to the
foregoing provisions, we have been informed that in the opinion of the SEC such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.
Duties of Directors
Under Cayman Islands law, our directors have a fiduciary duty to act honestly, in good faith and with a view to our best interests. Our
directors also have a duty to exercise the 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 that we comply with our memorandum and articles of association, as amended from time to time. Our company has the right to seek damages if a duty owed by our
directors is breached.
The
functions and powers of our board of directors include, among others:
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-
convening shareholders' annual general meetings and reporting its work to shareholders at such meetings;
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declaring dividends and distributions;
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appointing officers and determining the term of office of officers;
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exercising the borrowing powers of our company and mortgaging the property of our company; and
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approving the transfer of shares of our company, including the registering of such shares in our share register.
Terms of Directors
Each of our directors is subject to a term of office set forth in their agreements with us and hold office until the earlier of the
expiration of his or her term under the agreements or such time as he or she is removed from office by special resolution or the unanimous written resolution of all shareholders or by the board of
directors. 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) dies or is found by our company to be or becomes of unsound mind.
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Committees of the Board of Directors
We have established an audit committee, a compensation committee and a corporate governance and nominating committee.
Our audit committee consists of Messrs. Shujun Li, Ming Huang and Xiangdong Qi. Each of Mr. Li and Mr. Huang is an "independant
director" within the meaning of
Section 303A of the Corporate Governance Rules of the New York Stock Exchange. In addition, Messrs. Li and Huang meet the "independence" standards under
Rule 10A-3 under the Securities Exchange Act. Mr. Li will be the chair of our audit committee.
The
purpose of the audit committee is to assist our board of directors with its oversight responsibilities regarding: (i) the integrity of our financial statements,
(ii) our compliance with legal and regulatory requirements, (iii) the independent auditor's qualifications and independence and (iv) the performance of our internal audit function
and independent auditor.
The
audit committee is responsible for, among other things:
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appointing the independent auditors and pre-approving all audit and non-audit services permitted
to be performed by the independent auditors;
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-
reviewing with the independent auditors any audit problems or difficulties and management's response;
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discussing the annual audited financial statements with management and the independent auditors;
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-
reviewing major issues as to the adequacy of our internal controls and any special audit steps adopted in light of
material control deficiencies; and
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meeting separately and periodically with management and the independent auditors.
Our compensation committee consists of Messrs. Neil Nanpeng Shen, William Mark Evans and Hongyi Zhou. Our board of directors has
determined that each of Mr. Shen and Mr. Evans is an "independent director" within the meaning of Section 303A of the Corporate Governance Rules of the New York Stock Exchange.
Our
compensation committee assists the board in reviewing and approving the compensation structure of our directors and executive officers, including all forms of compensation to be
provided to our directors and executive officers. Members of our compensation committee are not prohibited from direct involvement in determining their own compensation. Our chief executive officer
may not be present at any compensation committee meeting during which his compensation is deliberated. Our compensation committee is responsible for, among
other things:
-
-
approving and overseeing the compensation package for our executive officers;
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-
reviewing and making recommendations to our board with respect to our compensation policies and the compensation of our
directors; and
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reviewing periodically and making recommendations to the board regarding any long-term incentive compensation
or equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans.
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Our corporate governance and nominating committee consists of Messrs. Hong Chuan Thor, Gongquan Wang and Ming Huang. Our board
of directors has determined that each member of the corporate governance and nominating committee is an "independent director" within the meaning of Section 303A of the Corporate Governance
Rules of the New York Stock Exchange.
Our
corporate governance and nominating committee assists our 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, among other things:
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identifying and recommending to the board nominees for election or re-election to the board, or for
appointment to fill any vacancy;
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-
reviewing annually with the board the current composition of the board in light of the characteristics of independence,
skills, experience and availability of service to us;
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-
identifying and recommending to the board the names of directors to serve as members of the audit committee and the
compensation committee, as well as the corporate governance and nominating committee itself;
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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
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monitoring compliance with our code of business conduct and ethics, including reviewing the adequacy and effectiveness of
our procedures to ensure proper compliance.
Interested Transactions
A director may, subject to any separate requirement for audit committee approval under applicable law or the listing rules of the
New York Stock Exchange, and unless disqualified by the chairman of the relevant Board meeting, vote in respect of any contract or transaction in which he or she is interested, provided that
the nature of the interest of any directors in such contract or transaction is disclosed by him or her at or prior to its consideration and any vote in that matter.
Compensation of Directors and Executive Officers
For the year ended December 31, 2010, we paid an aggregate of approximately $0.3 million in cash compensation to our
directors and executive officers. For the year ended December 31, 2010, we did not set aside or accrue any amounts to provide pension, retirement or similar benefits for our executive officers
and directors.
Share Option Plans
Our board of directors and shareholders have adopted three incentive plans, namely, our 2011 share incentive plan, 2006 employee share
option scheme and 2006 share vesting scheme. These incentive plans were adopted to attract and retain the best available personnel for positions of substantial responsibility, to provide additional
incentive directors, officers, advisors and key employees and to promote the success of our business.
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2011 Share Incentive Plan
The maximum aggregate number of Class A ordinary shares that may be issued pursuant to all awards under the 2011 share incentive
plan, or the 2011 Plan, is 6,272,601 shares plus an annual increase on the first day of each year beginning in 2012 and ending in 2021, equal to the greater of (i) five percent (5%) of the
shares outstanding (on an as converted basis) on the last day of the immediately preceding fiscal year and (ii) such greater number of shares as determined by our board of directors. The
following paragraphs describe the principal terms of the 2011 Plan.
Types of Awards.
The types of awards we may grant under our 2011 Plan include the options to purchase our ordinary shares at a specified
price and in
a specified period determined by our compensation committee. Under the 2011 Plan, we may also grant awards of our (i) restricted shares, (ii) restricted share units,
(iii) dividend equivalents, (iv) deferred shares, (v) share payments and (vi) share appreciation rights under the terms and conditions determined by our compensation
committee.
Plan Administration.
The compensation committee of our board of directors (or another committee or a subcommittee of our board of
directors assuming
the functions of our compensation committee under the 2011 Plan) will administer the 2011 Plan. The committee will determine the terms and conditions of each grant, including but not limited to, the
exercise, grant or purchase prices, any reload provision, any restrictions or limitations on the awards, vesting schedules, restrictions on the exercisability of the awards, any acceleration or
waivers, and any provision related to non-competition and recapture of gain on the awards.
Eligibility.
We may grant awards to directors, officers, advisors and employees of our company, which include our subsidiaries and any
entity in
which we hold actual or de facto control by equity ownership or contractual arrangement.
Award Agreement.
Awards granted under the 2011 Plan will be evidenced by an award agreement that will set forth the terms and conditions
and
limitations for each award. Share awards may be evidenced by way of an issuance of certificates or book entries with appropriate legends. The certificates and book entry procedures may be subject to
counsels' advice, stop-transfer orders of other conditions or restrictions where the 2011 Plan administrator deems necessary or advisable to comply with the required laws and regulations.
Vesting.
The 2011 Plan provides that the administrator may set the period during which an option or a share appreciation right can be
exercised and
may determine that an option or a share appreciation right may not be exercised for a specified period after it is granted. Such vesting can be based on criteria selected by the administrator. At any
time after the grant of an option or a share appreciation right, the administrator may, in its sole discretion and subject to terms and conditions it determines, accelerate the period during which an
option or a share appreciation right vests. No portion of an option or a share appreciation right unexercisable at the termination of service of an option or a share appreciation right holder with our
company or subsidiaries can become exercisable afterwards, unless otherwise provided by the administrator.
Exercise Price and Term of Awards.
The exercise price per share of options granted under the 2011 Plan is determined by the plan
administrator in the
award agreement. The price may be fixed or variable related to the fair market value of our ordinary shares. The term of any option granted should not exceed ten years. However, in the case where our
incentive option is granted to individual who, at the date of grant, owns more than ten percent of the total combined voting power of all classes of our shares, the price granted shall not be less
than 110% of fair market value on the date of grant and the option is exercisable for no more than five years from the date of grant.
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For
ordinary share awards granted under the 2011 Plan, namely (i) restricted shares, (ii) restricted share units, (iii) dividend equivalents, (iv) deferred
shares, and (v) share payments, the consideration shall not be less than the par value of the shares purchased unless otherwise permitted by applicable laws and regulations. The terms of the
share awards are set by the plan administrator in its sole discretion.
The
exercise price of share appreciation right under the 2011 Plan is determined by the plan administrator and set forth in the award agreement which may be a fixed or variable price
related to the fair market value of the shares. The term of the share appreciation right will not exceed ten years.
Transfer Restriction.
The awards granted under the 2011 Plan may not be sold, pledged, assigned or transferred in a manner other than
by will or the
laws of descent and distribution or, subject to the consent of the plan administrator, as required under the applicable domestic relations laws.
Amendments or Termination.
The 2011 Plan provides that in the event of any changes affecting our ordinary shares or our share price,
the plan
administrator can make proportionate and equitable adjustments to reflect such changes. Upon or in anticipation of a corporate transaction, including acquisition, disposal of substantially all or all
assets, reverse takeover, dissolution, the plan administrator should in its discretion provide for replacement or assumption of such award. In the event of other changes, the compensation committee
should in its discretion make adjustments in the number and class of shares subject to awards outstanding on the date of such change to prevent dilution or enlargement of rights. The 2011 Plan will
expire and no further awards may be granted after the tenth anniversary of the plan was adopted.
2006 Employee Share Option Scheme
In November 2010 and January 2011, our board of directors approved increases of the number of shares under our 2006 employee
share option scheme. As of the date of this prospectus, we have reserved an aggregate of 16,652,751 of our ordinary shares for issuance under our 2006 employee share option scheme. The following
paragraphs describe the principal terms of our 2006 employee share option scheme.
Types of Awards.
We may grant options to purchase our ordinary shares under our 2006 employee share option scheme.
Plan Administration.
The 2006 employee share option scheme is, upon the approval of the compensation committee established from time to
time under
our board of directors, administered by our chief executive officer. Our chief executive officer will determine the provisions and terms and conditions of each award grant, including, among other
things, the number of awards, exercise price, option vesting schedules, forfeiture provisions and form of payment upon settlement of an award.
Eligibility.
We may grant awards to our employees, officers, directors of or consultants to our company, which include our subsidiaries
or any
entities in which we hold actual or de facto control by equity ownership or contractual arrangement.
Notice of Grant.
A grantee is delivered a written notice in the form our chief executive, subject to the 2006 employee share option
scheme,
determines from time to time. The notice specifies the number of options granted as well as other terms and conditions of the award, including performance criteria on which the grant is made. The
grantee may by written notice given to us renounce his or her rights to the notice of grant, and the grant is deemed not having been made.
Vesting Schedule.
The options granted in each award vests in the grantee as follows: (i) 25% vests twelve months after the grant
is made;
(ii) 25% vests 24 months after the grant is made; (iii) 25% vests 36 months after the grant is made; and (iv) 25% vests 48 months after the grant is made. If
the grantee
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ceases
to become eligible for any reason prior to certain exit events, including this offering, the option vested but not exercised as well as the options not yet vested will automatically lapse
and expire.
Exercise of Option.
Options are personable to the grantee, who may not transfer, mortgage or create interests (legal or beneficial) on
the option
unless having received prior written consent by our chief executive officer. Grantees do not enjoy any rights, interests or benefits attached to the underlying shares unless the options have vested in
and exercised by the grantees. Unless our chief executive officer agrees and so notifies the grantee separately in writing, grantees may not exercise any vested options prior to the occurrence of
certain material events such as our initial public offering, sale of all or substantially all of our issued share capital, sale of all or substantially all of its assets and winding up of our company
until any of these events is consummated. Under the 2006 employee share option scheme, the grantees are deemed to have authorized the nominee as designated by us to act and execute documents to
exercise the options. Unless agreed by our chief executive officer in writing, all rights, including voting rights, attached to the shares allotted under the 2006 employee share option scheme and held
by the nominee belong to and are exercised by the nominee at its sole and absolute discretion. The grantees have the right to all monetary benefits deriving from the shares when the shares are
disposed of.
Exercise Price.
The exercise price is fixed by reference to the date on which the grant is made. Generally, our chief executive officer
may determine
the price at either (i) the latest valuation price per share certified by our auditors or (ii) the latest price per share at which we have issued any shares prior to the date the subject
grant is made. We shall permit payment of the exercise price by an appropriate assignment, transfer, direction or authorization, which is in the form our chief executive officer may reasonably
require, to the extent that the cash proceeds receivable by the grantee from certain enumerated events, including this offering, equals to the exercise price payable by the grantee to us.
Amendment and Termination.
Our chief executive officer may at any time terminate our 2006 employee share option scheme. Amendments to
our 2006
employee share option scheme are subject to resolution of our compensation committee. Any amendment of our 2006 employee share option scheme must not adversely affect awards already granted or agreed
to be granted without written consent of a majority in the number of holders of unexercised options. Unless terminated earlier, the 2006 employee share option scheme will expire and we may not grant
awards after the tenth anniversary of its adoption date on January 25, 2006.
As
of the date of this prospectus, we have granted options to purchase a total of 1,049,000 ordinary shares to our directors and executive officers with exercise prices of $2.80
and $5.20 per share under our 2006 employee share option scheme.
2006 Employee Share Vesting Scheme
In January 2006, Young Vision, one of our principal shareholders, holders of Series A preferred shares and certain other
parties entered into a share incentive agreement. The share incentive agreement was subsequently amended and restated when we issued our Series B preferred shares in November 2006 and
Series C preferred shares in January 2010. Under the incentive agreement, Young Vision allocated a total of 21,603,645 ordinary shares of our company to an equity incentive pool
designed to award our employees and consultants according to our 2006 Employee Share Vesting Scheme. 18,086,101 of these 21,603,645 shares in the equity pool are to vest in grantees on a
four-year vesting schedule commencing from November 7, 2006. The remaining 3,517,544 ordinary shares will be granted to employees who join our company as a result of
acquisitions or mergers. In February 2011, Young Vision transferred 11,826,000 and 5,550,654 ordinary shares of our company in the equity pool to Sino Honor Limited and Strengthen Goal
Limited, respectively. Sino Honor Limited, a British Virgin Islands company, is wholly-owned by Shu Cao, our director and chief engineer. Strengthen Goal
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Limited,
a British Virgin Islands company, is wholly-owned by Xiaohong Shi, our vice president of technology. Each of Mr. Cao and Mr. Shi disclaims beneficial ownership in the shares
held by Sino Honor Limited and Strengthen Goal Limited, respectively. Grantees are only entitled to rights to monetary benefits by receiving dividends, if any, on the vested shares. Unless our company
agrees in writing, grantees may not dispose of the vested shares prior to the occurrence of certain material events such as our initial public offering, sale of all or substantially all of our issued
share capital, sale of all or substantially all of our assets and winding up of our company until any of these events is consummated. Young Vision holds the voting rights for the ordinary shares
reserved in this equity incentive pool, including those shares underlying the options that have been granted and vested. Subject to limited circumstances such as the termination of his employment with
us, Hongyi Zhou, our
chairman and chief executive officer, administers this equity incentive pool and has the discretion to change or impose any restrictions on the manner in which the shares in this equity incentive pool
will be granted. Under the 2006 Employee Share Vesting Scheme, if the grantee's employment is terminated, we may repurchase all or part of the vested shares at RMB1.0, depending on the date on which
his employment is terminated and the reasons for such termination.
As
of the date of this prospectus, a total of 2,352,952 shares from this equity incentive pool were granted to our directors and executive officers under our 2006 employee share
vesting scheme.
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PRINCIPAL SHAREHOLDERS
The following table sets forth information with respect to beneficial ownership of our ordinary shares as of the date of this
prospectus by:
-
-
each of our directors and executive officers; and
-
-
each person known to us to beneficially own 5% and more of our ordinary shares.
The
calculations in the table below assume there are 149,874,756 ordinary shares outstanding as of the date of this prospectus, including 78,314,016 ordinary shares that
the preferred shares will automatically
convert into upon the closing of this offering, and 173,213,370 ordinary shares outstanding immediately after the closing of this offering, comprising of 51,332,336 Class A ordinary shares and
121,881,034 Class B ordinary shares, assuming the issuance of 5,172,414 Class A ordinary shares in the form of restricted ADSs in our concurrent private placement at the
initial public offering price of $14.50 per ADS and that underwriters do not exercise their over-allotment option.
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, 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.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ordinary Shares Beneficially Owned Prior to This Offering
|
|
Ordinary Shares Beneficially Owned After This Offering
|
|
Percentage of
Votes Held After This Offering
|
|
Name
|
|
Number
|
|
Percent
|
|
Number
|
|
Percent
|
|
Percent
|
|
Directors and Executive Officers:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Hongyi Zhou
(1)
|
|
|
32,228,158
|
|
|
21.50
|
|
|
32,228,158
|
|
|
18.61
|
|
|
24.39
|
|
Xiangdong Qi
(2)
|
|
|
18,633,343
|
|
|
12.43
|
|
|
18,633,343
|
|
|
10.76
|
|
|
14.10
|
|
Shu Cao
(3)
|
|
|
12,228,250
|
|
|
8.16
|
|
|
12,228,250
|
|
|
7.06
|
|
|
9.25
|
|
Neil Nanpeng Shen
(4)
|
|
|
14,202,219
|
|
|
9.48
|
|
|
14,719,460
|
|
|
8.50
|
|
|
10.83
|
|
Gongquan Wang
(5)
|
|
|
10,572,556
|
|
|
7.05
|
|
|
11,607,039
|
|
|
6.70
|
|
|
8.16
|
|
Hong Chuan Thor
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ming Huang
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shujun Li
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
William Mark Evans
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Alex Zuoli Xu
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Jue Yao
|
|
|
*
|
|
|
*
|
|
|
*
|
|
|
*
|
|
|
*
|
|
Xiaohong Shi
(6)
|
|
|
6,550,654
|
|
|
4.37
|
|
|
6,550,654
|
|
|
3.78
|
|
|
4.96
|
|
All directors and executive officers as a group
|
|
|
94,792,680
|
|
|
63.25
|
|
|
96,344,404
|
|
|
54.73
|
|
|
71.68
|
|
|
|
|
|
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|
|
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|
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Table of Contents
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|
|
|
|
|
|
|
|
|
Ordinary Shares Beneficially Owned Prior to This Offering
|
|
Ordinary Shares Beneficially Owned After This Offering
|
|
Percentage of
Votes Held After This Offering
|
|
Name
|
|
Number
|
|
Percent
|
|
Number
|
|
Percent
|
|
Percent
|
|
Principal Shareholders:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Global Village Associates Limited
(7)
|
|
|
32,228,158
|
|
|
21.50
|
|
|
32,228,158
|
|
|
18.61
|
|
|
24.39
|
|
Young Vision Group Limited
(8)
|
|
|
18,633,343
|
|
|
12.43
|
|
|
18,633,343
|
|
|
10.76
|
|
|
14.10
|
|
Highland Capital Partners VI Limited Partnership and its affiliates
(9)
|
|
|
26,515,152
|
|
|
17.69
|
|
|
27,549,635
|
|
|
15.91
|
|
|
20.22
|
|
Sequoia Capital China I, L.P. and its affiliates
(10)
|
|
|
14,202,219
|
|
|
9.48
|
|
|
14,719,460
|
|
|
8.50
|
|
|
10.83
|
|
Sino Honor Limited
(11)
|
|
|
11,826,000
|
|
|
7.89
|
|
|
11,826,000
|
|
|
6.83
|
|
|
8.95
|
|
CDH Net Technology Limited
(12)
|
|
|
10,572,556
|
|
|
7.05
|
|
|
11,607,039
|
|
|
6.70
|
|
|
8.16
|
|
Trustbridge Partners III, L.P. and its affiliate
(13)
|
|
|
7,831,467
|
|
|
5.23
|
|
|
10,417,674
|
|
|
6.01
|
|
|
1.58
|
|
Redpoint Ventures III, L.P. and its affiliate
(14)
|
|
|
7,575,758
|
|
|
5.05
|
|
|
7,575,758
|
|
|
4.37
|
|
|
1.15
|
|
Notes:
-
*
-
Less
than 1% of our ordinary shares.
-
(1)
-
Consists
of 32,228,158 ordinary shares held by Global Village. Global Village, a British Virgin Islands company, is wholly-owned by Fair Point
International Limited, or Fair Point, a British Virgin Islands company. Fair Point is wholly owned by Precise Focus Holdings, a Bahamas company, which is in turn wholly owned by a revocable trust
constituted under the laws of Singapore with Hongyi Zhou, our chairman and chief executive officer, and his wife as the settlers and certain family members of Mr. Zhou as the beneficiaries. The
registered address of Global Village is P.O. Box 957, Offshore Incorporations Centre, Road Town, Tortola, British Virgin Islands. The registered address of Fair Point is
P.O. Box 957, Offshore Incorporations Centre, Road Town, Tortola, British Virgin Islands. The registered address of Precise Focus Holdings Limited is The Bahamas Financial Centre,
Shirley and Charlotte Streets, P.O. Box N-3023, Nassau, Bahamas.
-
(2)
-
Consists
of 18,633,343 ordinary shares held by Young Vision. Young Vision, a British Virgin Islands company, is wholly-owned by East Line. East Line,
a British Virgin Islands company, is wholly-owned by Mr. Xiangdong Qi, our director and president. Mr. Qi is the sole director of Young Vision. The registered address of Young Vision is
2nd Floor, Abbott Building, Road Town, Tortola, British Virgin Islands. The registered address of East Line is Abbott Building, Road Town, Tortola, British Virgin Islands.
-
(3)
-
Consists
of 11,826,000 ordinary shares held by Sino Honor Limited, 400,000 ordinary shares held by Flying Great Limited and
2,250 ordinary shares that could be acquired by Shu Cao within 60 days through exercise of share options. Mr. Cao disclaims beneficial ownership in all of the
11,826,000 ordinary shares held by Sino Honor Limited. Such shares were allocated to award our employees and consultants under our 2006 Employee Share Vesting Scheme. Sino Honor Limited, a
British Virgin Islands company, is wholly-owned by Shu Cao, our director and chief engineer. The registered address of Sino Honor Limited is P.O. Box 933, 3rd Floor, Omar Hodge
Building, Wickhams Cay 1, Road Town, Tortola, British Virgin Islands. Flying Great Limited, a British Virgin Islands company, is wholly-owned by Shu Cao. The registered address of Flying Great Limited
is P.O. Box 933, 3rd Floor, Omar Hodge Building, Wickhams Cay 1, Road Town, Tortola, British Virgin Islands.
-
(4)
-
Consists
of (i) 9,992,335 ordinary shares issuable upon conversion of 9,992,335 Series A convertible participating redeemable preferred
shares held by Sequoia Capital China I., L.P., (ii) 1,148,180 ordinary shares issuable upon conversion of 1,148,180 Series A convertible participating redeemable preferred
shares held by Sequoia Capital China Partners Fund I, L.P., (iii) 1,546,553 ordinary shares issuable upon conversion 1,546,553 Series A convertible participating
redeemable preferred shares held by Sequoia Capital China Principals Fund I, L.P., (iv) 1,193,333 ordinary shares issuable upon conversion of 1,193,333 Series B convertible
participating redeemable preferred shares held by Sequoia Capital China I, L.P., (v) 137,121 ordinary shares issuable upon conversion of 137,121 Series B convertible
participating redeemable preferred shares held by Sequoia Capital China Partners Fund I, L.P., and (vi) 184,697 ordinary shares issuable upon conversion of 184,697 Series B
convertible participating redeemable preferred shares held by Sequoia Capital China Principals Fund I, L.P., Sequoia Capital China I, L.P. Sequoia Capital China Partners Fund
I, L.P. and Sequoia Capital China Principals Fund I, L.P. are collectively referred to as the Sequoia Funds. The Sequoia Funds are managed by Sequoia Capital China Advisors Limited, a
company incorporated in the Cayman Islands. The Sequoia Funds' general partner is Sequoia Capital China Management I, L.P. The general partner for Sequoia Capital China
Management I, L.P. is SC China Holding Limited, a company incorporated in the Cayman Islands. SC China Holding Limited is wholly-owned by Max
116
Table of Contents
Wealth
Enterprises Limited, a company wholly-owned by Neil Nanpeng Shen. Neil Nanpeng Shen disclaims beneficial ownership in all securities shown except to the extent of his pecuniary interests
therein. The registered address of Sequoia Capital China I., L.P. and its affiliates is Cricket Square, Hutchins Dr., P.O. Box 2681, Grand Cayman KY1-1111,
Cayman Islands. After the closing of this offering, and giving effect to the closing of the concurrent private placement, affiliates of Sequoia Capital China I, L.P. will acquire an
additional 517,241 Class A ordinary shares in the form of restricted ADSs to be issued at the initial public offering price of $14.50 per ADS.
-
(5)
-
Consists
of (i) 10,001,014 ordinary shares issuable upon conversion of 10,001,014 Series A convertible participating redeemable
preferred shares and (ii) 571,542 ordinary shares issuable upon conversion of 571,542 Series A convertible participating redeemable preferred shares held by CDH Net Technology
Limited, a British Virgin Islands company. Mr. Gongquan Wang is a director of CDH Net Technology Limited and disclaims beneficial ownership in all securities shown except to the extent of his
pecuniary interests therein. The registered address of CDH Net Technology Limited is P.O. Box 173, Kingston Chambers, Road Town, Tortola, British Virgin Islands. After the closing of
this offering, and giving effect to the closing of the concurrent private placement, CDH Net Technology Limited will acquire an additional 1,034,483 Class A ordinary shares in the form of
restricted ADSs to be issued at the initial public offering price of $14.50 per ADS.
-
(6)
-
Consists
of (i) 5,550,654 ordinary shares held by Strengthen Goal Limited and (ii) 1,000,000 ordinary shares held by Elite Wisdom Development
Limited. Mr. Shi disclaims beneficial ownership in all of the 5,550,654 ordinary shares held by Strengthen Goal Limited. Such shares were allocated to award our employees and consultants
under our 2006 Employee Share Vesting Scheme. Strengthen Goal Limited, a British Virgin Islands company, is wholly-owned by Xiaohong Shi, our vice president of technology. The registered address of
Strengthen Goal Limited is P.O. Box 933, 3rd Floor, Omar Hodge Building, Wickhams Cay 1, Road Town, Tortola, British Virgin Islands. Elite Wisdom Development Limited, a British
Virgin Islands company, is wholly-owned by Xiaohong Shi. The registered address of Elite Wisdom Development Limited is P.O. Box 933, 3rd Floor, Omar Hodge Building, Wickhams Cay
1, Road Town, Tortola, British Virgin Islands.
-
(7)
-
Global
Village, a British Virgin Islands company, is wholly-owned by Fair Point. Fair Point is wholly-owned by Precise Focus Holdings, a Bahamas company,
which is in turn wholly-owned by a revocable trust constituted under the laws of Singapore with Hongyi Zhou, our chairman and chief executive officer, and his wife as the settlers and certain family
members of Mr. Zhou as the beneficiaries. The registered address of Fair Point is P.O. Box 957, Offshore Incorporations Centre, Road Town, Tortola, British Virgin Islands. The
registered address of Precise Focus Holdings Limited is The Bahamas Financial Centre, Shirley and Charlotte Streets, P.O. Box N-3023, Nassau, Bahamas.
-
(8)
-
Young
Vision is wholly-owned by East Line. East Line, a British Virgin Islands company, is wholly-owned by Mr. Xiangdong Qi, our director and
president. The registered address of Young Vision is 2nd Floor, Abbott Building, Road Town, Tortola, British Virgin Islands. The registered address of East Line is Abbott Building, Road Town,
Tortola, British Virgin Islands.
-
(9)
-
Consists
of (i) 16,595,171 ordinary shares issuable upon conversion of 16,595,171 Series B convertible participating redeemable
preferred shares held by Highland Capital Partners VI Limited Partnership, (ii) 9,098,011 ordinary shares issuable upon conversion of 9,098,011 Series B convertible participating
redeemable preferred shares held by Highland Capital Partners VI-B Limited Partnership, and (iii) 821,970 Series B convertible participating redeemable preferred shares held
by Highland Entrepreneurs' Fund VI Limited Partnership. Highland Capital Partners VI Limited Partnership, Highland Capital Partners VI-B Limited Partnership and Highland Entrepreneurs'
Fund VI Limited Partnership are collectively referred to as the Highland Funds. Highland Management Partners VI Limited Partnership, or HMP, is the general partner of Highland Capital VI and Highland
Capital VI-B. HEF VI Limited Partnership, or HEF, is the general partner of Highland Entrepreneurs' Fund. Highland Management Partners VI, Inc., or Highland Management, is the
general partner of both HMP and HEF. Robert F. Higgins, Paul A. Maeder, Daniel J. Nova, Robert J. Davis, Sean M. Dalton, Corey M. Mulloy and Fergal J. Mullen are the managing directors of Highland
Management. Highland Management, as the general partner of the general partners of the Highland Funds, may be deemed to have beneficial ownership of the shares held by the Highland Funds. The managing
directors of Highland Management have shared voting and investment control over all the shares held by the Highland Investing Entities and therefore may be deemed to share beneficial ownership of the
shares held by Highland Investing Entities by virtue of their status as controlling persons of Highland Management. Each of the managing directors of Highland Management disclaims beneficial ownership
of the shares held by the Highland Investing Entities, except to the extent of such managing director's pecuniary interest therein. The registered address of Highland Capital Partners VI Limited
Partnership and its affiliates is c/o Highland Capital Partners LLC, 92 Hayden Avenue, Lexington, MA 02421, U.S.A. After the closing of this offering, and giving effect to the
closing of the concurrent private placement, affiliates of Highland Capital Partners VI Limited Partnership will acquire an additional 1,034,483 Class A ordinary shares in the form of
restricted ADSs to be issued at the initial public offering price of $14.50 per ADS.
-
(10)
-
Consists
of (i) 9,992,335 ordinary shares issuable upon conversion of 9,992,335 Series A convertible participating redeemable
preferred shares held by Sequoia Capital China I., L.P., (ii) 1,148,180 ordinary shares issuable upon conversion of 1,148,180 Series A convertible participating redeemable
preferred shares held by Sequoia Capital China Partners Fund I, L.P., (iii) 1,546,553 ordinary shares issuable upon conversion 1,546,553 Series A convertible
participating redeemable preferred shares held by Sequoia Capital China Principals Fund I, L.P., (iv) 1,193,333 ordinary shares issuable
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upon
conversion of 1,193,333 Series B convertible participating redeemable preferred shares held by Sequoia Capital China I, L.P., (v) 137,121 ordinary shares issuable upon
conversion of 137,121 Series B convertible participating redeemable preferred shares held by Sequoia Capital China Partners Fund I, L.P., and (vi) 184,697 ordinary shares
issuable upon conversion of 184,697 Series B convertible participating redeemable preferred shares held by Sequoia Capital China Principals Fund I, L.P.. The Sequoia Funds are
managed by Sequoia Capital China Advisors Limited, a company incorporated in the Cayman Islands. The Sequoia Funds' general partner is Sequoia Capital China Management I, L.P. The
general partner for Sequoia Capital China Management I, L.P. is SC China Holding Limited, a company incorporated in the Cayman Islands. SC China Holding Limited is wholly-owned by Max Wealth
Enterprises Limited, a company wholly-owned by Neil Nanpeng Shen. Neil Nanpeng Shen disclaims beneficial ownership in all securities shown except to the extent of his pecuniary interests therein. The
registered address of Sequoia Capital China I., L.P. and its affiliates is Cricket Square, Hutchins Dr., P.O. Box 2681, Grand Cayman KY1-1111, Cayman Islands.
After the closing of this offering, and giving effect to the closing of the concurrent private placement, affiliates of Sequoia Capital China I, L.P. will acquire an additional 517,241
Class A ordinary shares in the form of restricted ADSs to be issued at the initial public offering price of $14.50 per ADS.
-
(11)
-
Sino
Honor Limited, a British Virgin Islands company, is wholly-owned by Shu Cao, our director and chief engineer. Mr. Cao disclaims beneficial
ownership in all of the 11,826,000 ordinary shares held by Sino Honor Limited. Such shares were allocated to award our employees and consultants under our 2006 Employee Share Vesting Scheme.
The registered address of Sino Honor Limited is P.O. Box 933, 3rd Floor, Omar Hodge Building, Wickhams Cay 1, Road Town, Tortola, British Virgin Islands.
-
(12)
-
Consists
of (i) 10,001,014 ordinary shares issuable upon conversion of 10,001,014 Series A convertible participating redeemable
preferred shares and (ii) 571,542 ordinary shares issuable upon conversion of 571,542 Series A convertible participating redeemable preferred shares. All of the issued and
outstanding shares of CDH Net Technology Limited, a British Virgin Islands Company, are wholly owned by CDH China Growth Capital Fund II, L.P., or CDH Fund II, a Cayman Islands
exempted limited partnership. CDH China Growth Capital Holdings Company Limited, a Cayman Islands exempted limited liability company, is the general partner of CDH Fund II and has the power to
direct CDH Fund II as to the voting and disposition of shares directly and indirectly held by CDH Fund II. The investment committee of CDH China Growth Capital Holdings Company Limited
comprises Shangzhi Wu, Shuge Jiao and Xin Lai Liu. Each of Shangzhi Wu, Shuge Jiao and Xin Lai Liu disclaims beneficial ownership of all of our shares held by CDH Net Technology Limited except to the
extent of his pecuniary interest therein. The registered address of CDH Net Technology Limited is P.O. Box 173, Kingston Chambers, Road Town, Tortola, British Virgin Islands. After the
closing of this offering, and giving effect to the closing of the concurrent private placement, CDH Net Technology Limited will acquire an additional 1,034,483 Class A ordinary shares in the
form of restricted ADSs to be issued at the initial public offering price of $14.50 per ADS.
-
(13)
-
Consists
of (i) 391,573 ordinary shares and (ii) 7,439,894 ordinary shares issuable upon conversion of 7,439,894 Series C
convertible participating redeemable preferred shares. Trustbridge Partners III, L.P. is a Cayman Islands exempted limited partnership whose general partner is TB Partners
GP3, L.P.. The general partner of TB Partners GP3, L.P. is TB Partners GP Limited. The investment committee of TB Partners GP Limited comprises four
individual members. Each of the members disclaims beneficial ownership in all of our shares held by Trustbridge Partners III, L.P. except to the extent his pecuniary interests therein.
The registered address of Trustbridge Partners III, L.P. is Walker House, 87 Mary Street, George Town, Grand Cayman KY1-9002, Cayman Islands.
After
the closing of this offering, and giving effect to the closing of the concurrent private placement, the Trustees of Columbia University in the City of New York, or Columbia, through a
proprietary investment account managed by TB Alternative Assets Ltd., will acquire 2,586,207 Class A ordinary shares in the form of restricted ADSs to be issued at the initial public
offering price of $14.50 per ADS. Pursuant to an Investment Management Agreement dated January 23, 2008, TB Alternative Assets Ltd. provides investment advisory services and
discretionary investment management services to Columbia in respect of this account. TB Alternative Assets Ltd. is affiliated with TB Partners GP Limited, which is the general partner of
the general partner of Trustbridge Partners III, L.P. The registered address of Columbia is 405 Lexington Avenue, 63rd Floor, New York, New York 10174. Columbia is
also a limited partner in Trustbridge Partners III, L.P. Each of TB Alternative Assets Ltd., Trustbridge Partners III, L.P., TB Partners GP3, L.P. and TB
Partners GP Limited disclaims beneficial ownership in all of the company shares purchased by Columbia except to the extent their pecuniary interests therein.
-
(14)
-
Consists
of (i) 7,291,667 ordinary shares issuable upon conversion of 7,291,667 Series B convertible participating redeemable
preferred shares held by Redpoint Ventures III, L.P. and (ii) 284,091 ordinary shares issuable upon conversion of 284,091 Series B convertible participating redeemable
preferred shares held by Redpoint Associates III, LLC. (H Redpoint Ventures III, L.P. and Redpoint Associates III, LLC, or collectively, the Redpoint Funds.) Redpoint
Ventures III, L.P., a Cayman Islands exempted limited partnership. Redpoint Ventures III, LLC, the general partner of Redpoint Ventures III, L.P., holds the
voting right and the disposition right of our shares held by Redpoint Ventures III, L.P. Geoffrey Yang and other individuals are the managing members of Redpoint
Ventures III, LLC. Redpoint Ventures III, LLC have the voting and investment power over the shares held by Redpoint Ventures III, L.P. The managing members of
Redpoint Ventures III, LLC disclaim beneficial ownership in all of our shares held Redpoint Ventures III, L.P.
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Table of Contents
and
Redpoint Associates III, LLC, except to the extent of their respective pecuniary interest therein. The registered address of Redpoint Ventures III, L.P. and its affiliate is
3000 Sand Hill Road, Building 2, Suite 290, Menlo Park, CA 94025, USA.
As of the date of this prospectus, none of our outstanding ordinary shares is held by record shareholders in the United States, and a total of
3,028,719 convertible participating redeemable preferred shares are held by two record holders in the United States, representing 2% of our total outstanding shares on a pro forma basis. None of our
shareholders has different voting rights from other shareholders after the closing of this offering. Immediately upon the completion of this offering, our ordinary shares will be divided into
Class A ordinary shares and Class B ordinary shares. Holders of Class A ordinary shares are entitled to one vote per share, while holders of Class B ordinary shares are
entitled to five votes per share. We will issue Class A ordinary shares represented by our ADSs in this offering. Immediately upon the completion of this offering, (i) each of the
ordinary shares held by Global Village, which is controlled by Mr. Hongyi Zhou, and Young Vision, which is controlled by Mr. Xiangdong Qi, will be automatically re-designated
as one Class B ordinary share, (ii) each of the preferred shares held by Highland, Sequoia or CDH, or their respective affiliates, will be automatically converted into one Class B
ordinary share, (iii) each of the ordinary shares held by certain British Virgin Islands companies controlled by our executive officers will be automatically converted into one Class B
ordinary share, and (iv) each of the remaining outstanding ordinary shares and preferred shares will be automatically converted into one Class A ordinary 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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RELATED PARTY TRANSACTIONS
Termination of VIE Arrangement
In order to focus on our Internet and mobile security business, we terminated in November 2007 our VIE control contracts with
Beijing Qizhi Haotian Technology Co., Ltd., a company that we set up to undertake B2B business. These control arrangements entailed the registration of the nominees of
Mr. Xiangdong Qi, our director and president, as a shareholder of Beijing Qizhi Haotian. As part of the termination arrangements, we extended in February 2008, and subsequently in the
same year waived the repayment of, an unsecured, interest-free loan of $220,000 to Beijing Qizhi Haotian to finance its operations as it transitioned into a non-VIE.
Purchases of Products and Services
In his personal capacity, Mr. Hongyi Zhou, our chairman, chief executive officer and principal shareholder, has been an angel
investor in the Internet and high-tech industries in China. From time to time, on an arm's length basis, we purchase products and services from or enter into revenue sharing arrangements
with companies in which Mr. Zhou is a principal shareholder or a director. None of these transactions was material.
In
2009, we purchased browser source code and related technical services from Shengjing Wanwei for an aggregate consideration of $950,000. We subsequently acquired the Internet business
of Shengjing Wanwei in September 2009 for (i) $2.2 million in cash paid to Genius Land Services Limited, a company wholly owned by a family member of Mr. Hongyi Zhou, and
the designee of Shengjing Wanwei for receiving the payment in connection with this acquisition, and (ii) and 2,125,176 of our ordinary shares issued to Global Village, a company wholly owned by
Mr. Hongyi Zhou, which will be automatically re-designated as Class B ordinary shares upon the completion of this offering.
Investment Advisory Services
In July 2010, we engaged a family member of a shareholder and executive officer to provide investment advisory services. As
remuneration for these services, we granted this advisor options to purchase 300,000 of our ordinary shares, which will be automatically re-designated as Class A ordinary shares
upon the completion of this offering. The fair value of these options as of the grant date was $420,000.
Contractual Arrangements among Qizhi Software, the VIEs and the Respective Shareholders of the VIEs
Qizhi
Software, our wholly-owned PRC subsidiary, has entered into contractual arrangements with various VIEs and their respective shareholders who are our directors, officers or key
employees. For a detailed description of the contractual agreements, see "Corporate History and StructureContractual Arrangements Among Qizhi Software, the VIEs and the Respective
Shareholders of the VIEs."
Private Placements
In January 2006, we issued in a private placement a total of 28,002,840 series A convertible participating
redeemable preferred shares at $0.4999 per share for an aggregate cash consideration of $14.0 million, including (i) 12,001,217 series A convertible participating redeemable
preferred shares to Sequoia Capital China I, L.P.; (ii) 2,000,203 series A convertible participating redeemable preferred shares to Joinway Investments Limited;
(iii) 2,000,203 series A convertible participating redeemable preferred shares to GMO Venture Partners Investment Limited Partnership; (iv) 2,000,203 series A convertible
participating redeemable preferred shares to IDG Technology Venture Investment III, LP;
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and
(v) 10,001,014 series A convertible participating redeemable preferred shares CDH Net Technology Limited. All of the consideration was paid in cash.
In
May 2006, we issued 2,988,148 series A convertible participating redeemable preferred shares to Matrix Partners VII, L.P. and 12,452 series A
convertible participating redeemable preferred shares to Weston & Co. VII, LL, each at a price of $0.4999 per share.
In
August 2006, certain holders of our series A convertible participating redeemable preferred shares exercised their warrants and we issued a total of
1,600,320 series A convertible participating redeemable preferred shares at $0.4999 per share for an aggregate cash consideration of $800,000, including (i) 685,851
series A convertible participating redeemable preferred shares to Sequoia Capital China I, L.P.; (ii) 114,309 series A convertible participating redeemable preferred shares
to Joinway Investments Limited; (iii) 114,309 series A convertible participating redeemable preferred shares to GMO Venture Partners Investment Limited Partnership; (iv) 114,309
series A convertible participating redeemable preferred shares to IDG Technology Venture Investment III, LP; and (v) 571,542 series A convertible participating redeemable
preferred shares to CDH Net Technology Limited.
In
January 2010, Sequoia Capital China I, L.P. sold and transferred (i) 1,148,180 series A convertible participating redeemable preferred shares to Sequoia
Capital China Partners Fund I, L.P. for an aggregate amount of $574,028.48 and (ii) 1,546,553 series A convertible participating redeemable preferred shares to Sequoia
Capital China Principals Fund I, L.P. for an aggregate amount of $773,194.08.
In
April 2010, GMO Venture Partners Investment Limited Partnership sold and transferred (i) 156,631 series A convertible participating redeemable preferred shares to
IDG Technology Venture Investment IV, LP for an aggregate amount of $400,004.25, (ii) 1,476,189 series A convertible participating redeemable preferred shares to Ceyuan Ventures
II, L.P. for an aggregate amount of $3,769,891.47, and (iii) 58,790 series A convertible participating redeemable preferred shares to Ceyuan Ventures Advisors Fund II, LLC
for an aggregate amount of $150,137.90. The rights attached to the 156,631 Series A convertible participating redeemable preferred shares purchased by IDG Technology Venture
Investment IV, LP are the same as those attached to the rights attached to Series C convertible participating redeemable preferred shares. In connections with these transactions,
156,631 Series A convertible participating redeemable preferred shares held by IDG Technology Venture Investment IV, LP were cancelled and the same number of
Series C convertible participating redeemable preferred shares was issued to IDG Technology Venture Investment IV, LP in January 2011.
Each
of our Series A convertible participating redeemable preferred shares held by Sequoia and CDH will automatically convert into one Class B ordinary share upon the
closing of this offering. Each of the other Series A convertible participating redeemable preferred shares will automatically convert into one Class A ordinary share upon the completion
of this offering.
In November 2006, we issued in a private placement a total of 37,878,789 series B convertible participating
redeemable preferred shares at $0.660 per share for an aggregate cash consideration of $25.0 million, including (i) 16,595,171 shares to Highland Capital Partners VI Limited Partnership;
(ii) 9,098,011 shares to Highland Capital Partners VI-B Limited Partnership; (iii) 821,970 shares to Highland Entrepreneurs' Fund VI Limited Partnership;
(iv) 7,291,667 shares to Redpoint Ventures III, L.P.; (v) 284,091 shares to Redpoint Ventures III, LLC; (vi) 1,193,333 shares to Sequoia Capital China
I, L.P.; (vii) 137,121 shares to Sequoia Capital China Partners Fund I, L.P.; (viii) 184,697 shares to Sequoia Capital China Principals Fund I, L.P.;
(ix) 1,508,864 shares to Matrix Partners VII, L.P.; (x) 6,288 shares to Weston & Co. VII LLC; and (ix) 757,576 shares to IDG Technology Venture
Investment III, L.P..
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Each
of our Series B convertible participating redeemable preferred shares held by Highland and Sequoia will automatically convert into one Class B ordinary share upon the
closing of this offering. Each of the other Series B convertible participating redeemable preferred shares will automatically convert into one Class A ordinary share upon closing of this
offering.
In January 2010, we issued in a private placement 7,439,894 series C convertible participating redeemable
preferred shares to Trustbridge Partners III, L.P. for an aggregate amount of $19 million and 391,573 series C convertible participating redeemable preferred shares to
Zero2IPO China Fund II, L.P. for an aggregate amount of $1.0 million, each at a price of $2.5538 per share.
In
January 2011, we issued 156,631 Series C convertible participating redeemable preferred shares to IDG Technology Ventures Investment IV, LP while at the
same time cancelled the same number of Series A convertible participating redeemable preferred shares held by IDG Technology Ventures Investment IV, LP.
Each
of our Series C convertible participating redeemable preferred shares will automatically convert into one Class A ordinary share upon the completion of
this offering.
Concurrent Private Placement
See "UnderwritingConcurrent Private Placement."
Share Option Plan
See "ManagementShare Option Plans."
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REGULATION
Regulations Relating to Our Business
The PRC Telecommunications Regulations implemented on September 25, 2000 sets out a regulatory framework for telecommunications
services providers in China. The
Telecommunications Regulations require telecommunications services providers to obtain an operating license prior to the commencement of their operations. The Telecommunications Regulations categorize
telecommunications services into basic telecommunications services and value-added telecommunications services. According to the Catalogue of Telecommunications Business attached to the
Telecommunications Regulations, information services provided via fixed network, mobile network and Internet belong to value-added telecommunications services.
Foreign
direct investment in telecommunications companies in China is governed by the Regulations for the Administration of Foreign-Invested Telecommunications Enterprises promulgated in
December 2001 and amended in September 2008, or the FITE Regulations. The FITE Regulations requires foreign-invested telecommunications enterprises in China to be established as
Sino-foreign equity joint ventures. In addition, pursuant to the FITE Regulations and the relevant WTO agreements, foreign investors in a foreign-invested telecommunications enterprise
engaging in value-added telecommunications services may hold up to 50% of the equity interest of such enterprise. The relevant rules do not impose geographic restrictions on the operations of a
foreign-invested telecommunications enterprise.
However,
for a foreign investor to acquire any equity interest in a value-added telecommunications business in China, it must satisfy a number of stringent performance and operational
experience requirements, including demonstrating a track record and experience in operating a value-added telecommunications business overseas. Moreover, foreign investors that meet these requirements
must obtain approvals from MIIT and MOFCOM or their authorized local counterparts, which retain considerable discretion in granting approvals.
In
July 2006, MIIT publicly released the Notice on Strengthening the Administration of Foreign Investment in Operating Value-added Telecommunications Business, or the MIIT Notice,
which reiterates certain provisions under the 2002 Administrative Rules on Foreign-invested Telecommunications Enterprises. According to the MIIT Notice, if any foreign investor intends to invest in a
PRC telecommunications business, a foreign-invested telecommunications enterprise must be established and such enterprise must apply for the relevant telecommunications business licenses. Under the
MIIT Notice, domestic telecommunications enterprises may not rent, transfer or sell a telecommunications license to foreign investors in any form, nor may they provide any resources, premises,
facilities and other assistance in any form to foreign investors for their illegal operation of any telecommunications business in China.
On
September 28, 2009, the PRC General Administration of Press and Publishing, or the GAPP, together with the National Copyright Administration, and National Office of Combating
Pornography and Illegal Publications jointly issued a Notice on Further Strengthening on the Administration of Pre-examination and Approval of Online Game and the Examination and Approval
of Imported Online Game, or the GAPP notice. The GAPP notice provides that foreign investors are not permitted to invest in online game operation businesses in China through wholly owned joint
ventures or cooperative joint venture investments and prohibits foreign investors from gaining control over or becoming domestic online game operators through indirect ways such as establishing other
joint venture companies or contractual or technical arrangements. There are still substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including the MIIT
circular and the GAPP notice.
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On September 25, 2000, the State Council promulgated the Administrative Measures on Internet Information Services, or the
Internet Measures. According to the Internet Measures, commercial operators of Internet information services in China must obtain a value-added telecommunications license, or ICP license, from the
relevant government authorities.
National security considerations are an important factor in the regulation of Internet content in China. According to the Decision of
the Standing Committee of the National People's Congress on Maintaining Internet Security, the following actions may be regarded as violations of laws and are subject to penalties, including criminal
sanctions: (i) breaking into a computer or a system of strategic importance; (ii) disseminating politically disruptive information; (iii) leaking state secrets;
(iv) spreading false commercial information; or (v) infringing intellectual property rights.
In
addition, the MPS promulgated measures on December 16, 1997 that prohibit the use of the Internet in ways which, among other things, result in a leakage of national secrets or
the distribution of socially destabilizing content. On December 13, 2005, the MPS promulgated Provisions on Technological Measures for Internet Security Protection, or the Internet Protection
Measures, which require all ICPs to keep records of certain information about its users (including user registration information, log-in and log-out time, IP address, content
and time of posts by users) for at least 60 days and submit the above information as required by laws and regulations. The ICPs must regularly update information security and censorship systems
for their websites with local public security authorities, and must also report any public dissemination of prohibited content. If the ICPs violate these measures, the PRC government may revoke its
ICP license and shut down its websites. In addition, the PRC State Secrecy Bureau has issued provisions authorizing the blocking of access to any website it deems to be leaking national secrets or
failing to comply with the relevant legislation regarding the protection of state secrets.
In recent years, PRC government authorities have legislated on the use of the Internet to protect personal information from
unauthorized disclosure. For example, the Internet Measures prohibits an Internet information services provider from insulting or slandering a third party or infringing upon the lawful rights and
interests of a third party. Pursuant to the BBS Measures, ICPs that provide electronic messaging services shall not disclose any user's personal information to any third party without such user's
consent, unless the disclosure is required by law. ICPs are subject to legal liability if unauthorized disclosure results in damages or losses to users. In addition, the PRC regulations authorize the
relevant telecommunications authorities to demand rectification of unauthorized disclosure by ICPs.
The
PRC laws do not prohibit ICPs from collecting and analyzing person information of their users. The PRC government, however, has the power and authority to order ICPs to submit
personal information of an Internet user if such user posts any prohibited content or engages in illegal activities on the Internet.
The principal regulations governing foreign ownership in advertising businesses in China include:
-
-
The Foreign Investment Industrial Guidance Catalog;
-
-
The Administrative Regulations on Foreign-invested Advertising Enterprises; and
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-
The Circular Regarding Investment in the Advertising Industry by Foreign Investors through Equity Acquisition.
These
regulations require foreign entities that directly invest in the PRC advertising industry to have at least a two-year track record with a principal business in the
advertising industry outside China. Since December 2005, foreign investors have been permitted to directly own a 100% interest in advertising companies in China, but such foreign investors are
also required to have at least a three-year track record with a principal business in the advertising industry outside China. PRC laws, rules and regulations do not permit the transfer of
any approvals or licenses, including business licenses containing a scope of business that permits engagement in the advertising business.
As
a result of the current PRC laws, rules and regulations that impose substantial restrictions on foreign investment in the Internet and advertising businesses in China, we conduct this
portion of our operations through a series of contractual arrangements among our PRC subsidiaries and our consolidated controlled entities. See "Corporate History and Structure."
SAIC is responsible for regulating advertising activities in China. The principal regulations governing advertising in China, including
online advertising, include:
-
-
The Advertising Law;
-
-
The Administration of Advertising Regulations; and
-
-
The Implementation Rules for the Administration of Advertising Regulations.
These
regulations stipulate that companies that engage in advertising activities in China must obtain from SAIC or its local branches a business license which specifically includes
operating an advertising business within its business scope. Companies conducting advertising activities without such a license may be subject to penalties, including fines, confiscation of illegal
revenues 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 law or regulation.
According to the PRC Regulation of Computer Information System Security and the Administrative Measures on Inspection and Sales License
of Security Products for Computer Information System, sale of security products for computer information system, including hardware and software products, requires approval and a sales license. A new
sales license is required if an approved security product has any functional changes.
On
March 1, 2009, MIIT issued the Administrative Measures on Software Products, or the Software Measures, to regulate software products and promote the development of the PRC
software industry. The Software Measures provide for a registration and filing system for software products both made in China and imported from overseas and require registration of all software
products with the competent local government authorities in charge of software industry administration. Registered software products may enjoy certain preferential treatments granted by relevant
software industry regulations. Software developers or producers may sell or license their registered software products directly or through distributors. Each registration is valid for five years and
renewable upon expiration.
The Rules for the Administration of Electronic Publications, or Electronic Publication Rules, regulate the production, publishing and
import of electronic publications in the PRC. In addition, under
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the
Provisional Measures for Administration of Internet Publication promulgated, Internet publishing is broadly defined as any act of Internet information providers to select, edit and process content
or programs and post such content or programs on the Internet for users to view, use or download, including books, newspapers, electronic publications and so on. Under relevant rules and measures
issued by the GAPP, providing online download services of software may be deemed as Internet publishing activities, which require an Internet publishing license.
The Provisional Regulations for the Administration of Online Culture promulgated in 2003 and as amended in 2004 applies to
entities engaging in activities related to "online cultural products," including music and video files, network games, animation features, audiovisual products, performed plays and artwork converted
for dissemination via the Internet. Such entities are required to apply for an online culture operating permit from the relevant local branches of the Ministry of Culture, or the MOC, for engaging in
any of the following types of activities:
-
-
production, duplication, importation, wholesale, retail, leasing or broadcasting of online cultural products;
-
-
dissemination of online cultural products on the Internet or transmission of such products to computers,
fixed-line or mobile phones, radios, television sets or gaming consoles for the purpose of browsing, reading, using or downloading such products; or
-
-
exhibition or holding of contests related to online cultural products.
Notice
35 issued by the State Commission Office for Public Sector Reform on September 17, 2009 interprets the responsibilities of relevant governmental authorities
on the administration and supervision of the animation, online game and culture market. Notice 35 provides that the GAPP shall be responsible for reviewing a online game before its publication
on the Internet and the MOC shall administer and supervise published online games.
Furthermore,
the Provisional Measures for the Administration of Online Games, or the Online Game Measures, strengthens the MOC's supervision of the development, production, online
operation and issuance of online games, including web games, virtual currency. A company shall obtain the online culture operating permit in order to conduct online game operation and issuance and
transaction of virtual currency. Such permit is valid for three years and renewable before its expiration. The Online Game Measures sets out detailed restrictions on online game operations, such as
examination and filing of web games' content, installment of anti-fatigue system and implementation of real-name registration. In addition, based on the Online Game Measures,
the virtual currency issued by a web game operator could be only used to exchange such operator's online game products.
On
February 15, 2007, the MOC, the People's Bank of China and other relevant government authorities jointly issued the Notice on Internet Cafes. The Notice on Internet Cafes
authorizes the People's Bank of China to strengthen the administration of virtual currency in web games in order to avoid any adverse impact on the economy and financial system. This notice strictly
limits the total amount of virtual currency that a web game operator can issue and an individual game player can purchase. It also distinguishes virtual transactions from real transactions through
electronic commerce and that specifies virtual currency should only be used to purchase virtual items.
Laws Relating to Intellectual Property
China has adopted comprehensive legislation governing intellectual property rights, including trademarks, patents and copyrights. China
is a signatory to the main international conventions on intellectual property rights and has been a member of the Agreement on Trade related Aspects of Intellectual Property Rights since its accession
to the WTO in December 2001.
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In accordance with the PRC Patent Law, the State Intellectual Property Office is responsible for administering patents in the PRC. The
patent administration departments of provincial, autonomous region or municipal governments are responsible for administering patents within their respective jurisdictions.
The
Chinese patent system adopts a "first to file" principle, which means that, where more than one person files a patent application for the same invention, a patent will be
granted to the person who filed the application first. To be patentable, invention or utility models must meet three conditions: novelty, inventiveness and practical applicability. A patent is valid
for 20 years in the case of an invention and 10 years in the case of utility models and designs. A third-party user must obtain consent or a proper license from the patent owner to use
the patent. Otherwise, the use constitutes an infringement upon patent rights.
In accordance with the PRC Trademark Law, the Trademark Office of the Administration for Industry and Commerce is responsible for the
registration and administration of trademarks in China. The Administration for Industry and Commerce under the State Council has established a Trademark Review and Adjudication Board for resolving
trademark disputes.
As
with patents, China has adopted a "first-to-file" principle for trademarks. If two or more applicants apply for registration of identical or similar trademarks
for the same or similar commodities, the application that was filed first will receive preliminary approval and will be publicly announced. For applications filed on the same day, the trademark that
was first used will receive preliminary approval and will be publicly announced.
Registered
trademarks are valid for ten years from the date the registration is approved. A registrant may apply to renew a registration within six months before the expiration date of
the registration. If
the registrant fails to apply in a timely manner, a grace period of six additional months may be granted. If the registrant fails to apply before the grace period expires, the registered trademark
shall be deregistered. Renewed registrations are valid for ten years.
The Copyright Law extends copyright protection to Internet activities, products disseminated over the Internet and software products.
In addition, there is a voluntary registration system administered by the China Copyright Protection Center.
The
Rules of Protection on Information Network Dissemination Rights address copyright issues relating to the Internet. In addition, the Interpretations on Some Issues Concerning
Applicable Laws for Trial of Disputes Over Internet Copyright, or the Interpretations, establish joint liability for ICPs who knowingly infringe upon other's copyright or refuse to remove the
infringing content after receiving notice from the holder of the copyright. The Interpretations also provides that any act to circumvent the technologies designed to protect copyrights constitutes
copyright infringement.
Regulation of Foreign Currency Exchange and Dividend Distributions
The principal regulations governing foreign currency exchange in China are the Foreign Exchange Administration Regulations, as amended
in August 2008. Under the Regulations, RMB are freely convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign
exchange transactions. In order to convert RMB for capital account items,
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such
as direct investments, loans, repatriation of investments and investments in securities outside of China, the prior approval of, and registration with, SAFE are required.
On
August 29, 2008, SAFE promulgated Circular 142, which regulates the purposes for which foreign-invested companies may convert foreign currency into RMB. The notice
requires that the registered capital of a foreign-invested company settled in RMB converted from foreign currencies may only be used within the business scope approved by the applicable governmental
authority and may not be used for equity investments in the PRC. In addition, foreign-invested companies may not change how they use such capital without SAFE's approval, and may not in any case use
such capital to repay RMB loans if they have not used the proceeds of such loans. Violations of Circular 142 can result in severe penalties, including heavy fines. Furthermore, SAFE
promulgated a circular on November 19, 2010, or Circular No. 59, which tightens the regulation over settlement of net proceeds from overseas offerings like this offering and requires
that the settlement of net proceeds must be consistent with the description in the prospectus for the offering.
The
dividends paid by a subsidiary to its overseas shareholders are deemed income to the shareholders and are taxable in China. Pursuant to the Administration Rules of the Settlement,
Sale and Payment of Foreign Exchange (1996), foreign-invested enterprises in China may purchase or remit foreign currency, subject to a cap approved by SAFE, for settlement of current account
transactions without the approval of SAFE. Foreign currency transactions under the capital account are still subject to limitations and require approvals from, or registration with, SAFE and other
relevant PRC governmental authorities.
The principal regulations governing distributions of dividends of foreign holding companies include the Foreign-invested Enterprise Law
(1986), as amended, and the Administrative Rules under the Foreign-invested Enterprise Law (2001).
Under
these 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 accumulated profits each year, if any, to fund certain reserve funds unless
these reserves have reached 50% of the registered capital of the enterprises. These reserves are not distributable as cash dividends.
SAFE issued on October 21, 2005 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 on November 1, 2005, pursuant to which (i) a PRC citizen residing in the
PRC or non-PRC citizen primarily residing in the PRC due to his or her economic tie to the PRC, who is referred to as a "PRC resident" in this circular, must register with the local branch
of the SAFE before it establishes or controls an overseas SPV, for the purpose of overseas equity financing; (ii) when a PRC resident contributes assets of or equity interests in a domestic
enterprise into an overseas SPV, or engages in overseas financing after contributing assets or equity interests into a SPV, such PRC resident must register his or her interest in the SPV and the
change thereof with the local branch of the SAFE; and (iii) when the SPV undergoes a material event outside of China not involving inbound investments, such as change in share capital, creation
of any security interests on its assets or merger and division, the PRC resident shall, within 30 days from the occurrence of such event, register such change with the local branch of the SAFE.
To further clarify the implementation of Circular 75, the SAFE issued several regulations. These regulations require PRC residents to register with local branches of SAFE in connection with
their direct or indirect offshore
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investment
activities and PRC subsidiaries are required to coordinate and supervise such filing and registration. These regulations apply to our shareholders who are PRC residents and may apply to any
offshore acquisitions that we make in the future.
Under
these foreign exchange regulations, PRC residents who make, or have previously made prior to the implementation of these foreign exchange regulations, direct or indirect
investments in SPVs will be required to register those investments. In addition, any PRC resident who is a direct or indirect shareholder of an SPV is required to update the previously filed
registration with the local branch of SAFE to reflect any material change. Moreover, the PRC subsidiaries of that SPV are required to urge the PRC resident shareholders to update their registration
with the local branch of SAFE. If any PRC shareholder fails to make the required registration or update the previously filed registration, the PRC subsidiaries of that SPV may be prohibited from
distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to their SPV parent, and the SPV may also be prohibited from injecting additional capital into
its PRC subsidiaries. Moreover, failure to comply with the various foreign exchange registration requirements described above could result in liabilities for such PRC subsidiaries under PRC laws for
evasion of applicable foreign exchange restrictions. Furthermore, the responsible persons and other persons in such PRC subsidiaries who are held directly liable for the violations may be subject to
administrative sanctions.
Failure
to comply with the above SAFE rules may result in restrictions on the foreign exchange activities of the onshore company, including restricting its PRC subsidiaries' ability to
pay dividends to, or obtain foreign-denominated loans from, the offshore parent, or prevent the offshore parent from
making distributions or paying dividends. PRC residents who control our company from time to time are required to register with SAFE in connection with their investments in us.
On December 25, 2006, the People's Bank of China issued the Administrative Measures of Foreign Exchange Matters for Individuals,
and SAFE issued implementation rules on January 5, 2007, both of which became effective on February 1, 2007. Under these regulations, all foreign exchange matters involved in employee
stock ownership plans, stock option plans or related plans in which onshore individuals participate require the approval of SAFE or its authorized branch. On March 28, 2007, SAFE promulgated
the Application Procedure of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Ownership Plan or Stock Option Plan of Overseas-Listed Company, or
Circular 78.
Under
Circular 78, PRC citizens who participate in an employee stock option plan in an overseas publicly-listed company are required to register with SAFE or its local office and
complete certain other procedures. A PRC agent, which could be the PRC subsidiary of such overseas publicly-listed company, is required to retain a financial institution with stock brokerage
qualification at the listing place or a qualified institution to handle matters relating to the exercise or sale of share options. For participants who had already participated in an employee stock
option plan before the date of Circular 78, their PRC employers or PRC agents are required to complete the relevant formalities within three months of the date of this Circular. We and our PRC
employees who receive share options will be subject to these regulations when we are listed in the United States. If we or our PRC optionees fail to comply with these regulations, we or our PRC
optionees may be subject to fines and other legal or administrative sanctions.
New M&A Regulations and Overseas Listings
On August 8, 2006, six PRC regulatory agencies, including the Ministry of Commerce, the State-owned Assets Supervision and
Administration Commission, the State Administration of Taxation, the State Administration for Industry and Commerce, CSRC and SAFE, jointly issued the New M&A
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Rules,
which became effective on September 8, 2006. The New M&A Rules require offshore special purpose vehicles controlled directly or indirectly by PRC companies or individuals and
formed for the
purpose of listing equity interests in PRC companies on overseas exchanges to obtain CSRC approval prior to such listing.
On
September 21, 2006, the CSRC published procedures regarding its approval of overseas listings by special purpose vehicles. The CSRC approval procedures require filing documents
with the CSRC and take several months to complete. The application of this new PRC regulation remains unclear, with no consensus currently existing among leading PRC law firms regarding the scope of
the CSRC approval requirement.
Labor Laws
The principal labor laws and regulations in the PRC include the PRC Labor Law, the PRC Labor Contract Law, the Implementation Rules of
the PRC Labor Contract Law, the Work-related Injury Insurance Regulations, the Interim Provisions on Registration of Social Insurance and the Interim Regulations on the Collection and
Payment of Social Insurance Fees. Pursuant to the PRC Labor Law and the PRC Labor Contract Law, employers must enter into written labor contracts with full-time employees in order to establish an
employment relationship.
Employers
must pay their employees wages equal to or above local minimum wage standards, establish labor safety and workplace sanitation systems, comply with state labor rules and
standards and provide employees with appropriate training regarding workplace safety. Violations of the PRC Labor Contract Law and the PRC Labor Law may result in fines or other administrative
sanctions or, in the case of serious violations, criminal liability.
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DESCRIPTION OF SHARE CAPITAL
We are a Cayman Islands exempted company and our affairs are governed by our amended and restated memorandum and articles of
association and the Companies Law of the Cayman Islands and the common law of the Cayman Islands. A Cayman Islands exempted company is a company that conducts its business outside of the Cayman
Islands and as such is exempted from certain requirements of the Companies Law.
As
of the date of this prospectus, our authorized share capital was $244,998.154, consisting of 244,998,154 shares, comprising (i) 166,527,507 ordinary shares with a par
value of $0.001 per share, of which 71,560,740 ordinary shares were issued and outstanding; (ii) 32,603,760 Series A convertible participating redeemable preferred shares with a
par value of $0.001 per share, of which 32,447,129 shares were issued and outstanding; (iii) 37,878,789 Series B convertible participating redeemable preferred shares with a par
value of $0.001 per share, all of which were issued and outstanding; and (iv) 7,988,098 Series C convertible participating redeemable preferred shares with a par value of $0.001 per
share, all of which were issued and outstanding. Each of our issued and outstanding Series A convertible participating redeemable preferred shares, Series B convertible participating
redeemable preferred shares and Series C convertible participating redeemable preferred shares will convert into one ordinary share immediately upon the closing of this offering.
Upon
the closing of this offering, we will adopt an amended and restated memorandum and articles of association, which will replace our current memorandum and articles of association in
its entirety, and our authorized share capital will consist of (i) 378,000,000 Class A ordinary shares and (ii) 122,000,000 Class B ordinary shares, each with a par value
of US$0.001. The following are summaries of material provisions of our proposed amended and restated memorandum and articles of association and the Companies Law as they relate to the material terms
of our ordinary shares that we expect will become effective upon the closing of this offering.
Ordinary Shares
Our ordinary shares are divided into Class A ordinary shares and Class B ordinary shares. Holders of Class A
ordinary shares and Class B ordinary shares have the same rights except for voting and conversion rights. All of our outstanding ordinary shares are fully paid. Certificates representing the
ordinary shares are issued in registered form. Our shareholders who are non-residents of the Cayman Islands may freely hold and vote their ordinary shares.
Under Cayman Islands law, we must keep a register of members and there shall be entered therein:
-
(a)
-
the
names and addresses of the members, a statement of the shares held by each member, and of the amount paid or agreed to be considered as paid, on the
shares of each member;
-
(b)
-
the
date on which the name of any person was entered on the register as a member; and
-
(c)
-
the
date on which any person ceased to be a member.
Under
Cayman Islands law, the register of members of our company is prima facie evidence of the matters set out therein (i.e. the register of members will raise a presumption of
fact on the matters referred to above unless rebutted) and a member registered in the register of members shall be deemed as a matter of Cayman Islands law to have legal title to the shares as set
against its name in the register of members. Upon the closing of this public offering, the register of members shall be immediately updated to reflect the issue of shares by us to The Bank of New York
Mellon as the
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depositary.
Once our register of members has been updated, the shareholders recorded in the register of members shall be deemed to have legal title to the shares set against their name.
The holders of our ordinary shares are entitled to such dividends as may be declared by our board of directors subject to the
Companies Law.
Each Class B ordinary share is convertible into one Class A ordinary share at any time by the holder thereof.
Class A ordinary shares are not convertible into Class B ordinary shares under any circumstances. Upon any sale, pledge, transfer, assignment or disposition of Class B ordinary
shares by a holder thereof to any person or entity which is not an affiliate of such holder (as defined in our amended and restated memorandum and articles of association, as amended), such
Class B ordinary share shall be automatically and immediately converted into the equal number of Class A ordinary shares.
Holders of Class A ordinary shares and Class B ordinary shares shall at all time vote together as one class on all
matters submitted to a vote for shareholders' consent. Each Class A ordinary share is entitled to one vote and each Class B ordinary share is entitled to five votes on all matters
subject to the vote at our general meetings. Voting at any shareholders' meeting is by show of hands unless a poll is demanded by the chairman or one or more shareholders present in person or by proxy
entitled to vote and who together hold not less than 10 percent of our paid up voting share capital. To the extent allowed by the Companies Law and other laws and regulations of the Cayman
Islands, shareholders may vote electronically.
A
quorum required for a meeting of shareholders consists of shareholders who hold at least one-third of our paid-up voting share capital at the meeting present in person or
by proxy or, if a corporation or other non-natural person, by its duly authorized representative. Although not required by the Companies Law or our amended and restated memorandum and
articles of association, we expect to hold shareholders' meetings annually and such meetings may be convened by our board of directors on its own initiative or upon a request to the directors by
shareholders holding in aggregate at least one-third in par value of our share capital carrying the right of voting at general meetings. Advance notice of at least twenty-one days is required for the
convening of our annual general meeting and other shareholders meetings.
An
ordinary resolution to be passed by the shareholders requires the affirmative vote of a simple majority of the votes attaching to the ordinary shares cast in a general meeting, while
a special resolution requires the affirmative vote of no less than two-thirds of the votes attaching to the ordinary shares cast in a general meeting. Both ordinary resolutions and special
resolutions may also be passed by a unanimous written resolution signed by all of our shareholders, as permitted by the Companies Law and our amended and restated memorandum and articles of
association. A special resolution will be required for important matters such as a change of name or making changes to our memorandum and articles of association.
Transfer of Ordinary Shares
Subject to the restrictions of our amended and restated memorandum and articles of association, as applicable, any of our shareholders
may transfer all or any of his or her ordinary shares by an instrument of transfer in the usual or common form or any other form approved by our board.
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Our
board of directors may, in its absolute discretion, decline to register any transfer of any ordinary share which is not fully paid up or on which we have a lien. Our directors may
also decline to register any transfer of any ordinary share unless:
-
-
the instrument of transfer is lodged with us, accompanied by the certificate for the ordinary shares to which it relates
and such other evidence as our board of directors may reasonably require to show the right of the transferor to make the transfer;
-
-
the instrument of transfer is in respect of only one class of ordinary shares;
-
-
the instrument of transfer is properly stamped, if required;
-
-
in the case of a transfer to joint holders, the number of joint holders to whom the ordinary share is to be transferred
does not exceed four; or
-
-
the ordinary shares transferred are free of any lien in favor of us.
If
our directors refuse to register a transfer they shall, within two months after the date on which the instrument of transfer was lodged, send to each of the transferor and the
transferee notice of such refusal. The registration of transfers may be suspended and the register closed at such times and for such periods as our board of directors may from time to time determine,
provided, however, that the registration of transfers shall not be suspended nor the register closed for more than 30 days in any year.
On a return of capital on winding up or otherwise (other than on conversion, redemption or purchase of ordinary shares), assets
available for distribution among the holders of ordinary shares shall be distributed among the holders of the ordinary shares on a pro rata basis. If our assets available for distribution are
insufficient to repay all of the paid-up capital, the assets will be distributed so that the losses are borne by our shareholders proportionately.
Our board of directors may from time to time make calls upon shareholders for any amounts unpaid on their ordinary shares in a notice
served to such shareholders at least 14 days prior to the specified time and place of payment. The ordinary shares that have been called upon and remain unpaid on the specified time are subject
to forfeiture.
Subject to the provisions of the Companies Law, we may issue shares on terms that such shares are subject to redemption, at our option
or at the option of the holders thereof, on such terms and in such manner as may be determined, before the issue of such shares, by our board of directors or by a special resolution of our
shareholders.
All or any of the special rights attached to any class of shares may, subject to the provisions of the Companies Law, be varied either
with the written consent of the holders of a majority of the issued shares of that class or with the sanction of a special resolution passed at a general meeting of the holders of the shares of
that class.
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Holders of our ordinary shares will have no general right under Cayman Islands law to inspect or obtain copies of our list of
shareholders or our corporate records. However, we will provide our shareholders with annual audited financial statements. See "Where You Can Find More Information."
Our shareholders may from time to time by ordinary resolutions:
-
-
increase our share capital by such sum, to be divided into shares of such classes and amount, as the resolution shall
prescribe;
-
-
consolidate and divide all or any of our share capital into shares of a larger amount than our existing shares;
-
-
sub-divide our existing shares, or any of them into shares of an amount smaller than the amount fixed by our
amended and restated memorandum and articles of association provided that in the subdivision the proportion between the amount paid and the amount, if any unpaid on each reduced share shall be the
same as it was in case of the share from which the reduced share is derived;
-
-
cancel any shares which, at the date of the passing of the resolution, have not been taken or agreed to be taken by any
person and diminish the amount of our share capital by the amount of the shares so cancelled.
Subject
to the Companies Law, our shareholders may by special resolution reduce our share capital and any capital redemption reserve in any manner authorized by law.
History of Securities Issuances
We were incorporated in the Cayman Islands as an exempted limited liability company on June 9, 2005. We issued a total of
100 ordinary shares, par value $1.00 each, including 55 shares to Young Vision and 45 shares to Global Village. In January 2006, we subdivided our ordinary shares at a 1 to
1,000 ratio. As a result, Young Vision held 55,000 ordinary shares, par value $0.001 each, and Global Village held 45,000 ordinary shares, par value $0.001 each. In
January 2006, we issued 35,881,978 ordinary shares to Young Vision and 29,357,982 ordinary shares to Global Village in connection with the private placement of series A
convertible participating preferred shares. In January 2010, we issued to Young Vision 3,517,544 nonvested shares to be granted to the key employees of certain businesses we acquired.
Such nonvested shares will vest upon the completion of this offering. In January 2010, we also issued to Global Village 2,125,176 ordinary shares in connection with our acquisition of
The World Browser. The ordinary shares held by Young Vision and Global Village will be automatically re-designated as Class B ordinary shares upon the completion of this offering.
In
April 2010, we issued 578,060 ordinary shares to CRP Holdings Limited pursuant to the exercise of share options at an exercise price of $0.65 per share,
which will be automatically re-designated as Class A ordinary shares upon the completion of this offering.
See "Related Party TransactionsPrivate Placements."
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We have granted options to certain of our directors, officers, employees and consultants. As of the date of this prospectus, options to
purchase an aggregate of 11,047,650 ordinary shares were outstanding. See "ManagementShare Option Plans."
Differences in Corporate Law
The Companies Law of the Cayman Islands is modeled after that of English Companies legislation but does not follow recent English
statutory enactments. In addition, the Companies Law differs from laws applicable to Delaware corporations and their shareholders. Set forth below is a summary of the significant differences between
the provisions of the Companies Law applicable to us and the laws applicable to companies incorporated in Delaware and their shareholders.
The Companies Law permits mergers and consolidations between Cayman Islands companies and mergers and acquisitions between Cayman
Islands companies and non-Cayman Islands companies. For these purposes, (a) "merger" means the merging of two or more constituent companies and the vesting of their undertaking,
property and liabilities in one of such companies as the surviving company and (b) a "consolidation" means the combination of two or
more constituent companies into a consolidated company and the vesting of the undertaking, property and liabilities of such companies to the consolidated company.
In
order to effect such a merger or consolidation, the directors of each constituent company must approve a written plan of merger or consolidation, which must then be authorized by
either (a) a special resolution of the shareholders of each constituent company voting together as one class, if the shares to be issued to each shareholder in the consolidated or surviving
company will have the same rights and economic value as the shares held in the relevant constituent company or (b) a shareholder resolution of each constituent company passed by a majority in
number representing 75% in value of the shareholders voting together as one class. The written plan of merger or consolidation must be filed with the Registrar of Companies together with a declaration
as to the solvency of the consolidated or surviving company, a list of the assets and liabilities of each constituent company and an undertaking that a copy of the certificate of merger or
consolidation will be given to the members and creditors of each constituent company and published in the Cayman Islands Gazette. Dissenting shareholders have the right to receive the fair value of
their shares (which, if not agreed between the parties, will be determined by the Cayman Islands court) if they follow the required procedures, subject to certain exceptions. Court approval is not
required for a merger or consolidation which is effected in compliance with these statutory procedures.
In
addition, there are statutory provisions that facilitate the reconstruction and amalgamation of companies, provided that the arrangement is approved by a majority in number of each
class of shareholders and creditors with whom the arrangement is to be made, and who must, in addition, represent three-fourths in value of each such class of shareholders or creditors, as the case
may be, that are present and voting either in person or by proxy at a meeting, or meetings, convened for that purpose. The convening of the meetings and subsequently the arrangement must be sanctioned
by the Grand Court of the Cayman Islands. While a dissenting shareholder has the right to express to the court the view that the transaction ought not to be approved, the court can be expected to
approve the arrangement if it determines that:
-
-
the statutory provisions as to the required majority vote have been met;
-
-
the shareholders have been fairly represented at the meeting in question;
-
-
the arrangement is such that may be reasonably approved; and
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-
-
the arrangement is not one that would more properly be sanctioned under some other provision of the Companies Law.
When
a take over offer is made and accepted by holders of 90% of the shares affected within four months, the offeror may, within a two-month period commencing on the
expiration of such four month period, require the holders of the remaining shares to transfer such shares on the terms of the offer. An objection can be made to the Grand Court of the Cayman Islands
but this is unlikely to succeed in the case of an offer that has been so approved unless there is evidence of fraud, bad faith or collusion.
If
an arrangement and reconstruction is thus approved, the dissenting shareholder would have no rights comparable to appraisal rights, which would otherwise ordinarily be available to
dissenting shareholders of Delaware corporations, providing rights to receive payment in cash for the judicially determined value of the shares.
In principle, we will normally be the proper plaintiff and a derivative action may not be brought by a minority shareholder. However,
based on English authorities, which would in all likelihood be of persuasive authority in the Cayman Islands, the Cayman Islands courts can be expected to apply and follow the common law principles
(namely the rule in
Foss v. Harbottle
and the exceptions thereto) which permit a minority shareholder to commence a class action against, or derivative
actions in the name of, a company to challenge:
-
-
an act which is illegal or ultra vires;
-
-
an action which requires a resolution with a qualified or special majority which has not been obtained; and
-
-
an act which constitutes a fraud on the minority where the wrongdoers are themselves in control of the company.
Under
Delaware law, a stockholder may bring a derivative action on behalf of the corporation to enforce the rights of the corporation. Delaware law expressly authorizes stockholder
derivative suits on the condition that the stockholder either held the stock at the time of the transaction of which the stockholder complains, or acquired the stock thereafter by operation of law and
continues to hold it throughout the duration of the suit. An individual may also commence a class action suit on behalf of himself and other similarly situated stockholders where the requirements for
maintaining a class action under Delaware law have been met. A plaintiff instituting a derivative suit is required to serve a demand on the corporation before bringing suit, unless such demand would
be futile.
Cayman Islands laws do not restrict transactions with directors, requiring only that directors exercise a duty of care and owe a
fiduciary duty to the companies for which they serve. Under our amended and restated memorandum and articles of association, subject to any separate requirement for audit committee approval under the
applicable rules of the New York Stock Exchange or unless disqualified by the chairman of the relevant board meeting, so long as a director discloses the nature of his interest in any contract
or arrangement in which he is interested, such a director may vote in respect of any contract or proposed contract or arrangement in which such director is interested and may be counted in the quorum
at such meeting.
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As a matter of Cayman Islands law, a director of a Cayman Islands company is in the position of a fiduciary with respect to the company
and therefore he owes the following duties to the company:
-
-
a duty to act bona fide in the best interests of the company;
-
-
a duty not to make a profit based on his or her position as director (unless the company permits him to do so); and
-
-
a duty not to put himself in a position where the interests of the company conflict with his or her personal interest or
his or her duty to a third party.
A
director of a Cayman Islands company owes to the company a duty to act with skill and care. It was previously considered that a director did not need to exhibit in the performance of
his or her duties a greater degree of skill than what was reasonably be expected from a person of his or her knowledge and experience. However, English and Commonwealth courts have moved towards an
objective standard with regard to the required skill and care and these authorities are likely to be followed in the Cayman Islands.
The Companies Law does not require a director who is interested in a transaction entered into by a Cayman company to disclose his
interest nor does the Companies Law render such director liable to such company for any profit realized pursuant to such transaction. Such an obligation is imposed under our amended and restated
memorandum and articles of association and a director must act in accordance with his duties at common law (as above).
Under Cayman Islands law, the voting rights of shareholders are regulated by a company's articles of association and, in certain
circumstances, the Companies Law. The articles of association will govern matters such as quorum for the transaction of business, rights of shares and majority votes required to approve any action or
resolution at a meeting of the shareholders or board of directors. Under the Companies Law, certain matters must be approved by a special resolution, which is defined as two-thirds of the
votes cast by shareholders present at a meeting and entitled to vote, or such higher majority as imposed by a company's articles of association; otherwise, unless the articles of association otherwise
provide, the requisite majority is a simple majority of votes cast.
Cayman Islands law does not limit the extent to which a company's articles of association may provide for indemnification of officers
and directors, except to the extent any such provision may be held by the Cayman Islands courts to be contrary to public policy, such as to provide indemnification against civil fraud or the
consequences of committing a crime. Our amended and restated memorandum and articles of association permit indemnification of officers and directors for losses, damages, costs and expenses incurred in
their capacities as such unless such losses or damages arise from dishonesty or fraud which may attach to such directors or officers.
Cayman Islands law provides shareholders with only limited rights to requisition a general meeting, and does not provide shareholders
with any right to put any proposal before a general meeting. However, these rights may be provided in a company's articles of association. Our amended and restated memorandum and articles of
association allow our shareholders holding not less than one-third
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of
our voting share capital to requisition a special meeting of the shareholders, in which case the directors are obliged to call such meeting and to put the resolutions so requisitioned to a vote at
such meeting; however, our amended and restated memorandum and articles of association do not provide
our shareholders with any right to put any proposals before annual general meetings or extraordinary general meetings not called by such shareholders.
As
a Cayman Islands exempted company, we are not obliged by the Companies Law to call shareholders' annual general meetings. Our amended and restated memorandum and articles of
association provide that we may (but are not obliged to) in each year hold a general meeting as our annual general meeting in which case we shall specify the meeting as such in the notices
calling it, and the annual general meeting shall be held at such time and place as may be determined by our directors. We, however, will hold an annual shareholders' meeting during each fiscal year,
as required by the rules of the New York Stock Exchange.
The Companies Law and our amended and restated memorandum and articles of association provide that shareholders may approve corporate
matters by way of a unanimous written resolution signed by or on behalf of each shareholder who would have been entitled to vote on such matter at a general meeting without a meeting
being held.
The Companies Law does not have provisions governing the proceedings of shareholders meetings, which are usually provided in the
articles of association.
The Companies Law allows shares to be issued with preferred, deferred or other special rights, whether in regard to dividends, voting,
return of share capital or otherwise. Our amended and restated memorandum and articles of association provide that the directors may allot, issue, grant options over or otherwise dispose of shares
(including fractions of a share) with or without preferred, deferred or other special rights or restrictions, in one or more series, whether with regard to dividend rights, dividend rates, conversion
rights, voting rights, rights and terms of redemption and liquidation preferences or otherwise and to such persons, at such times and on such other terms as they think proper.
The Companies Law does not prevent companies from adopting a wide range of defensive measures, such as staggered boards, blank check
preferred shares, removal of directors only for cause and provisions that restrict the rights of shareholders to call meetings and submit shareholder proposals. Our amended and restated articles of
association contain the following provisions which may be regarded as defensive measures: (i) the ability to issue preferred shares and (ii) directors may in their absolute discretion
decline to register any transfer of shares (not being a fully paid share) without assigning any reason.
Registration Rights in Connection with Pre-IPO Financing
Pursuant to the second amended and restated registration rights agreement entered into on January 8, 2010, we have granted
certain registration rights to holders of our registrable securities, which mean ordinary shares issuable or issued upon conversion of the Series A, Series B and Series C
convertible participating redeemable preferred shares as of the date of the second amended and rested registration rights agreement. Set forth below is a description of the registration rights.
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Demand registration rights.
At any time after the earlier of (i) June 30, 2011 or (ii) twelve months after the
completion of our
initial public offering, including this offering, holders of at least 50% of the registrable securities then outstanding have the right to demand that we file a registration statement other
than on Form F-4, S-4, F-8 or S-8 for at least 20% of the registrable securities then held by such holders (or any lesser
percentage if the anticipated aggregate offering price (before deduction of underwriting discounts and commissions) exceeds $5,000,000). We, however, are not obliged to effect a demand registration if
we have already effected (i) two demand registrations or (ii) any demand registration or F-3 registration within the prior six months. We have the right to defer the
filing of a registration statement up to 90 days if our board of directors determine in good faith that such registration and offering would be materially detrimental to us and our
shareholders, provided that we may not utilize this right more than once in any 12-month period.
Piggyback registration rights.
If we propose to register any of our shares under the Securities Act on Form F-4, S-4
or S-8 in connection with the public offering of such securities, we must offer holders of registrable securities an opportunity to include in the registration all or any part of
their registrable securities that each such holder may request to be registered.
Form F-3 registration.
Holders of our registrable securities then outstanding have the right to request that we file a
registration statement under Form F-3 when we are eligible to use Form F-3.
We
also have the right to postpone a registration pursuant to this request up to 60 days if our board of directors determine in good faith that it would be materially detrimental
to us and our shareholders for such Form F-3 registration. We may not utilize this right more than once in any 12-month period. There is no limit on the number of the
registration made pursuant to this request so long as the anticipated gross offering proceeds (before deduction of underwriting discounts and commissions) exceed $500,000; provided that we are not
obliged to effect any such registration if (i) Form F-3 is not available for such offering by the holders, (ii) we have already effective two registrations within
twelve months preceding such request, or (iii) the request is made within 90 days after we have effected a registration.
Expenses of registration.
We will pay all expenses (other than underwriting discounts and commissions and stock transfer taxes) in
connection with
the demand registration, Form F-3 registration and piggyback registration including all registration and filing fees, printers' and accounting fees, the reasonable legal fees,
charges and expenses incurred by one counsel selected by the initiating holders. The holders participating in the registration on Form F-3 shall bear all expenses in connection with
such registration if the registration request is subsequently withdrawn at the request of the initiating holders.
Registration Rights in Connection with Concurrent Private Placement
Under the registration rights agreement entered into on March 14, 2011 in connection with our concurrent private placement of
Class A ordinary shares in the form of restricted ADSs, we have granted certain registration rights to the investors in the private placement, which we refer to as holders of our registrable
securities below. Set forth below is a description of the registration rights.
Demand registration rights.
At any time 180 days after the closing of this offering, any holder of registrable securities then
outstanding
have the right to demand that we file a registration statement. We, however, are not obliged to effect a demand registration if we have already effected (i) three demand registrations or
(ii) any demand registration or F-3 registration within the prior six months. We have the right to defer the filing of a registration statement up to 60 days if our
board of directors determine in good faith that such registration and offering would be materially detrimental to us and our shareholders, provided that we may not utilize this right more than once in
any 12-month period.
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Piggyback registration rights.
If we propose to register any of our shares under the Securities Act in connection with the public
offering of such
securities, we must offer holders of registrable securities an opportunity to include in the registration all or any part of their registrable securities that each such holder may request to
be registered.
Form F-3 registration.
Holders of our registrable securities then outstanding have the right to request that we file a
registration statement under Form F-3 when we are eligible to use Form F-3. We also have the right to postpone a registration pursuant to this request up to
60 days if our board of directors determine in good faith that it would be materially detrimental to us and our shareholders for such Form F-3 registration. We may not
utilize this right more than once in any 12-month period. There is no limit on the number of the registration made pursuant to this request so long as the anticipated gross offering
proceeds (before deduction of underwriting discounts and commissions) exceed $1,000,000; provided that we are not obliged to effect any such registration if (i) Form F-3 is
not available for such offering by the holders, (ii) we have already effective two registrations within twelve months preceding such request, (iii) the request is made within six
months after we have effected a registration.
Expenses of registration.
We will pay all expenses (other than underwriting discounts and commissions and stock transfer taxes) in
connection with
the demand registration, Form F-3 registration and piggyback registration including all registration and filing fees, printers' and accounting fees, the legal fees, charges and
expenses of counsel to the initiating holders. We will not be required
to pay for any expenses of any demand registration if the registration request is subsequently withdrawn at the request of the initiating holders.
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SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering and our concurrent private placement, we will have 15,559,076 outstanding ADSs, including
3,448,276 restricted ADSs issued and outstanding in connection with our concurrent private placement, representing approximately 13.47% of our ordinary shares in issue. All of the ADSs sold in this
offering and the Class A ordinary shares they represent will be freely transferable by persons other than our "affiliates" without restriction or further registration under the Securities Act.
Sales or perceived sales of substantial amounts of our ADSs in the public market could adversely affect prevailing market prices of our ADSs. Prior to this offering, there has been no public market
for our ordinary shares or the ADSs, and we cannot assure you that a regular trading market for our ADSs will develop. Our ordinary shares will not be listed on any exchange or quoted for trading on
any over-the-counter trading system. We do not expect that a trading market will develop for our ordinary shares not represented by the ADSs.
Lock-up Agreements
We, our directors, executive officers, all of our existing shareholders and the private placement investors have agreed with the
underwriters to certain lock-up arrangements. See "Underwriting."
Rule 144
In general, under Rule 144, a person (or persons whose shares are aggregated) who is not deemed to have been an affiliate
of ours at any time during the three months preceding a sale, and who has beneficially owned restricted securities within the meaning of Rule 144
for at least six months (including any period of consecutive ownership of preceding non-affiliated holders) will be entitled to sell those shares, subject only to the availability of
current public information about us. A non-affiliated person who has beneficially owned restricted securities within the meaning of Rule 144 for at least one year will be entitled
to sell those shares without regard to the provisions of Rule 144.
In
general, under Rule 144, our affiliates or persons selling shares on behalf of our affiliates are entitled to sell, upon the expiration of the lock-up agreements
described above, a number of shares that does not exceed the greater of:
-
-
1% of the number of ordinary shares then outstanding, in the form of ADSs or otherwise, which will equal approximately
shares immediately after this offering; or
-
-
the average weekly trading volume of the ADSs representing our ordinary shares on the New York Stock Exchange
during the four calendar weeks preceding the filing of a notice on Form 144 with respect to such sale.
Sales
under Rule 144 by our affiliates or persons selling shares on behalf of our affiliates are also subject to certain manner of sale provisions and notice requirements and to
the availability of current public information about us.
Rule 701
Beginning 90 days after the date of this prospectus, persons other than affiliates who purchased ordinary shares under a written
compensatory plan or contract may be entitled to sell such shares in the United States in reliance on Rule 701. Rule 701 permits affiliates to sell their Rule 701 shares
under Rule 144 without complying with the holding period requirements of Rule 144. Rule 701 further provides that non-affiliates may sell these shares in reliance on
Rule 144 subject only to its manner-of-sale requirements. However, the Rule 701 shares would remain subject to lock-up arrangements and would only
become eligible for sale when the lock-up period expires in the form of restricted ADSs.
Registration Rights
We have granted certain registration rights to holders of our Series A, Series B and Series C convertible
participating redeemable preferred shares. See "Related Party TransactionsPrivate Placements." We have also granted certain registration rights to investors in our concurrent private
placement of Class A ordinary shares.
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DESCRIPTION OF AMERICAN DEPOSITARY SHARES
American Depositary Shares
The Bank of New York Mellon, as depositary, will register and deliver American Depositary Shares, also referred to as ADSs. Every two
ADSs will represent three Class A ordinary shares (or a right to receive three Class A ordinary shares) deposited with the principal Hong Kong office of The Hongkong and Shanghai Banking
Corporation Limited, as custodian for the depositary. Each ADS will also represent any other securities, cash or other property which may be held by the depositary. The depositary's corporate trust
office at which the ADSs will be administered is located at 101 Barclay Street, New York, New York 10286. The Bank of New York's principal executive office is located at One Wall Street, New York, New
York 10286.
You
may hold ADSs either (A) directly (i) by having an American Depositary Receipt, also referred to as an ADR, which is a certificate evidencing a specific number of ADSs,
registered in your name, or (ii) by having ADSs registered in your name in the Direct Registration System, or (B) indirectly by holding a security entitlement in ADSs through your broker
or other financial institution. If you hold ADSs directly, you are a registered ADS holder, also referred to as an ADS holder. This description assumes you are an ADS holder. If you hold the ADSs
indirectly, you must rely on the procedures of your broker or other financial institution to assert the rights of ADS holders described in this section. You should consult with your broker or
financial institution to find out what those procedures are.
The
Direct Registration System, or DRS, is a system administered by The Depository Trust Company, also referred to as DTC, pursuant to which the depositary may register the ownership of
uncertificated ADSs, which ownership is confirmed by periodic statements sent by the depositary to the registered holders of uncertificated ADSs.
As
an ADS holder, we will not treat you as one of our ordinary shareholders and you will not have ordinary shareholder rights. Cayman Islands law governs ordinary shareholder rights. The
depositary will be the holder of the Class A ordinary shares underlying your ADSs. As a registered holder of ADSs, you will have ADS holder rights. A deposit agreement among us, the depositary
and you, as an ADS holder, and all other persons indirectly holding ADSs sets out ADS holder rights as well as the rights and obligations of the depositary. New York law governs the deposit agreement
and the ADSs.
The
following is a summary of the material provisions of the deposit agreement. For more complete information, you should read the entire deposit agreement and the form of ADR.
Directions on how to obtain copies of those documents are provided in "Where You Can Find More Information."
Dividends and Other Distributions
How will you receive dividends and other distributions on the Class A ordinary shares?
The depositary has agreed to pay to ADS holders the cash dividends or other distributions it or the custodian receives on
Class A ordinary shares or other deposited securities, after deducting its fees and expenses. You will receive these distributions in proportion to the number of Class A Ordinary shares
your ADSs represent.
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Cash.
The depositary will convert any cash dividend or other cash distribution we pay
on the Class A ordinary shares into U.S. dollars, if it can do so on a reasonable basis and can transfer the U.S. dollars to the United States. If that is not possible or if any government
approval is needed and cannot be obtained, the deposit agreement allows the depositary to distribute the foreign currency only to those ADS holders to whom it is possible to do so. It will hold the
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Before
making a distribution, any withholding taxes, or other governmental charges that must be paid will be deducted. See "Taxation." It will distribute only whole U.S. dollars and cents and will
round fractional cents to the nearest whole cent.
If the exchange rates fluctuate during a time when the depositary cannot convert the foreign currency, you may lose some or
all of the value of the distribution.
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Ordinary
shares.
The depositary may distribute additional ADSs representing any Class A ordinary shares we distribute as a dividend or
free distribution. The depositary will only distribute whole ADSs. It will sell Class A ordinary shares which would require it to deliver a fractional ADS and distribute the net proceeds in the
same way as it does with cash. If the depositary does not distribute additional ADSs, the outstanding ADSs will also represent the new Class A ordinary shares. The depositary may sell a portion
of the distributed Class A ordinary shares sufficient to pay its fees and expenses in connection with that distribution.
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Rights to purchase additional ordinary
shares.
If we offer holders of our securities any rights to subscribe for additional Class A ordinary shares or any other rights,
the depositary may make these rights available to ADS holders. If the depositary decides it is not legal and practical to make the rights available but that it is practical to sell the rights, the
depositary will use reasonable efforts to sell the rights and distribute the proceeds in the same way as it does with cash. The depositary will allow rights that are not distributed or sold to lapse.
In that case, you will
receive no value for them.
If
the depositary makes rights available to ADS holders, it will exercise the rights and purchase the Class A ordinary shares on your behalf. The depositary will then deposit the Class A
ordinary shares and
deliver ADSs to the persons entitled to them. It will only exercise rights if you pay it the exercise price and any other charges the rights require you to pay.
U.S.
securities laws may restrict transfers and cancellation of the ADSs represented by Class A ordinary shares purchased upon exercise of rights. For example, you may not be able to trade
these ADSs freely in the United States. In this case, the depositary may deliver restricted depositary ordinary shares that have the same terms as the ADSs described in this section except for changes
needed to put the necessary restrictions in place.
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Other
Distributions.
The depositary will send to ADS holders anything else we distribute on deposited securities by any means it thinks is
legal, fair and practical. If it cannot make the distribution in that way, the depositary has a choice. It may decide to sell what we distributed and distribute the net proceeds, in the same way as it
does with cash. Or, it may decide to hold what we distributed, in which case ADSs will also represent the newly distributed property. However, the depositary is not required to distribute any
securities (other than ADSs) to ADS holders unless it receives satisfactory evidence from us that it is legal to make that distribution.
The
depositary is not responsible if it decides that it is unlawful or impractical to make a distribution available to any ADS holders. We have no obligation to register ADSs, ordinary
shares, rights or other securities under the Securities Act. We also have no obligation to take any other action to permit the distribution of ADSs, ordinary shares, rights or anything else to ADS
holders.
This means that you may not receive the distributions we make on our Class A ordinary shares or any value for them if it is illegal or impractical for us to
make them available to you
. The depositary would continue to hold any property received in respect of deposited shares that is not distributed as deposited securities under the
deposit agreement, in its account with the custodian or in another place it determines, for the benefit of ADS holders until that property can be distributed to ADS holders or otherwise disposed of
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for
their benefit. The depositary may sell a portion of the distributed securities or property sufficient to pay its fees and expenses in connection with that distribution.
Deposit, Withdrawal and Cancellation
How are ADSs issued?
The depositary will deliver ADSs if you or your broker deposit Class A ordinary shares or evidence of rights to receive
Class A ordinary shares with the custodian. Upon payment of its fees and expenses and of any taxes or charges, such as stamp taxes or stock transfer taxes or fees, the depositary will register
the appropriate number of ADSs in the names you request and will deliver the ADSs to or upon the order of the person or persons that made the deposit. The depositary will not be required to accept for
deposit any number of Class A ordinary shares that would result in creation of a fraction of an ADS.
How can ADS holders withdraw the deposited securities?
You may surrender your ADSs at the depositary's corporate trust office. Upon payment of its fees and expenses and of any taxes or
charges, such as stamp taxes or stock transfer taxes or fees, the depositary will deliver the Class A ordinary shares and any other deposited securities underlying the ADSs to the ADS holder or
a person the ADS holder designates at the office of the custodian. Or, at your request, risk and expense, the depositary will deliver the deposited securities at its corporate trust office, if
feasible. The depositary will not be required to accept a surrender of any number of ADSs that would result in the delivery of a fraction of a deposited security.
How do ADS holders interchange between certificated ADSs and uncertificated ADSs?
You may surrender your ADR to the depositary for the purpose of exchanging your ADR for uncertificated ADSs. The depositary will cancel
that ADR and will send to the ADS holder a statement confirming that the ADS holder is the registered holder of uncertificated ADSs. Alternatively, upon receipt by the depositary of a proper
instruction from a registered holder of uncertificated ADSs requesting the exchange of uncertificated ADSs for certificated ADSs, the depositary will execute and deliver to the ADS holder an ADR
evidencing those ADSs.
Voting Rights
How do you vote?
ADS holders may instruct the depositary to vote the number of deposited Class A ordinary shares their ADSs represent. The
depositary will notify ADS holders of ordinary shareholders' meetings and arrange to deliver our voting materials to them if we ask it to. Those materials will describe the matters to be voted on and
explain how ADS holders may instruct the depositary how to vote. For instructions to be valid, they must reach the depositary by a date set by the depositary or as described in the following
paragraph.
If
we asked for your instructions but the depositary does not receive your instructions by the cutoff date it sets, the depositary will give us a discretionary proxy to vote the
Class A ordinary shares underlying your ADSs as to all matters at shareholders' meetings unless we inform the depositary that:
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we do not wish to receive a discretionary proxy;
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there is substantial opposition to the particular matter; or
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the particular matter would have a material adverse impact on shareholders.
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Otherwise, you won't be able to exercise your right to vote unless you withdraw the ordinary shares. However, you may not know about the meeting enough in advance
to withdraw the ordinary shares.
The
depositary will try, as far as practical, subject to the laws of the Cayman Islands and of our articles of association or similar documents, to vote or to have its agents vote the
ordinary shares or other deposited securities as instructed by ADS holders. The depositary will only vote or attempt to vote as instructed.
We
cannot assure you that you will receive the voting materials or otherwise learn of an upcoming shareholder meeting in time to ensure that you can instruct the depositary to vote your
ordinary shares. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for the manner of carrying out voting instructions.
This means that you may not be able to
exercise your right to vote and there may be nothing you can do if your ordinary shares are not voted as you
requested.
If
we ask for your voting instructions, we will give the Depositary notice of the meeting and details concerning the matters to be voted upon at least 30 days in advance of the
meeting date and the depositary will distribute a notice to the registered holders of ADSs, as soon as practicable after it receives materials from us.
Fees and Expenses
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Persons depositing or withdrawing Class A ordinary shares or ADS holders must pay:
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For:
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$5.00 (or less) per 100 ADSs (or portion of 100 ADSs)
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Issuance of ADSs, including issuances resulting from a
distribution of ordinary shares or rights or other property
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Cancellation of ADSs for the purpose of withdrawal,
including if the deposit agreement terminates
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$.05 (or less) per ADS
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Any cash distribution to ADS holders
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A fee equivalent to the fee that would be payable if securities distributed to you had been Class A ordinary shares and the
Class A ordinary shares had been deposited for issuance of ADSs
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Distribution of securities distributed to holders of
deposited securities which are distributed by the depositary to ADS holders
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$.05 (or less) per ADSs per calendar year
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Depositary services
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Registration or transfer fees
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Transfer and registration of Class A ordinary shares
on our ordinary share register to or from the name of the depositary or its agent when you deposit or withdraw Class A ordinary shares
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Expenses of the depositary
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Cable, telex and facsimile transmissions (when expressly
provided in the deposit agreement)
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converting foreign currency to U.S. dollars
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Taxes and other governmental charges the depositary or the custodian have to pay on any ADS or Class A ordinary share underlying an ADS,
for example, stock transfer taxes, stamp duty or withholding taxes
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As necessary
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Any charges incurred by the depositary or its agents for servicing the deposited securities
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As necessary
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The
Bank of New York Mellon, as depositary, has agreed to reimburse us for expenses we incur that are related to establishment and maintenance of the ADS program, including investor
relations expenses and stock market application and listing fees.
The
depositary collects its fees for delivery and surrender of ADSs directly from investors depositing Class A ordinary shares or surrendering ADSs for the purpose of withdrawal
or from intermediaries acting for them. The depositary collects fees for making distributions to investors by deducting those fees from the amounts distributed or by selling a portion of distributable
property to pay the fees. The depositary may collect its annual fee for depositary services by deduction from cash distributions or by directly billing investors or by charging the
book-entry system accounts of participants acting for them. The depositary may generally refuse to provide fee-attracting services until its fees for those services are paid.
Payment of Taxes
You will be responsible for any taxes or other governmental charges payable on your ADSs or on the deposited securities represented by
any of your ADSs. The depositary may refuse to register any transfer of your ADSs or allow you to withdraw the deposited securities represented by your ADSs until such taxes or other charges are paid.
It may apply payments owed to you or sell deposited securities represented by your American Depositary Ordinary shares to pay any taxes owed and you will remain liable for any deficiency. If the
depositary sells deposited securities, it
will, if appropriate, reduce the number of ADSs to reflect the sale and pay to ADS holders any proceeds, or send to ADS holders any property, remaining after it has paid the taxes.
Reclassifications, Recapitalizations and Mergers
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If we:
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Then:
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Change the nominal or par value of our Class A
ordinary shares
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The cash, ordinary shares or other securities received by the depositary will become deposited securities. Each ADS will
automatically represent
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Reclassify, split up or consolidate any of the deposited
securities
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its equal ordinary share of the new deposited securities.
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Distribute securities on the Class A ordinary shares
that are not distributed to you
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The depositary may, and will if we ask it to, distribute some or all of the cash, ordinary shares or other securities it
received. It may also deliver
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Recapitalize, reorganize, merge, liquidate, sell all or
substantially all of our assets, or take any similar action
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new ADRs or ask you to surrender your outstanding ADRs in exchange for new ADRs identifying the new deposited securities.
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