20-F 1 d500262d20f.htm FORM 20-F Form 20-F
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 20-F

 

 

(Mark One)

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

OR

 

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

For the fiscal year ended December 31, 2012.

OR

 

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

OR

 

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

Date of event requiring this shell company report             

For the transition period from              to             

Commission file number: 001-35145

 

 

NQ MOBILE INC.

(Exact name of Registrant as specified in its charter)

 

 

N/A

(Translation of Registrant’s name into English)

Cayman Islands

(Jurisdiction of incorporation or organization)

No. 4 Building, 11 Heping Li East Street

Dongcheng District, Beijing 100013

The People’s Republic of China

(Address of principal executive offices)

4514 Travis Street, Suite 200

Dallas, TX 75205

The United States

(Address of principal executive offices)

Suhai Ji, Chief Financial Officer

Tel: +86 (10) 8565-5555

E-mail: suhai@nq.com

Fax: +86 (10) 8565-5518

No. 4 Building

11 Heping Li East Street

Dongcheng District

Beijing 100013

The People’s Republic of China

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

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

 

Title of Each Class

 

Name of Exchange on Which Registered

Class A common shares, par value US$0.0001 per share

  New York Stock Exchange*

 

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

 

 

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

None

(Title of Class)

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

None

(Title of Class)

 

 

Indicate the number of outstanding shares of each of the Issuer’s classes of capital or common stock as of the close of the period covered by the annual report. 136,120,102 Class A common shares (excluding 556,485 Class A common shares represented by ADSs that are reserved for issuance upon the exercise of outstanding options), par value US$0.0001 per share, and 105,152,531 Class B common shares, par value US$0.0001 per share, as of December 31, 2012.

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

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

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

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

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

 

 

Large accelerated filer  ¨        

      Accelerated filer  x               Non-accelerated filer  ¨  

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

 

U.S. GAAP x

     International Financial Reporting Standards as issued by the International Accounting Standards Board ¨    Other ¨

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

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

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

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

 

 

 


Table of Contents

TABLE OF CONTENTS

 

INTRODUCTION

     1   

FORWARD-LOOKING STATEMENTS

     2   

PART I

     3   

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS

     3   

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

     3   

ITEM 3. KEY INFORMATION

     3   

ITEM 4. INFORMATION ON THE COMPANY

     36   

ITEM 4A UNRESOLVED STAFF COMMENTS

     58   

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

     58   

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

     83   

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

     96   

ITEM 8. FINANCIAL INFORMATION

     99   

ITEM 9. THE OFFER AND LISTING

     100   

ITEM 10. ADDITIONAL INFORMATION

     101   

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     109   

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

     109   

PART II

     112   

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

     112   

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

     112   

ITEM 15. CONTROLS AND PROCEDURES

     112   

ITEM 16. [RESERVED]

     113   

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

     113   

ITEM 16B. CODE OF ETHICS

     113   

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

     114   

ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

     114   

ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

     114   

ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

     115   

ITEM 16G. CORPORATE GOVERNANCE

     115   

ITEM 16H. MINE SAFETY DISCLOSURE

     115   

PART III

     116   

ITEM 17. FINANCIAL STATEMENTS

     116   

ITEM 18. FINANCIAL STATEMENTS

     116   

ITEM 19. EXHIBITS

     116   

Exhibit 4.2 

 

2011 Share Incentive Plan, as amended

  
Exhibit 4.5   English translation of Amended and Restated Business Operations Agreement, dated as of June 6, 2012, among NQ Beijing, Beijing Technology and the shareholders of Beijing Technology   
Exhibit 4.6   English translation of Amended and Restated Equity Interest Pledge Agreement, dated as of June 6, 2012, among NQ Beijing and the shareholders of Beijing Technology   
Exhibit 4.8   English translation of Amended and Restated Equity Disposition Agreement, dated as of June 6, 2012, among NQ Beijing, Beijing Technology and the shareholders of Beijing Technology   
Exhibit 4.11   English translation of Loan Agreements, dated as of May 31, 2012 among NQ Beijing and the shareholders of Beijing Technology   
Exhibit 4.13   English translation of Wireless Value-Added Application Services Channel Cooperation Agreement (Domestic), dated as of June 1, 2012, as amended, between Beijing Technology and Tianjin Yidatong Technology Development Co., Ltd.   
Exhibit 4.16   English translation of the Capital Increase and Stock Transfer Agreement among Beijing Technology, NationSky, Shuli Hou and Wen Yang dated as of May 2, 2012   
Exhibit 4.17   English translation of the Shareholders’ Agreement among Beijing Technology, NationSky and Shuli Hou, dated as of May 2, 2012   
Exhibit 4.18   English translation of the Restricted Common Shares Purchase Agreement between NQ Mobile Inc. and Gather Benefit Holding Limited, dated as of May 2, 2012   
Exhibit 4.19   English translation of the Stock Transfer Agreement among Beijing Technology, Beijing Feiliu and the original shareholders of Beijing Feiliu dated as of November 12, 2012   
Exhibit 4.20   English translation of the Restricted Common Shares Purchase Agreement among NQ Mobile Inc., Beijing Feiliu and Zhong Liang, dated as of November 12, 2012   
Exhibit 4.21   Lock-up Agreement between NQ Mobile Inc. and RPL Holdings Limited, dated as of September 5, 2012   

Exhibit 8.1

 

List of Significant Subsidiaries

  

Exhibit 12.1

 

Certification by the Principal Executive Officers Pursuant to Section  302 of the Sarbanes-Oxley Act of 2002

  

Exhibit 12.2

 

Certification by the Principal Financial Officer Pursuant to Section  302 of the Sarbanes-Oxley Act of 2002

  

Exhibit 13.1

 

Certification by the Principal Executive Officers Pursuant to Section  906 of the Sarbanes-Oxley Act of 2002

  

Exhibit 13.2

 

Certification by the Principal Financial Officer Pursuant to Section  906 of the Sarbanes-Oxley Act of 2002

  

Exhibit 15.1

 

Consent of Maples and Calder

  

Exhibit 15.2

 

Consent of Jingcheng Tongda & Neal

  

Exhibit 15.3

 

Consent of Independent Registered Public Accounting Firm

  


Table of Contents

INTRODUCTION

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

 

   

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

 

   

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

 

   

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

 

   

“registered user account” or “activated user account” means a user account that was registered with us. We calculate registered user accounts for any particular period as the cumulative number of user accounts at the end of the relevant period. Because every time a person activates one of our mobile security products after the initial installation, an unique registered user account is generated, and each person can install and activate more than one of our products on his or her smartphone device, each smartphone device could be associated with more than one of our registered users accounts. In addition, each person could have more than one smartphone device with our mobile security products installed and activated. Consequently, the number of registered user accounts we present in this annual report overstates the number of persons who are our registered users;

 

   

“active user account” for a specific period means the registered user account that has accessed our services at least once during such relevant period; and

 

   

“paying user account” means the user account that has paid or subscribed for our premium services during the relevant period.

 

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FORWARD-LOOKING STATEMENTS

This annual report contains forward-looking statements that involve risks and uncertainties. All statements other than statements of historical facts are forward-looking statements. These forward-looking statements are made under the “safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements.

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

 

   

our goals and strategies;

 

   

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

 

   

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

 

   

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

 

   

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

 

   

competition in our industries in China and globally; and

 

   

relevant government policies and regulations relating to our industries.

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

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

 

2


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PART I

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS

Not applicable.

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

ITEM 3. KEY INFORMATION

 

A. Selected Financial Data

The following table presents the selected consolidated financial information for our company. The selected consolidated statements of comprehensive income data for the three years ended December 31, 2010, 2011 and 2012 and the consolidated balance sheet data as of December 31, 2011 and 2012 have been derived from our audited consolidated financial statements, which are included in this annual report beginning on page F-1. Our selected consolidated statements of comprehensive income data for the years ended December 31, 2008 and 2009 and our consolidated balance sheet data as of December 31, 2008, 2009 and 2010 have been derived from our audited consolidated financial statements not included in this annual report. Our selected consolidated financial statements are prepared and presented in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. Our historical results for any period are not necessarily indicative of results to be expected for any future period. You should read the following selected financial information in conjunction with the consolidated financial statements and related notes and the information under “Item 5. Operating and Financial Review and Prospects” included elsewhere in this annual report.

 

     For the Year Ended December 31,  
     2008     2009     2010     2011     2012  
     (in thousands of dollars, except for share, per share and per ADS data)  

Consolidated Statements of Comprehensive Income Data:

          

Net revenues:

          

Service Revenues

          

Consumer mobile security

     3,867        5,014        15,268        36,202        67,938   

Enterprise mobility

     —          —          —          —          3,249   

Mobile games and advertising

     —          —          —          —          664   

Other services

     94        250        2,427        4,469        10,614   

Product Revenues

          

Enterprise mobility

     —          —          —          —          9,303   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenues

     3,961        5,264        17,695        40,671        91,768   

Cost of revenues

          

Cost of services

     (2,044     (2,812 )     (5,193     (8,057     (16,773

Cost of products sold

     —          —          —          —          (8,966

Total cost of revenues (1)

     (2,044     (2,812     (5,193     (8,057     (25,739
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     1,917        2,452        12,502        32,614        66,029   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

          

Selling and marketing expenses (1)

     (2,404     (3,344     (4,436     (7,955     (17,396

General and administrative expenses (1)

     (2,067     (2,139     (14,750     (14,024     (36,776

Research and development expenses (1)

     (1,201     (2,312     (2,959     (5,095     (9,585
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     (5,672     (7,795     (22,145     (27,074     (63,757
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/Income from operations

     (3,755     (5,343     (9,643     5,540        2,272   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income

     86        159        234        1,342        3,193   

Realized gain/(loss) from available-for-sale investments

     294        47        (102     29        —     

Foreign exchange (losses)/gain, net

     (156     (2     (46     3,011        67   

Gain on change of interest in an associate

     —          —          —          —          943   

Other (expense)/income, net

     (16     (12     135        306        3,364   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/Income before income taxes

     (3,547     (5,151     (9,422     10,228        9,839   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income tax expense

     (48     —          (401     (97     (420

Share of (loss)/profit from an associate

     —          —          (7     119        543   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income

     (3,595     (5,151     (9,830     10,250        9,962   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

     —          1        3        1        (532
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

     (3,595     (5,150     (9,827     10,251        9,430   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Accretion of redeemable convertible preferred shares

     (1,263     (1,393     (1,533     (535     —     

 

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     For the Year Ended December 31,  
     2008     2009     2010     2011     2012  
     (in thousands of dollars, except for share, per share and per ADS data)  

Beneficial conversion feature of redeemable convertible preferred shares

     —          —          (5,693     —          —     

Allocation of net income to participating preferred shareholders

     —          —          —          (1,595     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income attributable to common shareholders

     (4,858     (6,543     (17,053     8,121        9,430   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income

     (3,595     (5,151     (9,830     10,250        9,962   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

          

Foreign currency translation adjustments

     826        10        689        1,249        390   

Disposal of available-for-sale investments

     (5     47        (42     —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

     821        57        647        1,249        390   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive (loss)/income

     (2,774     (5,094     (9,183     11,499        10,352   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

     —          1        3        1        (532
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

     (2,774     (5,093     (9,180     11,500        9,820   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

          

Basic

     (0.15     (0.15     (0.34     0.05        0.04   

Diluted

     (0.15     (0.15     (0.34     0.04        0.04   

Net (loss)/earnings per ADS: (2)

          

Basic

     (0.73     (0.77     (1.72     0.23        0.20   

Diluted

     (0.73     (0.77     (1.72     0.21        0.18   

Weighted average number of common shares outstanding:

          

Basic

     33,089,052        42,251,533        49,683,230        173,373,462        235,257,651   

Diluted

     33,089,052        42,251,533        49,683,230        193,537,974        255,722,551   

 

(1) Share-based compensation expenses included:

 

     For the Year Ended December 31,  
         2008              2009              2010              2011              2012      
     (in thousands of dollars)  

Cost of revenues

     5         13         19         130         214   

Selling and marketing expenses

     31         35         102         1,923         2,342   

General and administrative expenses

     1,128         1,087         12,299         7,895         20,534   

Research and development expenses

     32         43         146         724         1,453   

 

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

 

     As of December 31,  
         2008             2009             2010             2011              2012      
     (in thousands of dollars)  

Summary Consolidated Balance Sheet Data:

           

Cash and cash equivalents

     587        1,704        17,966        69,510         18,862   

Total current assets

     11,631        7,645        44,611        156,258         199,856   

Total assets

     13,253        10,339        48,404        160,482         247,718   

Total current liabilities

     1,230        2,161        5,562        12,231         32,286   

Total liabilities

     1,230        2,161        5,749        12,231         34,369   

Net assets

     12,023        8,178        42,655        148,251         213,349   

Class A Common Shares.

     —          —          —          6         13   

Class B Common Shares

     5        5        5        16         11   

Series A convertible preferred shares

     3,242        3,242        3,242        —           —     

Series B redeemable convertible preferred shares

     13,717        15,109        16,638        —           —     

Series C redeemable convertible preferred shares

     —          —          16,983        —           —     

Series C-1 redeemable convertible preferred shares

     —          —          14,115        —           —     

Total shareholders’ (deficit)/equity

     (4,936     (10,173     (8,323     148,251         213,349   

Non-GAAP Financial Measures

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

 

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

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

 

     For the Year Ended December 31,  
         2008             2009             2010             2011              2012      
     (in thousands of dollars)  

Net (loss)/income

     (3,595     (5,151     (9,830     10,250         9,962   

Add: share-based compensation expenses

     1,196        1,178        12,566        10,672         24,543   

Adjusted net (loss)/income

     (2,399     (3,973     2,736        20,922         34,505   

Selected Operating Data

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

Our registered user accounts may overstate the actual number of our individual registered users, and our active and paying user accounts derived from our operational system may differ from the actual numbers of active and paying user accounts. For more information, see “Item 3. Key Information—D. Risk Factors — Risks Related to Our Business and Industry — The number of our registered user accounts overstates the number of unique individuals who register to use our products. Our active user and paying user account figures may differ from the actual numbers of active and paying user accounts. “

The following tables set forth our registered user accounts as of December 31, 2008, 2009, 2010, 2011 and 2012, respectively, as well as the average monthly active user accounts and average monthly paying user accounts for the three months ended December 31, 2008, 2009, 2010, 2011 and 2012, respectively. The data does not include registered user accounts, active user accounts and paying user accounts from Beijing Feiliu Jiutian Technology Co., Ltd., or Beijing Feiliu.

 

     As of December 31,  
     2008      2009      2010      2011      2012  
     (in millions)  

Registered user accounts

     15.2         35.6         71.7         146.7         283.4   

China

     12.4         26.9         48.5         91.6         164.0   

Overseas

     2.8         8.7         23.2         55.1         119.4   
     For the three months ended December 31,  
         2008              2009              2010              2011              2012      
     (in millions)  

Average monthly active user accounts

     5.5         12.0         25.4         52.3         97.7   

China

     4.5         9.1         17.4         32.9         56.9   

Overseas

     1.0         2.9         8.0         19.4         40.8   

Average monthly paying user accounts

     1.0         1.1         3.2         5.6         8.9   

China

     1.0         1.0         2.5         4.0         5.9   

Overseas

     0.0         0.1         0.7         1.6         3.0   

 

B. Capitalization and Indebtedness

Not applicable.

 

C. Reasons for the Offer and Use of Proceeds

Not applicable.

 

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D. Risk Factors

Risks Related to Our Business and Industry

Our limited operating history makes it difficult to evaluate our business and prospects.

We commenced operations in October 2005 and have experienced rapid growth since then. As such, we have a limited operating history for you to evaluate our business, financial performance and prospects. It is also difficult to evaluate our prospects because we may not have sufficient experience to address the risks frequently encountered by fast-growing companies entering new and rapidly evolving markets such as the mobile security, privacy and productivity market. We incurred net losses in 2008, 2009 and 2010, and although we achieved profitability in 2011 and 2012, we may incur losses in the future. Our ability to achieve, maintain and increase net profit may be affected by various factors including the development of our industry, the continued acceptance of our products and services by users, our ability to maintain good relationships with other participants in the mobile ecosystem and our ability to control our costs and expenses. We may not be able to sustain our profitability on a quarterly or annual basis. Due to our limited operating history, our historical growth rate may not be indicative of our future performance. We cannot assure you that we will grow at the same rate as we did in the past. You should consider our prospects in light of the risks and uncertainties that fast-growing companies with a limited operating history may encounter or to which such companies may be exposed.

Our Freemium subscription business model for consumer mobile security services is relatively new in our industry and we may not be able to continuously meet user demand and increase the number of paying users, which may have material and adverse effects on our business and results of operations.

We offer our consumer mobile security services to users globally through an innovative “Freemium” subscription business model. Our Freemium subscription business model provides users with free services and the ability to upgrade to a selection of premium services to meet individual needs. This model is relatively new in the mobile security, privacy and productivity industry. The success of our business model depends on, among other factors, our ability to convert our registered user accounts into paying user accounts and our ability to encourage user spending on additional products and services by improving and marketing our existing products and services and developing and pricing new products and services in response to evolving user needs. Although we constantly monitor and research user needs, we may be unable to meet user demands on a continuous basis or anticipate future user demands, which may adversely affect our ability to convert free user accounts into paying user accounts, and materially and adversely affect our business and results of operations. In addition, we may not be able to maintain and increase the prices of our premium products and services, which may have material and adverse effects on our growth and prospects.

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

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

 

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

International expansion forms an important component of our growth strategy. Expanding our business internationally exposes us to a number of risks, including:

 

   

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

 

   

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

 

   

difficulty in understanding local market and culture;

 

   

fluctuations in currency exchange rates;

 

   

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

 

   

increased costs associated with doing business in foreign jurisdictions.

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

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

We plan to grow both organically and through acquisitions, investments, joint ventures or other strategic alliances if the appropriate opportunities arise. For example, in 2012, we acquired 55% equity interest in Beijing NationSky Network Technology Co., Ltd., or NationSky, a leading provider of mobile services to enterprises in China, increased the equity interest we hold in Beijing Feiliu Jiutian Technology, Co., Ltd., or Beijing Feiliu, through Beijing Technology from 26.4% to 100%, acquired 31.71% of the equity interests in Hesine Technologies International Worldwide Inc., a provider of mobile messaging solution, and invested, through Tianjin Qingyuan as a limited partner, in 49.5% of the equity interest in Beijing NQ Guotai Investment Management Limited Partnership, or NQ Guotai, a PRC limited liability partnership formed in December 2012 to primarily make venture investments in China’s mobile Internet industry. These and any future acquisitions, investments, joint ventures and strategic alliances may expose us to new operational, regulatory and market risks, as well as risks associated with additional capital requirements, including risks associated with the assimilation of new operations, technologies and personnel, unforeseen or hidden liabilities, the inability to generate sufficient revenue to offset the costs and expenses of acquisitions, and potentially significant loss of investments. We may not be able to identify suitable future acquisition or investment candidates or alliance partners. Even if we identify suitable candidates or partners, we may be unable to complete an acquisition, investment or alliance on terms commercially acceptable to us. If we fail to identify appropriate candidates or partners, or complete the desired acquisitions, investments or alliances, we may not be able to implement our strategies effectively or efficiently. Furthermore, we may not be able to maintain a satisfactory relationship with our joint venture or other partners or handle other risks associated with our future alliances, which could adversely affect our business and results of operations. Our ability to successfully integrate acquired companies and their operations and our ability to benefit from our alliances, joint ventures and investments may be adversely affected by a number of factors. These factors include diversion of management’s attention, difficulties in retaining personnel of acquired companies, unanticipated problems or legal liabilities, and tax and accounting issues.

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

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

 

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If we are not successful in executing our strategy of expanding into the enterprise market, our business and financial condition could be materially and adversely affected.

An important part of our growth strategy is to build on our strong consumer brand while expanding into enterprise mobility business. Sales to enterprises involve risks that may not be present (or that are present to a lesser extent) with sales to individual consumers. These risks include:

 

   

increased competition from larger competitors that traditionally target enterprise customers and that may already have purchase commitments from those enterprise customers;

 

   

lower gross and net margins due to the higher costs of revenues and the selling and marketing expenses incurred to develop and expand this new business;

 

   

increased purchasing power and leverage held by enterprise customers in negotiating contractual arrangements with us, e.g., demanding more favorable credit terms;

 

   

longer sales cycles due to a significant evaluation process, and the associated risk that substantial time and resources may be spent on a potential enterprise customer who elects not to purchase our solutions;

 

   

delayed purchases due to their longer implementation cycles resulting from budget constraints, multiple approvals, and unplanned administrative, processing and other delays;

 

   

demands for greater solution functionality and scalability and a broader range of services, including design services and customization to specific industries; and

 

   

more stringent requirements in support services, including stricter support response time and increased penalties for any failure to meet support requirements.

All these factors add further risks to business conducted with enterprise customers. If we are not successful in executing our strategy of expanding into the enterprise mobility market, our business and financial condition may be materially and adversely affected.

Beijing Feiliu’s limited operating history makes it difficult to evaluate its future prospects and results of operations.

In 2012, we increased the equity interest in Beijing Feiliu from 26.4% to 100%. It is difficult to evaluate the viability and sustainability of Beijing Feiliu’s business because of its limited operating history of mobile games. Beijing Feiliu only started to generate revenue from mobile game operations since 2012. As a result, Beijing Feiliu is exposed to the risks and uncertainties experienced by early stage companies in evolving industries and the mobile game industry in China in particular. Our success in mobile game operations through Beijing Feiliu depends on, among other factors:

 

   

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

 

   

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

 

   

our ability to maintain and expand our distribution network; and

 

   

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

 

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Failure to maintain relationship with top mobile game developers and to maintain operating rights of popular mobile games will adversely and materially affect our financial results of mobile game operations.

Beijing Feiliu identifies and develops relationship with top mobile game developers in China and overseas to obtain the operating rights of popular mobile games. Revenues derived from mobile game operations contributed to a significant portion of Beijing Feiliu’s total revenues in the years ended December 31, 2012. If Beijing Feiliu fails to renew the operating rights of popular games after the contracts expire or fails to continuously obtain right to operate new popular games in the future, our mobile game operations results will be adversely and materially affected.

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

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

Undetected errors, flaws or failures in our products or services, failure to detect new security threats, failure to respond to security events with sufficient speed and efficiency, or failure to maintain updated knowledge repositories could harm our reputation or decrease market acceptance of our consumer mobile security services and products.

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

Maintaining comprehensive repositories of mobile viruses, malware and spam massages helps also increase the efficiency and accuracy of our mobile security, privacy and productivity products and services. Failure to maintain such updated repositories may materially and adversely affect our business and results of operations.

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

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

 

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

We may be unsuccessful in executing our business model of adding compelling new services and monetizing our registered and active user base for our consumer mobile security business. Our primary means of monetizing our active user base has been providing our users with diversified security, privacy and productivity service offerings. For example, we have introduced services catering to families which include security and privacy services. If our family service or other new services are not accepted by our users, our business and financial performance will suffer. In addition, we may introduce new services beyond our current offerings, which may not be accepted by users and, as a result, affect our revenue growth and operations. If we cannot develop or maintain additional channels of monetizing our registered and active user base and introduce additional services that users find compelling, we will not be able to continue our recent growth and increase our revenues and profitability.

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

The growth of our consumer mobile security business depends on the expansion of our user base and the acquiring of new paying users for the related products and services. We plan to continue to diversify our user acquisition channels. For example, in 2012, we introduced our consumer mobile security products and services to overseas consumers through additional retail channels such as wireless retailers including The Cellular Connection, A Wireless and Go Wireless in the United States, epay in Australia and Phones 4u in the United Kingdom. If we fail to continue to acquire new users through additional new channels or the new channels fail to meet our expectation to generate new paying users, our business, results of operations and financial condition will be materially and adversely affected.

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

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

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

 

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

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

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

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

We have experienced rapid growth since we commenced operations and began offering our first anti-virus services and products for mobile phones in 2005. The number of our registered user accounts increased from 35.6 million as of December 31, 2009 to 283.4 million as of December 31, 2012, not including the 67.4 million registered user accounts from Beijing Feiliu as of December 31, 2012. We also expanded the scale of our operations outside of China, particularly in the United States, and now our operating headquarters are located in both Beijing, China and Dallas, Texas. Our rapid expansion may expose us to new challenges and risks. To manage the further expansion of our business and the growth of our operations and personnel, we need to continuously expand and enhance our infrastructure and technology as well as improve our operational and financial systems, procedures and controls. We also need to expand, train and manage our growing employee base. In addition, our management will be required to obtain, maintain or expand relationships with wireless carriers, handset manufacturer partners, chipmakers and other third-party business partners. We cannot assure you that our current and planned personnel, infrastructure, systems, procedures and controls will be adequate to support our expanding operations. If we fail to manage our expansions effectively, our business, results of operations and prospects may be materially and adversely affected.

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

We derive most of our net revenues for the years ended December 31, 2010, 2011 and 2012 from mobile security, privacy and productivity applications for smartphones. For the year ended December 31, 2012, 74.0% of all our net revenues are derived from consumer mobile security services. Any significant downturn in the overall demand for smartphones could adversely affect the demand for mobile security, privacy and productivity applications, which in turn would materially reduce our revenues. Although the smartphone market has grown rapidly in recent years, it is uncertain whether the number of smartphones to be manufactured will grow at a similar rate in the future. To the extent that our future revenues substantially depend on the sales of smartphones, our business would be vulnerable to any downturns in the smartphone market.

 

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

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

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

For the years ended December 31, 2010, 2011 and 2012, a substantial portion of our revenues were collected through the payment channels of wireless carriers, and other third party service providers, including pre-paid card distributors and other mobile service providers. We cooperate with wireless carriers, either directly or through mobile payment service providers. Wireless carriers provide us with billing and collection services for a fixed percentage of the total billing. If we cooperate with wireless carriers through mobile payment service providers and pre-paid card distributors, we share the payments with them. Approximately 60%, 40.2% and 30.4% of our net revenues were collected through wireless carriers and mobile payment service providers in 2010, 2011 and 2012, respectively. If the payment channels or collection systems of wireless carriers, mobile payment service providers or any third-party service providers we use for the collection of our revenues becomes unavailable or malfunctions, we may experience delays associated with attempts to resolve the problems, which may result in a loss of revenues to us. This problem may be particularly serious if a wireless carrier is involved, because several large wireless carriers hold dominant positions in their respective markets and therefore may occupy a relatively important position in our revenue collection. In addition, any loss or deterioration of our relationships with wireless carriers, mobile payment service providers, pre-paid card distributors and other mobile service providers may result in disruptions to our business operations, the loss of our revenues and a material and adverse effect on our financial condition and results of operations.

Our relationships with mobile payment service providers and pre-paid card distributors are also critical for us to collect revenues. For example, net revenues generated through our top mobile payment service provider, Tianjin Yidatong Technology Development Co., Ltd., or Yidatong, as a percentage of our total net revenues, were 21.4%, 25.8% and 22.1% in 2010, 2011 and 2012, respectively. Yidatong charges us at a lower fee rate than other mobile payment service providers through which we cooperate with wireless carriers. Our agreements with mobile payment service providers are generally for terms of one to five years and we generally renew these agreements when they expire. Our agreement with Yidatong, for example, has a term of five years and will expire in June 2015. If mobile payment service providers, especially those through which we generate significant revenues, do not perform their contracts with us due to any reason, our business and results of operations may be materially and adversely affected. In addition, if mobile payment service providers and pre-paid card distributors increase the fee rates they charge us or if our relationships with them deteriorate, our business and results of operations would be adversely affected.

 

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

Historically, a significant majority of our active user accounts for consumer mobile security have used our free services. Our growth strategy is based in part on offering premium products and services on top of our free products and services and to attract users to renew their subscriptions. To the extent we are not able to attract existing users to renew subscriptions to our services or attract existing users to purchase new services, our ability to generate revenues from consumer mobile security services would be adversely affected. We generally provide our premium products and services pursuant to one month, three months, six months or one year subscriptions, after which the relevant product or services either cease to operate or are no longer updated with the latest online threat information (rendering the product increasingly less useful as new threats emerge). In 2010, 2011 and 2012, subscription revenue from consumer mobile security services accounted for 86.3%, 89.0% and 74.0% of our total revenues. While we offer our paying user accounts the option to renew their subscriptions, a portion of them choose not to renew. We have taken steps to increase our renewal rates by, for example, adding an auto-renew option on our premium services, but there can be no assurance that these efforts will be successful in increasing our renewal rates. Any failure to maintain or improve the renewal rates of our subscriptions or to attract new subscriptions could have a material adverse effect on our results of operations. Uncertainty about the renewal rates of our subscription users also limits visibility with respect to future revenues from subscriptions to premium consumer mobile security services.

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

We believe that maintaining and enhancing our “NQ Mobile”, “NQ”, and other brands is of significant importance to the success of our business. A well-recognized brand is critical to increasing the number of our user accounts and, in turn, enhancing our attractiveness to the top mobile device manufacturers. Since the mobile security, privacy and productivity industry is highly competitive, maintaining and enhancing our brand depends largely on our ability to retain our current position as a market leader in China and a significant market player in the rest of the world, and the retaining of such position may be difficult and expensive.

Historically, with our comprehensive and reliable mobile security, privacy and productivity services, we have established our reputation and our market position. In April 2012, we changed our name from “NetQin Mobile Inc.” to “NQ Mobile Inc.” and commenced relevant advertising campaigns under the new corporate name. Although we have conducted and will continue to conduct various marketing and brand promotion activities to enhance our NQ brand name and publicize our new corporate name, our users may not be receptive or respond positively to these changes, and we cannot assure you that these promotional activities will be successful and achieve the brand promotion effect we expect. In 2012, we acquired a majority stake in NationSky, a leading provider of mobile services to enterprises in China, and we increased the equity interest we hold in Beijing Feiliu to 100%. In connection with these acquisitions, we also acquired the “NationSky” and “Feiliu” brand names. We will continue to conduct various marketing and branding activities to enhance our “NationSky” and “Feiliu” brands. We cannot assure you that our users will be receptive to these acquisitions and positively associate the “NationSky” and “Feiliu” brands with us. Any failure to maintain and enhance our brand may result in a reduced number of user accounts and material and adverse effects on our business, financial condition and results of operations.

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

Negative publicity and allegations about us, our products and services, our financial results or our market position may adversely damage our brand, public image and reputation, seriously harm our ability to attract and retain users and result in material adverse impact on our results of operations and prospects. For example, on March 15, 2011, a program broadcast by China Central Television Station, or CCTV, reported various complaints of certain alleged fraudulent practices by us and by Beijing Feiliu Jiutian Technology Co., Ltd., or Beijing Feiliu, our affiliate at the time which later became a wholly owned subsidiary of Beijing Technology. Such alleged fraudulent practices included uploading malware or viruses to imported mobile phones to promote our mobile security products. We were subject to negative publicity as a result. We and Beijing Feiliu both interviewed employees and examined or tested the mobile software products in question, in addition to submitting the software products to third party testing centers established by authoritative government agencies for review, and did not find any evidence of malware or alleged fraudulent practices. In December 2012, an article published on seekingalpha.com made certain allegations concerning the operating data of our company. We have subsequently rejected such allegations as false, but our share price fluctuated after such publicity.

 

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Negative publicity in relation to our services or products, regardless of their veracity, could seriously harm our brand, public image and reputation, which in turn may result in a loss of users and business partners and have a material adverse effect on our business, results of operation and prospects.

We depend on the billing and payment systems of third parties such as wireless carriers, mobile payment service providers, third-party payment processors and pre-paid card distributors for our consumer mobile security business; if these systems fail to accurately account for or calculate the revenues generated from the sales of our mobile products and services, our results of operations may be adversely affected. In addition, any payment delays or failures by these wireless carriers, mobile payment service providers, third-party payment processors and pre-paid card distributors could significantly harm our cash flow and profitability.

We depend on the billing and payment systems of third parties such as wireless carriers, mobile payment service providers, third-party payment processors and pre-paid card distributors to maintain accurate records of payments of sales proceeds by users and collect such payments. We receive periodic statements from these third parties which indicate the aggregate amount of fees that were charged to users for our products and services. Although our proprietary Business and Operation Support System, or BOSS, when reconciled with the systems of the relevant third parties, can help ensure maximum accuracy in the user data and payment we receive from these business associates, inaccurate reporting is still possible and our business and results of operations could be adversely affected if these third parties fail to accurately account for or calculate the revenues generated from the sales of our mobile products and services.

We generally offer third parties whose billing and payment systems we use credit terms ranging from 60 to 210 days for overseas payment and from 30 to 90 days for domestic payment. We are experiencing rapid expansion overseas, and the accounts receivable from overseas wireless carriers, mobile payment service providers, third-party payment processors and pre-paid card distributors have longer settlement periods in general. Substantially all of our accounts receivable was due from wireless carriers, mobile payment service providers, third-party payment processors and pre-paid card distributors as of the date of this annual report. Failure to timely collect our receivables from them, especially from overseas mobile payment service providers, third-party payment processors and pre-paid card distributors, may adversely affect our cash flows. Our wireless carriers, mobile payment service providers, third-party payment processors and pre-paid card distributors may from time to time experience cash flow difficulties. Consequently, they may delay their payments to us or fail to pay us at all. Any delay in payment or inability of current or potential wireless carriers, mobile payment service providers, third-party payment processors and pre-paid card distributors to pay us may significantly harm our cash flow and profitability.

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

Apple is currently the primary distribution, marketing, promotion and payment platform for Beijing Feiliu’s mobile games. To date, Beijing Feiliu has derived a significant portion of its mobile games revenues and acquired the majority of its mobile game players through the Apple platform and we expect this will continue in the near future. Beijing Feiliu is subject to Apple’s standard terms and conditions for application developers and operators, which govern the promotion, distribution and operation of games and payment collection on the Apple platform, and which are subject to change by Apple at its sole discretion at any time. Our business may be harmed if Apple discontinues or limits access to its platform by us, terminates or does not renew our contractual relationship, modifies its terms of service or other policies with us, establishes more favorable relationships with one or more of our competitors, or develops its own competitive offerings. In addition, mobile games for sale in the Apple App Store are subject to approval by Apple. The Apple App Store has complete control over the approval of each mobile game submitted to the store. The terms and policies for the mobile game approval process are very broad and subject to interpretation and frequent changes by the Apple App Store. If Apple changes its standard terms and conditions for developers or operators and the mobile game approval process in a way that is detrimental to us, our mobile games and advertising business could be materially and adversely affected.

 

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

The mobile security, privacy and productivity application industry is highly competitive. The industry is characterized by the frequent introduction of new products and services, short product life cycles, evolving industry standards, continual improvement in performance characteristics, rapid adoption of technological and product advancements, as well as price sensitivity on part of users. On the mobile security front, we compete directly with (i) domestic PC/mobile security vendors such as Qihoo 360, Tencent and Kingsoft, (ii) overseas security software providers such as Avast, Symantec, McAfee, AVG, Trend Micro, F-Secure and Kaspersky, and (iii) other emerging companies offering mobile security products, such as Lookout. While we have focused on providing mobile security services since the founding of our company, most of our competitors are traditional PC anti-virus providers who later entered into the mobile security market. On the mobile productivity front, we compete with services such as Apple iCloud and Location Labs, although we are not in direct competition with them because we are manufacturer-neutral and platform neutral, whereas products and services such as Apple iCloud are largely limited by platform or mobile device manufacturer.

For our mobile game business, we compete primarily with other mobile game operators in China, such as 91 Assistant, d.cn, UC web, M.QQ.com (Tencent) and PunchBox. For our enterprise mobility business, our mobile device management software “NQSky” competes with similar offerings from international vendors such as MobileIron, AirWatch and SAP Afaria. As an integrated enterprise mobility service provider, we also compete with other global and domestic players such as IBM, Accenture, Neusoft, Techown and Cyberwise.

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

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

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

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

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

 

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

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

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

In recent years, the PRC government has adopted several administrative rules governing and reinforced the supervision over paid services and products delivered over the Internet. Under these administrative rules, telecommunications and Internet information providers are required to follow a formal procedure in handling user complaints, and the activities such as arbitrary charges or trapped charges are subject to severe penalties from the relevant authorities. Failure to comply with these administrative rules may subject us to liabilities including refund, damages payments to users or, in the most serious scenario, suspension of our business.

To our knowledge, as of March 15, 2013, there is no outstanding formal user complaint concerning our products and services lodged against us with any local authority. If we are unable to duly resolve user complaints in a timely manner in the future, or if the PRC government promulgates regulations or administrative rules that have more restrictive provisions or more severe penalties, our business operations may be adversely affected.

Our business may be adversely affected due to our failure to ensure the security and privacy of confidential user information.

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

Intensifying legal protection for the confidential information of users may subject us to greater liability. For example, MIIT has promulgated “Several Provisions on Regulating the Market Order of Internet Information Services” to ensure a level playing ground for website operators in China and to enhance protection to Internet users in areas such as Internet security, web advertising and data protection. The provisions came into effect on March 15, 2012. These provisions echo the Chinese government’s policy of intensifying protection of personal privacy. Internet information service providers are required to obtain users’ consent prior to collecting any users’ personal information or disclosing it to a third party. Non-compliance with these protection requirements may incur a fine of RMB10,000 to RMB30,000. On December 28, 2012, the Standing Committee of Congress of the PRC issued the Decision on Strengthen Internet Information Protection, reiterating that Internet service provider to explicitly specify the purpose, way, scope of collecting user’s individual information and obtain user’s consent prior to such collection. The Internet service provider is also prohibited from sending unsolicited commercial information to users. Non-compliance of these provision may incur civil, administrative or criminal penalty.

 

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

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

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

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

We adopted two share incentive plans, the 2007 Global Share Plan and the 2011 Share Incentive Plan (together, the “Plans”). We granted awards such as options and restricted shares to directors, executive officers, employees, third-party consultants and business partners both pursuant to and outside of the Plans. See “Item 6. Directors, Senior Management and Employee — B. Compensation of Directors and Executive Officers — Share Incentive Plans” for detailed discussion. For the years ended December 31, 2010, 2011 and 2012, we recorded US$12.6 million, US$10.7 million and US$24.5 million, respectively, in share-based compensation expenses. As of March 15, 2013, 45,304,476 restricted shares and options to purchase a total of 30,829,361 common shares of our company were outstanding. As of March 15, 2013, 463,000 restricted ADSs were also granted and outstanding under the 2011 Share Incentive Plan; subject to the fulfillment of certain performance goals, up to 578,750 restricted ADSs shall become vested and non-forfeitable under the relevant award agreements. We believe the granting of stock options and restricted shares is of significant importance to our ability to attract and retain key personnel, employees and third-party consultants, and we will continue to grant stock options and restricted shares to key personnel, employees, third-party consultants and business partners in the future. We have incurred, and expect to continue to incur, share-based compensation expenses, which may have a material and adverse effect on our results of operations.

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

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

 

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

Our success depends on the continuous effort and services of our experienced senior management team, particularly our founders, Dr. Henry Yu Lin and Dr. Vincent Wenyong Shi, both experienced engineers with a successful track record of developing products and services, and our director and co-chief executive officer Omar Khan, a highly regarded veteran in the mobile industry who joined us in January 2012.

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

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

The global financial markets experienced significant disruptions in 2008 and the United States, Europe and other economies went into recession. The recovery from the lows of 2008 and 2009 was uneven and it is facing new challenges, including the escalation of the European sovereign debt crisis since 2011 and the slowdown of the Chinese economy in 2012. It is unclear whether the European sovereign debt crisis will be contained and whether the Chinese economy will resume its high growth rate. There is considerable uncertainty over the long-term effects of the expansionary monetary and fiscal policies that have been adopted by the central banks and financial authorities of some of the world’s leading economies, including China’s. There have also been concerns over unrest in the Middle East and Africa, which have resulted in volatility in oil prices and other markets, and over the possibility of a war involving Iran. There have also been concerns about the economic effect of the earthquake, tsunami and nuclear crisis in Japan and tensions in the relationship between China and Japan. Economic conditions in China are sensitive to global economic conditions, as well as changes in domestic economic and political policies and the expected or perceived overall economic growth rate in China. Since the demand for high-end mobile applications is particularly sensitive to macroeconomic conditions, our business and prospects may be affected by the macroeconomic environment. Any prolonged slowdown in the global or Chinese economy may have a material and adverse effect on our business, results of operations and financial condition, and continued turbulence in the international markets may materially and adversely affect our ability to access the capital markets to meet liquidity needs.

 

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

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

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

We define registered user accounts for a period as the cumulative number of user accounts at the end of the period. Because every time a person activates one of our mobile security products after the initial installation, an unique registered user account is generated, and each person can install and activate more than one of our products on his or her smartphone device, each smartphone device could be associated with more than one of our registered users accounts. In addition, each person could have more than one smartphone device with our mobile security products installed and activated. Consequently, the actual number of unique individual users of our products and services is lower than the number of registered user accounts we provide in this annual report, which difference could be potentially significantly.

We define active user accounts for a specific period as the registered user accounts that have accessed our services at least once during such period. We define paying user accounts for a specific period as the registered user accounts that have paid or subscribed for our premium services during such period. The numbers of active and paying user accounts derived from our operational system may differ from the actual numbers of active and paying user accounts.

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

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

Our management has concluded that our internal control over financial reporting is effective as of December 31, 2012. See “Item 15. Controls and Procedures — Management’s Annual Report on Internal Control over Financial Reporting.” Our independent registered public accounting firm has issued an attestation report, which has concluded that our internal control over financial reporting is effective as of December 31, 2012. However, if we fail to maintain effective internal control over financial reporting in the future, our management and our independent registered public accounting firm may not be able to conclude that we have effective internal control over financial reporting at a reasonable assurance level. This could in turn result in the loss of investor confidence in the reliability of our financial statements and negatively impact the trading price of our ADSs. Furthermore, we have incurred and anticipate that we will continue to incur considerable costs, management time and other resources in an effort to maintain compliance with Section 404 and other requirements of the Sarbanes-Oxley Act.

 

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Proceedings instituted recently by the SEC against five PRC-based accounting firms, including our independent registered public accounting firm, could result in financial statements being determined to not be in compliance with the requirements of the Securities Exchange Act of 1934.

In December 2012, the SEC instituted proceedings under Rule 102(e)(1)(iii) of the SEC’s Rules of Practice against five PRC-based accounting firms, including our independent registered public accounting firm, alleging that these firms had violated U.S. securities laws and the SEC’s rules and regulations thereunder by failing to provide to the SEC the firms’ work papers related to their audits of certain PRC-based companies that are publicly traded in the United States. Rule 102(e)(1)(iii) grants to the SEC the authority to deny to any person, temporarily or permanently, the ability to practice before the SEC who is found by the SEC, after notice and opportunity for a hearing, to have willfully violated any such laws or rules and regulations. While we cannot predict the outcome of the SEC’s proceedings, if our independent registered public accounting firm were denied, temporarily or permanently, the ability to practice before the SEC, and we are unable to find another registered public accounting firm which can audit and issue a report on our financial statements, our financial statements could be determined to not be in compliance with the requirements for financial statements of public companies with a class of securities registered under the Securities Exchange Act of 1934, as amended, or the Exchange Act. Such a determination could ultimately lead to the delisting of our common stock from the NYSE, which event would effectively terminate the trading market for our common stock in the United States, and/or to the SEC’s revoking the registration of our common stock under the Exchange Act pursuant to Section 12(j) thereof, in which event broker-dealers thereafter would be prohibited from effecting transactions in, or inducing the purchase or sale of, our common stock in the United States.

Our independent registered public accounting firm, like others operating in China, is not permitted to be subject to inspection by Public Company Accounting Oversight Board, and as such, investors may be deprived of the benefits of such inspection.

The independent registered public accounting firms operating in China, including ours, are required by the laws of the United States to undergo regular inspections by PCAOB to assess its compliance with the laws of the United States and professional standards. Because our independent registered public accounting firm is located in China, a jurisdiction where PCAOB is currently unable to conduct inspections without the approval of the PRC authorities, they, like other independent registered public accounting firms operating in China, are currently not inspected by PCAOB.

Inspections of other firms that PCAOB has conducted outside of China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. The inability of PCAOB to conduct inspections of independent registered public accounting firms operating in China makes it more difficult to evaluate the effectiveness of our independent registered public accounting firm’s audit procedures or quality control procedures, and to the extent that such inspections might have facilitated improvements in their audit procedures and quality control procedures, investors may be deprived of such benefits.

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

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

 

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Risks Related to Our Corporate Structure

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

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

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

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

 

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The relevant regulatory authorities would have broad discretion in dealing with such violations. In 2011, various media sources have reported that the CSRC prepared a report proposing pre-approval by a competent central government authority of offshore listings by China-based companies with variable interest entity structures, such as ours, that operate in industry sectors subject to foreign investment restrictions. However, it is unclear whether the CSRC officially issued or submitted such a report to a higher level government authority or what any such report provides, or whether any new PRC laws or regulations relating to variable interest entity structures will be adopted or what they would provide. If a relevant authority determines that we do not fully comply with applicable laws and regulations, the relevant PRC regulatory authorities, including the CSRC, could revoke our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues, impose additional conditions or requirements with which we may not be able to comply, or take other regulatory or enforcement actions against us that could be harmful to our business. The relevant regulatory authorities may also require us to restructure our operations entirely if it finds that our contractual arrangements do not comply with applicable laws and regulations. It is unclear how a restructuring could impact our business and operating results, as no PRC authorities has yet found any such contractual arrangements to be non-compliant. However, any such restructuring may significantly disrupt our business operations. In addition, if the imposition of any of these penalties causes us to lose our rights to direct the activities of the VIE and its subsidiaries or the right to receive their economic benefits, this may result in our being unable to control, and hence unable to consolidate, the VIE and its subsidiaries.

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

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

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

All of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. Uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements, which may make it difficult to exert effective control over our consolidated affiliated entities, and our ability to conduct our business may be negatively affected.

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

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

 

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

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

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

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

Under PRC laws and regulations, NQ Beijing, as wholly foreign-owned enterprises in the PRC, may pay dividends only out of its cumulative profits as determined in accordance with PRC accounting standards and regulations. In addition, wholly foreign-owned enterprises such as NQ Beijing is required to set aside at least 10% of their cumulative after-tax profits each year, if any, to fund certain statutory reserve funds, until the aggregate amount of such a fund reaches 50% of their respective registered capital. Although the statutory reserves can be used, among other ways, to increase the registered capital and eliminate future losses in excess of retained earnings of the respective companies, the reserve funds are not distributable as cash dividends except in the event of liquidation. At their discretion, they may allocate a portion of their after-tax profits based on PRC accounting standards to staff welfare and bonus funds. These reserve funds and staff welfare and bonus funds are not distributable as cash dividends. The registered capital of NQ Beijing is US$50 million. As of December 31, 2012, NQ Beijing turned into cumulative profit pursuant to PRC accounting standards since its inception and therefore, in accordance with applicable PRC laws and regulations, it set aside US$2.7 million statutory reserve in 2012.

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

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

In addition, under the PRC Enterprise Income Tax Law and the Implementing Rules, both of which became effective on January 1, 2008, dividends generated from the business of our PRC subsidiary, NQ Beijing after January 1, 2008 and payable to us may be subject to a withholding tax rate of 10% if the PRC tax authorities subsequently determine that we are a non-PRC resident enterprise, unless there is a tax treaty with China that provides for a different withholding arrangement.

 

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PRC regulation of loans to, and direct investment in, PRC entities by offshore holding companies and governmental control of currency conversion may restrict or prevent us from making loans to our PRC subsidiary and consolidated affiliated entities or making additional capital contributions to our PRC subsidiary, which may materially and adversely affect our liquidity and our ability to fund and expand our business.

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

Any loans we issue to our PRC subsidiary, which is treated as a foreign-invested enterprise under PRC law, are subject to PRC regulations and foreign exchange loan registrations. Pursuant to Article 18 of the Provisional Rules on Management of Foreign Debt effective on March 1, 2003, the total amount of foreign debts of a foreign-invested company shall be subject to a statutory limit which is the difference between the amount of total investment and the amount of registered capital of such foreign-invested company. The current amount of total investment and amount of registered capital of our PRC subsidiary are US$80 million and US$50 million, respectively, and the current statutory limits on the loans to the PRC subsidiary is US$30 million. Such statutory limits can increase if the amount of total investment of the PRC subsidiary increases; under PRC laws and regulations, the maximum amount of total investment of a foreign-invested company with a registered capital of more than US$12 million shall not exceed three times of its registered capital. For example, loans by us to NQ Beijing to finance its activities cannot exceed statutory limits and must be registered with the local counterpart of the State Administration of Foreign Exchange, or SAFE. We may also decide to finance NQ Beijing by means of capital contributions. These capital contributions must be approved by the PRC Ministry of Commerce or its local counterpart. Due to the restrictions imposed on loans in foreign currencies extended to any PRC domestic companies, we are not likely to make such loans to our consolidated affiliated entities, Beijing Technology, NationSky, Beijing Feiliu, and QingYun (Tianjin) Financial Management Co., Ltd., or Tianjin QingYun, each a PRC domestic company. However, if such loans become necessary for the operations of our PRC subsidiary or consolidated affiliated entities, these statutory limits and other restrictions may materially and adversely affect our liquidity and ability to fund operations in the PRC by limiting a source of cash for these PRC entities. Meanwhile, we are also not likely to finance the activities of our consolidated affiliated entities by means of capital contributions due to regulatory restrictions relating to foreign investment in PRC domestic enterprises engaged in our line of business.

On August 29, 2008, SAFE promulgated the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of the Payment and Settlement of Foreign Currency Capital of Foreign Invested Enterprises, or SAFE Circular 142, regulating the conversion by a foreign-invested enterprise of foreign currency registered capital into RMB by restricting how the converted RMB may be used. SAFE Circular 142 provides that the RMB capital converted from foreign currency registered capital of a foreign-invested enterprise may only be used for purposes within the business scope approved by the applicable governmental authority and may not be used for equity investments within the PRC. In addition, SAFE strengthened its oversight of the flow and use of the RMB capital converted from foreign currency registered capital of a foreign-invested company. The use of such RMB capital may not be altered without SAFE approval, and such RMB capital may not in any case be used to repay RMB loans if the proceeds of such loans have not been used. Violations of SAFE Circular 142 could result in severe monetary or other penalties. On November 16, 2011, SAFE promulgated the Circular of the State Administration of Foreign Exchange on Issues Relating to Further Clarification and Regulation of Certain Capital Account Items under Foreign Exchange Control (“Circular 45”) to further strengthen and clarify its existing regulations on foreign exchange control under SAFE Circular 142. Circular 45 expressly prohibits foreign invested entities, including wholly foreign owned enterprises, from converting registered capital in foreign exchange into RMB for the purpose of equity investment, granting certain loans, repayment of inter-company loans, and repayment of bank loans which have been transferred to a third party. Further, Circular 45 generally prohibits a foreign invested entity, such as our PRC subsidiary, from converting registered capital in foreign exchange into RMB for the payment of various types of cash deposits. If our variable interest entity requires financial support from us or our PRC subsidiary in the future and we find it necessary to use foreign currency-denominated capital to provide such financial support, our ability to fund our variable interest entity’s operations will be subject to statutory limits and restrictions, including those described above.

 

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In light of the various requirements imposed by PRC regulations on loans to and direct investment in PRC entities by offshore holding companies, including SAFE Circular 142, we cannot assure you that we will be able to complete the necessary government registrations or obtain the necessary government approvals on a timely basis, if at all, with respect to future loans by us to our PRC subsidiary or any consolidated affiliated entities or with respect to future capital contributions by us to our PRC subsidiary. If we fail to complete such registrations or obtain such approvals, our ability to capitalize or otherwise fund our PRC operations may be negatively affected, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

Risks Related to Doing Business in China

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

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

The Chinese economy differs from the economies of most developed countries in many respects, including the level of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. Although the Chinese government has implemented measures since the late 1970s emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets, and the establishment of improved corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the Chinese government. In addition, the Chinese government continues to play a significant role in regulating industry development by imposing industrial policies. The Chinese government also exercises significant control over China’s economic growth through allocating resources, controlling payment of foreign currency-denominated obligations, setting monetary policy, and providing preferential treatment to particular industries or companies.

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

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

We conduct our business in China primarily through our PRC subsidiary and consolidated affiliated entities, currently including Beijing Technology and its subsidiaries, Tianjin QingYun, NationSky and Beijing Feiliu in China. Our operations in China are governed by PRC laws and regulations. Our PRC subsidiary is a foreign-invested enterprise and is subject to laws and regulations applicable to foreign investment in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is a civil law system based on written statutes. Unlike the common law system, prior court decisions may be cited for reference but have limited precedential value.

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

 

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Furthermore, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all, which may have a retroactive effect. As a result, we may not be aware of our violation of any of these policies and rules until sometime after the violation. In addition, any administrative and court proceedings in China may be protracted, resulting in substantial costs and diversion of resources and management attention.

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

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

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

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

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

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

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

 

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There remains significant international pressure on the Chinese government to adopt a substantial liberalization of its currency policy, which could result in further appreciation in the value of the RMB against the U.S. dollar. To the extent that we need to convert U.S. dollars into RMB for capital expenditures and working capital and other business purposes, appreciation of the RMB against the U.S. dollar would have an adverse effect on the RMB amount we would receive from the conversion. Conversely, if we decide to convert RMB into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs, strategic acquisitions or investments or other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect on the U.S. dollar amount available to us.

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

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

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

Our business could be materially and adversely affected by the outbreak of epidemics such as H1N1, or swine influenza, avian influenza, or severe acute respiratory syndrome, or SARS. In 2009 and early 2010, there were outbreaks of swine influenza in certain regions of the world, including China. Any prolonged recurrence of swine influenza, avian influenza, SARS or other adverse public health developments in China could adversely affect economic activities in China and require the temporary closure of our offices. Such closures could severely disrupt our business operations and adversely affect our results of operations.

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

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

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

 

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

Recently enacted regulations in the PRC may make it more difficult for us to pursue growth through acquisitions.

Among others, the regulation discussed in the preceding risk factor established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex. Such regulation requires, among others, that the Ministry of Commerce be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise or a foreign company with substantial PRC operations, if certain thresholds under the Provisions on Thresholds for Prior Notification of Concentrations of Undertakings, issued by the State Council on August 3, 2008, were triggered.

We may grow our business in part by directly acquiring complementary businesses in China and elsewhere in the world. Complying with the requirements of these PRC regulations to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval from the Ministry of Commerce, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.

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

SAFE has promulgated several regulations, including the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-Raising and Round-trip Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or SAFE Circular No. 75, issued on October 21, 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. To further clarify and simplify the implementation of the SAFE Circular No. 75, the SAFE issued various rules, including SAFE Circular No.19 issued on May 20, 2011 and took effect on July 1, 2011, which established more specific and stringent supervision on the registration process required by Circular No.75. For example, Circular No.19 imposes obligations on onshore subsidiaries of an offshore entity to make true and accurate statements to the local SAFE authorities concerning any shareholder or beneficial owner of the offshore entity who is a PRC citizen or resident. Untrue statements by the onshore subsidiaries may lead to potential liability for the subsidiaries, and in some instances, for their legal representatives or other liable individuals.

 

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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, with respect to that SPV, to reflect any material change not involving its round-trip investment, capital variation, such as an increase or decrease in capital, a transfer or swap of shares, a merger, division, long-term equity or debt investment or creation of any security interest. 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 when such updates are required under applicable foreign exchange regulations. 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 liability under PRC laws for evasion of applicable foreign exchange restrictions.

We have requested our current shareholders and/or beneficial owners to disclose whether they or their shareholders or beneficial owners fall within the coverage of Circular 75 and urge those who are PRC residents to register with the local SAFE branch as required under Circular 75. However, we cannot assure that all of these individuals can successfully make or update any applicable registration or obtain necessary approval required by these foreign exchange regulations. The failure or inability of such individuals to comply with the registration procedures set forth in these regulations may subject us to fines or legal sanctions, restrictions on our cross-border investment activities or our PRC subsidiary’s ability to distribute dividends to, or obtain foreign-exchange-denominated loans 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.

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

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

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

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

 

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

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

The New EIT Law and its implementation rules permit certain “high and new technology enterprises strongly supported by the state” which hold independent ownership of core intellectual property to enjoy a preferential enterprise income tax rate of 15% subject to certain new qualification criteria. Beijing Technology, our consolidated affiliated entity, was recognized by the Beijing Municipal Science and Technology Commission as a “high and new technology enterprise” on December 24, 2008, and therefore was eligible for the reduced 15% enterprise income tax rate upon its filing with its in-charge tax authority. The qualification as a “high and new technology enterprise” is subject to review by the relevant authorities in China every three years. Beijing Technology was qualified as a high and new technology enterprise and has successfully renewed this status in late 2011, which enabled it to enjoy preferential income tax treatment through 2013. However, if Beijing Technology fails to maintain its “high and new technology enterprise” qualification or renew its qualification when the relevant term expires, its applicable enterprise income tax rate may increase to 25%, which could have a material adverse effect on our financial condition and results of operations. In addition, according to the Notice of the State Administration of Taxation on Further Clarifying the Standards for the Implementation of Preferential Policies Regarding Corporate Income Tax during the Transition Period issued on April 21, 2010, or Circular 157, where a resident enterprise is qualified as a high and new technology enterprise, and simultaneously is entitled to a term holiday under the phase-out rules of the New EIT Law, the resident enterprise can choose either to enjoy the term holiday based on the phase-out tax rates (i.e., 18% for 2008, 20% for 2009, 22% for 2010, 24% for 2011 and 25% for 2012 and onwards) or enjoy the preferential tax rate of 15% as a high-tech enterprise. Beijing Technology, however, has applied the tax rate of 7.5% as its applicable tax rate from 2008 to 2010 despite of relevant provisions in Circular 157. Since it is uncertain whether the State Administration of Taxation will enforce Circular 157 retrospectively, we cannot assure you that Beijing Technology will maintain the tax benefits it previously enjoyed, or that the local tax authorities will not, in the future, order the return of such tax benefits. NQ Beijing has already obtained the Software Enterprise Certification. Therefore, it qualifies for preferential tax treatment as a “software enterprise” under the New EIT Law and is entitled to a two-year exemption from the first year it becomes profitable and a three-year 50% reduction in corporate income tax, upon its filing with its in-charge tax authority. In 2012, the applicable corporate income tax rate of NQ Beijing was 0%.

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

 

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

Under the New EIT Law and its implementation rules, both became effective on January 1, 2008, an enterprise established outside of the PRC with “de facto management bodies” within the PRC is considered a resident enterprise and will be subject to the enterprise income tax at the rate of 25% 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, properties, etc. of an enterprise.” The State Tax Administration 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 SAT Circular 82, on April 22, 2009. SAT Circular 82 provides certain specific criteria for determining whether the “de facto management body” of a Chinese-controlled offshore-incorporated enterprise is located in China. See “Item 4. Information on the Company — B. Business Overview — PRC Regulation — Regulations on Tax — PRC Enterprise Income Tax.” Although SAT Circular 82 only applies to offshore enterprises controlled by PRC enterprises, not those controlled by PRC individuals, the determining criteria set forth in Circular 82 may reflect the State Administration of Taxation’s general position on how the “de facto management body” test should be applied in determining the tax resident status of offshore enterprises, regardless of whether they are controlled by PRC enterprises or individuals. Accordingly, we may be considered a resident enterprise and may therefore be subject to the enterprise income tax at 25% on our global income. If we are considered a resident enterprise and earn income other than dividends from our PRC subsidiary, a 25% enterprise income tax on our global income could significantly increase our tax burden and materially and adversely affect our cash flow and profitability.

Under the Old EIT Law applicable to us prior January 1, 2008, dividend payments to foreign investors made by foreign-invested enterprises in China, such as NQ Beijing, were exempt from PRC withholding tax. Pursuant to the New EIT Law and its implementation rules, however, dividends generated after January 1, 2008 and payable by a foreign-invested enterprise in China to its foreign investors, which are non-PRC tax resident enterprises without an establishment in China, or whose income has no connection with their institutions and establishments inside China, are subject to withholding tax at a rate of 10%, unless any such foreign investor’s jurisdiction of incorporation has a tax treaty with China that provides for a different withholding arrangement. We are a Cayman Islands holding company and we conduct most of our business and derive substantially all of our income from dividends through NQ Beijing, which is our wholly owned PRC subsidiary that is directly and wholly owned by NQ International, our wholly owned subsidiary located in Hong Kong. As long as our Hong Kong subsidiary is considered a non-PRC resident enterprise and holds at least 25% of the equity interest of NQ Beijing, dividends that it receives from NQ Beijing may be subject to withholding tax at a preferential rate of 5% under the Arrangement between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion, effective on January 1, 2007, upon receiving approval from the local tax authority. However, if our Hong Kong subsidiary is not considered to be the beneficial owner of such dividends under Circular Guoshuifa (2009) No. 601, or Circular 601, issued by the SAT on October 27, 2009, such dividends would be subject to withholding tax at a rate of 10%. See “Item 4. Information on the Company — B. Business Overview — PRC Regulation — Tax Regulation.”.

According to Circular 601, for the purpose of determining whether a non-resident enterprise is entitled to the reduced withholding tax rate on certain PRC-sourced income as provided under tax treaties, the non-resident enterprise shall be a beneficial owner. The term “beneficial owner” refers to a person who has the right of ownership and control over the item of income, or the right or property from which that item of income is derived. A beneficial owner generally shall engage in substantive business operations, and can be an individual, corporation or any other organization. Agents or conduit companies do not qualify as beneficial owners for tax treaty purposes.

Circular 601 requires the PRC tax authorities to determine beneficial ownership not just from a technical or domestic law perspective, but also to apply the principle of substance over form to the facts of each case in light of the object and purposes of the tax treaty. Circular 601 only sets forth certain negative factors for the recognition of beneficial ownership, but does not provide any quantitative guidance on how some of the factors would be looked at by the SAT when evaluating beneficial ownership.

We believe our offshore holding company is not a PRC resident enterprise. However, we have been advised by our PRC counsel, Jincheng Tongda & Neal, that because there remains uncertainty regarding the interpretation and implementation of the New EIT Law and its implementation rules, it is uncertain whether, if we are regarded as a PRC resident enterprise, any dividends to be distributed by us to our non-PRC shareholders and ADS holders would be subject to any PRC withholding tax. If we are required under the New EIT Law to withhold PRC income tax on our dividends payable to our non-PRC enterprise shareholders and ADS holders, your investment in our common shares or ADSs may be materially and adversely affected.

 

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

On June 29, 2007, the Standing Committee of the National People’s Congress of China enacted the Labor Contract Law, which became effective on January 1, 2008. The Labor Contract Law introduces specific provisions related to fixed-term employment contracts, part-time employment, probation, consultation with labor union and employee assemblies, employment without a written contract, dismissal of employees, severance, and collective bargaining, which together represent enhanced enforcement of labor laws and regulations. According to the Labor Contract Law, an employer is obliged to sign an unlimited-term labor contract with any employee who has worked for the employer for ten consecutive years. Further, if an employee requests or agrees to renew a fixed-term labor contract that has already been entered into twice consecutively, the resulting contract must have an unlimited term, with certain exceptions. The employer must also pay severance to an employee in nearly all instances where a labor contract, including a contract with an unlimited term, is terminated or expires. In addition, the government has continued to introduce various new labor-related regulations after the Labor Contract Law. Among other things, new annual leave requirements mandate that annual leave ranging from five to 15 days is available to nearly all employees and further require that the employer compensate an employee for any annual leave day the employee is unable to take in the amount of three times the employee’s daily salary, subject to certain exceptions. We cannot assure you that our employment practices do not or will not violate the Labor Contract Law and other labor-related regulations. If we are subject to severe penalties or incur significant liabilities in connection with labor disputes or investigations, our business and results of operations may be adversely affected.

Risks Related to Our ADSs

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

The trading price of our ADSs has been and may continue to be subject to significant fluctuations. From January 1, 2012 to April 12, 2013, the trading price of our ADSs on the New York Stock Exchange ranged from US$12.70 to US$5.07 per ADS, and the closing price on April 12, 2013 was US$8.59 per ADS. The trading price for our ADSs may continue to be volatile and subject to wide fluctuations in response to factors including the following:

 

   

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

 

   

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

 

   

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

 

   

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

 

   

changes in financial estimates by securities research analysts;

 

   

conditions in the value-added telecommunication or Internet services industries;

 

   

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

 

   

additions to or departures of our senior management;

 

   

sales or perceived potential sales of additional shares or ADSs;

 

   

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

 

   

market and volume fluctuations in the stock market in general.

 

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In addition, the stock market in general, and the market prices for companies with operations in China in particular have experienced volatility that might have been unrelated to the operating performance of such companies. The securities of some China-based companies that have listed their securities in the United States have experienced significant volatility since their initial public offerings, including, in some cases, substantial price declines in the trading prices of their securities. The trading performances of the securities of these China-based companies after their offerings may affect the attitudes of investors toward Chinese companies listed in the United States, which consequently may impact the trading performance of our ADSs, regardless of our actual operating performance. In addition, any negative news or perceptions about inadequate corporate governance practices or fraudulent accounting, corporate structure or other matters of other China-based companies, such as news of the Securities and Exchange Commission initiating administrative proceedings against the China affiliates of the Big Four public accounting firms for refusing to produce audit work papers and other documents related to China-based companies under investigation by the commission for potential accounting fraud, may also negatively affect the attitudes of investors towards China-based companies in general, including us, regardless of whether we have engaged in any inappropriate activities. The global financial crisis and the ensuing economic recessions in many countries have also contributed and may continue to contribute to extreme volatility in the global stock markets, such as the large decline in share prices in the United States, China and other jurisdictions in late 2008, early 2009 the second half of 2011 and part of 2012. These broad market and industry fluctuations may adversely affect the price of our ADSs, regardless of our operating performance.

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

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

Our board of directors has complete discretion as to whether to distribute dividends. Even if our board of directors decides to declare and pay dividends, the timing, amount and form of future dividends, if any, will depend on, among other things, our future results of operations and cash flow, our capital requirements and surplus, the amount of distributions, if any, received by us from our subsidiaries, our financial condition, contractual restrictions and other factors deemed relevant by our board of directors. Accordingly, the return on your investment in our ADSs will likely depend entirely upon any future price appreciation of our ADSs. There is no guarantee that our ADSs will appreciate in value or even maintain the price at which you purchased the ADSs. You may not realize a return on your investment in our ADSs and you may even lose your entire investment in our ADSs.

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

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

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

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

 

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

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

The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on our common shares or other deposited securities after deducting its fees and expenses. You will receive these distributions in proportion to the number of common shares your ADSs represent. However, the depositary may, at its discretion, decide that it is impractical to make a distribution available to any holders of ADSs. For example, the depositary may determine that it is not practicable to distribute certain property through the mail, or that the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may decide not to distribute such property to you.

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

Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deems it advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

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

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

Our corporate affairs are governed by our memorandum and articles of association, as amended and restated from time to time, and by the Companies Law (2012 Revision) and common law of the Cayman Islands. The rights of shareholders to take legal action against us and our directors, actions by minority shareholders and the fiduciary responsibilities of our directors are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which provides persuasive, but not binding, authority. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands has a less developed body of securities laws than the United States and provides significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in U.S. federal courts.

 

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

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

Our common shares are divided into Class A common shares and Class B common shares. Holders of Class A common shares are entitled to one vote per share, while holders of Class B common shares are entitled to ten votes per share. We issued Class A common shares represented by our ADSs in our initial public offering. All of our outstanding common shares prior to the offering were redesignated as Class B common shares and our outstanding preferred shares were automatically converted into Class B common shares upon the completion of our initial public offering. In addition, all options issued prior to the completion of our initial public offering entitle option holders to the equivalent number of Class B common shares once the options are vested and exercised. Due to the disparate voting powers attached to these two classes, certain shareholders have significant voting power of our outstanding common shares and have considerable influence over matters requiring shareholder approval, including election of directors and significant corporate transactions, such as a merger or sale of our company or our assets. In particular, as of March 15, 2013, our three founders, Dr. Henry Yu Lin, Mr. Xu Zhou and Dr. Vincent Wenyong Shi, and their affiliates own approximately 21.6% of our outstanding common shares, representing 44.8% of our total voting power. This concentrated control will limit your ability to influence corporate matters and could discourage others from pursuing any potential merger, takeover or other change of control transactions that holders of Class A common shares and ADSs may view as beneficial.

Our memorandum and articles of association contain anti-takeover provisions that could adversely affect the rights of holders of our common shares and ADSs.

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

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

As of March 15, 2013, our directors, executive officers and principal shareholders collectively hold approximately 87.5% of the total voting power of our outstanding common shares. These shareholders, if acting together, could exert substantial influence over matters such as electing directors and approving material mergers, acquisitions or other business combination transactions. Our three founders in particular, Dr. Henry Yu Lin, Mr. Xu Zhou and Dr. Vincent Wenyong Shi, together beneficially own 21.6% of our outstanding common shares. If our founders and directors retain their shares in our company, they will continue to have substantial influence over our company in the foreseeable future. This concentration of ownership may also discourage, delay or prevent a change in control of our company, which could have the dual effect of depriving our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and reducing the price of our ADSs. These actions may be taken even if they are opposed by our other shareholders, including those who purchase our ADSs. In addition, these persons could divert business opportunities away from us to themselves or others.

 

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

Although we do not believe that we were classified as a “passive foreign investment company,” or “PFIC,” for United States federal income tax purposes for the taxable year ended December 31, 2012, there is a significant risk that we will become a PFIC for our current taxable year ending December 31, 2013. We will be classified as a PFIC, for United States federal income tax purposes for any taxable year, if either (a) 75% or more of our gross income for such year consists of certain types of “passive” income or (b) 50% or more of the average quarterly value of our assets (as generally determined on the basis of fair market value) during such year produce or are held for the production of passive income.

There is a significant risk that we will become a PFIC for our current taxable year ending December 31, 2013 and future taxable years because of our significant cash balances and because the value of our assets for purposes of the PFIC test will generally be determined by reference to the market price of our ADSs and common shares. Accordingly, fluctuations in the market price of our ADSs and common shares may cause us to become a PFIC for the current taxable year or future taxable years. The determination of whether we will be or become a PFIC will also depend, in part, upon the nature of our income and assets over time, which are subject to change from year to year. There can be no assurance that our business plans will not change in a manner that will affect our PFIC status. Because there are uncertainties in the application of the relevant rules and PFIC status is a fact-intensive determination made on an annual basis after the close of each taxable year, there can be no assurance that we are not or will not become classified as a PFIC.

If we were to be classified as a PFIC in any taxable year, a U.S. Holder (as defined in “Item 10. Additional Information — E. Taxation — Material United States Federal Income Tax Considerations”) may incur significantly increased United States income tax on gain recognized on the sale or other disposition of the ADSs or common shares and on the receipt of distributions on the ADSs or common shares to the extent such gain or distribution is treated as an “excess distribution” under United States federal income tax rules. Further, if we are classified as a PFIC for any year during which a U.S. Holder holds our ADSs or common shares, we generally will continue to be treated as a PFIC for all succeeding years during which such U.S. Holder holds our ADSs or common shares. Each U.S. Holder is urged to consult with its tax advisor concerning the United States federal income tax consequences of an investment in our ADSs or common shares if we are treated as a PFIC for our current taxable year ending 2013 or any future taxable year, including the possibility of making a “mark-to-market” election. For more information, see “Item 10. Additional Information — E. Taxation — Material United States Federal Income Tax Considerations — Passive Foreign Investment Company Considerations.”

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

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

ITEM 4. INFORMATION ON THE COMPANY

 

A. History and Development of the Company

We commenced operations on October 21, 2005 when our founders incorporated Beijing Technology in China. Beijing Technology is primarily engaged in the research and development of products and services related to mobile security, privacy and productivity. On March 14, 2007, our founders incorporated NetQin Mobile Inc., the offshore holding company for our operations in China, in the Cayman Islands. We changed the name of NetQin Mobile Inc. to NQ Mobile Inc. in April 2012.

On May 15, 2007, we established our wholly owned subsidiary, NQ Beijing in China.

On April 26, 2010, we established NQ HK in Hong Kong; NQ HK became the directly wholly owned subsidiary of NQ Mobile Inc. and the immediate holding company of NQ Beijing. NQ HK conducts part of our business activities and operations outside of China.

 

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On November 5, 2010, we established NQ Mobile US Inc., or NQ US, in the United States, which became the directly wholly owned subsidiary of NQ Mobile Inc. The major functions of NQ US include analyzing market information in the U.S. mobile industry. On December 2, 2011, we established Taiwan NQ Technology Limited, or NQ Taiwan, in Taiwan, which became the directly wholly owned subsidiary of NQ Mobile Inc.

The international business of our company are handled by us, NQ US, NQ Taiwan, NQ HK and NQ Beijing, with the allocation of business being determined by relevant tax considerations, among other things.

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

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

 

   

exercise effective control over Beijing Technology;

 

   

receive substantially all of the economic benefits of Beijing Technology in consideration for the technical and consulting services provided by and the intellectual property rights licensed by NQ Beijing; and

 

   

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

As a result of these contractual arrangements, we are considered the primary beneficiary of Beijing Technology, and we treat it as our consolidated affiliated entity under the accounting principles generally accepted in the United States, or U.S. GAAP. We have consolidated the financial results of Beijing Technology in our consolidated financial statements in accordance with U.S. GAAP. For a description of these contractual arrangements, see “Item 7. Major Shareholders and Related Party Transactions — B. Related Party Transactions.”

We completed an initial public offering of 7,750,000 ADSs in May 2011. On May 5, 2011, we listed our ADSs on the New York Stock Exchange under the symbol “NQ.”

In September 2011, we announced the opening of a Security Research Center in Raleigh, North Carolina. The center focuses on identifying and monitoring mobile security threats that could impact consumers.

On February 21, 2012, Beijing Technology set up a wholly owned PRC venture, QingYun (Tianjin) Financial Management Co., Ltd., or Tianjin QingYun. Tianjin QingYun primarily engages in financial management services.

In May 2012, we acquired, through Beijing Technology, a 55.0% majority stake in NationSky, a leading provider of mobile services for enterprises in China, with total consideration of US$7.4 million in cash and stock, if certain performance based milestones are met. The consideration included approximately US$3.2 million in cash, and 2,300,000 Class A common shares. We also granted the non-controlling shareholder of NationSky, who owns 45.0% of NationSky after the acquisition, 1,150,000 restricted shares pursuant to the achievement of pre-determined performance targets and 1,725,000 restricted shares pursuant to the fulfillment of certain service conditions. We have since consolidated the financial results of NationSky into our consolidated financial statements.

In June 2012, we established NQ Mobile International AG, or NQ Mobile International, in Switzerland. NQ Mobile International and NQ Mobile U.S. Inc., both direct wholly owned subsidiaries of NQ Mobile Inc., are collectively known as NQ Global. NQ Global primarily engages in the worldwide sale and general distribution of software products, particularly in North America, Latin America, Europe, Japan, Korea and India.

In September 2012, we set up NQ Mobile Lux S.A, or NQ Lux, a direct wholly owned subsidiary of NQ International Limited in Luxembourg. NQ Lux is expected to manage our intellectual properties in Luxembourg.

 

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In November 2012, Beijing Feiliu acquired Beijing Red Infinity Technology Co. Ltd (“Beijing Red”), a company that engages in development and operation of mobile games. Also in November 2012, we acquired, through Beijing Technology, 73.6% of equity interest in Beijing Feiliu not already owned by us by paying a total consideration of 12,346,647 Class A common shares of NQ Mobile Inc. We also granted to certain shareholders of Beijing Feiliu 12,346,647 restricted shares pursuant to the achievement of pre-determined performance targets and 6,173,324 restricted shares pursuant to the fulfillment of certain service conditions. As a result of the these transactions, Beijing Red became a wholly owned indirect subsidiary of Beijing Technology, and we have since consolidated the financial results of Beijing Feiliu and Beijing Red in our consolidated financial statements.

In December 2012, we entered into an agreement to invest a 49.5% equity stake through Tianjin QingYun as a limited partner in NQ Guotai, a PRC limited liability partnership formed in December 2012 to primarily make venture investments in China’s mobile Internet industry. NQ Guotai is managed by a general partner not related to us. Our total committed capital amounted to RMB99.0 million (US$15.8 million) and we injected RMB65.0 million (US$10.4 million) capital in March 2013. On April 9, 2013, Beijing WuYue Tianxia Investment Consulting Ltd withdrew from NQ Guotai as the general partner and transferred its 0.5% equity interest in NQ Guotai to Tianjin QingYun. On the same time, Wangqin Guotai (Beijing) Capital Fund Management Ltd was appointed as the new general partner, which made a capital injection of RMB2 million (US$0.3 million). As a result of these transactions, we own 49.505% of equity interest in NQ Guotai.

In December 2012 and January 2013, we set up NQ Mobile (Chengdu) Co., Ltd., or NQ Chengdu, and NQ (Beijing) Co., Ltd., or NQ Tongzhou, respectively, in China. We plan to use NQ Chengdu as our research and development center in the PRC and use NQ Tongzhou to engage in software design and development for computer and mobile devices and other technology consulting services.

In January 2013, we established FL Mobile Inc., or FL Cayman, in the Cayman Islands and FL Mobile Hong Kong Limited, or FL HK, in Hong Kong (collectively, the “FL Corporations”). FL Cayman is a wholly owned subsidiary of NQ Mobile Inc. and FL HK is a wholly-owned subsidiary of FL Cayman. We plan to use FL Corporations to develop the mobile platform primarily for real-time online group activities, mobile technology, automotive and health care information, entertainment, online books and games.

On January 31, 2013, Beijing Feiliu entered into an agreement to acquire 51% stake in Beijing Fanyue Information Technology Co., Ltd., a mobile internet advertisement integration and marketing solution provider.

We have dual headquarters in Beijing and Dallas. Our principal executive offices and headquarters in Beijing are located at No. 4 Building, 11 Heping Li East Street, Dongcheng District, Beijing, 100013, the People’s Republic of China. Our telephone number at this address is +86 (10) 8565-5555. Our Dallas headquarters is located at 4514 Travis St, Dallas, Texas, 75205. Our registered office in the Cayman Islands is located at Maples Corporate Services Limited, PO Box 309, Ugland House, Grand Cayman KY1-1104, Cayman Islands. Our agent for service of process in the United States is Law Debenture Corporate Services Inc., 400 Madison Avenue, 4th Floor, New York, New York 10017.

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

 

B. Business Overview

Overview

We are a leading global provider of mobile Internet services. We pioneered the consumer mobile security industry in 2005 and have since built a world-class cloud-based platform with proven competency to acquire, engage, and monetize customers globally. We currently offer a variety of products and services for the consumer and enterprise markets in consumer mobile security, mobile games and advertising, and enterprise mobility. As of December 31, 2012, we maintain a large, global user base of approximately 283.4 million registered user accounts and 97.7 million monthly active user accounts in our consumer mobile security business; 67.4 million registered user accounts and 12.5 million monthly active user accounts in our mobile games and advertising business, and over 1,200 enterprise customers in China in our enterprise mobility business.

 

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Our vision is to become the most trusted mobile Internet platform for consumers and enterprises globally. We began our business by offering consumers mobile security services to address the fundamental and rapidly growing needs of smartphone users. Over the years, our proprietary, cloud-based security solution has been recognized as among the most effective for detecting and combating mobile threats. Building upon the success of our mobile security offerings, we expanded our service solutions to protect privacy and enhance productivity of mobile usage for consumers, and started to offer additional consumer mobile Internet services such as mobile games and interest-based online communities. We also extended mobile security, privacy and productivity products to families and enterprise customers. In September 2012, we launched our family protection product, NQ Family Guardian, and in December 2012, we launched NQSky, our Mobile Device Management (MDM) product for enterprise customers. Today, our services cater to the ever-expanding needs of consumers and enterprises in their usage of mobile devices, and we believe we are well positioned to capture market opportunities presented by the rapidly evolving mobile Internet industry.

We offer products and services in the following main categories:

 

   

Consumer mobile security: We provide mobile security, privacy, and productivity services that are designed to protect users from mobile malware threats, data theft and privacy intrusion, as well as increase productivity. Our products and services include features such as mobile malware scanning, Internet firewall, account and communication safety, anti-theft, performance optimization, hostile software rating and reporting, contacts and media file protection, cloud storage, parental control and other services. We offer consumer mobile security services mostly through a Freemium subscription model. We provide users with free services and the option to upgrade to premium services for a fee.

 

   

Mobile games and advertising: Through our subsidiary Beijing Feiliu, we provide mobile Internet value added services, which include a portfolio of mobile game offerings, applications of interest-based online communities, and advertising services. As of December 31, 2012, we publish, distribute and operate 12 free-to-play games on the Apple iOS smartphone platform and 19 games on the Android smartphone platform. We provide an online mobile portal for users to access our mobile games, as well as other interest-based mobile community applications focused on games, gadgets/IT, automobiles and healthcare. We generate revenues mainly through the sale of in-game virtual items to mobile game players, as well as advertisements in our interest-based online community applications.

 

   

Enterprise mobility: Through our subsidiary Beijing NationSky, we deliver a comprehensive suite of mobility solutions to assist enterprises to build an efficient, productive and secure mobile environment. We provide mobility strategy consulting, architecture design, hardware and software procurement and deployment, mobile device and application management, training, maintenance and other ongoing support services. We generate revenues through mobility service delivery, software licensing, hardware procurement and deployment, technical support, maintenance and other services provided to our enterprise customers.

We provide a wide range of mobile security related services to address fundamental user requirements, which have allowed us to build a large user base while enhancing user engagement and loyalty. Our large user base provides us with significant monetization opportunities, such as up-selling our premium consumer mobile security and other mobile Internet services, cross-selling third-party mobile Internet applications on our platform as well as advertising. This large user base will expand further with the adoption of our enterprise mobility services by an increasing number of businesses and employees.

Our cloud-based platform enables us to compile and update a database of information based on usage and actions of each of our registered users. By knowing our users, we are able to deliver the most applicable mobile Internet services and advertisements, further enhancing our engagement, up-selling and cross-selling capabilities. This allows us to simultaneously deliver strengthened security from our continuously increasing cloud-based repository of security threats, and also provide other relevant mobile Internet services and advertisements through our powerful database of user information. This continuous strengthening of our security services, as well as development of additional mobile Internet services based on our understanding of users enhance our platform for the purpose of attracting new users, resulting in a virtuous cycle that allows us to continually acquire, engage, and monetize.

 

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We generate revenue primarily through the sale of user subscriptions to our premium consumer mobile security services, mobile games and advertising and the provision of enterprise mobility services. We have grown significantly since we commenced our operations. Our total net revenues were US$17.7 million, US$40.7 million and US$91.8 million in the year ended December 31, 2010, 2011 and 2012, respectively. The contribution from our international operation increased from US$6.2 million in 2010 to US$17.7 million in 2011 and US$36.5 million in 2012, demonstrating our rapidly expanding global footprint. We incurred a net loss attributable to NQ Mobile Inc. of US$9.8 million in 2010 and had a net income attributable to NQ Mobile Inc. of US$10.3 million and US$9.4 million in 2011 and 2012, respectively. Our net loss/income amounts reflect the impact of non-cash share-based compensation expenses of US$12.6 million, US$10.7 million and US$24.5 million in 2010, 2011 and 2012, respectively.

Products and Services

We began our business by offering mobile security products for consumers and subsequently expanded to include a variety of products and services for consumers, enterprises, developers and advertisers.

A. Consumer Mobile Security

We offer a wide range of products and services in the area of mobile security, privacy, productivity, personalized cloud, and family protection mostly through our Freemium subscription model. We provide users with free services and the option to upgrade to premium services for a fee. Our current product offerings are in the following categories:

Mobile Security: Our mobile security product “NQ Mobile Security” protects users’ mobile voice and data from malicious software (viruses, malware), data theft and privacy intrusion. We provide mobile malware scanning, Internet firewall, account and communication safety, anti-theft, performance optimization, hostile software rating and reporting. We also provide backup and restore tools to protect users’ data and enable users to remotely locate, lock and delete information from lost or stolen phones.

Mobile Privacy: Our mobile privacy product “NQ Mobile Vault” ensures users’ digital privacy through active control and on-device encryption of content and communication, including contacts, call logs, SMS, pictures and videos.

Mobile Productivity: Our mobile productivity products “Android Booster”, “Mobile Manager” and “NQ Mobile Call Blocker” intelligently enhance users’ time and relationship management, including screening incoming calls, filtering unwanted spam and SMS messages, protecting communication privacy and managing calendar activities. In addition, we offer cloud-side synchronization of personal data, including address books, text messages, calendars and other data.

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

Personalized Cloud: “NQ Space” provides personalized cloud services and synchronizes user information to provide a tailored user experience and extend the functionalities of our core services.

We also provide a cloud security and vault / storage software development kit (SDK) that allows third-party developers to incorporate the function to their own applications and products.

B. Mobile Games, Interest-Based Online Community Applications and Advertising

We operate an open platform for third party developers to offer products to our users. Through the Beijing Feiliu platform, we offer mobile games and interest-based community apps to our users.

 

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Mobile Games: Beijing Feiliu had 12 games in operation on the iOS platform and 19 games on the Android platform as of December 31, 2012. Most of these games were developed by third parties but operated by Beijing Feiliu. From September 2012 to October 2012, Beijing Feiliu had 4 games ranked among the 100 top-grossing applications on Apple’s app store in China. From November 2012 to December 2012, Beijing Feiliu had 6 games ranked among the 100 top-grossing applications on Apple’s app store in China. For the year ended December 31, 2012, the top four mobile games published by Beijing Feiliu, ranked according to revenue contributions, were QQ Yu Jian, City of Splendors, Di Wang San Guo and Xiao Xiao Yong Zhe. These games are free to play and we generate revenues through the sale of in-game virtual items.

 

   

QQ Yu Jian (QQ 御剑飞流至尊版) is a Massively Multiplayer Online Role-playing Game (MMORPG) mobile game with the backstory about conflicts among different martial arts schools in ancient China. The game was developed by Tencent and is one of the top mobile games in China in terms of revenues and popularity. The game was launched in August 2012.

 

   

City of Splendors (光辉之城) is a mobile strategy fantasy game with a backstory about heroes fighting with monsters in western settings. The game was launched in October 2012 and operated exclusively by Beijing Feiliu.

 

   

Di Wang San Guo (帝王飞流至尊版) is a mobile strategy game with a backstory set in the period of the Romance of the Three Kingdoms, a popular novel about a period of constant warfare in ancient China. The game was launched in August 2012.

 

   

Xiao Xiao Yong Zhe (小小勇者) is a Role Playing Game (RPG) social game. The game allows gamers to build their own villages, attract residents, explore natural resources, produce food and products, and raise children within the environs of the game. The game was launched in March 2012.

Interest-Based Community Apps: Beijing Feiliu offers vertical interest based community apps that are focused on mobile games, gadgets/IT, automobile, and health care.

 

   

Gadget forums/communities: Beijing Feiliu launched its gadget community application “Tech Bible (玩机宝典)” in October 2011, which ranked as one of the most downloaded apps on Apple’s app store in China soon after its launch. It provides users a platform to communicate topics on features and functions of smartphones and other electronic gadget.

 

   

Game forum/communities: Beijing Feiliu launched its mobile community application “Game Center (游戏中心)” in September 2012 to help mobile gamers engage and interact with other parties. Users can discuss and exchange in-game playing tactics, comment on game performance and features, and develop online social network for game playing. The app also provides users with mobile game related news, updates, game tips, and promotional coupons to try out new games.

 

   

Automobile forums/communities: Beijing Feiliu launched its automobile community application “Automobile Owners’ Home (车主之家)” in December 2012, providing users a platform that covers a wide range of topics and information on cars. Users can comment and discuss with other individuals. Beijing Feiliu displays advertisers’ cars and accessories for users to browse, discover and purchase within the application.

 

   

Healthcare forums/communities: Beijing Feiliu launched its health care community applications “Fitness Bar (减肥吧)” in August 2012 and “Bible on Child Fostering” (育儿宝典)” in July 2012, targeting female white collar users between 18 and 45 years old. With the app “Fitness Bar”, users can obtain information and updates on health and fitness topics, including discussion and comments from other users. Users can also interact with others to ask and answer questions, recommend tips, products and services to become and stay healthy and fit. It can also help users track their exercise schedule, as well as food and drink calorie intake. “Bible on Child Fostering” is a platform that covers a wide range of topics on babies and children, such as food, health, exercise and areas of special concern for parents of children at different ages. Users can exchange ideas on how to raise children and recommend certain food, drinks, as well as other products and services to other parents.

 

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Mobile App Download Services: Feiliu Download is an app store application for Android and Symbian platforms that was launched in 2009. It provides a wide range of applications, ratings and user feedback to help users make informed decisions. It had accumulated 48 million registered user accounts by the end of 2012.

Developer SDK: Developers can integrate their games with Beijing Feiliu’s proprietary SDK that enables developers and Beijing Feiliu to track and analyze user behavior and improve user experience based on real time operating data. As of December 31, 2012, more than 20 games were integrated with Beijing Feiliu’s SDK.

Advertising: Beijing Feiliu offers banner advertising inventory to advertisers of the games and vertical interest-based applications and charges on a cost per action (CPA) and a cost per time displayed (CPT) basis. Users can browse the product categories offered in the advertisements and click on the relevant product links to be directed to merchants’ websites to complete purchases or other transactions.

C. Enterprise Mobility

We expanded into the enterprise mobility market through the acquisition of NationSky in May 2012. As employees and knowledge workers increasingly use bring-your-own-device (BYOD) smartphones and mobile devices for both business and personal use, managing work productivity and keeping corporate owned information and sensitive employee data protected have become significant concerns for businesses and employees. We deliver a comprehensive suite of mobility solutions to our clients by architecting mobility strategies, sourcing suitable devices, optimizing and deploying devices and applications, and maintaining ongoing 24/7 support.

NQSky Mobile Device Management (MDM): Our MDM product, NQSky, enables enterprise IT managers to integrate mobile devices with existing IT policies and directly manage devices, applications and contents via centralized administration cloud.

BYOD platform: NationSky provides its enterprise customers a complete BYOD platform solution encompassing hardware, software, carrier voice/data plan and ongoing support services. The BYOD platform is device agnostic covering multiple operating systems including iOS, Android and Windows 8 and enables office mobility for enterprise employees.

Cross platform middleware/Center Enterprise Server: NationSky’s Center Enterprise Server (CES) provides cross platform middleware for enterprise customers to enable data collection, storage, compression, encryption and analysis on mobile devices.

Enterprise mobile security platform: Our enterprise security product “NQ Enterprise Shield” provides enterprise customers and their employees with the privacy and security features they need to protect their businesses by securing sensitive device data from mobile threats and insecure mobile environments.

Our application programming interface (API) monitoring platform enables customers to connect with the NQ Mobile cloud-based mobile virus database in order to provide online security detection and protection services for their WEB / WAP site, application stores, mobile phone browser software. The services can be customized, enabling the customers to reduce their total initial investment.

Our SDK monitoring platform provides customers with Internet malware intelligence detection and solutions on their mobile terminals. The service helps detect malware and screens SMS, MMS, URL, and other possible loopholes on each mobile device locally.

 

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Our e-commerce payment protection capability is embedded in clients’ terminals through an SDK. It prevents unauthorized changes on applications and provides general protection and an anti-phishing function to secure online transactions of mobile phone users.

Our gateway test capability provides mobile phone security screening for telecom operators. It provides virus detection, malware detection, and system vulnerabilities detection, ensuring that mobile phones are secured before entering the market for sale.

Industry mobility solutions: NationSky provides vertical mobility solutions by extending existing IT functionalities to mobile devices for industries such as banking, insurance and brokerage. NationSky’s industry mobility solutions also enable capabilities such as mobile Office Automation (OA), mobile Business Intelligence (BI) and mobile Customer Relationship Management (CRM) for its enterprise customers.

Architecting mobility strategies: NationSky works with enterprise customers and designs the strategy roadmap based on specific needs and priorities. It designs the mobility architecture and recommends the most suitable devices, mobile device management software and data packages with detailed analysis.

Sourcing suitable devices: Based on customers’ specific needs, NationSky recommends and procures the most suitable devices from vendors covering Apple iOS, Blackberry, Android and Windows.

Optimizing and deploying devices and applications: NationSky installs mobile device management (MDM) software, branded NQSky, and maintains consistent standards for configuration over the course of a broad, high-volume enterprise device roll-out. With the mobile device management installed and mobile devices registered, enterprises can remotely control mobile devices, including: locating and locking devices, erasing content, mobile application installation and updates, and unified configuration of network settings.

Training and 24/7 support: NationSky provides training to employees of enterprise customers and familiarize them with the technology, architecture design and software. NationSky also provides 24/7 support for enterprise customers.

Technology

In relation to our products and services, we have developed the following categories of technology:

A. Security and Supporting Technology

Our core security technologies consist of proprietary engines located on our cloud and an optimized local engine built for mobile devices.

Cloud Technology: Capable of intelligently detecting, analyzing, and determining potential malware threats based on algorithms factoring user feedback, threat origin location, timing and source code.

Junk SMS Engine: Capable of intelligently detecting, analyzing, determining and blocking text messages based on user preference, tolerance level and other behaviors.

Policy Management Engine: Directly integrated with existing enterprise IT policies, our policy management engine can be customized based on actual enterprise mobile IT policy and implement such policy on individual devices.

RiskRank Engine: RiskRank is a unique analysis system that can automatically detect whether a particular app exhibits dangerous behavior. It differs from other malware tools by identifying apps with risky behavior while they are in the app market and before they make their way to a user’s phone.

 

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Anti-Malware Engine: Integrated with RiskRanker Engine, the device-level Anti-Malware Engine can detect and remove malware from devices. It can also prevent potential hacking and rooting of devices.

Anti-Spamming Engine: Integrated with the Junk SMS Engine, the device level Anti-Spamming Engine can detect and transfer spam text messages to a virtual trash bin.

App Control Engine: Based on the Policy Management Engine, the device level app control engine is able to prevent users from installing apps not approved by the policy.

Analyzing User Acquisition Channels: Our Business Operation and Support System (BOSS) records and stores user acquisition data, including channel mix, user contribution from each channel, user quality rating, and acquisition cost. The system is designed to detect data anomalies and handle exceptions, simulate operating scenarios and output analysis results in real-time to improve operation efficiency. By analyzing these data, we are able to adjust execution strategies accordingly to maximize user acquisition potentials and optimize user acquisition cost efficiency.

Transaction Recording for Payment Channels: Our BOSS facilitates transaction recording for our payment channels in more than 50 countries. We have a proprietary BOSS interface that can be integrated with all types of payment channel billing systems. The system automatically and accurately records all user transactions in real-time and provides evidence to reconcile billings with our payment channels. Based on studying user payment behavior, we are able to select suitable payment channels, adjust service and pricing policies and launch effective promotional campaigns.

B. Beijing Feiliu Technology

Game Monetization: A set of SDK tools that can be bundled with third-party developed games. It includes user profile management, a customer support forum, a payment settlement engine and other tools designed to enable developers to generate revenues directly on the Beijing Feiliu platform.

Game Analytics: Based on users’ in-game behavior as well as their usage of other Beijing Feiliu applications, the technology can help Beijing Feiliu and third-party developers optimize game design, improve user balance and enhance overall game user experiences.

Interest-based Social Graph: A relationship mapping technology based on users’ personal usage of applications that is bundled with Beijing Feiliu platform technology.

C. Enterprise: Mobile Device Management

NQ Mobile developed and launched its own MDM product called “NQSky” in December 2012. The software secures, monitors, manages and supports mobile devices deployed across different mobile operators, mobile operating systems and enterprises. With the mobile device management system installed and mobile devices registered, enterprises can remotely control their registered mobile devices, including locating and locking devices, erasing content, installing and updating mobile applications, synchronizing data and network configurations. MDM software such as this effectively reduces security risks associated with mobile devices, minimizes enterprise IT support costs while optimizing the functionality and security of the mobile communication network.

 

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Our Users and Customers

A. Consumer Mobile Security

Our user base for consumer mobile security has expanded rapidly in recent years. As of December 31, 2010, 2011 and 2012, we had 71.7 million, 146.7 million and 283.4 million registered user accounts, respectively. We had 23.2 million, 55.1 million and 119.4 million overseas registered user accounts as of December 31, 2010 and 2011 and 2012, respectively, representing 32.3%, 37.6% and 42.1% of our total registered user accounts as of the same dates. For the fourth quarter ended December 31, 2010, 2011 and 2012, we had 25.4 million, 52.3 million and 97.7 million monthly average active user accounts, respectively, and 3.2 million, 5.6 million and 8.9 million monthly average paying user accounts, respectively. However, our methods of calculating registered user accounts, active user accounts and paying user accounts may be subject to adjustment. Please see “Item 3. Key Information—D. Risk Factors—Risks Related to Our Business and Industry—The number of our registered user accounts overstates the number of unique individuals who register to use our products. Our active user and paying user account figures may differ from the actual numbers of active and paying user accounts.” and “Item 3. Key Information—A. Selected Financial Data—Selected Operating Data.”

We have captured a dominant market share in China’s mobile security market. An independent study conducted by SinoMR Research during the fourth quarter of 2012 indicated that our market share, in terms of registered user accounts in China, was approximately 60% as of December 31, 2012. Our overseas user base has also expanded rapidly. We currently have a significant number of registered and active user accounts in areas such as Asia and Europe, the Middle East and North America, and plan to continue our overseas expansion. Our Freemium subscription model enables us to initially gain as many registered user accounts as we can through the offering of basic services to registered user accounts free of charge, and then turning some of these registered user accounts into paying user accounts by providing fee-generating premium services.

Once registered, our users are able to communicate directly with our customer service and technical teams through hotlines and instant messages. Our cloud-side security knowledge repository grows with user contributions of security knowledge, such as malware and spam samples, each time a user accesses our services. Therefore, the larger user base we have, the more powerful our platform becomes, which we believe presents a significant competitive advantage and entry barrier to potential competitors.

User Acquisition Channels

We have established diversified user acquisition channels through strong relationships with key players in the mobile ecosystem. In addition to viral marketing, we acquire users through pre-installation, retail and online channels.

Viral Marketing

A significant percentage of our users come from our own user acquisition channel, namely our Internet and mobile Internet website. These users learn of our services through existing user referrals. We expect the viral marketing channel to continue to account for a significant portion of our user acquisition in the foreseeable future.

Pre-installation

Pre-installation in mobile handsets is another important user acquisition channel. We have formed strong collaborative relationships with many handset manufacturers, including HTC, Huawei, Lenovo, Motorola, Nokia, Samsung and ZTE to pre-install our products on different types and models of their mobile phones. As of December 31, 2012, we had cooperative agreements with more than 10 handset manufacturers. We also work with wireless carriers such as Taiwan Mobile in Taiwan and Cricket Wireless in the United States to pre-install our products. We intend to further expand our pre-installation relationship to include additional mobile handset manufacturers, wireless carriers, mobile handset distributors and retailers to pre-install and promote our products.

Retail

We expanded our user acquisition channels to wireless retailers in certain international markets in 2012 to offer our products and acquire premium paying users. Our products will be promoted and sold at retail store locations by our wireless retail partners such as The Cellular Connection, A Wireless and Go Wireless in the United States, epay in Australia and Phones 4u in the United Kingdom.

Online Download

We provide online downloads via various mobile Internet websites, mobile application stores and mobile Internet portals. These mobile Internet websites and portals promote the download link to our products and help expand our user base for a fee. We also run mobile advertising campaigns with various mobile advertising networks such as Admob by Google and Millennial Media to generate user downloads of our products.

 

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Payment Channels

We collect net revenues from consumer mobile security services through three payment channels. We provide our users with various payment channels through major wireless carriers and mobile payment service providers in China and overseas, prepaid card distributors and third-party payment processors.

Wireless Carriers and Mobile Payment Service Providers

We collect a significant portion of payments from our users through major Chinese wireless carriers such as China Mobile and overseas wireless carriers, such as Taiwan Mobile in Taiwan and Telefonica in Spain, and mobile payment service providers. We cooperate with wireless carriers, either directly or through mobile payment service providers, to provide services to users, and wireless carriers provide us billing and collection services for a fixed percentage of the total billing. If we cooperate with wireless carriers through mobile payment service providers, we share the revenues with the mobile payment service providers. Our agreements with wireless carriers are generally for a term of one year and we generally renew such agreements when they expire. Our agreements with mobile payment service providers are generally for terms of one to five years and we generally renew these agreements when they expire. See also “Risk Factors—Risks Related to Our Business and Industry—We depend on wireless carriers and mobile payment service providers as well as other third party service providers for the collection of a substantial portion of our revenues, and any loss or deterioration of our relationship with wireless carriers, mobile payment service providers or any of these third-party service providers may result in disruptions to our business operations and the loss of revenues.”

Prepaid Cards

We sell prepaid cards that can be used in activating our services. These cards are sold through distributors online and at various points of sale in China and overseas including our wireless retail partners’ store locations. These prepaid cards primarily offer monthly, three-month, six-month and twelve-month subscriptions. Users can choose in-app service activation by entering the card serial number and subscribe our services for the stated time periods.

Third-party Payments

We offer a variety of third-party payment options to our subscribers to further diversify payment channels. These third-party payment channels include Alipay in China, Paypal overseas, tenpay.com, yeepay.com, zong.com and also UnionPay, as well as credit and debit cards.

B. Mobile Games, Interest-Based Online Community Applications and Advertising

As of December 31, 2012, Beijing Feiliu had 67.4 million registered user accounts and 12.5 million monthly active user accounts through its mobile game center, various interest-based community apps and Feiliu Download. Since Beijing Feiliu commenced operating mobile games, its gaming community has undergone a rapid expansion and the number of game developers Beijing Feiliu cooperated with reached over 100 by the end of 2012. We believe our rich game portfolio and cross promotion across different games and services will enable us to continue building the scale of our gaming community.

We offer advertisers the access to our users through games and on interest-based online community applications on the Beijing Feiliu platforms. Our advertisers consist of those from mobile game companies and online/offline merchants. As we expand our interest-based online communities and further diversify our user base, we plan to collaborate with advertisers from additional industries.

Beijing Feiliu acquires users through advertising on various mobile advertising networks, social recommendations and online downloads from app stores such as Apple’ app store. On the iOS platform, Beijing Feiliu relies on the Apple’s app store as its primary payment channel. On the Android platform, Beijing Feiliu cooperates with multiple third-party payment service providers such as Alipay, Shenzhoufu, and Yibao, as well as prepaid cards of China Mobile, China Unicom and China Telecom.

 

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C. Enterprises Mobility

NationSky is a leading provider of managed mobility services to Chinese enterprises. As of December 31, 2012, we have more than 1,200 large and medium enterprise customers, covering a significant number of the Fortune 500 companies in China. Our enterprise customer are diversified across different industries, including financial services, insurance, health care, pharmaceutical, manufacturing and energy. We have also built strong industry alliances with global brands such as Apple, BlackBerry, China Mobile and Global Enterprise Mobility Association (GEMA).

As of December 31, 2012, NationSky had over 80 sales, presales and marketing professionals in major cities including Beijing, Shanghai, Shenzhen, Tianjin, Guangzhou, Chengdu, Qingdao, Jinan, Ningbo and Nanjing. NationSky acquires its enterprise customers through direct inbound customer requests, direct outbound customer engagements or partner referrals.

Customer Support

For our consumer mobile security business, we operate a 24/7 global customer service center with trained professional staff for customer inquiries and technical support. We provide multiple support channels, including telephone, fax, SMS, email, instant messenger and online forums, among others, to address inquiries and collect user feedback. We deploy more than 60 customer service hotlines to provide multi-lingual assistance to answer user inquiries and resolve technical issues promptly. We have a team of highly trained customer service specialists and technology support personnel. For our mobile games business on the Beijing Feiliu platform, we provide 24/7 multiple support channels including telephone hotline, email, online instant messenger and online forums, among others, to address inquiries and questions from our users. For our enterprise mobility business, NationSky provides 24/7 customer support through a centralized customer service hotline and its 11 service centers located in major cities across China.

Research and Development

We believe we have one of the largest research and development teams in the mobile security, privacy and productivity services industry. As of December 31, 2012, our research and development consisted of 309 engineers and technicians. Supervisors in charge of our research and development department have educational backgrounds from leading universities in China and have significant industry experience before joining NQ Mobile. We recruit our engineers throughout China and have established various recruiting and training programs with leading universities in China.

We will continue to devote substantial resources to research and development to improve the performance level of existing services and develop new services. We will continue to launch new products and services for mobile tablets and other Internet-enabled mobile devices. To maintain and strengthen our technology leadership, we will focus resources on four key technologies: mobile security, cloud platform, intelligent technology and enterprise mobility, described as following:

Mobile Security: We will research and develop more efficient client-side malware-scanning and spam-filtering engines and more powerful cloud-side mobile threat discovery, identification and fast-response technology. We will continue to advance the capabilities, efficiency and functionalities of our proprietary engine technology, including the speed, accuracy and efficiency of our malware scanning engines and intelligent anti-spam SMS engine.

Cloud Platform: We will utilize cloud SDK, storage and parallel computing technologies to provide simultaneous processing capability supporting huge user traffic and cross product promotions.

 

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Intelligent Technology: In conjunction with our partners, we will develop and utilize image and voice recognition technologies to provide mobile image-based and voice-based search product.

Enterprise Mobility: We will enhance technology enabling integration between enterprise IT systems and mobile devices, as well as continue to develop cross-client platform technologies.

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

Intellectual Property

Our business success has benefited from our continuous efforts on intellectual property protection, including patent, trademark, copyright and trade secrets. We have 104 patent registrations, applications and exclusive licenses in China and overseas, including but not limited to patents covering anti-virus, anti-spam firewall, anti-phishing, contact management, agenda management and parental controls. Some of these patents have been issued and are currently held by us, while others are still pending. Seventeen of our patents applications have been filed with the United States Patent and Trademark Office, or USPTO, and claim the benefits of initial patent applications, one of which has been approved by USPTO. Some of the intellectual property our company currently uses are held by individuals, all of whom have entered into assignment or exclusive patent licensing agreements with us. We have also made 63 copyright registrations and 74 trademark registrations and applications in China and in the U.S., and have applied with USPTO to register the word “NQ” and related logo as a trademark. In addition, we have registered 83 domain names, including www.NQ.com, our primary operation website. The figures discussed herein include copyright registrations, trademark registrations and applications as well as domain names currently held by Beijing Feiliu.

Our business operations substantially rely on the techniques covered by following patents: (1) a patent for the systematic testing of bottleneck links and remaining bandwidth, filed in China in November 2005 and granted in September 2008; (2) a patent on a system and method for detecting and acquiring mobile virus signatures, which was filed in China in November 2005 and granted in August 2008; (3) a patent on a system and method for the fast acquisition of Internet information service with a mobile terminal, which was filed in China in September 2007 and granted in April 2011; (4) a patent on a method and system to subscribe, configure and move mobile telephone software service conveniently, which was filed in China in September 2007 and has a corresponding U.S. patent application filed in May 2010, both were granted; and (5) a patent on a method and system for a self-learning intellectualized short massage firewall for mobile terminals, which was filed in China in December 2009 and has a corresponding PCT application filed in December 2010. The last patent application is still pending and undergoing examination by the State Intellectual Property Office of the PRC, or SIPO, and USPTO. According to Article 42 of Chinese Patent Law, each of our granted patents would have a term of twenty years, starting from its application date.

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

Seasonality

Seasonal fluctuations and industry cyclicality have had minimal effect on our consumer mobile service business in the past, and we expect this trend to continue for the foreseeable future. For our enterprise mobility business, we experience seasonality and fluctuations in our quarterly revenues which reflect the seasonal fluctuations driven by our customers’ procurement cycles for mobile devices and enterprise software. China-based enterprises typically procure IT related services toward the end of the year, as a result, our revenues in the second half of the year are higher than the first.

 

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Competition

The mobile services market in China and globally is competitive. On the mobile security front, we compete directly with (i) domestic PC/mobile security vendors such as Qihoo 360, Tencent and Kingsoft, (ii) overseas security software providers such as Avast, Symantec, McAfee, AVG, Trend Micro, F-Secure and Kaspersky, and (iii) other emerging companies offering mobile security products, such as Lookout. While we have focused on providing mobile security services since the founding of our company, most of our competitors are traditional PC anti-virus providers who later entered into the mobile security market. On the mobile productivity front, we compete with services such as Apple iCloud and Location Labs, although we are not in direct competition with them because we are manufacturer-neutral and platform neutral, whereas products and services such as Apple iCloud are largely limited by platform or mobile device manufacturer.

For our mobile game business, we compete primarily with other mobile game operators in China, such as 91 Assistant, d.cn, UC web, M.QQ.com (Tencent) and PunchBox. For our enterprise mobility business, our mobile device management software “NQSky”, competes with similar offerings from international vendors such as MobileIron, AirWatch and SAP Afaria. As an integrated enterprise mobility service provider, we also compete with other global and domestic players such as IBM, Accenture, Neusoft, Techown and Cyberwise.

Insurance

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

Legal Proceedings

From time to time, we may be subject to various claims or legal, arbitral or administrative proceedings that arise in the ordinary course of our business. We are currently not a party to, and we are not aware of any threat of, any legal, arbitral or administrative proceedings, which in the opinion of our management is likely to have a material adverse effect on our business, financial condition or results of operations. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Business and Industry—Our results of operations, financial performance and business may be adversely affected by potential intellectual property rights infringement claims against us.”

PRC Regulation

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

Regulation on the Telecommunications Industry

Types of Telecommunications Services

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

 

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Value-added Telecommunications Services

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

 

   

the applicant is a duly incorporated company;

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

Short Message Services

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

Telecommunications Networks Code Number Resources

On January 29, 2003, the MII issued the Administrative Measures on Telecommunications Networks Code Number Resources to administer the code number resources including mobile communications network code number. According to the administrative measures, the entity shall apply to the MII for a code number to be used in the inter-provincial operations and shall apply to the relevant CAB for a separate code number for intra-provincial operations. The administrative measures specify the qualifications for a code number, required application materials and application procedures.

Specifications for Telecommunications Services

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

 

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Foreign Investments in Value-added Telecommunications Services Industry

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

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

Regulations Concerning the Software Development Industry

Software Products

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

Software Enterprises

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

 

   

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

 

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

Enterprises that qualified as “software enterprises” are entitled to certain preferential treatments in the PRC. According to the Circular on Relevant Policies for Encouraging the Development of the Software and Integrate Circuit Industries (Circular No. 25) (2002) by the Ministry of Finance and the State Administration of Taxation, or the SAT, newly-established software manufacturing enterprises (i.e. those established after July 1, 2000) may be exempt from income tax in the first two years of profitability and enjoy 50% income taxes reduction for the next three years, such policy is known as the “Two Free, Three Half” preferential policy. On February 22, 2008, the Ministry of Finance and SAT promulgated the Notice on Several Preferential Policies in Respect of Enterprise Income Tax, or the Notice 2008 No. 1, which reiterated that a software production enterprise newly established within China may, upon certification, enjoy the Two Free, Three Half preferential treatment. On April 24, 2009, the Ministry of Finance and SAT promulgated the Notice on Several Issues Relevant to the Implementation of the Preferential Policies on Enterprise Income Tax, which states that, the software production enterprises and the integrated circuit production enterprises established prior to the end of 2007 may, upon certification, enjoy the preferential policies on the enterprise income tax reductions and exemptions within specified periods as provided in the Notice 2008 No. 1. An enterprise which became profitable in or before 2007 and started enjoying the enterprise income tax reductions and exemptions within specified periods may continue to enjoy the relevant preferential treatment from 2008 until the expiration of the specified periods.

Regulations on Special Products for Computer Information System Safety

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

Foreign Investments in Software Development Industry

According to the Catalog of Industries for Guiding Foreign Investment amended in 2011, foreign investment is encouraged in the software development and production sector. As such, there are no restrictions on foreign investment in the software development industry in the PRC aside from business licenses and other permits that every software development entity in the PRC must obtain.

 

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Regulations on Internet Domain Name and Content

Internet Domain Name

Internet domain names in the PRC are regulated by the Administrative Measures on the PRC Internet Domain Name, which were promulgated by the MII and which came into effect on December 20, 2004, and the Implementation Rules of Registration of Domain Name, which were promulgated by PRC’s domain name registrar, China Internet Network Information Center, or CNNIC and which came into effect on December 1, 2002. Domain name service organizations accept applications for network domain names; successful applicants become holders of the registered domain names after registration. A holder needs to pay operation fees on time to keep the registered domain names, otherwise the domain name registrar may revoke the domain names. In case there is any changes to the registration information of a domain name, the holder shall file the changes with the domain name registrar within 30 days after such changes. The CNNIC is responsible for the administration of .cn domain names and domain names in Chinese language. Disputes in respect of domain names are regulated by the Measures on Resolution of Disputes regarding Domain Names which were issued by CNNIC and revised on February 14, 2006, and shall be settled by organizations approved by the CNNIC.

Content of Internet Information

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

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

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

Regulations on Technology Export

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

 

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Regulations on Intellectual Property Rights

Trademarks

Registered trademarks in the PRC are protected by the Trademark Law of the PRC which came into effect in 1982 and was revised in 1993 and 2001 and the Regulations for the Implementation of Trademark Law of PRC which came into effect in 2002. A trademark can be registered in the PRC with the Trademark Office under the State Administration for Industry and Commerce, or the SAIC. The protection period for a registered trademark in the PRC is ten years starting from the date of registration and may be renewed if an application for renewal is filed within six months prior to expiration.

Copyright

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

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

Measures for the Registration of Computer Software Copyright

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

Regulations on Dividend Distribution

The principal regulations governing distribution of dividends in foreign-invested enterprises include the Foreign-invested Enterprise Law promulgated by the Standing Committee of the National People’s Congress, as amended on October 31, 2000, and the Implementation Rules of the Foreign-invested Enterprise Law issued by the State Council, as amended on April 12, 2001.

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

 

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Regulations on Foreign Currency Exchange

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

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

Regulations on Offshore Financing

On October 21, 2005, the SAFE issued Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Corporate Financing and Roundtrip Investment through Offshore Special Purpose Vehicles, or Circular 75, which became effective as of November 1, 2005. Under Circular 75, PRC residents, who use assets or equity interests in their PRC entities as capital contributions to establish offshore companies or inject assets or equity interests of their PRC entities into offshore companies to raise capital overseas, are required to register with local SAFE branches with respect to their overseas investments in offshore companies. PRC residents are also required to file amendments to their registrations if their offshore companies experience material events involving capital variation, such as changes in share capital, share transfers, mergers and acquisitions, spin-off transactions, long-term equity or debt investments or uses of assets in the PRC to guarantee offshore obligations.

Under the relevant rules, failure to comply with the registration procedures set forth in Circular 75 may result in restrictions on the foreign exchange activities of the relevant onshore company, including higher requirement for registered capital, restrictions on the payment of dividends and other distributions to its offshore parent or affiliate and the capital inflow from the offshore entity, and may also subject relevant PRC residents to penalties under PRC foreign exchange administration regulations. Under relevant regulations, our PRC resident founders are required to register their investments in our company with the SAFE.

 

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Tax Regulations

Income Tax

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

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

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

Labor Protection

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

 

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C. Organizational Structure

The following diagram illustrates our corporate structure as of the March 31, 2013:

 

LOGO

 

(1) Beijing NQ Technology Co., Ltd., or Beijing Technology, is our consolidated affiliated entity established in China and is 52.00% owned by our chairman and co-chief executive officer, Dr. Henry Yu Lin, 33.25% owned by one of our directors, Xu Zhou and 14.75% owned by Dr. Vincent Wenyong Shi, our chief operating officer. The three shareholders of Beijing Technology are the three founders of our company. We effectively control Beijing Technology through contractual arrangements.

 

(2) Beijing NationSky Network Technology Co., Ltd., or Beijing NationSky, is 55% owned by us through Beijing Technology and 45% beneficially owned by an individual previously not affiliated with us.

 

(3) Beijing Fanyue Information Technology Co., Ltd., or Beijing Fanyue, is 51% owned by us through Beijing Feiliu and the remaining equity interests are beneficially owned by two other individuals previously not affiliated with us.

 

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D. Property, Plants and Equipment

Our principal executive offices and headquarters in Beijing are located on premises comprising approximately 4,018 square meters at No. 4 and No. 5 Buildings, 11 Heping Li East Street, Dongcheng District, Beijing, China, which we lease from an unrelated third party. We plan to renew our lease when it expires in April 2018. The premises are shared by NQ Beijing and Beijing Technology. The lessor of the leased premises in Beijing has valid title to the property. We believe that our existing facilities are adequate for our current and foreseeable requirements.

Our headquarters in Dallas is located in premises comprising approximately 769 square meters at 4514 Travis Street, Suite 200, Dallas, Texas. We leased this premise from an unrelated third party.

We also lease an aggregate of approximately 2,859 square meters of office space in Beijing, Taipei, Hong Kong and San Jose, California, all from unrelated third parties.

We made capital expenditures of US$0.6 million, US$2.3 million and US$2.3 million for the years ended December 31, 2010, 2011 and 2012 respectively. Our capital expenditures were primarily used to purchase servers and other equipment, software and other intangible assets (such as the domain name www.nq.com) for our business. Our capital expenditures may increase in the near term as our business continues to grow.

See footnotes 9 and 10 to our financial statements for further information about our property and equipment and intangible assets.

ITEM 4A UNRESOLVED STAFF COMMENTS

None.

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

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

 

A. Operating Results

Overview

We are a leading global provider of mobile Internet services. We pioneered the consumer mobile security industry in 2005 and have since built a world-class cloud-based platform with proven competency to acquire, engage, and monetize customers globally. We currently offer a variety of products and services for the consumer and enterprise markets in consumer mobile security, mobile games and advertising, and enterprise mobility. Since our inception, we have focused on building a large and engaged user base. Our registered user accounts as of December 31, 2010, 2011 and 2012 were 71.7 million, 146.7 million and 283.4 million, respectively, not including the 67.4 million registered user accounts from Beijing Feiliu as of December 31, 2012. Our average monthly active user accounts for the three months ended December 31, 2010, 2011 and 2012 were 25.4 million, 52.3 million and 97.7 million, respectively, not including the 12.5 million active user accounts from Beijing Feiliu for the three months ended December 31, 2012. Our average monthly paying user accounts for the three months ended December 31, 2010, 2011 and 2012 were 3.2 million, 5.6 million and 8.9 million, respectively.

We generate revenues primarily through the sale of user subscriptions to our premium consumer mobile security services, mobile games and advertising, and the provision of enterprise mobility services. Our total net revenues increased from US$17.7 million in 2010 to US$40.7 million in 2011 and to US$91.8 million in 2012. We incurred a net loss attributable to NQ Mobile Inc. of US$9.8 million in 2010 and achieved net income attributable to NQ Mobile Inc. of US$10.3 million and US$9.4 million in 2011 and 2012, respectively.

We incur significant share-based compensation expenses during the course of our business. We incurred US$12.6 million, US$10.7 million and US$24.5 million in share-based compensation expenses for the fiscal year ended December 31, 2010, 2011 and 2012, respectively, and the granting or acceleration of our share-based awards will materially and adversely affect our financial results in the periods over the vesting period of the newly granted options and restricted shares.

 

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

Factors Affecting Our Results of Operations

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

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

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

The growth of the mobile game industry

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

The growth of the mobile advertising industry

Beijing Feiliu also generates revenues on a cost per action (CPA) and cost per time displayed (CPT) basis from offering advertisers in-game banner advertising and also advertising inventory within its vertical interest-based applications. Mobile advertising industry in China is still at the early stage of development and the revenue is mainly contributed by application-related marketing, downloads and in-application advertisements. The growth of this industry depends on factors including the penetration of mobile Internet, affordability of mobile phones, advertising budget shifting to mobile platforms and effectiveness of mobile advertising.

The growth of enterprise mobility industry

Our majority-owned subsidiary NationSky generates revenues by providing enterprise customers a full range of mobility solutions such as architecting mobility strategies; sourcing suitable devices, optimizing and deploying devices and applications, and maintaining ongoing 24/7 support. As employees and knowledge workers increasingly use bring-your-own-device (BYOD) smartphones and mobile equipment for both business and personal use, managing work productivity and keeping corporate owned information and sensitive employee data protected have become significant concerns for businesses and employees. Enterprise mobility is a relatively new and fast-growing industry in China and around the world and we believe factors such as IT consumerization, BYOD adoption and availability of smart mobile devices at affordable prices are the key drivers for the growth of enterprise mobility across different industry sectors.

 

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Our ability to expand our consumer mobile and enterprise user base

Our business is significantly affected by the overall size of our user base, which in turn is determined by, among other factors, (i) user experience of our services and products, (ii) our relationships with key players in the mobile ecosystem such as wireless carriers, handset manufacturers, chipmakers, distributors and retailers and third-party payment processors, (iii) the expansion of our business into overseas markets, (iv) the expansion of our target user base beyond smartphone users to mobile tablets and other Internet-enabled mobile devices, (v) our ability to provide high quality game content to attract mobile gamers, which in turn depends on our relationship with mobile game developers, (vi) our ability to attract mobile advertisers, and (vii) our ability to attract enterprise customers.

Our ability to monetize our consumer mobile security user base

Our revenues and results of operations depend to a large extent on our ability to obtain subscription renewals and further monetize our consumer mobile security user base. Our Freemium subscription business model provides users with free services and the ability to access premium, fee-charging services to meet their individual needs. We aim to attract more existing paying users to renew their subscriptions and turn more registered user accounts into paying user accounts through up-selling and cross-selling our premium services, among others, the success of which is affected by our ability to continually improve and promote our existing premium products and services, develop and introduce new services and features meeting user needs, and enhance user experience. In addition, our ability to monetize our user base is affected by our pricing power, which in turn depends on various factors such as local consumption levels, market prices for mobile applications, recognition and acceptance of our brand and services, and competition.

Our ability to continue to develop and offer new mobile security, privacy and productivity services

We generate revenues primarily through user subscriptions of our consumer mobile security, privacy and productivity services, which substantially depends on our ability to continue offering services and products that meet the changing requirements of our users and appropriately price our services and products. As the mobile security , privacy and productivity industry evolves and user preferences for mobile security, privacy and productivity services and products change, our results of operations depend on our ability to continually research, develop and update our products and services to meet user needs and offer such products at competitive prices. As the industry continues to evolve, we need to introduce products and services which provide competitive advantages over other competing products which may enter the market.

Our ability to continue to keep our interest-based user community highly active and engaged, and develop and operate high-quality mobile games

Beijing Feiliu generates mobile advertising revenues through its vertical interest-based user communities covering mobile games, gadgets, automobile, beauty and healthcare, among others. Feiliu also generates revenue from in-game virtual item sales through its mobile games operations. Thus, our ability to generate mobile advertising revenues and in-game virtual item revenues through Feiliu substantially depends on our ability to attract active and engaged users to our communities, the quality of the games and our operational capabilities.

Our ability to continue to improve our services for enterprise customers and to improve our MDM software

NationSky provides a full range of mobility services to enterprises and generates revenue from mobility strategy consulting, architecture design, hardware procurement and deployment, mobile device and application management and other training and ongoing support services, which substantially depend on our ability to continue to improve and expand our products and services to meet the changing needs of our enterprise customers.

Our ability to control our cost of revenues and operating expenses

Our cost of revenues includes, among others, user acquisition costs and payments to mobile payment service providers for our consumer mobile security business, hardware procurement cost for our enterprise mobility business and fees paid to third parties for placing advertisements on their platforms for our mobile games and advertising business. As we further expand our global user base and grow our revenue, we expect cost of revenue to continue to increase but cost of revenue as a percentage of our total net revenues to remain relatively stable or decrease over time as we achieve the economy of scale in each of our businesses.

 

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Our operating expenses include selling and marketing expenses, general and administrative expenses, and research and development expenses. Our total operating expenses increased from 2009 to 2012, as our business expanded rapidly in its recent years and we hired more personnel and incurred more expenses to support marketing administrative, and research and development efforts. We expect that our operating expenses, excluding the non-cash share-based compensation expenses, will continue to increase but in the longer term will decrease as a percentage of our total net revenues as we achieve economies of scale. Our results of operations are and will continue to be affected by our ability to control our cost of revenues and operating expenses.

Foreign Exchange Risks

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

Discussion of Selected Statements of Comprehensive Income Items

Net Revenues

We recognize revenues net of business tax and related surcharges. We derive our net revenues primarily from consumer mobile security (previously named as “premium mobile Internet services”), enterprise mobility and mobile games and advertising. For our consumer mobile security business, we focus on mobile security, privacy and productivity services and provide for free the basic functions of such services, such as the malware scanning, anti-spam, contact back-up and restore functions. We charge our users a subscription fee for subscribing to our premium services, such as access to continual updates of our virus library and advanced privacy protection services, on a monthly, three-month, six-month or twelve-month basis. We also charge our users for virus library updates on a pay-per-use basis. For our enterprise mobility business, we derive revenues from mobile hardware sales and the provision of managed mobility services for enterprises. For our mobile games and advertising business, we provide free-to-play mobile games but generate revenues from the sales of in-game virtual items as well as from mobile advertising on our interest-based community applications. In addition, we also derive a portion of our net revenues from other sources, such as secured download and delivery services for mobile applications produced by third parties and providing technology development services to third parties.

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

Enterprise mobility revenues are derived primarily from hardware sales to enterprise customers, technology and software development, and commission income shared with mobile network operators. We recognize the hardware procurement revenue once customers acknowledge the receipt of the hardware delivered and title and risk of loss have been transferred. Revenues from technology and software development are recognized when services are completed. Commission income is derived from bringing enterprise customers to the mobile network operators and is determined based on fixed percentages, agreed with the mobile operators, of actual charges to the enterprise customers. We recognize the commission incomes in the month in which the service is provided to the enterprise customers.

Mobile games and advertising revenue comprises of mainly the revenue from the advertisement placement services in our platform. We enter into pay-per-action arrangements for promoting applications, under which we bill our customers based on the volume of end users who click the advertisement and activate the application. Revenue is recognized based on the volume tracked and the pre-agreed unit price. We also enter into pay-for-time contracts, under which we bill our customers based on the period of time to display the advertisements in the specific formats on specific web pages. Revenue is recognized ratably over the period the advertising is displayed.

 

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Other services revenues are derived principally from fees paid by third party business partners for referring customers to them and providing technology development service. We recognize referral revenue when the referral occurs and the technology development revenue when the performance is completed. See “— Critical Accounting Policies — Revenue Recognition.”

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

 

     For the Year Ended December 31,  
     2010      2011      2012  
     US$      %      US$      %      US$      %  
     (in thousands of dollars, except for percentages)  

Service Revenues

                 

Consumer mobile security

     15,268         86.3         36,202         89.0         67,938         74.0   

Enterprise mobility

     —           —           —           —           3,249         3.5   

Mobile games and advertising

     —           —           —           —           664         0.7   

Others

     2,427         13.7         4,469         11.0         10,614         11.6   

Product Revenues

                 

Enterprise mobility

     —           —           —           —           9,303         10.2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total net revenue

     17,695         100.0         40,671         100.0         91,768         100.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net revenues from consumer mobile security services increased significantly from 2010 to 2011 and from 2011 to 2012, due primarily to (i) the growth of our paying user accounts, which in return reflected the growth of our registered and active user accounts and their increased use of our premium services, and (ii)an increase in our overseas paying user accounts as a percentage of our total paying user accounts, as our overseas paying user accounts generally have higher net revenues per user account. We price our products and services based on various factors, including, among other things, local consumption levels, market prices for mobile applications, recognition and acceptance of our brand and services, and competition. Overseas users account for an increasing portion of our net revenues as we further expand our presence in overseas markets. Net revenues attributable to overseas users as a percentage of our consumer mobile security revenues increased from 40.7% in 2010 to 48.9% in 2011 to 52.6% in 2012.

We recorded net revenues of US$12.6 million from enterprise mobility and US$0.7 million from mobile games and advertising in 2012 due to the acquisitions of NationSky and Beijing Feiliu, respectively.

We launched the secured download and delivery services for mobile applications produced by third parties in the fourth quarter of 2009. Net revenues from such services, which are recorded in other revenues, increased substantially in 2010, 2011 and 2012 with increased use of these services by our users.

Cost of Revenues

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

We acquire users primarily through viral marketing, or word-of-month marketing, pre-installation and online download. We provide online downloads of our products and services via various third-party websites, including online advertising networks, Internet portals and mobile application stores. We pay such third parties a fee for each registered user account acquired through them. Payments to these third parties increased from 2010 to 2011 and from 2011 to 2012 as we acquired more registered user accounts through them during these periods. We also pay fees to handset manufacturers to pre-install our applications on their handsets. As we further expand our global user base and grow our revenue, we expect payments to third parties in connection with user acquisition to continue to increase but such payments as a percentage of our total net revenues to remain relatively stable or decrease over time as we achieve the economy of scale in our business.

 

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Salaries and benefits for employees that provide customer services and other support directly related to our products and services increased from 2010 to 2011 and from 2011 to 2012, primarily reflecting the expansion of customer services and product support teams.

We cooperate with wireless carriers, either directly or through mobile payment service providers, to provide services to users. If we cooperate with wireless carriers through mobile payment service providers, we pay a fee to the mobile payment service providers and the amounts attributed to mobile payment service providers are recognized as costs of revenues. Approximately 60%, 40.2% and 30.4% of our net revenues were collected through wireless carriers and mobile payment service providers in 2010, 2011 and 2012, respectively. Net revenues collected through our top mobile payment service provider, Yidatong, contributed 21.4%, 25.8% and 22.1% of our total net revenues in 2010, 2011 and 2012, respectively. See also “Item 3. Key Information — D. Risk Factors — Risks Related to Our Business and Industry — We depend on wireless carriers and mobile payment service providers as well as other third party service providers for the collection of a substantial portion of our revenues, and any loss or deterioration of our relationship with wireless carriers or, mobile payment service providers or any of these third-party service providers may result in disruptions to our business operations and the loss of revenues.” The remaining net revenues were collected through prepaid cards and third-party payment channels including Alipay in China, Paypal overseas and also UnionPay, credit cards and debit cards in general. Having prepaid cards and third-party payment channels further diversifies our payment channels and reduces our dependence on existing wireless carriers and mobile payment service providers. Because we recognize net proceeds from the prepaid card distributors as net revenues, using the prepaid card to collect revenues has also decreased our cost of revenue. In 2012, a larger portion of our net revenues was collected through prepaid cards as compare to that of 2011 and 2010.

As we expanded into enterprise business through the acquisition of NationSky, we expect our cost of revenue to increase, which in turn will cause gross margins to decrease. Hardware procurement cost consists of the majority of cost of revenue for NationSky whose business has a much lower gross margin structure than our consumer mobile security and mobile games and advertising businesses.

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

Operating Expenses

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

 

     For the Year Ended December 31,  
     2010      2011      2012  
     US$      %      US$      %      US$      %  
     (in thousands of dollars, except for percentages)  

Selling and marketing expenses

     4,436         20.0         7,955         29.4         17,396         27.3   

General and administrative expenses

     14,750         66.6         14,024         51.8         36,776         57.7   

Research and development expenses

     2,959         13.4         5,095         18.8         9,585         15.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total operation expenses

     22,145         100.0         27,074         100.0         63,757         100.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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

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

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

 

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

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates.

An accounting policy is considered critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time such estimate is made, and if different accounting estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements. We believe that our accounting policies with respect to revenue recognition, allowance for doubtful accounts, share-based compensation, impairment of long-lived assets, income taxes and equity investment in associates represent critical accounting policies that reflect the more significant judgments and estimates used in the preparation of our consolidated financial statements.

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

Revenue Recognition

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

Revenues presented in the consolidated statements of comprehensive income include revenues from consumer mobile security, enterprise mobility, mobile games and advertising and other services.

 

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Consumer Mobile Security

Consumer mobile security revenues are derived principally from providing premium security, privacy and productivity services to end users. The basic functions of mobile security, privacy and productivity services, including anti-virus, anti-malware, anti-spam, privacy protection, data backup and recovery are free of charge. The software providing the basic service is offered to end users through pre-installation on mobile handsets or free downloads from mobile Internet websites or our website. Customers are charged for updating the anti-virus database on a pay-per-use basis or for subscribing to the premium security, privacy and productivity services including continuous update of anti-virus database, continuous update of the semantics of anti-spam, and advanced privacy protection on a monthly, three-month, six-month, or twelve-month basis. We recognize revenue for premium services considered to be software-related (e.g., mobile security services) in accordance with industry specific accounting guidance for software and software related transactions. For premium services where the customer does not take possession of a fully functioning software (e.g., mobile productivity services), we recognize revenue pursuant to ASC 605, Revenue Recognition. Provided collectability is probable, revenue is recognized over the usage period which is the same for software-related services and services where software is incidental to the provision of the services. Basic functions and customer support are provided to end users free of charge, whether they subscribe to our services or not. Customer arrangements may include premium security and productivity services which are multiple elements. Revenue on arrangements that include multiple elements is allocated to each element based on the relative fair value of each element. Fair value is generally determined by vendor specific objective evidence (“VSOE”). In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standard for multiple deliverable revenue arrangements, which provided updated guidance on whether multiple deliverables exist, how deliverables in an arrangement should be separated, and how consideration should be allocated. This standard eliminates the use of the residual method and requires arrangement consideration to be allocated based on the relative selling price for each deliverable. The selling price for each arrangement deliverable can be established based on VSOE or third-party evidence (“TPE”) if VSOE is not available. The new standard requires the application of an estimate of selling price (“ESP”) if neither VSOE nor TPE is available. On January 1, 2011, we adopted ASU 2009-13 on a prospective basis for applicable transactions originating or materially modified after December 31, 2010. The adoption of this standard did not have a significant impact on our revenue recognition for multiple deliverable arrangements. For all the periods presented, the usage period for the elements in arrangements that include multiple elements is the same. No allocation was performed as there is no impact from the allocation on revenue recognized.

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

The payment channels include wireless carriers and mobile payment service providers, prepaid cards, and third-party payment processors. These three payment channels are used in both China and overseas markets.

Wireless Carriers and Mobile Payment Service Providers

We contract with mobile payment service providers, which in turn contract with wireless carriers, to provide the mobile Internet services to end users. In China, mobile payment service providers have the exclusive licenses to contract with wireless carriers in offering mobile Internet services to the customers and they are only responsible for billing and collection from wireless carriers as intermediaries. We, via mobile payment service providers, cooperate with wireless carriers to provide mobile Internet services to the customers and wireless carriers’ role primarily includes billing and collection services. Under certain circumstances, we also act as a mobile payment service provider ourselves and contract directly with wireless carriers. Fees paid for premium service are charged to the customers’ telephone bills and shared with mobile payment service provider and us, after the wireless carriers’ deduction of their own service charges. Each party’s share of total billings is fixed pursuant to the co-operative arrangements between mobile payment service provider and us.

We recognize and report our consumer mobile security services revenues on a gross basis, based on our and mobile payment service providers’ portions of the gross billing to customers under these co-operative arrangements, as we have the primary responsibility for accepting the contract and fulfilling obligations under the consumer mobile security services, we determine the price and product specifications, and we have full discretion in selecting mobile payment service providers; and thus we are considered to be the principal in the transaction. The amounts attributed to mobile payment service providers’ share are recognized as costs of revenues.

We recognize our revenues net of the amounts retained by the wireless carriers. We do not enter into the arrangements directly with the wireless carriers except when we act as a mobile payment service provider ourselves. Wireless carriers determine the percentage they charge for consumer mobile security services, and from the customer’s perspective, we believe the service is viewed as provided jointly by wireless carriers and us. Accordingly, in these cases, we believe we and the wireless carriers do not act as each other’s agents. Therefore, the revenues recognized are net of the amounts retained by the wireless carriers.

To recognize consumer mobile security services revenues, we rely on wireless carriers and mobile payment service provider to provide us with the billing confirmations for the amount of services they have billed to their mobile customers. At the end of each reporting period, when the wireless carriers or mobile payment service providers have not provided us the monthly billing confirmations, we use information generated from our internal system as well as the historical data to estimate the amount of collectable consumer mobile security services fees and to recognize revenue. Historically, there have been no significant adjustments to the revenue estimates.

 

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Prepaid Cards

We sell prepaid cards to customers through independent distributors and retail channels. Those independent distributors and retailers will sell the prepaid cards directly to the end customers. Customers can then use the prepaid cards to subscribe to the premium services. Once the customers activate the premium service using the prepaid card, we start to recognize its revenues on a straight-line basis over the estimated service period. As we do not have control of, and generally does not know, the ultimate selling price of the prepaid cards sold by the distributors, net proceeds from the distributors are used to record our revenues.

Third Party Payments

The customer can subscribe to our premium services directly through our website, with billing and payment being handled by third-party payment processors. Under these circumstances, we have the primary responsibility for accepting and fulfilling our obligations, and therefore recognize the revenue on a gross basis. The service fees charged by third-party payment processors are recognized as costs of revenue.

Enterprise Mobility

Enterprise mobility revenues are derived principally from hardware sales to enterprise users, technology and software development, and commission income shared from mobile network operators.

Hardware is considered delivered to customers once customers acknowledge the receipt of the hardware delivered and title and risk of loss have been transferred. For most of our hardware sales, these criteria are met at the time customers sign delivery notes. We recognize technology and software development revenue when the project is completed as confirmed by the customer. Commission income derived from bringing enterprise users to the mobile network operators and is determined based on fixed percentages, agreed with the mobile operators, of actual charges to the enterprise users. Commission incomes are recognized in the month in which the service is provided to the enterprise users. For the amount of revenues to be recognized, we firstly estimate the amount of service fee and recognizes revenue based on the fixed commission rates as stipulated on the contract that multiply the estimated customer charges. When we later receive the statements of actual charge issued by the mobile network operators, we record a true-up adjustment. Based on the historical experience, there were no material adjustments identified.

Mobile Games and Advertising

Mobile games and advertising revenue comprises of mainly the revenue from the advertisement placement services in our platform.

We enter into pay-per-action arrangements for promoting applications, under which we bill our customers based on the volume of end users who click the advertisement and activate the application. Revenue is recognized based on the volume tracked and the pre-agreed unit price. We also enter into pay-for-time contracts, under which we bill our customers based on the period of time to display the advertisements in the specific formats on specific web pages. Revenue is recognized ratably over the period the advertising is displayed.

Other Services

Other services revenues are derived principally from fees paid by third party business partners for referring customers to them and providing technology development service. We recognize referral revenue when the referral occurs and the technology development revenue when the performance is completed.

Goodwill

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

 

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We tests goodwill for impairment at the reporting unit level on an annual basis as of December 31, and between annual tests when an event occurs or circumstances change that could indicate that the asset might be impaired. Commencing in September 2011, in accordance with the FASB revised guidance on “Testing of Goodwill for Impairment,” a company first has the option to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we decides, as a result of its qualitative assessment, that it is more-likely-than—not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is mandatory. Otherwise, no further testing is required. The quantitative impairment test consists of a two-step goodwill impairment test. The first step compares the fair value of each reporting unit to its carrying amount. If the fair value of each reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and the second step will not be required. If the carrying amount of a reporting unit exceeds its fair value, the second step compares the implied fair value of goodwill to the carrying value of a reporting unit’s goodwill. The implied fair value of goodwill is determined in a manner similar to accounting for a business combination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. This allocation process is only performed for purposes of evaluating goodwill impairment and does not result in an entry to adjust the value of any assets or liabilities. An impairment loss is recognized for any excess in the carrying value of goodwill over the implied fair value of goodwill.

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

Segment reporting

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

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

We has determined that the business segments that constitute its primary reportable segments are consumer and enterprise.

Before 2012, we principally engaged in consumer mobile security and other services and operated and managed this business as a single segment. In 2012, we expanded its business by the acquisition of NationSky in enterprise mobility services and the acquisition of Beijing Feiliu and its subsidiary (Collectively, the “Beijing Feiliu Group”) in mobile games and advertising services. We generated revenues from the operations of such businesses. Considering the short period for which Beijing Feiliu Group was consolidated, the operating results of Beijing Feiliu Group were not material to be a reportable segment and was combined with the operating results of consumer mobile security and others for CODM’s review. As a result, the CODM separately reviewed key information of each of two operating segments consisting of consumer and enterprise in order to optimize the management of operations.

Impairment of Long-Lived Assets

The carrying amounts of long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is evaluated by a comparison of the carrying amount of assets to future undiscounted net cash flows expected to be generated by the assets. Such assets are considered to be impaired if the sum of the expected undiscounted cash flow is less than carrying amount of the assets. The impairment to be recognized is measured by the amount by which the carrying amounts of the assets exceed the fair value of the assets. No impairment of long-lived assets was recognized for any of the periods presented.

 

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Allowance for Doubtful Accounts

An allowance for doubtful accounts is recorded in the period in which a loss is determined to be probable. We review the accounts receivable on a periodic basis and make specific allowances based on an assessment of specific evidence indicating doubtful collection, historical experience, account balance aging and prevailing economic conditions. If any of our intermediaries with significant outstanding accounts receivable balances were to become insolvent or unable to make payments in a timely manner, or refuse to pay us, we would have to make further provisions or write off the relevant amounts if the potential for recovery is considered remote. No significant allowance has been provided on accounts receivable for the periods presented.

Share-Based Compensation

Options

On June 7, 2007, our board of directors passed a resolution to adopt the 2007 Global Share Plan. The 2007 Global Share Plan provides for the granting of options to selected employees, directors, and non-employee consultants to acquire common shares of our company at an exercise price as determined by our board or the administrator appointed by the board at the time of grant. The maximum number of common shares in respect of which options may be granted under the 2007 Global Share Plan is 44,415,442. The following table sets forth the options granted under the 2007 Global Share Plan that were outstanding as of March 15, 2013.

 

Date of Option Grant

   Options Granted      Exercise
Price
(US$)
     Intrinsic
Value (1)
(US$)
     Weighted-Average
Fair Value of
Options

(US$)
     Fair Value
of
Common
Shares
(US$)
     Type of
Valuation

August 8, 2007

     124,800         0.07         1.574         0.040         0.062       Retrospective

February 8, 2008

     232,090         0.25         1.394         0.072         0.136       Retrospective

August 8, 2008

     181,775         0.25         1.394         0.092         0.163       Retrospective

April 8, 2009

     1,157,624         0.25         1.394         0.132         0.221       Retrospective

December 8, 2009

     469,992         0.25         1.394         0.197         0.307       Retrospective

August 8, 2010

     955,483         0.40         1.244         0.262         0.447       Retrospective

November 8, 2010

     24,710         0.40         1.244         0.672         0.939       Contemporaneous

December 15, 2010

     2,953,550         0.40         1.244         1.272         1.550       Contemporaneous

February 28, 2011

     8,020,000         1.52         0.124         1.620         2.170       Contemporaneous

March 15, 2011

     608,517         1.52         0.124         1.469         2.190       Contemporaneous
  

 

 

                

Total

     14,728,541                  

 

(1) As determined based on the difference between the exercise price of the options and our closing stock price on March 15, 2013 of US$8.22 per ADS, or US$1.64 per Class A common share as of that date.

On March 15, 2011, our Board of Directors passed a resolution to adopt the 2011 Share Incentive Plan (the “2011 Share Plan”) that provides for the granting of options to acquire common shares, restricted shares or restricted share units of our company to selected employees, directors, and non-employee consultants at an exercise price as determined by the Board or the administrator appointed by the Board at the time of grant. On April 13, 2013, our Board of Directors approved an amendment to the 2011 Share Plan to correct a clerical error and reflect our original, consistent intent throughout the period. Subject to Article 9 and Section 3.1(b) of the 2011 Share Plan, as amended, the maximum aggregate number of class A common shares which may be issued pursuant to all awards (option, restricted share or restricted share unit award granted pursuant to the 2011 Share Plan) shall be 13,000,000 plus an annual increase on the first day of each fiscal year, beginning in 2012, equal to the total number of shares underlying the options or other awards granted in the immediately preceding year that remain outstanding as of the same date; or such lesser amount of class A common shares as determined by the board. Thus, unless our board of directors determines to add a lesser amount of shares to the number of shares reserved under the 2011 Share Plan on or before the first day of each fiscal year, the maximum number of shares that can be issued in that year pursuant to all awards granted under the 2011 Share Plan is 13,000,000. The following table sets forth the options granted under the 2011 Share Plan that were outstanding as of March 15, 2013.

 

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Date of Option Grant

   Options Granted      Exercise
Price
(US$)
     Intrinsic
Value (1)
(US$)
     Weighted-Average
Fair Value of
Options (US$)
     Fair Value
of
Common
Shares
(US$)
     Type of
Valuation

June 13, 2011

     2,264,360         0.80         0.844         0.460         0.804       Contemporaneous

June 13, 2011

     250,000         0.80         0.844         0.530         0.804       Contemporaneous

November 2, 2011

     1,000,000         0.91         0.734         0.833         1.090       Retrospective

December 22, 2011

     328,510         0.95         0.694         0.541         0.968       Contemporaneous

December 22, 2011

     1,200,000         0.95         0.694         0.625         0.968       Contemporaneous

December 22, 2011

     66,000         0.95         0.694         0.492         0.968       Contemporaneous

December 22, 2011

     1,337,500         0.95         0.694         0.711         0.968       Contemporaneous

July 10, 2012

     2,269,450         1.35         0.290         0.860         1.604       Contemporaneous

July 10, 2012

     36,000         1.35         0.290         0.800         1.604       Contemporaneous

July 10, 2012

     1,115,000         1.35         0.290         0.950         1.604       Contemporaneous

July 10, 2012

     200,000         1.35         0.290         1.050         1.604       Contemporaneous

Jan 2, 2013

     5,057,000         1.18         0.460         0.584         1.206       Contemporaneous

Jan 2, 2013

     2,000         1.18         0.460         0.540         1.206       Contemporaneous

Jan 2, 2013

     250,000         1.18         0.460         0.750         1.206       Retrospective

Jan 2, 2013

     725,000         1.18         0.460         0.750         1.206       Contemporaneous
  

 

 

                

Total

     16,100,820                  

 

(1) As determined based on the difference between the exercise price of the options and the closing price of US$8.22 per ADS, or US$1.64 per Class A common share as of March 15, 2013.

Based on our closing stock price on March 15, 2013 of US$8.22 per ADS, or US$1.64 per Class A common share, the aggregate intrinsic value of our total outstanding share options as of March 15, 2013, which amounted to options to purchase 30,829,361 common shares, would be US$17.7 million.

Share-based compensation expense for all share-based awards granted to employees is determined based on the grant date fair value of the award and are recognized as an expense using graded vesting method, net of estimated forfeitures, over the requisite service period, which is generally the vesting period.

We account for awards to non-employee consultants are measured at fair value at the earlier of the commitment date or the date the services are completed. Generally, the measurement date of the fair value of the awards we issued is the date on which the non-consultant’s performance is completed. These awards are remeasured at each reporting date using the fair value as at each period end until the measurement date. The expense is recognized using the graded vesting method. Changes in fair value between the interim reporting dates are attributed in the same manner used to recognize the original compensation cost.

In determining the fair value of our equity instruments, we referred to valuation reports prepared by an independent third-party appraisal firm, based on data we provided. The valuation reports provided us with guidelines in determining the fair value of the equity instruments, but the determination was made by our management. Management also performed valuation on certain batches of awards in late 2012 taking similar approach adopted by the independent third-party appraisal firm.

In determining the fair value of our stock options, the binomial option pricing model was applied. The key assumptions used to determine the fair value of the options at the relevant grant dates in 2010, 2011 and 2012 were as follows. Changes in these assumptions could significantly affect the fair value of stock options and hence the amount of compensation expense we recognize in our consolidated financial statements.

 

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We estimated the risk-free rate based on the yield to maturity of China Sovereign bond denominated in U.S. dollars as at the option valuation date. Exercise multiple is estimated as the ratio of fair value of stock over the exercise price as at the time the option is exercised, based on a consideration of research study regarding exercise pattern based on historical statistical data. Multiples of two to three were used for the valuation analysis of employee options granted. Life of the stock options is the expected remaining contract life of the option. Based on the option agreement, the contract life of the option is 10 years commencing from the option granted date, at each valuation date, the remaining life of option should be the life between the valuation date and the expiry date of option. The expected volatility at the date of grant date and each option valuation date was estimated based on historical volatility of comparable companies for the period before the grant date with length commensurate with the life of the options. We have no history or expectation of paying dividends on our common shares.

If factors change and we employ different assumptions for estimating share-based compensation expenses in future periods or if we decide to use a different valuation model, our share-based compensation expenses in future periods may differ significantly from what we have recorded in prior periods and could materially affect our operating income, net income and net income per share.

The fair value of our common shares is based on the closing prices of our publicly traded shares for all awards granted after our initial public offering while prior to our initial public offering, as a private company with no quoted market in our common shares, we had to estimate the fair value of our common shares at the relevant grant dates for employee options and at each reporting date for non-employee options. The determination of the fair value of our common 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 each grant.

In determining the fair values of our common shares as of each award grant date prior to our initial public offering, three generally accepted approaches to value were considered: cost, market and income approaches. While useful for certain purposes, the cost approach is generally not considered applicable to the valuation of a company as a going concern, as it does not capture the future earning potential of the business. The comparability of our peer companies’ financial metrics and the relevance of the market approach were also considered low since our target market and stage of development are different from those of the publicly listed companies in the same industry. In view of the above, we determined that the income approach is the most appropriate method to derive the fair values of our common shares. In addition, we took into consideration of the guidance prescribed by the American Institute of Certified Public Accountants (AICPA) Audit and Accounting Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, or the Practice Aid.

The income approach involves applying appropriate discount rates to estimated cash flows that are subject to a number of assumptions. These assumptions include: no material changes in the existing political, legal, fiscal and economic conditions in China; our ability to recruit and retain competent management, key personnel and technical staff to support our ongoing operations; and no material deviation in industry trends and market conditions from economic forecasts. These assumptions are inherently uncertain and subjective. The risks associated with achieving the estimated cash flow were assessed in selecting the appropriate discount rates, which had been determined to be 35%, 34%, 33%, 31%, 30%, 30%, 27% and 23% as of February 8, 2008, August 8, 2008, December 31, 2008, April 8, 2009, September 30, 2009, December 8, 2009, August 8, 2010 and November 8, 2010, respectively. The discount rates were based on the estimated market required rate of return for investing in our company, or weighted average cost of capital, or WACC, which was derived by using the Capital Asset Pricing Model, a method that market participants commonly use to price securities. The change in WACC was the combined result of the changes in the risk-free rate, industry-average correlated relative volatility coefficient beta, equity risk premium, size of our company, scale of our business and our ability in achieving forecast projections.

A discount for lack of marketability, or DLOM, was also applied to reflect the fact that there is no ready public market for our shares as we are a closely held private company. When determining the discount for lack of marketability, the Black-Scholes option model was used. Under the 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 discount for lack of marketability. Based on the analysis, DLOM of 33%, 33%, 33%, 32%, 31%, 30%, 20% and 15% were used for the valuation of our common shares as of February 8, 2008, August 8, 2008, December 31, 2008, April 8, 2009, September 30, 2009, December 8, 2009, August 8, 2010 and November 8, 2010, respectively.

 

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The option-pricing method was used to allocate equity value of our company to preferred and common shares, taking into account the guidance prescribed by the Practice Aid. This 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 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. The volatility of our shares was estimated based on the historical volatility of comparable listed companies’ shares. Had we used different estimates of volatility, the allocations between preferred and common shares would have been different.

Determining the value of our share-based compensation expenses requires the input of highly subjective assumptions, including the expected life of the share-based awards, estimated forfeitures and the price volatility of the underlying shares. The assumptions used in calculating the fair value of share-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of our judgment. As a result, if factors change and we use different assumptions, our share-based compensation expenses could be materially different in the future.

Restricted shares

Share Awards granted under 2011 Share Plan

On May 6, 2011, we granted 1,075,000 of restricted shares with a value of US$1.8 million to one of the executive officers of NQ US as his signing incentives. These restricted shares were granted under our 2011 Share Plan and were valued at their estimated fair value on the grant date of the award. These restricted shares are subject to transfer restrictions with a vesting period of four years. On July 10, 2012, we granted 115,475 restricted shares with a value of US$0.2 million to him with the same vesting period. We also agreed to award additional number of restricted shares with a value of US$0.25 million to this executive officer for each contract executed with certain specific customers. The terms of each such additional grant shall provide for equal monthly vesting and full vesting on the second anniversary of the grant date. We continuously performed assessments on the granting criteria and considered none of these performance-related criteria had been met or expected to be met as of December 31, 2012, and no related compensation expense was recognized.

On July 10, 2012, we granted 1,000,000 of restricted shares with a value of US$1.6 million to an executive officer as signing incentives. These restricted shares were granted under our 2011 Share Plan and are subject to transfer restrictions with a vesting period of four years and were valued at their estimated fair value on the grant date of the award.

On July 27, 2012, we granted 463,000 restricted ADSs with a value of US$1.2 million to two executive officers of NQ US as incentives. The value of these restricted shares was calculated based on their grant date fair values. These restricted shares are subject to the achievement of either specific performance goals or certain market value for NQ Mobile Inc. for each of the four-year employment period beginning on the employment date and were valued at their estimated fair value on the date of the award. Up to 578,750 restricted ADSs shall become vested and non-forfeitable under our grants to these two executive officers, and the specific numbers to vest each year shall be determined on the last day of each fiscal year based on the percentage achievement of the performance goals or certain market value for NQ Mobile Inc. for each fiscal year. These restricted ADSs were granted under our 2011 Share Plan. We have first determined whether or not it was probable that the performance condition would be achieved. The fair value of the restricted ADSs calculated reflecting the market value condition represents the minimum amount that is recognized as compensation cost assuming the requisite service is completed, even if the performance or market value condition is not met. The fair value of the restricted ADSs (without considering the market value condition) would be recognized if the performance condition is probable of being achieved. As of December 31, 2012, we determined that it was not probable that the performance conditions will be achieved. As a result, the related compensation expense calculated based on the market value condition was recognized over the requisite service period using graded vesting method.

 

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On July 10, 2012, we granted 1,150,000 restricted shares to non-employee consultants for their services. The fair value of share-based compensation to be recognized for these restricted shares is measured on each period end. Twenty-five percent of these restricted shares will vest on the first-year anniversary of the grant date and 1/48 of these restricted shares will vest each month over a three-year period thereafter. These restricted shares were granted under our 2011 Share Plan. As all the criteria for establishing grant date were met, the fair value of share-based compensation to be recognized for these restricted shares is measured on the grant date.

Other Share Awards

On January 8, 2012, we granted 10,000,000 restricted shares to our director and co-chief executive officer, Mr. Omar Sharif Khan, pursuant to the employment agreement we entered into with Mr. Khan in December 2011. Of the 10,000,000 restricted shares, 6,000,000 restricted shares will vest over four years provided that Mr. Khan continues his employment with our company. Twenty five percent of the 6,000,000 restricted shares will vest on the first-year anniversary of the employment commencement date and 1/48 of 6,000,000 restricted shares will vest each month over a three-year period thereafter. The remaining 4,000,000 restricted shares are subject to the achievement of either specific performance or certain market value for NQ Mobile Inc. for each of the next four years. The value of the restricted shares under these conditions was calculated based on their grant date fair values without considering the possibility that the service conditions or performance conditions will be achieved. As all the criteria for establishing grant date were met, the fair value of share-based compensation being recognized for these restricted shares was measured on January 8, 2012. For the 6,000,000 restricted shares that are subject only to the service condition, the related compensation expenses are being recognized using graded vesting method over the next four years. For the 4,000,000 restricted shares subject to the conditions set forth above, we first determine whether or not it is probable that the performance condition would be achieved. The fair value of the restricted shares calculated reflecting the market value of NQ Mobile Inc. represents the minimum amount that is recognizable as compensation cost assuming the requisite service is completed, even if the performance or market value condition is not met. The fair value of the restricted shares (without considering the market value of NQ Mobile Inc.) would be recognized if the performance condition is probable of being achieved.

In estimating the number of restricted shares to be vested to Mr. Khan, both performance and the market value conditions were considered. The achievability of the performance condition was estimated based on the financial projections of NQ developed by our management. The market value condition relates to the market capitalization and the stock price of our company over the next four years. Our company considered Monte Carlo model to simulate future price paths of our stock. The Monte Carlo approach simulates stock price paths through the well-known geometric Brownian motion formulation which incorporates a drift rate, volatility and a Weiner process based on a random process modeled by the standard normal distribution and is a function of the square root of time.

In May 2012, we amended the employment agreement with Mr. Khan to grant him an additional 9,000,000 restricted shares in exchange for his agreement to give up 15% equity interest in NQ that we previously agreed to grant to him under his employment agreement. For more details, see “—Equity Shares of NQ Global” below. 3,500,000 restricted shares will start vesting from the first anniversary of his employment commencement date, with a portion vesting every month for the 36 months thereafter. The remaining 5,500,000 restricted shares will vest upon achievement of certain performance milestones from 2012 through 2015. Under our employment agreement with Mr. Khan, a total of up to 11,875,000 restricted shares shall become vested and non-forfeitable subject to either specific performance or certain market value for NQ Mobile Inc., and shall be determined on the last day of each fiscal year based on the percentage achievement of fiscal year performance goal or the target market value for NQ Mobile Inc.

As of December 31, 2012, we determined that it is not probable that the performance conditions will be achieved. As a result, the related compensation expense calculated based on the market value condition is recognized over the requisite service period using graded vesting method.

The employment agreement with Mr. Khan was amended in January 2013 and again in March 2013 such that any restricted shares that would have vested on January 8, 2013, January 31, 2013, February 28, 2013 or March 31, 2013 shall vest on March 29, 2013. The employment agreement was further amended in April 2013; under the amendment, the market value conditions for the restricted shares were removed and the performance condition was revised for the restricted shares that will vest in 2013 through 2015.

 

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We granted 2,875,000 restricted shares to the non-controlling interest shareholder of NationSky in May 2012. The value of the restricted shares was calculated based on the fair value of the acquisition date on which all the criteria for establishing grant date were met. These restricted shares are subject to a vesting period of four years and/or certain performance related targets. As all the criteria for establishing grant date were met, the fair value of share-based compensation to be recognized for these restricted shares is measured on the grant date. Of the 2,875,000 restricted shares, 1,725,000 restricted shares are subject only to the service condition. The related compensation expenses are being recognized using graded vesting method over the next four years. The remaining 1,150,000 restricted shares are subject to both performance and service condition. We have first determined whether or not it was probable that the performance condition would be achieved. The compensation expense would be recognized if the performance condition is probable of being achieved. As of December 31, 2012, we determine that it is not probable that the performance conditions will be achieved. As a result, the related compensation expense was not recognized.

We granted 18,519,971 restricted shares to the original shareholder of Beijing Feiliu and Beijing Red in November 2012. The value of the restricted shares was calculated based on the fair value of the acquisition date on which all the criteria for establishing grant date were met. These restricted shares are subject to a vesting period of four years and/or certain performance related targets. As all the criteria for establishing grant date were met, the fair value of share-based compensation to be recognized for these restricted shares is measured on the grant date. Of these 18,519,971 restricted shares, 6,173,324 restricted shares are subject only to certain service condition. The related compensation expenses are being recognized using graded vesting method over the next four years. The remaining 12,346,647 restricted shares are subject to both performance and service condition, we has first determined whether or not it was probable that the performance condition would be achieved. The compensation expense would be recognized if the performance condition would probably be achieved. As of December 31, 2012, we determined that it is not probable that these performance conditions will be achieved. As a result, the related compensation expense was not recognized.

In January and February of 2013. We also granted 3,264,105 restricted shares to employees, directors and non-employees.

Equity Shares of NQ Global

Pursuant to the employment agreement entered into by NQ US, Mr. Omar Sharif Khan and us in December 2011, we agreed to establish NQ Global and to issue 15% equity interest in NQ Global (“NQ Global Shares”) to Mr. Khan for a nominal value. Mr. Khan’s NQ Global Shares had an embedded put option where Mr. Khan would have the right, in his sole discretion, to require us to purchase a portion or all of his NQ Global Shares (“Put Option”) at their fair market value on the exercise date. While the NQ Global Shares are fully vested upon their issuance, the Put Option was to vest and become exercisable at the rate of 25% of the underlying shares upon each of the first four annual anniversaries of the employment commencement date. In February 2012, since (i) all the key terms and conditions of NQ Global, including its business model, operating markets, the support from our company, financing model, key management team, dividend policy and etc, were agreed among the counterparties, (ii) the establishment of the legal entity was approved by the board and fully expected by both our company and Mr. Khan, the grant date was established at that time. Since these NQ Global Shares were fully vested upon grant, the entire compensation expenses of US$0.5 million were recognized on the grant date. The fair value of 15% equity interest in NQ Global is determined based on the income approach. In May 2012, Mr. Khan and we amended his employment agreement and Mr. Khan gave up his 15% equity interest in NQ Global (and the associated Put Option) in exchange for an additional 9,000,000 restricted shares. See “—Restricted Shares.”

In estimating the fair value of the NQ Global Shares, our management relied primarily on the income approach in the form of a Discounted Cash Flow methodology. The income approach involves applying appropriate discount rate to estimated cash flows that are subject to a number of assumptions.

As of the valuation date of the NQ Global Shares, NQ Global has not yet been formally incorporated and has not commenced operations. Historical operation data and financial performance is not available as of the valuation date. Therefore, the financial projection was developed based on the prevailing business plan, experiences of the management in the mobile security market, and assumptions consistent with the strategic plan used to manage the underlying business. These assumptions are inherently uncertain and subjective. The discount rate was developed based on the estimated market required rate of return for investing in NQ Global, or WACC, which was derived by using the capital asset pricing model, a method that market participants commonly use to price securities. The risks associated with achieving the estimated cash flow were assessed in selecting the appropriate discount rate, which had been determined to be 35%.

 

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DLOM was also applied to reflect the fact that there is no ready public market for the Equity as NQ Global is private. The DLOM was assumed by our management based on a consideration of the various research studies including restricted stock studies that attempted to quantify marketability discounts. The management believes a DLOM of 30% is appropriate for shares of a new start-up like NQ Global.

Changes in these assumptions could significantly affect the fair value of restricted shares and hence the amount of compensation expense we recognize in our consolidated financial statements.

The summary of restricted share activities as of March 15, 2013 and changes during the period is presented below:

 

     Number of shares    

Fair value per share

at grant date

US$

 

Unvested as of January 1, 2012

     1,075,000        1.6800   

Granted

     47,973,506        1.2379   

Vested

     (2,992,985     0.8971   

Forfeited or cancelled

     (1,021,995     1.4936   

Unvested as of December 31, 2012

     45,033,526        1.2653   

Granted

     3,264,105        1.2127   

Vested

     (99,405     1.5553   

Unvested as of March 15, 2013

     48,198,226        1.2612   

Income Taxes

Current income tax are provided on the basis of income for financial reporting purpose, adjusted for income and expense items which are not assessable or deductible for income tax purpose, in accordance with the regulations of the relevant tax jurisdictions, deferred income taxes are accounted for using the liability approach which requires the recognition of income taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in our financial statements or tax returns. Deferred income taxes are determined based on the differences between the financial reporting and tax basis of assets and liabilities and are measured using the currently enacted tax rates and laws. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the consolidated statements of comprehensive income in the period that includes the enactment date.

We currently have deferred tax assets resulting from net operating loss carryforwards and deductible temporary differences, all of which are available to reduce future tax payable in our significant tax jurisdictions. The largest component of our deferred assets are operating loss carryforwards generated by our PRC subsidiary and VIE due to their historical operating losses. In assessing whether such deferred tax assets can be realized in the future, we need to make judgments and estimates on the ability of each of our PRC subsidiary and VIE to generate taxable income in the future years. To the extent that we believe it is more likely than not that some portion or the entire amount of deferred tax assets will not be realized, we established a total valuation allowance to offset the deferred tax assets. As of December 31, 2010, 2011 and 2012, we recognized a total valuation allowance of US$0.5 million, US$1.2 million and US$1.4 million against deferred tax assets, respectively. If we subsequently determine that all or a portion of the carryforwards are more like than not to be realized, the valuation allowance will be released, which will result in a tax benefit in our consolidated statements of comprehensive income.

We adopted the guidance on accounting for uncertainty in income taxes on January 1, 2008. The guidance prescribes a more likely than not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Guidance was also provided on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods, and income tax disclosures. Significant judgment is required in evaluating our uncertain tax positions and determining its provision for income taxes. We did not have any adjustment to the opening balance of retained earnings as of January 1, 2008 as a result of the implementation of the guidance. We did not have any interest and penalties associated with tax positions for the years ended December 31, 2010, 2011 and 2012. As of December 31, 2010, 2011 and 2012, we did not have any significant unrecognized uncertain tax positions.

 

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Investments in Associates

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

Cost method investments

In accordance with ASC subtopic 325-20 (“ASC 325-20”), Investments-Other: Cost Method Investments, for investments in an investee over which we do not have significant influence, we carry the investment at cost and only adjusts for other-than-temporary declines in fair value and distributions of earnings. We regularly evaluate the impairment of the cost method investments based on performance and financial position of the investee as well as other evidence of market value. Such evaluation includes, but is not limited to, reviewing the investee’s cash position, recent financing, projected and historical financial performance, cash flow forecasts and financing needs. An impairment loss is recognized in the consolidated statements of comprehensive income equal to the excess of the investment’s cost over its fair value at the balance sheet date of the reporting period for which the assessment is made. The fair value would then become the new cost basis of investment.

Equity method investments

Investments in entities in which we can exercise significant influence but does not own a majority equity interest or control are accounted for using the equity method of accounting in accordance with ASC subtopic 323-10 (“ASC 323-10”), Investments-Equity Method and Joint Ventures: Overall. Under the equity method, we initially record our investment at cost and the difference between the cost of the equity investee and the amount of the underlying equity in the net assets of the equity investee is recognized as equity method goodwill, which is included in the equity method investment on the consolidated balance sheets. We subsequently adjust the carrying amount of the investment to recognize our proportionate share of each equity investee’s net income or loss into consolidated statements of comprehensive income after the date of acquisition. We will discontinue applying the equity method if an investment (and additional financial supports to the investee, if any) has been reduced to zero.

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

Impairment for equity investments

We assess our equity investments for other-than-temporary impairment by considering factors including, but not limited to, current economic and market conditions, operating performance of the companies, including current earnings trends and undiscounted cash flows, and other company-specific information. The fair value determination, particularly for investments in privately-held companies, requires significant judgment to determine appropriate estimates and assumptions. Changes in these estimates and assumptions could affect the calculation of the fair value of the investments and determination of whether any identified impairment is other-than-temporary.

Results of Operations

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

 

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     For the Year Ended December 31,  
     2010     2011     2012  
     US$     % of Net
Revenues
    US$     % of Net
Revenues
    US$     % of Net
Revenues
 
     (in thousands of dollars, except for percentages)  

Net Revenues:

            

Service Revenues

            

Consumer mobile security

     15,268        86.3        36,202        89.0        67,938        74.0   

Enterprise mobility

     —          —          —          —          3,249        3.5   

Mobile games and advertising

     —          —          —          —          664        0.7   

Other services

     2,427        13.7        4,469        11.0        10,614        11.6   

Product Revenues

            

Enterprise mobility

     —          —          —          —          9,303        10.2   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenues

     17,695        100.0        40,671        100.0        91,768        100.0   

Cost of revenues

            

Cost of services

     (5,193     (29.3     (8,057     (19.8     (16,773     (18.2

Cost of products sold

     —          —          —          —          (8,966     (9.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenues (1)

     (5,193     (29.3     (8,057     (19.8     (25,739     (28.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     12,502        70.7        32,614        80.2        66,029        72.0   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

            

Selling and marketing expenses (1)

     (4,436     (25.1     (7,955     (19.6     (17,396     (19.0

General and administrative expenses (1)

     (14,750     (83.4     (14,024     (34.5     (36,776     (40.1

Research and development expenses (1)

     (2,959     (16.7     (5,095     (12.5     (9,585     (10.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     (22,145     (125.2     (27,074     (66.6     (63,757     (69.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/Income from operations

     (9,643     (54.5     5,540        13.6        2,272        2.5   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income

     234        1.3        1,342        3.3        3,193        3.5   

Realized gain/(loss) from available-for-sale investments

     (102     (0.6     29        0.1        —          —     

Foreign exchange (losses)/gains, net

     (46     (0.3     3,011        7.4        67        0.1   

Foreign exchange (losses)/gains, net

     —          —          —          —          943        1.0   

Other (expense)/income, net

     135        0.8        306        0.7        3,364        3.7   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/Income before income taxes

     (9,422     (53.3     10,228        25.1        9,839        10.8   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income tax expense

     (401     (2.3     (97     (0.2     (420     (0.5

Share of (loss)/profit from an associate

     (7     —          119        0.3        543        0.6   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income

     (9,830     (55.6     10,250        25.2        9,962        10.9   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Share-based compensation expenses included in:

 

     For the Year Ended December 31,  
     2010      2011      2012  
         US$          % of Net
Revenues
         US$          % of Net
Revenues
         US$          % of Net
Revenues
 
     (in thousands of dollars, except for percentages)  

Cost of revenues

     19         0.1         130         0.3         214         0.2   

Selling and marketing expenses

     102         0.6         1,923         4.7         2,342         2.6   

General and administrative expenses

     12,299         69.5         7,895         19.4         20,534         22.4   

Research and development expenses

     146         0.8         724         1.8         1,453         1.6   

 

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Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

Net Revenues. Our total net revenues increased by 125.6% from US$40.7 million in 2011 to US$91.8 million in 2012, due primarily to the increase in net revenues from consumer mobile security services and, to a lesser extent, to an increase in net revenues from other services. In addition, the sales of hardware and mobility service revenue from NationSky and mobile game and advertising revenue from Beijing Feiliu were consolidated after their respective acquisitions. Net revenues from consumer mobile security, previously named as premium mobile Internet services, increased by 87.7% from US$36.2 million in 2011 to US$67.9 million in 2012, primarily due to the growth of our average monthly paying user accounts, which in turn reflected the growth of our registered and active user accounts and their increased use of our premium services, and, in particular, an increase in the number of our overseas paying user accounts, which generally pay for our products and services at a higher subscription fee level. The number of our registered user accounts increased from 146.7 million as of December 31, 2011 to 283.4 million as of December 31, 2012, not including Beijing Feiliu’s 67.4 million registered user accounts as of December 31, 2012. The number of our average monthly active user accounts increased from 52.4 million for the three months ended December 31, 2011 to 97.7 million for the three months ended December 31, 2012, not including Beijing Feiliu’s 12.5 million average monthly active users accounts. In line with the increase in our average monthly active user accounts, our average monthly paying user accounts increased from 5.6 million for the three months ended December 31, 2011 to 8.9 million for the three months ended December 31, 2012, not including Beijing Feiliu’s average monthly paying users accounts. Overseas users account for an increasing portion of our net revenues as we further expand consumer mobile security services in overseas markets. For the three months ended December 31, 2011, we had 1.6 million overseas average monthly paying user accounts, which was 28.6% of the total average monthly paying user accounts for that period, while for the three months ended December 31, 2012, we had 3.0 million overseas average monthly paying user accounts, which amounted to 33.7% of the total average monthly paying user accounts for that period. Net revenues attributable to overseas users as a percentage of our consumer mobile security revenues increased from 48.9% in 2011 to 52.6% in 2012. Our net revenues from other services increased from US$4.5 million in 2011 to US$10.6 million in 2012, primarily due to the increase in net revenues from secured download and delivery services for mobile applications produced by third parties.

Cost of Revenues. Our cost of revenues increased by 219.5% from US$8.1 million in 2011 to US$25.7 million in 2012. The increase was primarily due to (i) an increase in customer acquisition cost from US$3.3 million in 2011 to US$7.8 million in 2012, primarily as payments to third-party websites and handset manufacturers increased as we acquired more active user accounts through these channels; (ii) an increase in fees charged by mobile payment service providers from US$1.8 million in 2011 to US$3.3 million in 2012, in line with the revenues increase; (iii) an increase in staff cost, primarily in the form of salaries and benefits for employees that provide support directly related to our products and services, from US$1.8 million in 2011 to US$3.2 million in 2012, which in turn primarily reflected the expansion of our product and service support teams; and (iv) the cost of hardware procurement of US$9.0 million associated with the NationSky acquisition.

Gross Profit and Margin. As a result of the foregoing, our gross profit increased from US$32.6 million in 2011 to US$66.0 million in 2012. Our gross margin decreased from 80.2% in 2011 to 72.0% in 2012. This decrease was primarily due to the acquisition of NationSky which has much lower gross margin. Excluding NationSky, our gross profit in 2012 was US$62.9 million, representing an 92.8% increase from US$32.6 million in 2011. The gross margin of NationSky in the last seven months for the year ended December 31, 2012 was 25.2%. Our gross margin excluding NationSky was 79.4% for the year ended December 31, 2012.

Operating Expenses. Our operating expenses increased by 135.5% from US$27.1 million in 2011 to US$63.8 million in 2012.

Selling and Marketing Expenses. Our selling and marketing expenses increased by 118.7% from US$8.0 million in 2011 to US$17.4 million in 2012. This increase was primarily due to (i) an increase in share-based compensation expenses for our sales and marketing personnel from US$1.9 million in 2011 to US$2.3 million in 2012, resulting from additional options and restricted shares granted to our sales and marketing personnel in 2012; (ii) an increase in marketing and advertising spending from US$2.9 million in 2011 to US$8.5 million in 2012, resulting from our increased effort in marketing and brand building; and (iii) an increase in staff costs, including salaries, benefits and commissions to our sales and marketing personnel, from US$2.1 million in 2011 to US$4.4 million in 2012 mainly attributable to the increase in headcounts.

General and Administrative Expenses. Our general and administrative expenses increased by 162.2% from US$14.0 million in 2011 to US$36.8 million in 2012. The increase was primarily due to significantly higher share-based compensation expenses for our general and administrative personnel from US$7.9 million in 2011 to US$20.5 million in 2012, primarily attributable to the grant of restricted ADSs to newly hired senior executives in 2012, higher staff cost from US$2.0 million in 2011 to US$6.8 million in 2012, resulting mostly from salary increase and the hiring of additional senior executives, and higher legal and professional fees from US$1.4 million in 2011 to US$3.6 million in 2012, resulting mostly from the legal and professional fees associated with our attempted secondary offering in May 2012 and our acquisition of NationSky and Beijing Feiliu in May and November 2012 respectively.

 

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Research and Development Expenses. Our research and development expenses increased by 88.1% from US$5.1 million in 2011 to US$9.6 million in 2012. This increase was primarily due to the hiring of more research and development personnel which led to an increase in staff cost from US$3.5 million in 2011 to US$6.4 million in 2012 and an increase in share-based compensation for our research and development personnel which contributed to an increase in compensation cost from US$0.7 million in 2011 to US$1.5 in 2012.

Income from Operations. As a result of the foregoing, our income from operations decreased by 59.0% from US$5.5 million in 2011 to US$2.3 million in 2012. The decrease was mainly due to the significant increase in share-based compensation which was 24.5 million in 2012, compared to 10.7 million in 2011.

Income Tax Expense. Our income tax expense was US$0.1 in 2011 and US$0.4 million in 2012. The income tax expenses accrued for the 2012 was mainly attributable to our subsidiaries in China.

Net Income attributable to NQ Mobile Inc. As a result of the foregoing, our net income decreased from US$10.3 million in 2011 to US$9.4 million in 2012. The decrease was mainly due to the significant increase in share-based compensation, which was 24.5 million in 2012, compared to 10.7 million in 2011.

Year Ended December 31, 2011 Compared to Year Ended December 31, 2010

Net Revenues. Our total net revenues increased by 129.8% from US$17.7 million in 2010 to US$40.7 million in 2011, due primarily to an increase in net revenues from consumer mobile security services and, to a lesser extent, to an increase in net revenues from other services. Net revenues from consumer mobile security services increased by 137.1% from US$15.3 million in 2010 to US$36.2 million in 2011, primarily due to the growth of our average monthly paying user accounts, which in turn reflected the growth of our registered and active user accounts and their increased use of our premium services, and, in particular, an increase in the number of our overseas paying user accounts, which generally pay for our products and services at a higher subscription fee level. The number of our registered user accounts increased from 71.7 million as of December 31, 2010 to 146.7 million as of December 31, 2011. The number of our average monthly active user accounts increased from 25.4 million for the three months ended December 31, 2010 to 52.3 million for the three months ended December 31, 2011. In line with the increase in our average monthly active user accounts, our average monthly paying user accounts increased from 3.2 million for the three months ended December 31, 2010 to 5.6 million for the three months ended December 31, 2011. Overseas users account for an increasing portion of our net revenues as we further expand consumer mobile security services in overseas markets. For the three months ended December 31, 2010, we had 0.7 million overseas average monthly paying user accounts, which was 21.3% of the total average monthly paying user accounts for that period, while for the three months ended December 31, 2011, we had 1.6 million overseas average monthly paying user accounts, which amounted to 29.4% of the total average monthly paying user accounts for that period. Net revenues attributable to overseas users as a percentage of our total net revenues increased from 35.1% in 2010 to 43.4% in 2011. Our net revenues from other services increased from US$2.4 million in 2010 to US$4.5 million in 2011, primarily due to an increase in net revenues from secured download and delivery services for mobile applications produced by third parties.

Cost of Revenues. Our cost of revenues increased by 55.2% from US$5.2 million in 2010 to US$8.1 million in 2011. The increase was primarily due to (i) an increase in customer acquisition cost from US$2.5 million in 2010 to US$3.3 million in 2011, primarily as payments to third-party websites and handset manufacturers increased as we acquired more active user accounts through these channels; (ii) an increase in fees charged by mobile payment service providers from US$1.0 million in 2010 to US$1.8 million in 2011; and (iii) an increase in staff cost, primarily in the form of salaries and benefits for employees that provide support directly related to our products and services from US$0.8 million in 2010 to US$1.8 million in 2011, which in turn primarily reflected the expansion of our product and service support teams.

Gross Profit and Margin. As a result of the foregoing, our gross profit increased by 160.9% from US$12.5 million in 2010 to US$32.6 million in 2011. Our gross margin increased significantly from 70.7% in 2010 to 80.2% in 2011. This increase was primarily due to (i) the fact that we collected a larger portion of our net revenues through prepaid card distributors in 2011 than 2010, since we launched the prepaid card payment channel in the fourth quarter of 2009. As we recognize net proceeds from prepaid card distributors as net of revenues, the cost of revenues associated with revenues gained through prepaid card distributors is lower, increasing our gross margin; and (ii) the fact that a larger portion of our net revenues, from 35.1% in 2010 to 43.4% in 2011, were generated from overseas users who generally pay for our products and services at a higher subscription fee level than Chinese users and the fact that a higher portion of overseas users pay for our products and services by prepaid cards which have lower cost of revenues.

 

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Operating Expenses. Our operating expenses increased by 22.3% from US$22.1 million in 2010 to US$27.1 million in 2011.

Selling and Marketing Expenses. Our selling and marketing expenses increased by 79.3% from US$4.4 million in 2010 to US$8.0 million in 2011. This increase was primarily due to (i) an increase in share-based compensation expenses for our sales and marketing personnel from US$0.1 million in 2010 to US$1.9 million in 2011, resulting from additional options and restricted shares granted to our sales and marketing personnel in 2011; (ii) an increase in marketing and advertising spending from US$1.8 million in 2010 to US$2.9 million in 2011, resulting from our increased effort in marketing and brand building; and (iii) to a lesser extent, an increase in staff costs, including salaries, benefits and commissions to our sales and marketing personnel, from US$1.6 million in 2010 to US$2.1 million in 2011.

General and Administrative Expenses. Our general and administrative expenses decreased by 4.9% from US$14.8 million in 2010 to US$14.0 million in 2011. The decrease was primarily due to significantly lower share-based compensation expenses for our general and administrative personnel from US$12.3 million in 2010 to US$7.9 million in 2011, partially offset by higher staff cost from US$0.9 million in 2010 to US$2.0 million in 2011, resulting mostly from salary increase and the hiring of additional senior executives, and higher legal and professional fees from US$0.2 million in 2010 to US$1.4 million in 2011, resulting mostly from the additional cost on legal and professional fees as a public company. The significantly higher share-based compensation in 2010 was primarily attributable to the grant of share options in December 2010, a significant portion of which was immediately vested upon grant.

Research and Development Expenses. Our research and development expenses increased by 72.2% from US$3.0 million in 2010 to US$5.1 million in 2011. The increase was primarily due to higher staff cost from US$2.2 million in 2010 to US$3.5 million in 2011 resulting mostly from salary increase and higher share-based compensation expenses from US$0.1 million in 2010 to US$0.7 million in 2011 for our research and development personnel as a result of additional options granted.

(Loss)/Income from Operations. As a result of the foregoing, we had an income from operations of US$5.5 million in 2011, compared with a loss from operations of US$9.6 million in 2010.

Foreign Exchange Gain and Interest Income. Foreign exchange gain was US$3.0 million in fiscal year 2011, compared with a loss of US$0.05 million in 2010. Foreign exchange gain was primarily attributable to the appreciation of RMB against U.S. dollar when a portion of our initial public offering proceeds was converted into RMB and placed in bank deposits from the second quarter of 2011 onwards. Interest income was US$1.3 million in 2011, compared with US$0.2 million in 2010. Interest income was primarily due to the higher deposit position resulting from the proceeds of our initial public offering in May 2011.

Income Tax Expense. Our income tax expense was US$0.4 million in 2010 and US$0.1 million in 2011. The income tax expense accrued for the 2011 was mainly attributable to our subsidiary in China.

Net (Loss)/Income attributable to NQ Mobile Inc. As a result of the foregoing, we had a net income of US$10.3 million in 2011 compared to a net loss of US$9.8 million in 2010.

Inflation

Since our inception, inflation in China has not materially impacted our results of operations. According to the National Bureau of Statistics of China, the year-over-year percent changes in the consumer price index for December 2010, 2011 and 2012 were increases of 4.6%, 4.1% and 2.5%, respectively. Although we have not been materially affected by inflation in the past, we can provide no assurance that we will not be affected in the future by higher rates of inflation in China.

 

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Recent Accounting Pronouncements

In July 2012, the FASB issued revised guidance on “Testing Indefinite-Lived Intangible Assets for Impairment.” The revised guidance applies to all entities, both public and nonpublic, that have indefinite-lived intangible assets, other than goodwill, reported in their financial statements. Under the revised guidance, an entity has the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform a quantitative impairment test by comparing the fair value with the carrying amount in accordance with Subtopic 350-30. An entity also has the option to bypass a qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period. In conducting a qualitative assessment, an entity should consider the extent to which relevant events and circumstances, both individually and in the aggregate, could have affected the significant inputs used to determine the fair value of the indefinite-lived intangible asset since the last assessment. An entity also should consider whether there have been changes to the carrying amount of the indefinite-lived intangible asset when evaluating whether it is more likely than not that the indefinite-lived intangible asset is impaired. An entity should consider positive and mitigating events and circumstances that could affect its determination of whether it is more likely than not that the indefinite-lived intangible asset is impaired. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. There is no impact on our consolidated financial statements of adopting this guidance as there are no indefinite-lived intangible assets held by us for each of the three years ended and as of December 31, 2012.

In February 2013, the FASB issued revised guidance on “Comprehensive Income: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” The revised guidance does not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the revised guidance requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. The revised guidance is effective prospectively for reporting periods beginning after December 15, 2012 for public entities. The revised guidance will not have a material effect on us.

 

B. Liquidity and Capital Resources

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

As of December 31, 2012, we had US$18.9 million in cash and cash equivalents, and US$101.5 million in term deposits. Cash and cash equivalents represent cash on hand, demand deposits and other short-term highly liquid investments placed with banks that have original maturities of three months or less and are readily convertible to known amounts of cash. Term deposits are bank deposits with maturity terms of four to twelve months, which expect no risk of principal loss. Most of them are located in PRC state-owned banks.

 

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

 

     For the Year Ended December 31,  
     2010     2011     2012  
     (in thousands of dollars)  

Net cash (used in)/provided by operating activities

     (3,756     11,840        19,513   

Net cash used in investing activities

     (9,455     (47,091     (68,569

Net cash provided by/(used in) financing activities

     28,893        82,711        (1,203

Effect of exchange rate changes on cash and cash equivalents

     580        4,084        (389
  

 

 

   

 

 

   

 

 

 

Net increase/(decrease) in cash and cash equivalents

     16,262        51,544        (50,648

Cash and cash equivalents at the beginning of the year

     1,704        17,966        69,510   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at the end of the year

     17,966        69,510        18,862   
  

 

 

   

 

 

   

 

 

 

Current PRC regulations permit our subsidiary to pay dividends to us only out of its accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. Under PRC law, each of our wholly owned PRC subsidiary and consolidated affiliated entities is required to set aside at least 10% of its after-tax profits each year, if any, to fund a statutory reserve until such reserve reaches 50% of each of their respective registered capital. Although the statutory reserves can be used, among other ways, to increase the registered capital and offset future losses in excess of retained earnings of the respective companies, the reserve funds are not distributable as cash dividends except in the event of liquidation. As a result of these PRC laws and regulations, our PRC subsidiary and consolidated affiliated entities are restricted in their abilities to transfer net assets to us in the form of dividends, loans or advances. Total restricted net assets of our PRC subsidiary and consolidated affiliated entities were US$33.7 million, US$30.5 million and US$66.5 million as of December 31, 2010, 2011 and 2012, respectively. Furthermore, cash transfers from our PRC subsidiary to our subsidiaries outside of China are subject to PRC government control of currency conversion. Restrictions on the availability of foreign currency may affect the ability of our PRC subsidiaries and consolidated affiliated entities to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency denominated obligations. See “Item 3. Key Information — D. Risk Factors — Risks Related to Our Corporate Structure — We may rely principally on dividends and other distributions on equity paid by our PRC and HK subsidiaries to fund any cash and financing requirements we may have. Any limitation on the ability of our PRC and HK subsidiaries to pay dividends to us could have a material adverse effect on our ability to conduct our business” and “Risk Factors — Risks Related to Doing Business in China — Governmental control of currency conversion may limit our ability to utilize our revenues effectively and affect the value of your investment.”

Operating Activities

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

Net cash provided by operating activities amounted to US$19.5 million in 2012, which was primarily attributable to a net income of US$10.0 million, adjusted for certain non-cash expenses consisting principally of share-based compensation of US$24.5 million and depreciation and amortization of US$1.6 million, other income from ADR depositary arraignment and gain from step acquisition of US$3.2 million and by an increase in working capital. The increase in working capital was primarily attributed to an increase in accounts receivable of US$28.1 million, mainly from overseas mobile payment service providers that have longer credit terms, partially offset by an increase in accounts payable of US$5.3 million, deferred revenue of US$4.9 million and accrued expenses and other current liabilities of US$4.5 million.

Net cash provided by operating activities amounted to US$11.8 million in 2011, which was primarily attributable to a net income of US$10.3 million, adjusted for certain non-cash expenses consisting principally of share-based compensation of US$10.7 million and foreign exchange gain of US$3.0 million and an increase in working capital. The increase in working capital was primarily attributed to an increase in accounts receivable of US$11.6 million mainly from overseas mobile payment service providers that have longer credit terms, partially offset by an increase in deferred revenue of US$4.4 million due to our growth in net revenues.

 

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Net cash used in operating activities amounted to US$3.8 million in 2010, which was primarily attributable to a net loss of US$9.8 million, adjusted for certain non-cash expenses consisting principally of share-based compensation of US$12.6 million and an increase in working capital. The increase in working capital was primarily attributed to an increase in accounts receivable of US$9.1 million mainly from overseas mobile payment service providers that have longer credit terms and an increase in other non-current assets of US$1.2 million as a result of the prepaid customer acquisition costs to Beijing Feiliu, partially offset by an increase in deferred revenue of US$2.1 million due to our growth in net revenues.

Investing Activities

Net cash provided by or used in investing activities largely reflected placement and maturities of term deposits, purchase of and proceeds from disposal of short-term investments, loan advanced to a mobile payment service provider and purchase of property and equipment and intangible assets.

Net cash used in investing activities amounted to US$68.6 million in 2012, primarily attributable to a net placement of term deposits of US$42.1 million, net placement of financial products of US$7.6 million, cash paid for equity investment of US$6.3 million, bridge loan and prepayment made in connection with completed and ongoing investments of US$11.3 million and purchase of property and equipment and intangible assets of US$2.3 million, partially offset by US$1.2 million cash acquired from business acquisitions.

Net cash used in investing activities amounted to US$47.1 million in 2011, primarily attributable to net placement of term deposits of US$47.1 million and purchase of domain name use right (www.nq.com) of US$1.6 million, partially offset by proceeds from the repayment of the advance to a mobile payment service provider of US$2.2 million.

Net cash used in investing activities amounted to US$9.5 million in 2010, primarily attributable to placement of term deposits of US$11.3 million, a loan advanced to a mobile payment service provider of US$2.3 million and disbursement of housing loans to employees of US$1.8 million, partially offset by maturity of term deposits of US$2.2 million, proceeds from disposal of available-for-sale investments of US$2.2 million and proceeds from the repayment of the advance to a mobile payment service provider of US$1.9 million.

Financing Activities

Net cash used in financing activities amounted to US$1.2 million in 2012, primarily attributable to the US$1.3 million used to repurchase our common stock as part of our 2012 Repurchase Plan (described in detail in “Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers”).

Net cash provided by financing activities amounted to US$82.7 million in 2011, primarily attributable to the proceeds of US$82.9 million from our initial public offering, partially offset by the listing expenses of US$3.9 million.

Net cash provided by financing activities amounted to US$28.9 million in 2010, attributable to proceeds of US$17.0 million from the issuance of Series C convertible redeemable preferred shares and proceeds of US$11.9 million from the issuance of Series C-1 convertible redeemable preferred shares.

Capital Expenditures

We made capital expenditures of US$0.6 million, US$2.3 million and US$2.3 million for the years ended December 31, 2010, 2011 and 2012, respectively. In the past, our capital expenditures were primarily used to purchase servers and other equipment, software and other intangible assets (such as the domain name www.nq.com) for our business. Our capital expenditures may increase in the near term as our business continues to grow.

 

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

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

Research and development expenses consist primarily of salaries and benefits for research and development personnel. We expect our research and development expenses to increase as we intend to hire more research and development personnel to increase performance levels of existing products and services and develop new products and services. We incurred US$3.0 million, US$5.1 million and US$9.6 million of research and development expenses in 2010, 2011 and 2012, respectively.

 

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D. Trend Information

Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events since the beginning of our fiscal year 2012 that are reasonably likely to have a material effect on our net revenues, income from operations, profitability, liquidity or capital resources, or that would cause the disclosed financial information to be not necessarily indicative of future operating results or financial condition.

 

E. Off-Balance Sheet Arrangements

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

 

F. Tabular Disclosure of Contractual Obligations

The following table sets forth our contractual obligations as of December 31, 2012 by specified categories:

 

     Payment Due by Period
     Total    Less Than
1 Year
   1-3
Years
   3-5
Years
   More Than
5 Years
     (in thousands of dollars)
Operating Lease Obligations (1)    8,107    1,859    3,207    2,906    135

 

(1) Operating lease obligations are primarily related to the lease of office spaces in mainland China, Taiwan and the United States. The expiration dates for these leases ranged from 2013 to 2018 and are renewable upon negotiation.

Other than the obligations set forth above, we did not have any other long-term debt obligations, operating lease obligations, purchase obligations or other long-term liabilities as of December 31, 2012.

 

G. Safe Harbor

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

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

 

A. Directors and Senior Management

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

 

Name

   Age     

Position/Title

Henry Yu Lin, Ph.D

     37       Chairman, Co-Chief Executive Officer

Omar Sharif Khan

     39       Director, Co-Chief Executive Officer

Vincent Wenyong Shi, Ph.D

     36       Director, Chief Operating Officer

Xu Zhou

     44       Director

James Ding

     48       Independent Director

Jun Zhang

     49       Independent Director

Ying Han

     59       Independent Director

William Tiewei Li

     49       Independent Director

Xiuming Tao

     49       Independent Director

Zemin Xu

     50       President

Suhai Ji

     37       Chief Financial Officer

Bingshi Zhang

     48       Vice President, Finance & HR

Will Yiwei Jiang

     36       Vice President, Strategy

Gavin Kim

     38       Chief Product Officer

 

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Dr. Henry Yu Lin is a founder of our company. Dr. Lin has served as our chairman and chief architect since our inception in October 2005. Dr. Lin was also the chief executive officer from our inception in October 2005 to January 2012 when he became the co-chief executive officer. Dr. Lin is responsible for our overall strategic leadership and product planning. From 2004 to 2005, Dr. Lin served as an associate professor at Beijing University of Posts and Telecommunications. Dr. Lin received his dual bachelor’s degrees in telecommunication engineering and mechanical electrical engineering, and a Ph.D degree in communication and information systems from Beijing University of Posts and Telecommunications.

Omar Sharif Khan has served as our co-chief executive officer since January 2012. Mr. Khan focuses on the global expansion of our business into markets such as North America, Latin America, Europe, Japan, Korea and India. He joined us from Citigroup, where he was managing director and global head of the Mobile Center of Excellence and led the Citigroup’s mobile development and delivery efforts globally from July 2011 to January 2012. Prior to that, from 2008 to 2011, Mr. Khan served in multiple senior executive roles at Samsung Mobile. During this tenure, he served as chief strategy officer and the chief product and technology officer and was responsible for Samsung Mobile’s strategy, product, technology, content and services functions. Prior to joining Samsung, Mr. Khan spent eight years at Motorola from 2000 to 2008, where his last role was vice president, global supply chain and business operations for the mobile devices business. Mr. Khan holds bachelor’s and master’s degrees in electrical engineering from the Massachusetts Institute of Technology. He also completed his graduate work in conjunction with the Sloan School of Management in the field of System Dynamics.

Dr. Vincent Wenyong Shi is a founder of our company. Dr. Shi has served as our director since January 2011, and our chief operating officer since our inception in October 2005. He is responsible for the operations of our company, including management of business operations, channel development, online business development and customer support. Dr. Shi received a Ph.D and a master’s degree in geographic information system and a bachelor’s degree in computer science from Peking University.

Xu Zhou is a founder of our company. Mr. Zhou has served as our director since June 2007. Before joining our company, Mr. Zhou served as the president of Beijing Chineseall Culture Development Co., Ltd. from 2006 to 2007, and served as the chairman of the board of directors and chief executive officer of Beijing Polywin Technology Co., Ltd. from 2005 to 2006. Mr. Zhou received an Executive MBA degree from China Europe International Business School, and a bachelor’s degree from China Management Software Institute.

James Ding has served as our director since June 2007. Mr. Ding was appointed as our independent director in April 2012. Mr. Ding is also a general partner and managing director of the GSR Venture, LLP., a venture capital fund focusing on early stage technology companies in China. He also has served as the independent director of Baidu Inc., the leading Chinese language search engine listed on the Nasdaq Global Select Market, since August 2005. In 1993, Mr. Ding co-founded AsianInfo-Linkage, Inc., or AILK, a Nasdaq-listed company. He has served as the chairman of the board of directors of AILK since April 2003 and has served as a member of the board of AILK since its inception. He was AILK’s chief executive officer and president from May 1999 to April 2003. Mr. Ding received a master’s degree in information science from the University of California, Los Angeles and a bachelor’s degree in chemistry from Peking University. Mr. Ding is also a graduate of the executive program of Haas Business School at University of California, Berkeley.

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

 

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Ying Han has served as our independent director since January 2011. Ms. Han was the chief financial officer and executive vice president of AILK, a NASDAQ listed company, from 1998 to 2006. From 1988 to 1998, Ms. Han worked for Hewlett Packard China as chief controller, business development director and finance manager. Ms. Han has been an independent director of Wuxi PharmaTech (Cayman) Inc., a NYSE-listed company, since 2008. Ms. Han received a college degree from the International Accounting College of Xiamen University in China.

William Tiewei Li has served as our independent director since May 2012. Mr. Li has served as the general manager of Beijing Zhongchuang Telecom Test Co,. Ltd., or Beijing Zhongchuang, a company listed on Shanghai Stock Exchange, since 2001. Prior to that, Mr. Li held multiple positions at Beijing Zhongchuang from December 1998 to 2001, including assistant to the general manager and financial director. Prior to joining Beijing Zhongchuang, Mr. Li worked for World Capital Market (US) Investment Co., Ltd., or World Capital Market, from October 1997 to November 1998, during which he set up the Beijing representative office and served as the chief representative. Mr. Li joined World Capital Market from Jardin Fleming Securities Ltd. where he was mainly responsible for business related to B-shares and overseas listings from May 1996 to October 1997. Mr. Li holds a bachelor’s degree in engineering from Changchun University of Technology in China, a master’s degree in economics from Renmin University, and an MBA degree from the University of Edinburgh.

Xiuming Tao has served as our independent director since May 2012. Mr. Tao is a founding partner of JunZeJun Law Offices, where he has worked since 1995, and obtained multiple awards for his work in the legal field in China. Prior to that, Mr. Tao worked for the International Law Department of the Institute of Law of Chinese Academy of Social Sciences from 1992 to 1994 and worked at Tian Ping Law Office from 1989 to 1992. Mr. Tao holds a bachelor’s degree in law from the Law School of Jilin University and a master’s degree in law from the Graduate School of Chinese Academy of Social Sciences. In addition, Mr. Tao received a Ph.D degree from the Law School of University of International Business and Economics in China in 2007.

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

Suhai Ji is the chief financial officer of our company. Mr. Ji has served as our chief financial officer since November 2010. From June 2009 to November 2010, Mr. Ji was a director in the NYSE Beijing Representative Office where he was responsible for the business development of NYSE in China. From 2005 to 2009, Mr. Ji worked as an associate and vice president in investment banking at Deutsche Bank AG, Hong Kong Branch. Prior to that, Mr. Ji was a management consultant at A.T. Kearney Beijing Office from 2003 to 2005. Mr. Ji received a bachelor’s degree in economics and a master’s degree in international economics and finance from Brandeis University, as well as an MBA degree in finance from Columbia Business School.

Bingshi Zhang has served as our vice president of finance since July 2010 and vice president of human resources since August 2011. From 2006 to 2009, Ms. Zhang worked at Net Movie Limited Company in various capacities, including as financial controller and vice president of finance. Before 2006, Ms. Zhang was a core member of the management team of China Finance Online Co. Ltd., a company listed on the Nasdaq Global Market, for five years, and she had extensive work experience related to Section 404 of the Sarbanes-Oxley Act of 2002. Ms. Zhang graduated from Renmin University with a bachelor’s degree in accounting.

Will Yiwei Jiang has served as our vice president of strategy since September 2010. Prior to joining us, Mr. Jiang was responsible for the overall strategy and business development at Dell Greater China Small and Medium Business Unit from 2008 through 2010. Before that, Mr. Jiang was a representative at Research in Motion China office from 2006 through 2008. Mr. Jiang received a bachelor’s degree in applied science with concentration on electrical engineering from the University of Waterloo in Canada.

 

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Gavin Kim has served as our chief product officer since May 2012. Before joining our company, Mr. Kim held senior leadership positions with Microsoft as general manager for windows phone from September 2011 to May 2012 and with Samsung Mobile as vice president of value-added services and enterprise business from July 2008 to September 2011. He led product marketing, strategy and planning, and drove efforts to accelerate developer ecosystems and strategic business partnerships at both companies. Before that, he was a technology and software investor at Advanced Technology Ventures, an early-stage venture fund, from December 2006 to June 2008, and was with Motorola Mobile Devices as director of product operations from October 2003 to December 2006. From June 1999 to October 2003, Gavin was director of business development and sales at PacketVideo Corporation and was a consultant at Deloitte Consulting from June 1997 to June 1999. Gavin holds an MBA from Kellogg School of Management at Northwestern University and a Bachelor’s Degree in engineering from Cornell University.

Employment Agreements

We have entered into employment agreements with each of our executive officers. In general, we may terminate an executive officer’s employment for cause, at any time, without notice or remuneration, for certain acts of the officer, including, but not limited to, a conviction or plea of guilty to a felony, willful misconduct to our detriment or a failure to perform agreed duties. We may also terminate an executive officer’s employment without cause by one-month/ thirty days prior written notice. An executive officer may terminate his or her employment with us by one-month/ thirty days prior written notice for certain reasons, in which case the executive officer is entitled to the same severance benefits as in the situation of termination by us without cause.

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

 

B. Compensation of Directors and Executive Officers

For the fiscal year ended December 31, 2012, we paid an aggregate of approximately US$1.84 million in cash to our executive officers and directors. We also paid an aggregate of approximately US$0.08 million in cash compensation and granted 44,310 restricted shares to our non-executive directors in 2012. For the fiscal year ended December 31, 2012, our PRC subsidiary made contributions equal to certain percentages of each employee’s salary for his or her pension insurance, medical insurance, housing fund, unemployment and other statutory benefits as required by law. We did not set aside or accrue any pension or other retirement benefits for our named executive officers and directors for the fiscal year ended December 31, 2012.

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

Share Incentive Plans

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

The 2011 Share Plan

Under the 2011 Share Plan, as amended, the maximum aggregate number of Class A common shares which may be issued pursuant to all awards under the plan shall be 13,000,000 plus an annual increase on the first day of each fiscal year, beginning in 2012, equal to the total number of shares underlying the options or other awards granted in the immediately preceding year that remain outstanding as of the same date, or such lesser amount of Class A common shares as determined by the board. Thus, unless our board of directors determines to add a lesser amount of shares to the number of shares reserved under the 2011 Share Plan on or before the first day of each fiscal year, the maximum number of shares that can be issued in that year pursuant to all awards granted under the 2011 Share Plan is 13,000,000. As of March 15, 2013, 6,078,255 restricted shares and options to purchase 16,100,820 Class A common shares have been granted and were outstanding under the 2011 Share Plan. In addition, as of March 15, 2013, 463,000 restricted ADSs were also granted and outstanding under the 2011 Share Incentive Plan; subject to the fulfillment of certain performance goals, up to 578,750 restricted ADSs shall become vested and non-forfeitable under the relevant award agreements.

 

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

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

 

   

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

 

   

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

 

   

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

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

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

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

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

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

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

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

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

 

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The 2007 Global Share Plan

On June 7, 2007, we adopted our 2007 Global Share Plan to motivate, retain and attract talent and promote the success of our business. We amended the 2007 Global Share Plan on December 15, 2007, April 26, 2010, December 15, 2010 and February 28, 2011. Our board of directors authorized the issuance and reservation of up to 44,415,442 common shares under the Plan. As of March 15, 2013, options to purchase 14,728,541 common shares have been granted and were outstanding under the 2007 Global Share Plan.

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

 

   

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

 

   

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

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

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

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

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

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

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

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

The following table summarizes the options and restricted shares that our directors, executive officers and other individuals as a group beneficially and under the 2007 Global Share Plan and the 2011 Share Plan that were outstanding as of March 15, 2013. See “Item 5—A. Operating Results—Critical Accounting Policy—Share-Based Compensation” for equity awards granted to Mr. Khan, our director and co-chief executive officer.

 

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Name

   Class A Common
Shares  Underlying
Outstanding
Options/restricted
shares
    Class B Common  Shares
Underlying Outstanding
Options/restricted
shares
     Exercise
Price
(US$/Share)
    Grant Date   Expiration
Date
 

Henry Yu Lin

     —          *         1.52      February 28, 2011     (2

Xu Zhou

     —          —           0.07      November 8, 2007     (2

Vincent Wenyong Shi

     —          6,000,000         1.52      February 28, 2011     (2

Ying Han

     —          *         0.40      February 28, 2011     (2

William Tiewei Li

     *        —           N/A      July 10, 2012     (2
     *        —           N/A      January 2, 2013  

Xiuming Tao

     *        —           N/A      July 10, 2012     (2
     *        —           N/A      January 2, 2013  

Suhai Ji

     —          *         0.40      December 15, 2010     (2

Zemin Xu

     —          *         0.40      December 15, 2010     (2

Bingshi Zhang

     —          —   &nbs