F-1 1 d677329df1.htm FORM F-1 Form F-1
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As filed with the Securities and Exchange Commission on July 3, 2014

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM F-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

iDreamSky Technology Limited

(Exact name of registrant as specified in its charter)

 

 

Not Applicable

(Translation of Registrant’s name into English)

 

 

 

Cayman Islands   7372   Not Applicable

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

16/F, A3 Building, Kexing Science Park

15 Keyuan Road North, Nanshan District

Shenzhen, Guangdong, 518057

The People’s Republic of China

+86-755-8668-5111

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Law Debenture Corporate Services Inc.

400 Madison Avenue, 4th Floor

New York, NY 10017

+1-212-750-6474

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

David T. Zhang, Esq.

Benjamin Su, Esq.

Kirkland & Ellis International LLP

c/o 26th Floor, Gloucester Tower, The Landmark

15 Queen’s Road Central

Hong Kong

+852-3761-3318

 

James C. Lin, Esq.

Davis Polk & Wardwell LLP

c/o 18th Floor, The Hong Kong Club Building

3A Chater Road, Central

Hong Kong

+852-2533-3300

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.

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

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

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

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

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of each class of securities

to be registered(1)

 

Proposed
maximum

aggregate
offering price(2)(3)

  Amount of
registration fee

Class A ordinary shares, par value US$0.0001

  US$115,000,000   US$14,812

 

 

(1) American depositary shares issuable upon deposit of the Class A ordinary shares registered hereby will be registered under a separate registration statement on Form F-6 (Registration No. 333-             ). Each American depositary share represents                      Class A ordinary shares.
(2) Includes Class A ordinary shares that may be purchased by the underwriters pursuant to an option to purchase additional American depositary shares. Also includes Class A ordinary shares initially offered and sold outside the United States that may be resold from time to time in the United States either as part of their distribution or within 40 days after the later of the effective date of this registration statement and the date the shares are first bona fide offered to the public. These Class A ordinary shares are not being registered for the purposes of sales outside of the United States.
(3) Estimated solely for the purpose of determining the amount of registration fee in accordance with Rule 457(o) under the Securities Act.

 

 

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

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. We may not sell the securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and we are not soliciting any offer to buy these securities in any jurisdiction where such offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED                     , 2014

American Depositary Shares

 

LOGO

iDreamSky Technology Limited

Representing              Class A Ordinary Shares

 

 

This is an initial public offering of American depositary shares, or ADSs, by iDreamSky Technology Limited. We are offering                      ADSs. Each ADS represents                      Class A ordinary shares, par value US$0.0001.

Prior to this offering, there has been no public market for our ADSs or Class A ordinary shares. We anticipate the initial public offering price will be between US$             and US$             per ADS. We have applied to list our ADSs on the NASDAQ Global Select Market under the symbol “DSKY.”

We are an “emerging growth company,” as defined in Section 2(a) of the Securities Act of 1933, as amended, or the Securities Act, and Section 3(a) of the Securities Exchange Act of 1934, as amended, or the Exchange Act.

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

Upon the completion of this offering,              Class A ordinary shares and              Class B ordinary shares of our company will be issued and outstanding. Each Class A ordinary share will be entitled to one vote and each Class B ordinary share will be entitled to ten votes on all matters subject to shareholder vote. Accordingly, holders of our Class A ordinary shares and holders of our Class B ordinary shares will hold         % and         % of our aggregate voting power, respectively, assuming that the underwriters do not exercise their over-allotment option to purchase additional ADSs.

Investing in our ADSs involves a high degree of risk. See “Risk Factors” beginning on page 16.

 

     Price to Public      Underwriting
Discounts and
Commissions
     Proceeds to Us
Before Expenses
 

Per ADS

   US$                    US$                    US$                

Total

   US$                    US$                    US$                

The underwriters expect to deliver the ADSs to purchasers on or about                     , 2014.

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

 

 

 

The date of this prospectus is                     , 2014

(listed in alphabetical order)

 

Credit Suisse    J.P. Morgan


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Table of Contents

Table of Contents

 

     Page  

Prospectus Summary

     1   

Risk Factors

     16   

Special Note Regarding Forward-Looking Statements

     57   

Use of Proceeds

     59   

Dividend Policy

     60   

Capitalization

     61   

Dilution

     63   

Exchange Rate Information

     65   

Enforceability of Civil Liabilities

     66   

Our History and Corporate Structure

     68   

Selected Consolidated Financial Information and Operating Data

     78   

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

     81   

Industry

     111   

Business

     118   

Regulations

     137   

Management

     154   

Principal Shareholders

     163   

Related Party Transactions

     166   

Description of Share Capital

     168   

Description of American Depositary Shares

     179   

Shares Eligible for Future Sale

     186   

Taxation

     188   

Underwriting

     196   

Expenses Related to this Offering

     203   

Legal Matters

     204   

Experts

     205   

Where You Can Find Additional Information

     206   

Index to Consolidated Financial Statements

     F-1   

 

 

You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, ADSs only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our ADSs.

No action is being taken in any jurisdiction outside the United States to permit a public offering of the ADSs or possession or distribution of this prospectus in that jurisdiction. Persons who come into possession of this prospectus in jurisdictions outside the United States are required to inform themselves about and to observe any restrictions as to this offering and the distribution of this prospectus applicable to that jurisdiction.

Until            , 2014 (the 25th day after the date of this prospectus), all dealers that buy, sell or trade in our ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus and does not contain all the information that you should consider before investing in our ADSs. You should carefully read the entire prospectus, including our financial statements and related notes included in this prospectus and the information set forth under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” before making an investment decision. This prospectus contains information from a report prepared at our request by Analysys International, an independent market research firm, in June 2014, or the Analysys Report.

Our Business

We are the largest independent mobile game publishing platform in China based on the number of active users in 2013, according to the Analysys Report. In the first quarter of 2014, we had average monthly active users, or MAUs, of 98.3 million. Our mission is to deliver fun and engaging mobile games and entertainment to mobile users, thereby enriching their mobile lifestyle.

We believe we have redefined the role of a game publisher by redesigning and optimizing third-party games and delivering them to users through our proprietary distribution channels as part of our broader publishing solution. Our proprietary distribution channels include in-game cross promotions and our self-operated iDreamSky Game Center (“ LOGO ”) and www.uu.cc. Well-known international mobile game developers grant us access to the source codes of their games, allowing us greater control and efficiency in redesigning their games for the China market. We distribute our games, referring to third-party games published and operated on our publishing platform, through both our proprietary distribution channels and third-party channels, such as app stores and device pre-installations. Our proprietary distribution channels have become increasingly significant, having generated 97.7 million game downloads and activations in 2013, representing 36.0% of our total game downloads and activations in 2013 and an increase of 83.4% from 2012. In the first quarter of 2014, our proprietary distribution channels generated 23.8 million game downloads and activations, representing 32.2% of our total game downloads and activations in the first quarter of 2014 and an increase of 35.4% from the first quarter of 2013. Game download and activation refer to a completed download and installation of our game that successfully connects to our network through log-in or registration by a user.

We also operate games as a service, where we offer live game services and gain user insights through our multi-dimensional data analysis engine to drive ongoing game optimization and monetization. As a result, we have achieved a track record of consistently and successfully launching popular titles in China, including Fruit Ninja, the Temple Run series and Subway Surfers, each of which was ranked among the top ten casual games by active users in China in the first quarter of 2014, according to the Analysys Report.

Our value proposition for users

We are committed to bringing the best mobile entertainment to users. We currently offer 40 casual and mid- and hardcore mobile games of various genres. We frequently release graphics, functional and promotional updates for our existing game titles to surprise and engage our users, enhancing their enjoyment of our games. We provide our users with live game services and connect them through friend lists, message boards, leaderboards and user tournaments, enabling in-game interaction and social networking. We analyze user data to gain insights into user habits and preferences and improve our games and services. The fun games, continuous updates, live game services and social connectivity that we offer on our platform allow us to build a large, highly active and loyal user base.

Our value proposition for game developers

We are focused on becoming the partner of choice for global game developers, especially overseas game developers, seeking to launch their games in China. Our partnerships with game developers typically take the form of exclusive licensing, joint operations, game acquisition and strategic investments. Our proven platform

 

 

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offers a one-stop solution, including game redesign and porting, ongoing optimization, marketing, distribution, monetization, payment support and user-related services, which is especially valuable for overseas game developers. Our solutions help game developers acquire and monetize a large user base in China. All our games are free to download and play, and we monetize our game offerings and user base and generate revenue primarily through sales of in-game virtual items. Through our in-depth understanding of China’s mobile game users, proprietary distribution channels that access a large user base, strong publishing and operation capabilities and data-driven product and service optimization that leads to more effective monetization, we believe we bring, and will continue to bring, compelling value to our game developer partners.

Our collaboration with our distribution and payment channel partners

In addition to our proprietary distribution channels, we also distribute our games by partnering with major app stores and mobile browsers in China, such as Tencent App Store, Qihoo 360 Mobile, 91 Wireless and UCWeb, mobile device makers and retailers, such as Lenovo, Huawei, ZTE and Suning, mobile carriers and mobile advertising agents. We believe this third-party distribution network allows us to reach substantially all of the Android- and iOS-based mobile Internet population in China. We also partner with almost all major payment service providers in China, including all three mobile carriers and major third-party payment service providers such as Alipay, Weixin Payments, China UnionPay and Yeepay. Our high-quality game portfolio and large user base incentivize our distribution and payment partners to work with us. This helps us provide easy access to our games and convenient payment solutions to our users, as well as seamless game publishing and monetization to our game developer partners.

We have grown significantly since our inception in 2009. Average MAUs of mobile games we distributed increased from 56.7 million in the first quarter of 2013 to 98.3 million in the first quarter of 2014. Our total revenues increased from RMB19.4 million in 2012 to RMB246.6 million (US$40.7 million) in 2013, and from RMB22.1 million in the three months ended March 31, 2013 to RMB174.1 million (US$28.0 million) in the three months ended March 31, 2014. We had net loss of RMB9.3 million in 2012 and net income of RMB27.8 million (US$4.6 million) in 2013. We had net loss of RMB0.7 million in the three months ended March 31, 2013, and net income of RMB33.2 million (US$5.3 million) in the corresponding period in 2014. We had adjusted EBITDA of negative RMB5.8 million in 2012, compared to adjusted EBITDA of RMB38.7 million (US$6.4 million) in 2013. We had adjusted EBITDA of RMB0.1 million in the three months ended March 31, 2013, compared to adjusted EBITDA of RMB44.7 million (US$7.2 million) in the corresponding period in 2014. We had adjusted net loss of RMB7.3 million in 2012, compared to adjusted net income of RMB28.9 million (US$4.8 million) in 2013. We had adjusted net loss of RMB0.5 million in the three months ended March 31, 2013, compared to adjusted net income of RMB33.3 million (US$5.4 million) in the corresponding period in 2014. For information regarding non-GAAP measures, adjusted EBITDA and adjusted net (loss)/income, and a reconciliation of each adjusted EBITDA and adjusted net (loss)/income to net (loss)/income, see “Selected Consolidated Financial Information and Operating Data—Non-GAAP Measures.”

Our Industry

China’s mobile Internet population has experienced significant growth in recent years, increasing from 73.1 million in June 2008 to 463.8 million in June 2013, representing a compound annual growth rate, or CAGR, of 44.7%, according to China Internet Network Information Center, or CNNIC. The increasing availability and prevalence of mobile Internet in China has driven the rapid growth of the mobile game market in recent years. As of June 2013, 64.6% of China’s mobile Internet population, or 299.8 million mobile Internet users, played mobile games, according to the Analysys Report. The size of the mobile game market in China has grown from RMB3.3 billion in 2010 to RMB13.9 billion in 2013, and is expected to reach RMB42.7 billion by 2016, according to the Analysys Report. The growth drivers of China’s mobile game market include China’s economic growth, the increasing popularity of smartphones and the continuous development of network infrastructure.

 

 

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Historically, the key participants in China’s mobile game value chain have been game developers, traditional game publishers, distribution channels and users. In recent years, independent mobile game publishing platforms have emerged, with expanded coverage of the value chain. Mobile game publishing platforms are integrated service platforms built by mobile game publishers on the foundation of the strength of their products and user base. These platforms offer functions including publishing, promotion, operation, live in-game services, social connectivity and account management to game developers who may not have the resources or familiarity to enter into a new market.

The key competitive strengths of China’s mobile game publishing platforms include the abilities to: (i) obtain high quality game content, including major hit game titles, (ii) retain and grow a large and active user base, (iii) monetize the user base and (iv) integrate and penetrate into distribution channels. In addition, mobile game publishing platforms benefit from high entry barriers for game developers or distributors to enter into mobile game publishing business. These barriers include requirements for greater coverage of the mobile game value chain, brand and user resources, capital investment and strong relationships with various industry participants.

Our Strengths

We believe that the following strengths have been critical to our success and differentiate us from our competitors:

 

    large, fast-growing, active and loyal user base;

 

    sophisticated game operation capabilities resulting in effective user engagement, retention and monetization;

 

    high-quality and diversified game portfolio;

 

    strong and trusted partnerships with game developers;

 

    unique and effective proprietary distribution channels;

 

    advanced technology infrastructure and data analysis capabilities; and

 

    visionary and experienced senior management.

Our Strategies

Our vision is to become a leading global mobile entertainment platform that revolutionizes the mobile entertainment experience. We plan to execute the following key strategies to pursue our goal and to achieve long-term sustainable growth:

 

    attract new users and enhance user experience;

 

    enhance our mobile game offerings and monetization capabilities;

 

    expand our content portfolio through strategic alliance and acquisition opportunities;

 

    strengthen our collaboration with distribution and payment channel providers;

 

    further promote our mobile game platform and brand;

 

    continue to invest in our technology platform; and

 

    expand internationally.

 

 

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Our Challenges

Our ability to achieve our goal and execute our strategies is subject to risks and uncertainties, including, but not limited to, the following:

 

    effectively acquire, retain and monetize users;

 

    successfully extend the life cycle of our existing popular games and launch new popular games;

 

    maintain our relationship with game developers and effectively collaborate with other business partners;

 

    enhance our technology infrastructure to support our growth;

 

    attract and retain qualified personnel; and

 

    successfully implement our business model given our limited operating history.

In addition, we are subject to risks and uncertainties related to our corporate structure and doing business in China, including, but not limited to, the following:

 

    risks associated with our control over our consolidated affiliated entities in China, which is based on contractual arrangements rather than equity ownership; and

 

    uncertainties associated with our compliance with applicable PRC regulations and policies, including those relating to mobile games.

See “Risk Factors” for a more detailed discussion of the risks involved in investing in our ADSs.

Our History and Corporate Structure

We commenced operations in November 2009 with the establishment of Shenzhen Mengyu Technology Co., Ltd., or Shenzhen Mengyu, in China. In February 2011, we incorporated Shenzhen iDreamSky Technology Co., Ltd., or Shenzhen iDreamSky, which became the primary entity through which we operate our business. In January 2012, we established Beijing Chuangmeng Wuxian Technology Co., Ltd., or Beijing Chuangmeng, in China. Shenzhen Mengyu, Shenzhen iDreamSky and Beijing Chuangmeng, or collectively, our variable interest entities or VIEs, later became our PRC consolidated affiliated entities through the contractual arrangements described below. We hold licenses required for our business under PRC law through our VIEs.

On February 23, 2012, we incorporated our current holding company, iDreamSky Technology Limited, or iDreamSky, as a limited liability company in the Cayman Islands, for purposes of international financing. In March 2012, iDreamSky established its wholly owned subsidiary, iDreamSky Technology (HK) Limited, or iDreamSky HK, in Hong Kong. In April 2012, iDreamSky HK established its wholly owned subsidiary, Chuangmeng Wuxian (Beijing) Information & Technology Co., Ltd., or Chuangmeng Wuxian, in China. Chuangmeng Wuxian is currently engaged in the business of software development, which is a foreign investment industry encouraged under the latest version of Guiding Catalog for Foreign Investment Industries.

Foreign ownership of mobile and Internet-based businesses is subject to significant restrictions under current PRC laws and regulations. For a discussion of these restrictions, see “Regulations.” To comply with PRC laws, rules and regulations, we operate our business through our VIEs because we are a Cayman Islands company and Chuangmeng Wuxian is a foreign-invested enterprise, which is restricted from holding the licenses for operating our mobile game business in China. Through Chuangmeng Wuxian, we entered into certain contractual arrangements with each of our VIEs and their respective shareholders, which enable us to:

 

    exercise effective control over the operations of our VIEs;

 

    receive substantially all of the economic benefits from our VIEs; and

 

 

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    have an exclusive option to purchase all or part of the equity interest in our VIEs when and to the extent permitted by PRC law.

As a result of our ownership of Chuangmeng Wuxian, we became the primary beneficiary of the VIEs, and we treat them as our variable interest entities under United States generally accepted accounting principles, or U.S. GAAP. We have consolidated the financial results of our VIEs in our consolidated financial statements in accordance with U.S. GAAP. Our VIEs collectively contributed substantially all of our consolidated total revenues for the years ended December 31, 2012 and 2013 and the three months ended March 31, 2014, respectively.

However, these contractual arrangements may not be as effective in providing us with control over the VIEs as direct ownership of them. In addition, each of our VIEs or its shareholders may breach the contractual arrangements with us. In such cases, we would have to rely on legal remedies under PRC law, which may not always be effective, particularly in light of uncertainties in the PRC legal system. For detailed analysis of risks associated with these contractual arrangements, see “Risk Factors—Risks Related to Our Corporate Structure.”

The following diagram illustrates our shareholding and corporate structure and the place of incorporation of each of our significant subsidiaries and significant VIEs as of the date of this prospectus:

 

LOGO

 

LOGO Direct ownership
LOGO Contractual arrangements. See “Our History and Corporate Structure—Contractual Arrangements Among Chuangmeng Wuxian, our VIEs and the Respective Shareholders of our VIEs.”
(1)  Beijing Chuangmeng is 99% owned by Michael Xiangyu Chen, our co-founder, chairman and chief executive officer, and 1% owned by Anfernee Song Guan, our co-founder, director and chief technology officer. Beijing Chuangmeng currently does not have any business operations.
(2)  Shenzhen iDreamSky is 100% owned by Michael Xiangyu Chen, our co-founder, chairman and chief executive officer. Shenzhen iDreamSky is the primary entity through which we operate our mobile game publishing business.
(3)  Shenzhen Mengyu is 99% owned by Michael Xiangyu Chen, our co-founder, chairman and chief executive officer, and 1% owned by Anfernee Song Guan, our co-founder, director and chief technology officer. Shenzhen Mengyu operates some of our mobile game publishing business.

 

 

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(4)  Shenzhen Yiyou Technology Co., Ltd., or Shenzhen Yiyou, is 86.5% owned by Shenzhen iDreamSky, 9.7% owned by Qiyang Deng, an independent third party, and 3.8% owned by Wenhao Fan, an independent third party. We invested in Shenzhen Yiyou, which is engaged in the business of mobile game development, in order to obtain licenses to its games on favorable commercial terms.
(5) Shenzhen Zhuoyou Technology Co., Ltd., or Shenzhen Zhuoyou, is 90.9% owned by Shenzhen iDreamSky and 9.1% owned by Yang Wang, an independent third party. We invested in Shenzhen Zhuoyou, which is engaged in the business of mobile game development, in order to obtain licenses to its games on favorable commercial terms.
(6)  We plan to conduct certain of our game publishing business through Nanjing Zhuochuang Huyu Information Technology Co., Ltd.

Our Corporate Information

Our principal executive offices are located at 16/F, A3 Building, Kexing Science Park, 15 Keyuan Road North, Nanshan District, Shenzhen, Guangdong Province, China. Our telephone number at this address is +86-755-8668-5111 and our fax number is +86-755-8653-0126. Our registered office in the Cayman Islands is located at the offices of Maples Corporate Services Limited at PO Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands.

Investors should submit any inquiries to the address and telephone number of our principal executive offices. Our website is                     . The information contained on our website is not a part of this prospectus. Our agent for service of process in the United States is Law Debenture Corporate Services Inc., located at 400 Madison Avenue, 4th Floor, New York, NY10017.

Implications of Being an Emerging Growth Company

As a company with less than US$1.0 billion in revenue for our last fiscal year, we qualify as an “emerging growth company” pursuant to the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally to public companies. These provisions include exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, in the assessment of the emerging growth company’s internal control over financial reporting. The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards. However, we have elected to “opt out” of this provision, and such opt-out is irrevocable. As a result, we will comply with new or revised accounting standards as required when they are adopted for public companies.

We will remain an emerging growth company until the earliest of (a) the last day of our fiscal year during which we have total annual gross revenues of at least US$1.0 billion; (b) the last day of our fiscal year following the fifth anniversary of the completion of this offering; (c) the date on which we have, during the previous three-year period, issued more than US$1.0 billion in non-convertible debt; or (d) the date on which we are deemed to be a “large accelerated filer” under the Exchange Act, which would occur if the market value of our ADSs that are held by non-affiliates exceeds US$700.0 million as of the last business day of our most recently completed second fiscal quarter. Once we cease to be an emerging growth company, we will not be entitled to the exemptions provided in the JOBS Act discussed above.

Conventions that Apply to this Prospectus

In this prospectus, unless otherwise indicated or the context requires otherwise:

 

    “we,” “us,” “our,” “our company” or “iDreamSky” refers to iDreamSky Technology Limited, its subsidiaries and affiliated entities;

 

 

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    “ADSs” refer to our American depositary shares, each of which represents                    Class A ordinary shares;

 

    “ADRs” refer to the American depositary receipts, which, if issued, evidence our ADSs;

 

    “ARPPU” or “average revenue per paying user” refers to the average amount of the revenue that we generate from each of our paying users;

 

    “China” or the “PRC” refers to the People’s Republic of China, excluding Taiwan and the special administrative regions of Hong Kong and Macau for the purposes of this prospectus only;

 

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

 

    “shares” or “ordinary shares” refer to our ordinary shares, including Class A and Class B ordinary shares, par value US$0.0001;

 

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

 

    “Casual games” are games that can be played in short time intervals, feature simple gameplay, do not have high data or bandwidth requirements and have relatively low barriers to payment;

 

    “Daily active users,” or “DAUs,” refer to the number of unique accounts that interact with our SDK network on a particular day;

 

    “Game download and activation” refer to a completed download and installation of our mobile game that successfully connects to our SDK network through log-in or registration by a user;

 

    “Gross billings” refer to monetary value of all virtual items sold during a certain period;

 

    “Midcore games” are games that are easy to learn and yet provide players with more complexity and greater challenges than casual games;

 

    “Hardcore games” are games that provide players with the most complexity and the greatest challenges. They are typically versions of client-based massively multiplayer web games ported to mobile devices and are becoming more accessible and popular as smartphone technology and capabilities improve;

 

    “Mobile users” refer to users of mobile devices, including phones, tablets and other mobile devices;

 

    “Monthly active users,” or “MAUs,” refer to the number of unique accounts that interacted with our SDK network in a particular month. Average MAUs for a particular period is the average of the MAUs in each month during that period. An individual who has more than one unique account that interacted with our SDK network is counted as more than one active user;

 

    “Monthly paying users,” or “MPUs,” refer to the number of unique accounts through which a payment is made in our mobile games in a particular month. Average MPUs for a particular period is the average of the MPUs in each month during that period. An individual who has more than one unique account through which a payment is made is counted as more than one paying user;

 

    “Our games” refer to games that we publish through our game publishing platform;

 

    “Proprietary distribution channels” refer to our in-game cross promotions, our self-operated iDreamSky Game Center, a mobile application for game services, and www.uu.cc, a website for mobile game information and downloads; and

 

    “SDK” refers to a software development kit, or a set of software development tools that allows for the creation of application or functions for a software package or platform.

This prospectus contains translations of certain Renminbi amounts into U.S. dollars at specified rates, which is based on the rate certified for customs purposes by the Federal Reserve Bank of New York. For amounts not recorded in our consolidated financial statements included elsewhere in this prospectus, unless otherwise stated,

 

 

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all translations from Renminbi to U.S. dollars has been made at a rate as of the period end of the applicable periods, that is, RMB6.0537 to US$1.00, the noon buying rate in effect as of December 31, 2013 or RMB6.2164 to US$1.00, the noon buying rate in effect as of March 31, 2014, as applicable. We make no representation that the Renminbi or U.S. dollar amounts referred to in this prospectus could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. On June 27, 2014, the noon buying rate was RMB6.2180 to US$1.00.

Unless the context indicates otherwise, all share and per share data in this prospectus give effect to a share split effected on July 1, 2014, following which each of our previously issued ordinary shares and preferred shares was subdivided into ten ordinary shares and preferred shares, respectively. In addition, unless the context indicates otherwise, all information in this prospectus assumes no exercise by the underwriters of their option to purchase additional ADSs.

 

 

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The Offering

The following assumes that the underwriters will not exercise their option to purchase additional ADSs in the offering, unless otherwise indicated.

 

Offering price

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

 

ADSs offered by us

                     ADSs.

 

ADSs outstanding immediately after this offering

                     ADSs (or                      ADSs if the underwriters exercise their option to purchase additional ADSs in full).

 

Ordinary shares outstanding immediately after this offering

                    ordinary shares, comprised of (i)                      Class A ordinary shares (or                     Class A ordinary shares if the underwriters exercise their option to purchase additional ADSs in full) and (ii)                      Class B ordinary shares.

 

  In respect of matters requiring shareholders’ vote, each Class A ordinary share is entitled to one vote and each Class B ordinary share is entitled to ten votes. We plan to issue                      Class A ordinary shares represented by our ADSs in this offering. In addition, all options granted prior to or to be granted after the completion of this offering entitle option holders to the equivalent number of Class A ordinary shares once the options are vested and exercised. Upon any sale, pledge, transfer, assignment or disposition of a Class B ordinary share by its holder to any person who is not already a holder of Class B ordinary shares, such Class B ordinary share shall automatically convert into one Class A ordinary share without any actions on the part of the transferor or the transferee. In no event shall Class A ordinary shares be convertible into Class B ordinary shares. For more information on our ordinary shares, you should refer to the “Description of Share Capital” section of this prospectus.

 

  Upon the completion of this offering, our founders who hold Class B ordinary shares will hold an aggregate of             % of the total voting power of our outstanding share capital, assuming that the underwriters do not exercise their option to purchase additional ADSs.

 

NASDAQ Global Select Market symbol

DSKY.

 

The ADSs

Each ADS represents                      Class A ordinary shares. The ADSs may be evidenced by ADRs.

 

 

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  The depositary will hold the shares underlying your ADSs and you will have rights as provided in the deposit agreement.

 

  We do not expect to pay dividends in the foreseeable future. If, however, we declare dividends on our Class A ordinary shares, the depositary will pay you the cash dividends and other distributions it receives on our Class A ordinary shares, after deducting its fees and expenses. You may turn in your ADSs to the depositary in exchange for Class A ordinary shares. The depositary will charge you fees for any exchange. We may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs, you agree to be bound by the deposit agreement as amended.

 

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

 

Option to purchase additional ADSs

We have granted to the underwriters an option, exercisable within 30 days from the date of this prospectus, to purchase up to an additional                      ADSs.

 

Use of proceeds

We estimate that we will receive net proceeds of approximately US$             million from this offering (or US$             million if the underwriters exercise their option to purchase additional ADSs in full), after deducting the underwriting discounts, commissions and estimated offering expenses payable by us and assuming an initial public offering price of US$             per ADS, being the mid-point of the estimated range of the initial public offering price shown on the front cover of this prospectus.

 

  We plan to use the net proceeds we receive from this offering for the following purposes:

 

    US$             million for the acquisitions of game licenses and other intellectual property rights related to mobile games;

 

    US$             million for mergers and acquisitions; and

 

    US$             million for working capital and other general corporate purposes.

 

  See “Use of Proceeds” for additional information.

 

Lock-up

We, our directors and executive officers, and all of our existing shareholders have agreed with the underwriters, subject to certain exceptions, not to sell, transfer or otherwise dispose of any ADSs, ordinary shares or similar securities for a period of 180 days after the date of this prospectus. See “Underwriting” for more information.

 

Risk factors

See “Risk Factors” and other information included in this prospectus for a discussion of risks you should carefully consider before investing in the ADSs.

 

 

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Depositary

The Bank of New York Mellon.

 

Directed share program

We currently anticipate to undertake a directed share program, pursuant to which the underwriters will reserve for sale, at the initial public offering price, up to              ADSs offered by this prospectus to our directors, officers, employees, business associates and related persons.

 

 

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Summary Consolidated Financial Information and Operating Data

You should read the following information concerning us in conjunction with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

The following tables present our summary consolidated statement of operations data for the years ended December 31, 2012 and 2013 and the consolidated balance sheet data as of December 31, 2012 and 2013. All share and per share data in the tables below give effect to a share split effected on July 1, 2014, following which each of our previously issued ordinary shares and preferred shares were subdivided into ten ordinary shares and preferred shares, respectively. The data presented in these tables are derived from our audited consolidated financial statements included elsewhere in this prospectus. The consolidated financial statements are prepared and presented in accordance with U.S. GAAP. The summary consolidated statements of operations data for the three months ended March 31, 2013 and 2014 and summary consolidated balance sheet data as of March 31, 2014 have been derived from our unaudited interim consolidated financial statements included elsewhere in this prospectus. The unaudited interim consolidated financial statements have been prepared on the same basis as our audited consolidated financial statements and include all adjustments, consisting of normal recurring adjustments, that we consider necessary for a fair statement of our financial position and operating results for the periods presented. Our historical results are not necessarily indicative of our results for any future periods.

 

    For the Year Ended
December 31,
    For the Three Months Ended
March 31,
 
    2012     2013     2013     2014  
    RMB     RMB     US$     RMB     RMB     US$  
    (in thousands, except share and per share data)  

Consolidated Statement of Operations Data:

           

Revenues:

           

Game revenues

    18,059        244,806        40,439        21,891        173,968        27,985   

Other revenues

    1,319        1,762        292        184        134        22   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    19,378        246,568        40,731        22,075        174,102        28,007   

Cost of revenues

    (14,593     (155,898     (25,753     (13,487     (101,268     (16,290
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    4,785        90,670        14,978        8,588        72,834        11,717   

Operating expenses:

           

Research and development expenses

    (7,501     (14,214     (2,348     (2,343     (6,799     (1,094

Sales and marketing expenses

    (2,797     (27,940     (4,615     (4,698     (12,460     (2,004

General and administrative expenses

    (4,713     (14,780     (2,442     (2,263     (11,281     (1,816
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    (15,011     (56,934     (9,405     (9,304     (30,540     (4,914

Other gains, net

    946        106        17        46        1,194        192   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (loss)/profit

    (9,280     33,842        5,590        (670     43,488        6,995   

Interest income

    20        81        13        7        39        6   

Foreign exchange (loss)/gain and others

    (63     266        44        (19     (598     (96

Share of loss from an equity investment

           (170     (28            (29     (4
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/income before income tax

    (9,323     34,019        5,619        (682     42,900        6,901   

Income tax expense

           (6,174     (1,020            (9,735     (1,566
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income

    (9,323 )      27,845        4,599        (682     33,165        5,335   

Less: Net loss attributable to the noncontrolling interest

    32        287        47        87        (502     (81
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income attributable to iDreamSky Technology Limited

    (9,291 )      28,132        4,646        (595     32,663        5,254   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Accretion to convertible redeemable preferred shares redemption value

    (22,870     (262,782     (43,408     (3,349     (845,001     (135,931

Deemed dividend to series A convertible redeemable preferred shares

    (540     (14,402     (2,379                     

Deemed dividend to Li Meiping ordinary shares

    (300     (29,075     (4,803                     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to ordinary shareholders

    (33,001 )      (278,127 )      (45,944 )      (3,944     (812,338     (130,677
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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    For the Year Ended
December 31,
    For the Three Months Ended
March 31,
 
    2012     2013     2013     2014  
    RMB     RMB     US$     RMB     RMB     US$  
    (in thousands, except share and per share data)  

Net loss per ordinary share—basic

    (0.77     (6.97     (1.15     (0.09     (19.8     (3.18

Net loss per ordinary share—diluted

    (0.77     (6.97     (1.15     (0.09     (19.8     (3.18

Weighted average number of ordinary shares attributable to iDreamSky Technology Limited—basic (thousands)

    42,740        39,930        39,930        42,740        41,030        41,030   

Weighted average number of ordinary shares attributable to iDreamSky Technology Limited—diluted (thousands)

    42,740        39,930        39,930        42,740        41,030        41,030   

 

     As of December 31,     As of March 31,  
     2012     2013     2014  
     RMB     RMB     US$     RMB     US$  
     (in thousands, except share and per share data)  

Consolidated Balance Sheet Data:

          

Cash and cash equivalents

     31,365        179,658        29,677        158,502        25,497   

Accounts receivable, net

     5,052        76,900        12,703        125,496        20,188   

Prepayments and other current assets

     1,324        7,078        1,171        49,589        7,977   

Total current assets

     43,458        264,954        43,768        333,703        53,681   

Property and equipment, net

     2,207        8,684        1,434        10,126        1,629   

Total assets

     46,895        278,638        46,028        353,406        56,850   

Total liabilities

     23,242        123,153        20,344        163,199        26,251   

Total mezzanine equity

     61,085        470,664        77,748        1,323,008        212,826   

Ordinary shares (US$0.0001 par value; 461,500,000, 409,472,700 and 409,472,700 shares authorized, 42,740,000, 41,032,120 and 41,032,120 shares issued and outstanding as of December 31, 2012 and 2013 and March 31, 2014, respectively)

     27        26        4        26        4   

Additional paid-in capital

                                   

Statutory reserves

            2,701        446        2,701        434   

Accumulated deficit

     (37,664     (322,619     (53,293     (1,134,875     (182,560

Accumulated other comprehensive income

     102        4,661        770        (1,207     (194

Total shareholders’ deficit

     (37,432     (315,179     (52,064     (1,132,801     (182,227

Total liabilities, mezzanine equity and shareholders’ equity

     46,895        278,638        46,028        353,406        56,850   

Operating Data:

 

     As of December 31,      As of March 31,  
     2012      2013      2014  
     (in millions)  

Registered users

     127.5         398.8         472.7   

 

     For the Year Ended
December 31,
     For the Quarter Ended
March 31,
 
     2012      2013      2013      2014  
     (in millions)  

Downloads and activations

     111.6         271.3         63.0         73.9   

 

 

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    For the Quarter Ended  
    March 31,
2012
    June 30,
2012
    September 30,
2012
    December 31,
2012
    March 31,
2013
    June 30,
2013
    September 30,
2013
    December 31,
2013
    March 31,
2014
 
    (in millions, except percentages)        

Average MAUs

    5.6        11.6        22.0        34.0        56.7        70.3        81.3        91.0        98.3   

Average MPUs

    0.0        0.1        0.2        0.3        1.1        1.5        4.6        5.1        5.1   

Average DAUs

    1.9        4.6        7.6        10.6        16.8        21.8        25.0        25.4        25.8   

Paying ratio

    0.0     0.8     0.8     0.9     1.9     2.1     5.6     5.7     5.2

 

Note: Paying ratio for a given quarter equals to average MPUs divided by average MAUs for that quarter.

Non-GAAP Measures

Adjusted EBITDA and Adjusted Net Loss or Income

To provide investors with additional information about our financial results, we disclose in this prospectus non-GAAP financial measures, adjusted EBITDA and adjusted net (loss)/income. We have provided below a reconciliation between each adjusted EBITDA and adjusted net (loss)/income to net (loss)/income, the most directly comparable GAAP financial measure.

We have included adjusted EBITDA and adjusted net (loss)/income in this prospectus because they are key measures we use to evaluate our operating performance, generate future operating plans and make strategic decisions for the allocation of capital. Accordingly, we believe that adjusted EBITDA and adjusted net (loss)/income provide useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors. These non-GAAP financial measures enable our management to assess our operating results without considering the impact of non-cash charges, including share-based compensation, fair value change of preferred share warrant liability and share of loss from an equity investment. Furthermore, these non-GAAP financial measures eliminate the impact of items that we do not consider indicative of the performance of our business. While we believe that these non-GAAP financial measures are useful in evaluating our business, this information should be considered as supplemental in nature and is not meant as a substitute for the related financial information prepared in accordance with U.S. GAAP.

 

 

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The following tables present a reconciliation of each adjusted EBITDA and adjusted net (loss)/income to net (loss)/income, the most directly comparable GAAP financial measure.

 

     For the Year Ended
December 31,
    For the Three Months
Ended March 31,
 
     2012     2013     2013     2014  
     RMB     RMB     US$     RMB     RMB     US$  
     (in thousands)     (in thousands)  

Reconciliation of Net (Loss)/Income to Adjusted Net (Loss)/Income and Adjusted EBITDA:

            

Net (loss)/income

     (9,323     27,845        4,599        (682     33,165        5,335   

Share-based compensation

     1,415        329        54        82        82        14   

Fair value change of preferred share warrant liability

     564        514        85        111                 

Share of loss from an equity investment

            170        28               29        4   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net (loss)/income

     (7,344     28,858        4,766        (489     33,276        5,353   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Depreciation of property and equipment

     428        1,788        296        383        736        118   

Amortization of intangible assets

     1,151        1,990        329        235        955        154   

Income tax expense

            6,174        1,020               9,735        1,566   

Interest income

     (20     (81     (13     (7     (39     (6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

     (5,785     38,729        6,398        122        44,663        7,185   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The use of adjusted EBITDA and adjusted net (loss)/income has material limitations as an analytical tool, as adjusted EBITDA and adjusted net (loss)/income do not include all items that impact our net loss or income for the period. In addition, because these non-GAAP measures may not be calculated in the same manner by all companies, they may not be comparable to other similar titled measures used by other companies.

 

 

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RISK FACTORS

An investment in our ADSs involves significant risks. You should carefully consider all of the information in this prospectus, including the risks and uncertainties described below, before making an investment in our ADSs. Any of the following risks could have a material adverse effect on our business, financial condition and results of operations. In any such case, the market price of our ADSs could decline, and you may lose all or part of your investment.

Risks Related to Our Business

If we fail to maintain and grow our user base, we will not be able to sustain our growth and our business may be materially and adversely affected.

In order to achieve sustainable growth of our business, we must retain our existing users, attract new users, maximize the network effect of our platform and ultimately improve our monetization. This requires that we consistently launch popular games and release updates for our existing games to keep our users engaged and therefore staying within our platform of games. It also requires that we continue to strengthen the social connectivity of our platform to encourage viral social marketing and enhance user engagement. In order to deliver a better game-playing and social networking experience and deepen our understanding of our users, we need to invest in technology and research and development, including our cloud-based storage and computing infrastructure, data analysis engine and our technology related to software development kits, or SDKs, which are software development tools that allow for the creation of software packages or platforms. If we are unable to consistently deliver a satisfying user experience, we may lose our users. If we are unable to anticipate user preferences or behaviors or industry changes in order to market and promote new games, or if we are unable to extend the life cycle of the games that we currently operate, or if we are unable to provide sufficient social connectivity to our users as part of their game playing experience, our user base may not increase at the rate we anticipate, or at all, and it may even decrease.

Despite our efforts in sourcing high-quality games and our rigorous game selection process, we cannot guarantee that the games we launch will gain popularity within a short period of time, if at all. Neither can we guarantee that popular games that we operate will continue to sustain their current level of popularity. Users may lose interest in our games over time despite our efforts in offering a diversified portfolio of games and improving or upgrading our existing games. Users may not choose our games or services if our technology becomes unreliable. Users may choose to play games offered by other platforms if those platforms offer better game services or social networking opportunities. Furthermore, many of our new games require a build-up period when users are first introduced to the games, and the rise in popularity of some games can be slow, if it happens at all. If a build-up period coincides with the inevitable phasing-out period of our older games, the result could be a decrease in the number of total active and paying users as well as gross billings and revenue during that period. If a game fails to gain anticipated user acceptance and we do not introduce additional games to maintain our user base, the phasing out of previous games could result in a prolonged period of or permanent decrease in our total active and paying users. If we fail to effectively schedule the initial launches of our games, our results of operation may be materially and adversely affected.

The growth of our user base reinforces the popularity of our games. Our failure to effectively expand and engage our user base will materially and adversely affect our business, financial condition, results of operations and growth prospects.

If we fail to monetize our users effectively, our business may suffer.

All of the games we publish are free to download and play, adopting an item-based revenue model, and in line with the industry norms, only a small percentage of users who play our games in any period are paying users. For example, 5.7% and 5.2% of our active users were paying users in the fourth quarter of 2013 and the first quarter of 2014, respectively. As such, in order to sustain our revenue growth, we must effectively monetize our user base by converting active users to paying users. We invest in user data mining and analysis to better

 

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understand our users’ in-game consumption patterns. This allows us to create localized and culturally-adapted editions of overseas games and help refine domestic games, as well as design virtual items that are desirable to mobile users in China and to properly deploy and price them to enhance our monetization. Our users are willing to pay for premium functions and purchase virtual items in the games because of the perceived value of these functions or items, which is dependent on the benefits such services or items confer upon the users in the game. Spending in our games is discretionary and our users can be sensitive to the price, undermining our ability to convert active users to paying users. It is crucial to balance, on the one hand, creating sufficient in-game monetization opportunities, which enhances the profitability of our games, and, on the other hand, ensuring that users can enjoy our games even without paying for extra functions or items. To stimulate in-game spending, we need to constantly launch marketing and promotional activities to drive user interest. While free-to-play games help to maintain a sizable user base and the associated network effect, it may not be optimal in terms of user monetization. We must also provide easy, fast and safe payment solutions to our users to facilitate in-game purchasing so they are not discouraged or inconvenienced by online payment processing procedures. If we fail to effectively monetize our users, our business will suffer.

Because more than half of our revenues are generated from a small number of games, if we fail to extend the life cycle of our existing popular games or launch new popular games, we will not be able to maintain or grow our revenue and our financial results could be adversely affected.

We generate more than half of our revenues from a few popular games. In 2013, the Temple Run series, Fruit Ninja and Subway Surfers, our top three games in 2013, contributed approximately 85.4% of our total revenues, with the Temple Run series contributing approximately 41.7% of our total revenues. In the first quarter of 2014, these games contributed approximately 57.2% of our total revenues, with Subway Surfers contributing 24.2% of our total revenues. Our top games may have a finite life span and may fall out of favor from users. As a result, we must maximize the life cycle of our popular games by developing, releasing and marketing new editions or updates that will continue to engage our users. Failing to extend the life of our existing popular games will materially and adversely affect our revenue growth and financial results. We must also identify and launch new games that will gain widespread popularity and become revenue growth drivers. This requires our substantial investment in game selection, research and development, sales and marketing and game operations. It is difficult to consistently anticipate user preference on a large scale. While we continue to invest significant resources in the launch of new games, we cannot assure you that new games, game editions or updates will be popular among our users and become profitable.

We work with game developers to provide games to our users. Any loss or deterioration of our relationship with our game developer partners may result in the loss of user base and revenues.

We work with game developers to publish games on our platform. We have benefited from some of these developers’ strong brand recognition and the success of their games in overseas markets. Due to our strong relationship with many of our game developer partners, we are able to obtain the source code of many overseas games, which allows us to play a more substantial role in the games’ operation in China. We believe this is crucial to building and expanding our user base and therefore the success of our platform, as well as to our ability to operate and monetize our games.

However, we may not be able to maintain good and mutually beneficial commercial relationships with our game developer partners, including the developers of our most popular games, including Halfbrick Studios Pty. Ltd., or Halfbrick, the developer of Fruit Ninja, Imangi Studios, LLC, the developer of the Temple Run series, and Kiloo ApS, who licenses Subway Surfers to us. Any failure on our part to properly localize or operate or effectively market or monetize their games, safeguard their intellectual property, including the source code of their games, or perform our obligations under our agreements with them may cause substantial harm to our business relationships with the game developers. Where we are required to pay an advance royalty or a minimum profit guarantee by the game developer, should the game fail to meet its expected performance targets, we need to compensate the game developer and incur additional loss. Because we are in the process of obtaining certain regulatory approvals and licenses for our publishing business and games, we also may not be in strict compliance with the terms and conditions in some of our distribution agreements with game developers.

 

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The term of our content distribution agreements with game developers is typically one to three years, renewable upon both parties’ consent. Our game developer partners may terminate our agreements prior to their expiration voluntarily or as a result of our non-compliance with the terms or conditions, or they may refuse to renew the agreements. Even if they are willing to renew the agreements, they may demand commercial terms, such as revenue-sharing ratios, that are less favorable to us than under our existing agreements. They may choose to partner with our competitors, allowing our competitors to enhance their game portfolio and better compete against us. We began to publish games developed by the subsidiaries of our VIEs in the first quarter of 2014. We cannot assure you that such in-house development capability will not affect our relationship with our game developer partners. Any loss or deterioration of our relationship with any of our game developer partners may result in a loss of revenues and materially and adversely affect our business and results of operations.

We work with third-party channels to distribute our games, and our business and results of operations may be materially and adversely affected if they breach their obligations to us, or if we fail to maintain relationships with a sufficient number of platforms, or if the platforms lose popularity among Internet users.

In addition to our proprietary distribution channels, which includes in-game cross promotions and our self-operated iDreamSky Game Center and www.uu.cc, we publish our games through mobile app stores, mobile pre-installations and other mobile channels owned and operated by third parties. We rely on these third parties to promote and publish our games, record purchases, maintain the security of their platforms to prevent fraudulent activities, provide a certain portion of user services and, in some occasions, process payments from users.

We may be negatively impacted if these third-party channels fail to effectively promote our games or otherwise fulfill their obligations to us or if they do not obtain or maintain relevant government licenses to distribute our games. Disputes with third-party platforms, such as disputes relating to intellectual property rights and distribution fee arrangements, may also arise from time to time and we cannot assure you that we will be able to resolve such disputes in a timely manner or at all. If our collaboration with a major third-party platform terminates for any reason, we may not be able to find a replacement in a timely manner or at all and the distribution of our games may be adversely affected. Any failure on our part to maintain good relationships with a sufficient number of popular platforms for the distribution of our games could cause the number of our game downloads and activations to decrease, which will have a material adverse effect on our business, financial condition and results of operations.

We plan to build our own publishing platform to become a destination for fun and exciting mobile games. Our own platforms may compete with our distribution partners and adversely affect our relationships with them. Conversely, some of our distribution partners have their own in-house game development capabilities and our other distribution partners may consider establishing such capabilities in the future. We are therefore subject to direct competition and potential conflicts of interest with our distribution partners, which may intensify in the future, and we cannot assure you that our distribution partners will always maintain a cooperative relationship with us. If our distribution partners commit less resources to promote our games on their platforms, cease to promote our games or distribute our games, our business and results of operations may be adversely affected.

We plan to distribute some of our games through social networking platforms, such as Weixin. The games will benefit from the strong brand recognition, large user base and the stickiness of these social networking platforms. If any of these social networking platforms lose their market positions or are no longer popular with users, we would need to identify alternative channels for marketing, promoting and distributing our games, which would consume substantial resources and may not be effective.

 

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We work with China’s three mobile carriers to distribute our games and we rely on them to collect the gross billings generated from our games. The loss of or a change in any of these significant carrier relationships could materially harm our business.

China’s three mobile carriers, China Mobile, China Unicom and China Telecom, distribute our games and process payments made in our games. In particular, we collected through them a substantial majority of the gross billings generated from our games, after deducting their payment processing fees, and we expect to continue to rely on them for payment processing in our games going forward. The percentage of payment processing fees charged by mobile carriers are relatively higher than those charged by other third-party payment channels, such as Alipay, Weixin Payments, China UnionPay and Yeepay. Additionally, due to their dominant position in China’s telecommunications industry, we have limited ability to negotiate economic terms with them. Our relationships with and ability to negotiate the payment processing and distribution fee terms with these mobile carriers directly affects our costs and profitability.

Our agreements with the mobile carriers typically have a one- or two-year term. The carriers may terminate their agreements with us early or refuse to renew the agreements. They may also demand to renegotiate the economic or other terms with us. The agreements generally do not obligate the mobile carriers to market or distribute any of our games. In many of these agreements, we warrant that we have the requisite qualifications to publish our games, our games do not contain libelous or obscene content, do not contain material defects or viruses and do not violate third-party intellectual property rights, and we indemnify the mobile carriers for any breach of a third party’s intellectual property. If we fail to comply with these warrants, the mobile carrier may terminate their agreements with us or sue us for damages. Furthermore, our ability to generate revenue through a given mobile carrier may be impaired by factors outside our control, including the mobile carriers’ preference for our competitors’ mobile games, the mobile carrier’s decision not to include or highlight our games on its distribution platforms, and any failure in its billing system or network connection. There may be regulatory policies or changes that may impose requirements with respect to the procedures for distribution and payment processing of mobile games, including those with respect to push notifications to users, billing and payment, in-game advertisements or other consumer-protection measures. These policies may increase our compliance costs and affect the effectiveness of our marketing or monetization effort.

If any of our mobile carriers decides not to market or distribute our games or decides to terminate, not renew or modify the terms of its agreement with us, we may be unable to replace the affected agreement with acceptable alternatives, causing us to lose access to that carrier’s subscribers and the revenues generated from them, which could materially harm our business, operating results and financial condition.

Our ability to monetize our users is subject to third-party payment processing-related risks.

We offer our users a variety of payment options, including direct billing through mobile carriers and other third-party online payment platforms. Therefore, we rely on them to provide payment processing services to our users, which subjects us to fraud and other illegal activities in connection with these various payment methods.

We generally receive casual game gross billings through the mobile carriers and our mid- and hardcore game gross billings through a few third-party payment channels. The concentration of our payment channels could lead to a short-term disruption in our collection of the gross billings if one or more of them were to narrow or terminate its business cooperation with us, or demand commercial terms that are less favorable to us. Such concentration also makes us more vulnerable to collection risks should one or more of these providers become unable or unwilling to share the proceeds it receives with us. Our operations and business could be harmed if our relationships with one or more of these payment platforms deteriorate, or if one or more of the key payment platforms experience a decrease in their business generally or an increase in non-payment from users.

Furthermore, mobile carriers and third-party payment service providers are entitled to a prescribed percentage of the gross billings charged to our users. If these platforms fail to remit to us the proceeds collected from our user in a timely fashion or at all, if these platforms become unwilling or unable to provide these services to us, or if their service quality deteriorates, our business could be disrupted. Our payment platform

 

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partners are also subject to various rules, regulations and requirements, regulatory or otherwise, governing electronic funds transfers and virtual currencies, which could change or be reinterpreted to make it difficult or impossible for them to comply. If our payment partners fail to comply with these rules or requirements, they may be subject to fines and higher transaction fees and lose their ability to accept credit and debit card payments, process electronic funds transfers or facilitate other types of online payments from our users. This would materially and adversely affect our ability to monetize our users.

Our limited operating history makes it difficult to evaluate our future prospects and results of operations.

We have a limited operating history under our current business model upon which to evaluate the viability and sustainability of our business. Our company was incorporated in the Cayman Islands as an exempted limited liability company in February 2012. We began operating our business in November 2009 through our consolidated affiliated entity and commenced operations of our first mobile game in April 2011. We incurred a net loss of RMB9.3 million in 2012. Accordingly, you should consider our future prospects in light of the risks and uncertainties experienced by early stage companies in evolving industries, such as the mobile game industry in China. Some of these risks and uncertainties relate to our ability to:

 

    retain existing users, attract new users and increase user activity and monetization;

 

    license or acquire additional mobile games that are appealing to users;

 

    expand partnerships with domestic and overseas content developers;

 

    maintain and expand our distribution and payment network;

 

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

 

    anticipate and adapt to changing user preferences;

 

    adapt to competitive market conditions;

 

    maintain adequate control of our expenses; and

 

    attract and retain qualified personnel.

If we are unsuccessful in addressing any of these risks and uncertainties, our business may be materially and adversely affected.

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

The mobile game industry in China is highly competitive. The industry is characterized by the frequent introduction of new products and services, short product life cycles, evolving industry standards, rapid adoption of technological and product advancements, as well as price sensitivity on the part of users. In China, we compete directly with domestic companies with integrated mobile game operation capabilities, such as Chukong Holdings Limited, China Mobile Games and Entertainment Group, Yodo1, Ltd., Shanda Interactive Entertainment Limited, NetEase Inc. and FL Mobile Inc. We also compete with China’s leading Internet and technology companies such as Tencent Holdings Limited and Qihoo 360 Technology Co. Ltd., who may capitalize on their significant financial and technical resources and their large user bases to develop and publish mobile games. We also compete with overseas mobile game companies who may look to directly operate in the PRC market, such as GREE International, Inc., DeNa Co., Ltd., King Digital Entertainment plc and Electronic Arts Inc. In addition, we face competition from other entertainment formats and mobile applications and content, such as mobile music, mobile books and social network services.

Some of our existing and potential competitors have significantly greater financial, technological and marketing resources and stronger relationships with industry participants than we do. If there are new entrants in the market or intensified competition among existing competitors, we may have to provide more incentives to

 

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industry participants, such as game developers and distributing agents, which could adversely affect our profitability. If we fail to compete effectively, our market share could reduce and our results of operations could be materially and adversely affected.

If we fail to successfully execute our growth strategy, including our current expansion into new genres of games, the mobile social networking business and game development and acquisition, our future results of operations and growth prospects may be materially and adversely affected.

We have expanded our product offerings to include games of various genres. To operate games in a new genre, we must identify and obtain licenses for appealing games with high monetization potential from both overseas and domestic game developers. We also depend on these game developers to provide technical support, and to develop updates and expansion packs to sustain user interest and attract new users to our games. We may not be able to successfully establish relationships with high-quality game developers and obtain licenses to their games. Additionally, we have also begun to acquire games under game acquisition agreements. If the games that we acquire fail to become commercially successful, we may not be able to recoup our initial capital investments and receive the expected return, if at all. We have also began to publish games developed by the subsidiaries of our VIEs in the first quarter of 2014. We may need to invest more financial, technical and human resources in connection with developing the games and producing their updates and new editions than we typically do with respect to our licensed games. Expansion into new genres of mobile games or new operation models may present operating and marketing challenges that are different from those that we currently encounter with our existing games. We also face competition from existing players within these markets who may have more experience and resources.

We are also making significant investments in the development and upgrade of SkyNet, which enables our live in-game service, iDreamSky Game Center, which is our mobile application for game services, and www.uu.cc, which is our mobile game information website, all designed to provide social connectivity for our platform, enhance user engagement, promote our brand awareness and create additional monetization opportunities. However, these products may not be effective in achieving these goals and we may not be able to recover costs incurred for developing and marketing these products or services. As a result, our future results of operations and growth strategies could be materially and adversely affected. If we are unable to successfully implement our growth strategies, our revenue and profitability may not grow as expected, and our competitiveness may be materially and adversely affected.

Our growth strategy of acquiring and investing in complementary businesses, assets and technologies may result in operating difficulties, dilution to our investors and other negative consequences.

We have successfully acquired, and intend to selectively acquire and invest in, businesses, assets and technologies that complement our existing business. We may acquire companies, businesses, intellectual property rights and other assets, or invest in strategic partners. Acquisitions and investments involve uncertainties and risks, including:

 

    accurately identifying and evaluating potential acquisition targets with operations complementary to our existing operations;

 

    potential ongoing financial obligations and unforeseen or hidden liabilities;

 

    retaining key employees and maintaining the business relationships with the businesses we acquire;

 

    failure to achieve the intended objectives, benefits or revenue enhancement;

 

    costs and difficulties of integrating acquired businesses and managing a larger business;

 

    the need to integrate an acquired company’s accounting, management information, human resource and other administrative systems to permit effective management and timely reporting;

 

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    the possibility that, before the acquisition or investment, we will not discover important facts during due diligence that could have a material adverse impact on the value of the businesses we acquire or invest in;

 

    significant accounting charges resulting from the completion and integration of a sizeable acquisition and increased capital expenditures;

 

    the possibility that a change of control of a company we acquire triggers a termination of contractual or intellectual property rights important to the operation of its business; and

 

    diversion of resources and management attention.

Our failure to address these risks successfully may have a material adverse effect on our financial condition and results of operations. In addition, any such acquisition or investment may require a significant amount of capital investment, which would decrease the amount of cash available for working capital or capital expenditures. Furthermore, if we use our equity securities to pay for acquisitions, we may dilute the value of the ADSs and the underlying Class A ordinary shares. Our shareholders may not have the opportunity to review, vote on or evaluate future acquisitions or investments. If we borrow funds to finance acquisitions, such debt instruments may contain restrictive covenants that could, among other things, restrict us from distributing dividends.

Any failure or significant interruption in our technology infrastructure could impact our operations and harm our business.

Our technology infrastructure is critical to the performance of our games and to user satisfaction. Our games run on our proprietary SDK network, SkyNet and cloud computing system. Some elements of our technology infrastructure, such as our servers, are maintained by third parties that we do not control. We have experienced, and may in the future experience, website disruptions, outages and other performance problems due to a variety of factors, including infrastructure changes, human or software errors and capacity constraints. If a particular game is unavailable when users attempt to access it, users may stop playing the game and may be less likely to return to the game as often, if at all. A failure or significant interruption in our game service would harm our reputation and operations. We expect to continue to make significant investments in our technology infrastructure to maintain and improve all aspects of user experience and game performance. To the extent that our disaster recovery systems are not adequate, or we do not effectively address capacity constraints, upgrade our systems as needed and continually develop our technology and network architecture to accommodate increasing traffic, our business and operating results may suffer. We do not maintain insurance policies covering losses relating to our technology infrastructure and we do not have business interruption insurance, and our business and operations may suffer adverse effects as a result.

We operate in a new and rapidly changing industry, which makes it difficult to evaluate our business and prospects. Our ability to generate revenue could suffer if the PRC mobile game market does not develop as anticipated.

We derive substantially all of our revenue from the PRC mobile game industry, which is rapidly evolving. The growth of the mobile game industry in China and the level of demand and market acceptance of our games are subject to a high degree of uncertainty. Our future operating results depend on numerous factors affecting the mobile game industry, many of which are beyond our control, including:

 

    growth prospects of mobile games;

 

    changes in consumer demographics and public tastes and preferences;

 

    changes in technologies;

 

    the availability and popularity of other forms of entertainment;

 

    the growth of mobile device users, and the rate of any such growth;

 

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    the growth of China’s telecommunications infrastructure, mobile network and payment system; and

 

    general economic conditions, particularly economic conditions adversely affecting discretionary consumer spending.

Our ability to formulate and execute publishing, distribution and marketing strategies will be significantly affected by our ability to anticipate and adapt to relatively rapid changes in the tastes and preferences of our current and potential users. New and different types of entertainment may increase in popularity at the expense of mobile games. A decline in the popularity of mobile games or casual games in particular would harm our business and prospects.

As China’s mobile games market has evolved rapidly in recent years with developments such as the introduction of new business models and new technology, 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 the mobile game market. There are numerous other technologies and business models in varying stages of development, such as portable tablet computers, notebooks or other mobile Internet handsets involving fourth generation mobile technologies, which could render certain current technologies or applications obsolete. If we fail to anticipate or successfully implement new technologies, our games may become obsolete or uncompetitive, and our business prospects and results of operations could be materially and adversely affected.

Accordingly, it is extremely difficult to accurately predict user acceptance and demand for our existing and potential new games, and the future size, composition and growth of this market. Given the limited history and rapidly evolving nature of our market, we cannot predict how much 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.

Breaches of security measures of our website, games and third-party payment systems and unintended disclosures of user and game data may have materially and adversely affect our reputation and business.

As we conduct our business, we process, store and analyze personal information and other data. We rely on proprietary encryption and authentication technology to provide the security and authentication necessary to enable secure transmission of confidential user information, including user name and password. However, our security controls over user and game data may not prevent the improper disclosure of personally identifiable information. A party who is able to circumvent these security measures could misappropriate proprietary information or cause interruptions in our operations. A security breach that leads to disclosure of user account information, including mobile numbers or other personally identifiable information, could harm our reputation. Our actual or perceived failure to comply with governmental regulation and other legal obligations related to user privacy could harm our business. We may be required to expend significant capital and other resources to prevent such security breaches or to alleviate problems caused by such breaches. We may also lose current or potential users for our mobile games that allow us to access our users’ personal data of our users because of the perception that we cannot adequately protect our users’ privacy.

Additionally, our business operation may be harmed by users’ concerns over playing games on their mobile phones. Hackers may modify our games to charge our users for virtual items that they did not purchase. We can typically identify hacked game applications after our users start playing the game and alert users of the situation and urge them to uninstall the game application. However, such users may become hesitant in downloading the game again or other games operated by us in the future as a result of their experience. Concerns over the security and privacy of user information may inhibit the wireless business generally, and our mobile games in particular. Our security measures may not prevent security breaches and our users’ interest in playing mobile games may decrease if malware spreads to their mobile phones. Failure to prevent security breaches or respond to abuse or users’ concerns over development of mobile phone malware may have a material adverse effect on our business, prospects, financial condition and results of operations.

 

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In addition, secure transmission of confidential information, such as users’ debit and credit card numbers and expiration dates, personal information and billing addresses, over public networks, including our website, is essential for maintaining user confidence. We do not have control over the security measures of our third-party payment platform partners, and their security measures may not be adequate at present or may not be adequate with the expected increased usage of online payment systems. We could be exposed to litigation and possible liability if we fail to safeguard confidential user information, which could harm our reputation and our ability to attract or retain users and may have a material adverse effect on our business.

Undetected programming errors or defects in our mobile games could harm our reputation and materially and adversely affect our results of operations.

Our mobile games are subject to frequent improvement and updates, and may contain bugs or flaws that may become apparent only after the updated applications are accessed by mobile users, particularly as we launch new updates under tight time constraints. From time to time, our users may inform us of programming bugs affecting their experience, and we are generally able to resolve such flaws promptly. However, if for any reason, programming bugs or flaws are not resolved in a timely fashion, we may lose some of our users and our revenues will be affected negatively, and our reputation and market acceptance of our mobile games may also be harmed. In addition, PRC government has promulgated rules and regulations targeting mobile service providers that charge for applications and other content without user consent. If a programming error or flaw in our products inadvertently charges users without consent, we may be subject to administrative penalties and fines.

Unauthorized character enhancements, other hacking or cheating activities, and undetected programming errors or defects in our virtual worlds could harm our online business and reputation and materially and adversely affect our results of operations.

With the increase in the number of game users in China, game operators have increasingly encountered problems arising from the use of unauthorized character enhancements, theft of user account information and other hacking or cheating activities. We have from time to time detected a number of users who have gained an unfair advantage by installing hacking or cheating tools to facilitate character progression. In response to these activities, we have installed detection mechanisms in our games to identify various hacking and cheating activities, and have expanded our technical team dedicated to detecting unauthorized character enhancements and resolving other hacking issues. However, these measures may not be effective against hacking.

Continued occurrences of unauthorized character enhancements, other hacking or cheating activities, and undetected errors or defects in our games will harm user experience, which may negatively impact the image of our games and users’ perception of their reliability, reduce our user number and in-game spending, shorten the life span of the games and adversely affect our results of operations. A constant recurrence of these activities may require us to shift our management’s and personnel’s attention from research and development and other operations to focus instead primarily on anti-hacking programs and activities, which could hurt our ability to offer content updates and new games and could materially and adversely affect our business, financial condition, results of operations and growth prospects.

We may not be successful in effectively promoting our brand or enhancing our brand recognition, and any negative publicity, regardless of its veracity, may harm both the brand of our company and the specific games we publish.

The reputation of our “iDreamSky” brand is growing among mobile game players in China as a quality publishing platform of fun and exciting games. Promoting our iDreamSky brand and enhancing its recognition is an integral part of our growth strategy. However, we may not be able to effectively promote or develop our brand and if we fail to do so, our growth may be adversely affected. In addition, negative publicity or disputes regarding our brand, games and services, company or management could materially and adversely affect public perception of our brand and other products and services we offer. Any negative publicity in relation to us, regardless of its veracity, could harm the image of our company and the games we publish, which in turn would

 

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decrease the number of active users from the operation of our online business. Any impact on our ability to effectively promote our brand and any significant damage to the public perception of our iDreamSky brand or our products could materially and adversely affect our prospects and results of operations.

Unauthorized use of our intellectual property may harm our brands and reputation and adversely affect our business.

We regard the intellectual property rights granted to us by our game developer partners, as well as our own copyrights, trademarks and other intellectual property as critical to our success. Unauthorized use of these intellectual properties may harm our brands and reputation and adversely affect our business.

We have historically relied on a combination of trademark and copyright law, trade secret protection, restrictions on disclosure and other agreements that restrict the use of our intellectual properties to protect our intellectual property rights. Although our contracts with our business partners prohibit the unauthorized use of our franchises, brands and other intellectual property rights, we cannot assure you that they will always comply with these terms. These agreements may not effectively prevent disclosure of confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. In addition, third parties may independently discover our trade secrets and proprietary information, limiting our ability to assert any trade secret rights against such parties.

Although we presently enter into confidentiality agreements with all of our employees and impose stringent obligations on our core research and development employees with respect to confidentiality, we cannot assure you that these confidentiality agreements will not be breached, that we will have adequate remedies for any breach, or that our proprietary technology, know-how or other intellectual property will not otherwise become known to, or be independently developed by, third parties. Any failure to protect our game developer partners’ intellectual properties will also subject us to severe consequences, including loss of game distributorships and payment of damages.

While we actively take steps to protect our proprietary rights and those of our game developer partners, such steps may not be adequate to prevent the infringement or misappropriation of our and their intellectual property. Moreover, we have no control over third parties who clone and offer counterfeits of our games which may be misleading to users. In addition, we cannot assure you that our trademark applications will ultimately proceed to registration or will result in registration with adequate scope for our business. Some of our pending applications or registrations may be successfully challenged or invalidated by others. If our trademark applications are not successful, we may have to use different marks for affected products or services, or seek to enter into arrangements with any third parties who may have prior registrations, applications or rights, which might not be available on commercially reasonable terms, if at all.

Primarily due to ambiguities in the laws and difficulties in enforcement, intellectual property right protection in China may not be as effective as in the United States or other countries. Policing unauthorized use of our proprietary technology, trademarks and other intellectual property is difficult and expensive, and litigation may be necessary in the future to enforce our intellectual property rights. Future litigation could result in substantial costs and diversion of our resources, and could disrupt our business, as well as have a material adverse effect on our financial condition and results of operations.

Third parties may claim that we infringe their proprietary rights, which could cause us to incur significant legal expenses and prevent us from promoting our products and services.

We have from time to time received claims that we have infringed the intellectual property rights of others, and may in the future receive more claims. Although we are not the developer of the games that we license, third parties may claim that, as the publisher of the games, we are also liable for any infringement upon the third parties’ rights, jointly, with the developer. For example, we were named as a co-defendant in a civil complaint in the PRC claiming that a game that we started publishing in the first quarter of 2014 allegedly contained certain content during beta testing that infringed upon a third party’s intellectual property rights. The third party is

 

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seeking RMB5.0 million in damages against the co-defendants, which are the game developer, us and another third party that provides distribution channels for the game. We intend to contest the case vigorously. We typically rely on our game developer partners’ representations that their games do not infringe upon third parties’ intellectual property rights and we require indemnification should any such representations become inaccurate and we suffer damage as a result, including any damages resulting from third party claims. For example, pursuant to our agreement with this game developer, the developer is obligated to indemnify us for any losses that we may incur arising from the games’ infringing upon any third party’s intellectual property rights. However, games we license may from time to time infringe upon valid patents, trademarks, copyrights or other intellectual property rights held by third parties and indemnification may not be adequate in recovering our loss. Game features redesigned by us may also be claimed to have infringed upon third parities’ rights. Any such claim or litigation, with or without merit, could be costly and distract our management from day-to-day operations. If we fail to successfully defend against such claim or do not prevail in such litigation, we could be required to modify, redesign or cease operating the games, pay monetary amounts as damages, enter into royalty or licensing arrangements, or satisfy indemnification obligations that we have with some of our users. Any royalty or licensing arrangements that we may seek in such circumstances may not be available to us on commercially reasonable terms or at all. Also, if we acquire technology to include in our products from third parties, our exposure to infringement actions may increase because we must rely upon these third parties to verify the origin and ownership of such technology. This exposure to liability could result in disruptions in our business that could materially and adversely affect our operating results.

Some of our employees were previously employed at other companies, including our current and potential competitors. We also intend to hire additional personnel to expand our development team and technical support team. To the extent these employees are involved in the development of content or technology similar to ours at their former employers, we may become subject to claims that these employees or we have appropriated proprietary information or intellectual properties of the former employers of our employees. If we fail to successfully defend such claims against us, we may be exposed to liabilities which could have a material adverse effect on our business.

The successful operation of our business depends on the performance and reliability of the Internet infrastructure and telecommunications networks in China.

Our game operation and distribution depends on the performance and reliability of the Internet infrastructure in China. Almost all access to the Internet is maintained through state-owned telecommunication operators under the administrative control and regulatory supervision of the Ministry of Industry and Information Technology, or the MIIT. In addition, the national networks in China are connected to the Internet through international gateways controlled by the PRC government. These international gateways are the only channels through which a domestic user can connect to the Internet. Although the PRC government has pledged to improve the Internet infrastructure in China as part of its stimulus package introduced in the first quarter of 2009, a more sophisticated Internet infrastructure may not be developed in China. We may not have access to alternative networks in the event of disruptions, failures or other problems with China’s Internet infrastructure.

The mobile network in China is operated by three mobile carriers, including China Mobile, China Unicom and China Telecom, all of which are controlled by the PRC government. Mobile coverage may not be reliable, and any disruption in the operation of the mobile carriers may have a negative impact on our users’ ability to download and activate our games, as well as their gameplay and payment experience. There is no assurance that China’s mobile network infrastructure will continue to improve and further support the operation and expansion of our business.

Any failure to maintain the satisfactory performance, reliability, security and availability of our network and computer infrastructure may cause significant harm to our business operation and the distribution of our games. Any server interruptions, break-downs or system failures, including failures which may be attributable to events within or outside our control that could result in a sustained shutdown of all or a material portion of our services,

 

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could adversely impact our ability to operate our games and service our users and lead to user attrition and revenue reduction. Our network systems are also vulnerable to damage from computer viruses, fire, flood, earthquake, power loss, telecommunications failures, computer hacking and other similar events.

Expansion into international markets is important for our growth, and as we expand internationally, we will face additional business, political, regulatory, operational, financial and economic risks, any of which could increase our costs and hinder such growth.

We plan to expand our business internationally. We have little experience in overseas markets. It is costly to establish, develop and maintain international operations and promote our brand internationally. The expansion of our business into such geographic markets may not be profitable on a sustained basis for many reasons including, but not limited to:

 

    local economic and political conditions;

 

    government regulation of mobile usage and mobile games and restrictive governmental actions (such as trade protection measures), nationalization and restrictions on foreign ownership;

 

    restrictions on sales or distribution of mobile content and uncertainty regarding intellectual property rights and liability for content and services on our platform;

 

    business licensing or certification requirements, such as those for mobile game content;

 

    limited telecommunications, content distribution and payment infrastructure;

 

    laws and regulations regarding user protection, data protection, privacy, network security, encryption and restrictions on pricing;

 

    lower levels of mobile and Internet use;

 

    lower levels of consumer spending and fewer growth opportunities compared to our current geographic markets;

 

    lower levels of online payment and increased payment risk; and

 

    difficulty in staffing, developing and managing foreign operations as a result of language and cultural differences.

As we expand our game operations to other countries, competition will intensify. Local companies may have a substantial competitive advantage because of their greater understanding of, and focus on, local users, as well as their more established local brand names. They benefit from reduced logistics costs and local marketing experience in their competition with us.

Our success depends on the continuing and collaborative efforts of our management team and other key personnel, and our business may be harmed if we lose their services.

Our future success depends heavily upon the continuing services of our key management team, including our founders. If one or more of our executives or other key personnel are unable or unwilling to continue in their present positions, we may not be able to replace them easily or at all, and our business may be disrupted and our financial condition and results of operations may be materially and adversely affected. Competition for management and key personnel is intense, the pool of qualified candidates is limited, and we may not be able to retain the services of our executives or key personnel, or attract and retain experienced executives or key personnel in the future. If any of our executives or other key personnel joins a competitor or forms a competing company, we may lose customers, distributors, know-how and key personnel. Each of our executive officers and key employees has entered into an employment agreement with us that contains confidentiality provisions. If a dispute arises between any of our executives or key personnel and us, we cannot assure you to what extent any of these agreements may be enforced.

 

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We rely on highly skilled personnel. If we are unable to retain or motivate them or hire additional qualified personnel, we may not be able to grow effectively.

Our performance and future success depend on the talents and efforts of highly skilled individuals, especially research and development and sales and marketing personnel. We will need to continue to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization. Competition in the mobile games industry for qualified employees is intense. Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate our existing employees. Since the demand and competition for talent is intense in our industry, particularly for mobile game development personnel, engineers and related technical personnel, we may need to offer higher compensation and other benefits in order to attract and retain key personnel in the future, which could increase our compensation expenses. If we do not succeed in attracting additional highly skilled personnel or retaining or motivating our existing personnel, we may be unable to grow effectively.

If we fail to establish an effective system of internal control, we may be unable to accurately and timely report our financial results or prevent fraud.

We will be subject to reporting obligations under U.S. securities laws. Section 404 of the Sarbanes-Oxley Act and related rules require a public company to include a management report on the company’s internal control over financial reporting in its annual report, which contains management’s assessment of the effectiveness of the company’s internal control over financial reporting. In addition, under Section 404(b) of Sarbanes-Oxley Act, our independent registered public accounting firm will be required to attest to the effectiveness of our internal control over financial reporting beginning with our annual report on Form 20-F following the date on which we cease to qualify as an “emerging growth company” under the Securities Act, which may be up to five fiscal years from the date of this offering. Our reporting obligations as a public company will place a significant strain on our management, operational and financial resources and systems for the foreseeable future.

In the preparation of the consolidated financial statements as of and for the two years ended December 31, 2013, we identified two material weaknesses and other control deficiencies in our internal control over financial reporting. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control such that there is a reasonable possibility that a material misstatement of our company’s financial statements will not be prevented, or detected and corrected on a timely basis. A control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis. Effective internal control over financial reporting is necessary for us to provide reliable financial reports, effectively prevent fraud and operate as a public company.

One of the material weaknesses identified relates to our lack of sufficient accounting personnel with appropriate knowledge of U.S. GAAP and SEC reporting requirements to properly address complex U.S. GAAP technical accounting issues and prepare and review financial statements and related disclosures in accordance with U.S. GAAP and SEC reporting requirements. The other material weakness identified relates to our lack of effective control procedures, including the lack of a comprehensive accounting manual, to track, estimate and record the proceeds that we share with our game developer partners and to assess the completeness and accuracy of the related accruals on the proceeds sharing and withholding taxes.

We have taken initiatives to implement and plan to implement further measures to address the material weaknesses and control deficiencies identified. We have hired our chief financial officer and additional accounting staff with U.S. GAAP and SEC reporting experience. We have allocated greater resources to our finance department and are in the process of implementing a comprehensive accounting manual and offering trainings to our accounting staff to enhance our ability to track, estimate and record the proceeds that we share with our game developer partners and to assess the completeness and accuracy of the related accruals on the proceeds sharing and withholding taxes. In addition, we are building our internal audit function and have hired an

 

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internal auditor with prior experience working at a U.S. listed company overseeing Sarbanes-Oxley Act compliance matters and a “Big Four” accounting firm. We will implement policies to ensure the independence of our internal audit function. We plan to implement additional measures in 2014. For details on these initiatives, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Internal Control over Financial Reporting.”

However, the implementation of these initiatives may not fully address the material weaknesses and other control deficiencies in our internal control over financial reporting. In addition, the process of designing and implementing an effective financial reporting system is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to employ significant resources to maintain a financial reporting system that satisfies our reporting obligations. Our failure to remediate the material weaknesses and other control deficiencies or our failure to discover and address any other material weaknesses or deficiencies may result in inaccuracies in our financial statements or delay the preparation of our financial statements. As a result, our business, financial condition, results of operations and prospects, as well as the trading price of the ADSs, may be materially and adversely affected. Ineffective internal control over financial reporting could also expose us to increased risk of fraud or misappropriations of corporate assets and subject us to potential delisting from the stock exchange on which the ADSs are listed, regulatory investigations or civil or criminal sanctions.

We may be unable to secure additional funding in the future or to obtain such funding on favorable terms.

We may require additional cash resources to finance our continued growth or other future developments, including any investments or acquisitions we may decide to pursue. The amount and timing of such additional financing needs will vary principally depending on the timing of new product launches, investments and/or acquisitions, and the amount of cash flow from our operations. If our resources are insufficient to satisfy our cash requirements, we may seek to issue additional equity or debt securities or obtain a credit facility. The issuance of additional equity securities or securities convertible into our ordinary shares could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. Our ability to obtain additional capital on acceptable terms is subject to a variety of uncertainties. Financing may not be available in amounts or on terms acceptable to us, if at all, especially if there is a recession or other events causing volatilities in the capital markets worldwide.

We have limited insurance coverage which could expose us to significant costs and business disruption.

Other than mandatory and commercial insurance for our employees, we have not purchased any insurance to cover our assets, property and business. If we were to incur substantial losses or liabilities due to fire, explosions, floods, a wide range of other natural disasters or accidents or business interruption, our results of operations could be materially and adversely affected.

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

Our independent registered public accounting firm that issued the audit reports included in this prospectus filed with the SEC, as an auditor of companies that are traded publicly in the United States and a firm registered with the Public Company Accounting Oversight Board (United States), or PCAOB, is required by the laws of the United States to undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards. Because our auditor is located in China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the PRC authorities, our auditor, like other independent registered public accounting firms operating in China, is currently not inspected by the PCAOB.

 

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Inspections of other firms that the 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 the PCAOB to conduct inspections of independent registered public accounting firms operating in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections and lose confidence in our reported financial information and procedures and the quality of our financial statements.

The outcome of the administrative proceedings brought by the SEC against four PRC-based accounting firms, including our independent registered public accounting firm, could result in our financial statements being determined to be non-compliant with the requirements of the Exchange Act.

In December 2012, the SEC brought administrative proceedings against four 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 produce work papers and other documents related to certain other PRC companies under investigation by the SEC. On January 22, 2014, an initial administrative law decision was issued, sanctioning these accounting firms and suspending them from practicing before the SEC for a period of six months. On February 12, 2014, the four PRC-based accounting firms appealed the initial administrative law decision to the SEC. The decision is neither final nor legally effective unless and until it has been reviewed and approved by the SEC. Accordingly, the sanction will not become effective until after a full appeal process is concluded and a final decision is issued by the SEC. If the SEC’s final order is decided against the accounting firms, they can also further appeal the final decision of the SEC through the federal appellate courts. We are not involved in the proceedings brought by the SEC against the accounting firms. However, our independent registered public accounting firm is one of the four accounting firms subject to the six-month suspension from practicing before the SEC in the initial administrative law decision. We may therefore be adversely affected by the outcome of the proceedings, along with other U.S.-listed companies audited by these accounting firms.

On May 24, 2013, the PCAOB announced that it had entered into a Memorandum of Understanding on Enforcement Cooperation with the China Securities Regulatory Commission, or the CSRC, and the Ministry of Finance which establishes a cooperative framework between the parties for the production and exchange of audit documents relevant to investigations in the United States and China. However, it is not clear how these recent developments could affect the SEC’s final decision in the case against the four accounting firms or any subsequent appeal to courts that the accounting firms may initiate. Therefore, it is difficult to determine the final outcome of the administrative proceedings and the potential consequences thereof.

If our independent registered public accounting firm were denied, temporarily, the ability to practice before the SEC and we were unable to timely find another registered public accounting firm to audit and issue an opinion on our financial statements, our financial statements could be determined to be non-compliant with the requirements of the Exchange Act. Such a determination could ultimately lead to the delay or abandonment of this offering, delisting of our Class A ordinary shares from the NASDAQ Global Select Market or deregistration from the SEC, or both, which would substantially reduce or effectively terminate the trading of our ADSs in the United States.

Risks Related to Our Corporate Structure

We conduct certain aspects of our businesses in China through our VIEs by means of contractual arrangements. If the PRC government determines that these contractual arrangements do not comply with applicable regulations, our business could be materially and adversely affected.

We conduct the operation of our domestic business through Shenzhen Mengyu, Shenzhen iDreamSky and Beijing Chuangmeng, our VIEs. We receive substantially all of the economic benefits of our VIEs as their

 

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primary beneficiary through contractual arrangements with them and their shareholders. For a description of these contractual arrangements, see “Our History and Corporate Structure—Contractual Arrangements among Chuangmeng Wuxian, our VIEs and the Respective Shareholders of our VIEs.”

Various regulations in China currently restrict or prevent foreign-invested entities from engaging in telecommunication services, including operating mobile games. On December 11, 2001, the State Council promulgated the Provisions on Administration of Foreign Invested Telecommunications Enterprises, which were subsequently amended on September 10, 2008. Under such regulations, foreign ownership in companies that provide value-added telecommunication services shall not exceed 50%. The Guiding Catalog for Foreign Investment Industries (revised in 2011) catagorizes the value-added telecommunications services as “restricted.” Further, the Circular on Strengthening the Administration of Foreign Investment in and Operation of Value-added Telecommunications Business issued by the Ministry of Industry and Information Technology, or MIIT, in July 2006, or the MIIT Circular, reiterates restrictions on foreign investment in telecommunications businesses. Under the MIIT Circular, a PRC company that holds a license to conduct value-added telecommunications businesses, or a VATS License, in China is prohibited from leasing, transferring or selling the license to foreign investors in any form and from providing any assistance, including providing resources, sites or facilities, to foreign investors to conduct value-added telecommunications businesses illegally in China. Furthermore, the relevant trademarks and domain names that are used in a value-added telecommunications business must be owned by the local VATS License holder or its shareholder(s). The MIIT Circular further requires each VATS License holder to have appropriate facilities for its approved business operations and to maintain such facilities in the regions covered by its license. In addition, all value-added telecommunications service providers are required to maintain network and information security in accordance with the standards set forth under relevant PRC regulations. Each of Shenzhen iDreamSky and Shenzhen Mengyu holds a VATS License for information services excluding fixed telephone information services. Shenzhen iDreamSky owns idreamsky.com and Shenzhen Mengyu owns www.uu.cc, and each of them has applied to register the relevant trademarks. However, due to a lack of interpretative materials from the authorities, it is uncertain whether the MIIT would consider our corporate structures and contractual arrangements as a type of foreign investment in telecommunication services in China. Therefore, it is unclear what impact the MIIT Circular might have on us.

In August 2011, the Ministry of Commerce, or MOFCOM, promulgated the Rules of Ministry of Commerce on Implementation of Security Review System of Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the MOFCOM Security Review Rules, to implement the Notice of the General Office of the State Council on Establishing the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or Circular No. 6, promulgated on February 3, 2011. Under these rules, a security review by MOFCOM is required for foreign investors’ mergers and acquisitions that have “national defense and security” implications and mergers and acquisitions by which foreign investors may acquire “de facto control” of domestic enterprises that have “national security” implications. The MOFCOM Security Review Rules further prohibit foreign investors from bypassing the security review requirement by structuring transactions through proxies, trusts, indirect investments, leases, loans, control through contractual arrangements or offshore transactions. There is no explicit provision or official interpretation stating that mobile game businesses fall within the scope of transactions subject to security review. We do not believe we are required to submit our existing contractual arrangement to MOFCOM for a security review. However, as there is a lack of clear statutory interpretation regarding the implementation of the rules, there is no assurance that MOFCOM will have the same view as we do when applying these national security review-related circulars and rules.

The relevant PRC regulatory authorities have broad discretion in determining whether a particular contractual structure violates PRC laws and regulations. Although we believe we comply, and will continue to comply with current PRC regulations, the PRC government may not agree that these contractual arrangements comply with PRC licensing, registration or other regulatory requirements, with existing requirements or policies or with requirements or policies that may be adopted in the future. It is possible that a PRC court, arbitration tribunal or other regulatory authority may determine that such contractual arrangements are illegal or invalid. If

 

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the PRC government determines that we are not in compliance with applicable laws, it may levy fines on us, confiscate our income that they deem to have been obtained through illegal operations, revoke or refuse to renew any business and operating licenses required to conduct our operations in China, revoke the agreements constituting the contractual arrangements, require us to discontinue or restrict our operations, suspend the operation of our games, require us to alter our ownership structure or operations, or impose additional conditions or restrictions on our business operations 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.

If the PRC government determines that our ownership structure does not comply with the restrictions contained in the GAPP Notice, we could be subject to severe penalties.

We are subject to relevant PRC regulations on operators of online games. On September 28, 2009, the PRC General Administration of Press and Publication, or GAPP, which was consolidated with the State Administration of Radio, Film and Television and currently known as the State Administration of Press, Publication, Radio, Film and Television, or the SAPPRFT, together with the National Copyright Administration, and National Office of Combating Pornography and Illegal Publications jointly issued a Circular on Implementation of the Regulation on the Three Provisions of the State Council and the Relevant Interpretations and Further Strengthening of the Administration of Pre-examination and Approval of Online Game and the Examination and Approval of Imported Online Game, or the GAPP Notice. The GAPP Notice provides, among other things, that foreign investors are not permitted to invest in online game operating businesses in China via wholly owned, equity joint venture or cooperative joint venture investments, and expressly prohibits foreign investors from gaining control over or participating in PRC operating companies’ online game operations through indirect ways, such as establishing other joint venture companies, entering into contractual arrangements with or providing technical support for such operating companies, or through a disguised form, such as incorporating user registration, user account management or payment through game cards into online gaming platforms that are ultimately controlled or owned by foreign investors. We are not aware of any online game companies adopting the same or similar contractual arrangements as ours having been penalized or ordered to be terminated since the GAPP Notice first became effective. Due to the ambiguity among various regulations on online games and a lack of interpretative materials from the relevant PRC authorities governing online game operations, there are uncertainties regarding whether PRC authorities would consider our corporate structure and contractual arrangements to be foreign investment in online game operation businesses. While we are not aware of any online game companies which use the same or similar contractual arrangements as ours having been penalized or ordered to terminate operation by PRC authorities claiming that the contractual arrangements constitute control over, or participation in the operation of, online game operating businesses through indirect means, it is unclear whether and how the various regulations of the PRC authorities might be interpreted or implemented in the future. If our contractual arrangements were deemed to be such an “indirect means” or “disguised form” under the GAPP Notice, our contractual arrangements may be challenged by the SAPPRFT. If we, our PRC subsidiary or VIEs are found to be in violation of the GAPP Notice to operate our mobile games, the SAPPRFT, in conjunction with relevant regulatory authorities, would have the power to investigate and deal with such violations, including in the most serious cases where relevant licenses and registrations would be suspended or revoked.

Our contractual arrangements with our VIEs and their respective shareholders may not be as effective in providing control as direct ownership. Our VIEs and their shareholders may fail to perform their obligations under these contractual arrangements.

We have relied and expect to continue to rely on contractual arrangements with our VIEs to conduct our domestic business. For a description of these contractual arrangements, see “Our History and Corporate Structure—Contractual Arrangements among Chuangmeng Wuxian, our VIEs and the Respective Shareholders of our VIEs.” These contractual arrangements provide us with effective control over our VIEs through which we operate our business and allow us to obtain economic benefits from them. However, these contractual arrangements may not be as effective in providing control as direct ownership. For example, if our VIEs or their

 

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respective shareholders fail to perform their respective obligations under these contractual arrangements, or if they take other actions that are detrimental to our interests, we may incur substantial costs and resources in connection with our enforcing these arrangements. To enforce these arrangements, we may rely on legal remedies available under applicable PRC laws, including seeking specific performance and claiming damages. In particular, if shareholders of our VIEs refuse to transfer their equity interests to us or our designated persons when we exercise the purchase option pursuant to these contractual arrangements, we may need to initiate legal actions to compel them to fulfill their contractual obligations. Such arbitration and legal proceedings and disputes may cost us substantial financial and other resources and result in disruption of our business, and the outcome might not be in our favor. The relevant PRC arbitration panel may conclude that our contractual arrangements violate PRC law or are otherwise unenforceable and we could consequently lose our ability to consolidate our VIEs’ results of operations, assets and liabilities in our consolidated financial statements and/or to transfer the revenues of our VIEs to Chuangmeng Wuxian, our wholly owned subsidiary. In addition, the shareholders of our VIEs may not continuously act in the best interests of our company and follow our instructions despite their contractual obligations to do so.

If we had direct ownership in our VIEs, we would be able to exercise our rights as shareholders, rather than our rights under the powers of attorney, to effect changes to their boards of directors, which in turn could implement changes at the management and operational level. However, under the current contractual arrangements, as a legal matter, if our VIEs or their respective shareholders fail to perform their obligations under these contractual arrangements, we may incur substantial costs to enforce such arrangements and rely on legal remedies under PRC law, which may not be sufficient or effective. For example, if we sought to enforce the exclusive option agreements for the transfer of equity interests in any of our VIEs, the transfer would be subject to approval by governmental authorities, such as the MIIT and MOFCOM, and the transfer price requirements of the relevant government authorities. The transferee would be required to comply with various requirements, including qualification and maximum foreign shareholding percentage requirements. As these governmental authorities have wide discretion in granting such approvals, we could fail to obtain such approval. In addition, our contractual agreements might not be enforceable in China if PRC governmental authorities or courts took the view that such contracts contravened PRC law or were otherwise not enforceable for public policy reasons.

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. The legal system in the PRC is not as developed as in other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements. Under PRC law, prevailing parties in an arbitration proceeding may only enforce the arbitration awards in PRC courts through arbitration award recognition proceedings, which would incur additional expenses and delay. If we are unable to enforce these contractual arrangements, we may not be able to exert effective control over our VIEs, and our ability to conduct our business may be negatively affected.

If we are unable to enforce these contractual arrangements, or if we suffer significant delay, or other obstacles in the process of enforcing these contractual arrangements, our business and operations in China could be disrupted, which could materially and adversely affect our results of operations and damage our reputation. See “—Risks Related to Doing Business in China—Uncertainties and changes in the PRC legal system could materially and adversely affect our business.”

Our ability to enforce the share pledge agreements may be subject to limitations based on PRC laws and regulations.

Under the contractual arrangements, Chuangmeng Wuxian entered into an equity interests pledge agreement with each of our VIEs and the shareholders of our VIEs. Under the equity interests pledge agreements, the shareholders of our VIEs agreed to pledge their equity interests in the VIEs to Chuangmeng Wuxian to secure the VIEs’ and the shareholders’ performance of their obligations under the relevant contractual arrangements.

 

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However, the equity pledge under the equity interests pledge agreements among Chuangmeng Wuxian, Beijing Chuangmeng and its shareholders has not been registered with the local branch of State Administration of Industry and Commerce, or the SAIC. The PRC Property Rights Law that was promulgated on March 16, 2007 and became effective on October 1, 2007 provides that registration with the local branch of SAIC is necessary to create security interest on the equity interests of a PRC limited liability company, which means that before the equity pledge is duly registered with the local branch of SAIC, the equity pledge is unenforceable even though the relevant equity interests pledge agreement is binding. The shareholders of one of our VIEs, Beijing Chuangmeng, are in the process of applying with the local branch of SAIC in Beijing, for registration of their equity pledge. However, there is no guarantee that that the shareholders of Beijing Chuangmeng will complete the registration in a timely manner. If any shareholder fails to complete the registration of his equity pledge, then such pledge will not become effective and Chuangmeng Wuxian will not be able to effectively exercise the pledge of such shareholder’s equity interests in Beijing Chuangmeng. If we are unable to enforce the equity interests pledge agreements, we may not be able to exert effective control over Beijing Chuangmeng and our ability to conduct our business may be negatively affected.

Further, the equity interests pledge agreements with our VIEs’ shareholders provide that the pledged equity interests constitute security for all of the payment obligations of the VIEs and the shareholders under the contractual arrangements. However, it is possible that a PRC court may take the position that the amount indicated on the equity pledge registration documents filed with the local branch of SAIC represents the full debt amount that the pledge secures. If this is the case, the obligations that are supposed to be secured in these equity interests pledge agreements in excess of the amount indicated on the equity pledge registration documents could be determined by the PRC court as unsecured debt, in which case the protection of our interest in the VIEs’ payments to us is limited.

The shareholders of our VIEs have potential conflicts of interest with us, which may adversely affect our business.

The registered shareholders of our VIEs are two of our directors, namely, Michael Xiangyu Chen and Anfernee Song Guan. Thus, conflicts of interest between their duties to our company and their interests as the controlling shareholders of our VIEs may arise. They may not act entirely in our interest when conflicts of interest arise and conflicts of interest may not be resolved in our favor. In addition, Mr. Chen and Mr. Guan could violate their non-competition or employment agreements with us or their legal duties by diverting business opportunities from us. If we are unable to resolve any such conflicts, or if we suffer significant delays or other obstacles as a result of such conflicts, our business and operations could be severely disrupted, which could materially and adversely affect our results of operations and reputation.

The shareholders of our VIEs may be involved in personal disputes with third parties or other incidents that may have an adverse effect on their respective equity interests in our VIEs and the validity or enforceability of the contractual arrangements. For example, in the event that any shareholder of our VIEs divorces his or her spouse, the spouse may claim that the equity interest of our VIEs held by such shareholder is part of their marital or community property. If such claim is supported by the competent PRC court, the relevant equity interest may be obtained by the shareholder’s spouse or another third party who is not bound by our contractual arrangements, which could result in our losing effective control over our VIEs. Similarly, if any of the equity interests of our VIEs are inherited by a third party on whom the current contractual arrangements are not binding, we could lose our control over our VIEs or have to maintain such control at unpredictable cost, which could cause significant disruption to our business, operations and harm our financial condition and results of operations.

Although under our current contractual arrangements, (i) the spouse of each of the shareholders of our VIEs has executed a spousal consent letter, under which such spouse has undertaken that she will not make any assertions in connection with the equity interests of our VIEs, as the case may be, which are held by the registered shareholder, and if such spouse obtain any equity interests of our VIEs, as the case may be, for any reasons, she shall be bound by the contractual arrangements and comply with the obligations thereunder as a

 

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shareholder thereof, and (ii) it is expressly provided in the agreements that the rights and obligations thereunder shall be equally effective and binding on the successors of the contracting parties, we cannot assure you that these undertakings and arrangements will be complied with or effectively enforced. If any of these undertakings or arrangements is breached or becomes unenforceable and leads to legal proceedings, it could disrupt our business, distract management and subject us to substantial uncertainty as to the outcome of any such legal proceedings.

We may lose the ability to use and enjoy the benefits of the assets held by our VIEs that are important to the operations of our business if such entity goes bankrupt or becomes subject to a dissolution or liquidation proceeding.

Shenzhen iDreamSky is our primary operating entity. Shenzhen Mengyu operates some of our business and Beijing Chuangmeng currently does not engage in any business of our company. Our VIEs, particularly Shenzhen iDreamSky, hold assets and perform functions that are important to the operations of our business. If any of our VIEs enters into bankruptcy and all or part of their assets become subject to liens or rights of third-party creditors, we may be unable to continue some or all of our business activities, which could materially and adversely affect our business, financial condition and results of operations. If any of our VIEs undergoes a voluntary or involuntary dissolution or liquidation proceeding, third-party creditors may claim rights to some or all of these assets, thereby hindering our ability to operate our business in the PRC, which may materially and adversely affect our business, financial condition and results of operations.

Contractual arrangements with our VIEs may result in adverse tax consequences.

Under PRC laws and regulations, an arrangement or transaction among related parties may be subject to audit or challenge by the PRC tax authorities. If this occurs, the PRC tax authorities could request that our VIEs adjust their taxable income in the form of a transfer pricing adjustment for PRC tax purposes if contractual arrangements among related parties do not represent arm’s length prices. Such a pricing adjustment could adversely affect us by reducing, for PRC tax purposes, expense deductions recorded by our VIEs, which could in turn increase their tax liabilities and expenses. In addition, any of our VIEs may be subject to late payment fees and other penalties for underpayment of taxes. As a result, our contractual arrangements with our VIEs may result in adverse tax consequences to us. If our VIEs generate net income from transactions with our PRC subsidiary under the contractual arrangements in the future and the PRC tax authorities decide to make transfer pricing adjustments on their net income, our consolidated net income may be adversely affected. In addition, the PRC tax authorities may impose interest on late payments on our VIEs for the adjusted but unpaid taxes.

Risks Related to Doing Business in China

We have not obtained certain governmental approvals with respect to any of our mobile games and our game publishing business.

On June 3, 2010, the PRC Ministry of Culture, or the MOC, issued the Provisional Measures for Administration of Online Games, or the Online Game Measures, which came into effect on August 1, 2010. The Online Game Measures are intended to strengthen the MOC’s supervision over online games which include mobile games. Pursuant to the Online Game Measures, the MOC is responsible for the review and regulation of online games, both imported and domestically developed. With respect to an imported mobile game, online operation may not commence until such game has been approved by the MOC after its content review. With respect to a domestic mobile game, a record filing must be made with the MOC within 30 days from the commencement of its online operation.

We have not completed content review or record filing of any of our mobile games, as the case may be. We may not be able to receive approval or complete the record filing of our games in the near future or at all. In addition, the MOC may find that operating imported mobile games without prior content review or domestic

 

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mobile games without a timely record filing violates the Online Game Measures. As a result, the MOC may, among other things, order us to rectify the situation, levy fines of up to RMB30,000 against us, confiscate our income generated from the unlicensed games during the non-compliance period and/or restrict or suspend our operation of such games or our mobile game business as a whole, including revoking the Internet Culture Operation License, a license required for the operation of mobile games, of Shenzhen iDreamSky and Shenzhen Mengyu. Any such disruption in business operations would materially and adversely affect our financial condition and results of operations.

In addition to the MOC’s content review and record filing procedures, the GAPP Notice provides that the SAPPRFT, formerly known as the GAPP, is the governmental department with the authority to examine and approve online games. Under the GAPP Notice, each online game is required to be approved by the SAPPRFT prior to the commencement of its publication in China. We did not apply for approval from the SAPPRFT prior to the launch of our mobiles games and are in the process of applying to the SAPPRFT for the approval of some of our major games. We may not be able to obtain the SAPPRFT’s approval of our games in the near future or at all. In addition, the SAPPRFT may find that our publishing of the games without its pre-approval violates the GAPP Notice and may impose penalties on us, such as ordering us to rectify the situation, and/or restricting or suspending our operation of such games or our online game business as a whole, including terminating our Internet services and shutting down our websites. Any such disruption in business operations would materially and adversely affect our financial condition and results of operations.

The GAPP Notice also requires that each online game operator, including mobile game operator, must obtain an Internet Publishing License in order to provide online game services. Two of our VIEs have mobile game operations and have not obtained the Internet Publishing License, and are preparing to apply for the license from the SAPPRFT. However, we cannot assure you that we will obtain the Internet Publishing License in the near future or at all. If we are found to be operating online game businesses without the Internet Publishing License, the SAPPRFT may notify the relevant local telecommunications authorities to revoke our value-added telecommunications services operating license, or the VATS License, and notify the relevant local branch of the SAIC to amend or revoke our business license. In addition, the SAPPRFT may, among other things, levy fines on us of up to five to ten times of the turnover generated from our game operations during the non-compliance period, confiscate income generated from our game operations during the non-compliance period and require us to discontinue our mobile game publishing business. If the SAPPRFT brings such actions or imposes penalties against us, our business will be materially and adversely affected.

Certain penalties may be imposed on us for operations beyond the scope of the VATS License, which may materially and adversely affect our business and operations.

According to the Administrative Measures for Telecommunications Business Operating Permit, or the Telecom Permit Measures, which were issued by the MIIT and became effective on April 10, 2009, the VATS License, are categorized into trans-regional VATS Licenses and VATS Licenses for operation within a specific region. A holder of a trans-regional VATS License is required to set up its subsidiaries or branches at relevant administrative regions based on the requirements of the VATS License and file its trans-regional VATS License with the local branch of the MIIT in each region where it has operations. The operation scope of the license will detail the permitted activities of the operator to which the license was granted. An approved telecommunication services operator must conduct its business in accordance with the specifications listed in its VATS License. Each of Shenzhen iDreamSky and Shenzhen Mengyu holds a valid VATS License for information services excluding fixed telephone information services. The service coverage of both VATS Licenses is limited to Guangdong Province. However, we are advised by our PRC counsel, Han Kun Law Offices, that given the geographic coverage of our business, we are required to hold the trans-regional VATS license. Shenzhen iDreamSky is in the process of applying for the trans-regional VATS License. Under PRC laws and regulations, if Shenzhen iDreamSky and Shenzhen Mengyu are found to operate value added telecommunications business beyond the scope of its VATS License, they may face administrative penalties, including fines or the confiscation

 

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of income generated from any business that was not within the scope of the VATS License during the non-compliance period, or being ordered to suspend their operations. Any of these penalties, if imposed, may materially and adversely affect our business and results of operations.

Compliance with the laws or regulations governing virtual currency may result in us having to obtain additional approvals or licenses or change our current business model.

In January 2007, the Ministry of Public Security, the MOC, the MIIT and the GAPP jointly issued a circular regarding online gambling having implications for the use of virtual currency. To curtail games that involve online gambling, as well as address concerns that virtual currency could be used for money laundering or illicit trade, the circular (i) prohibits online game operators from charging commissions in the form of virtual currency in relation to winning or losing of games; (ii) requires online game operators to impose limits on the use of virtual currency in guessing and betting games; (iii) bans the conversion of virtual currency into real currency or property; and (iv) prohibits services that enable players to transfer virtual currency to other players. In February 2007, fourteen PRC regulatory authorities jointly promulgated a circular to further strengthen the oversight of Internet cafes and online games. Under the circular, the PBOC bas authority to regulate virtual currency, including: (i) setting limits on the aggregate amount of virtual currency that can be issued by game operators and the amount of virtual currency that can be purchased by an individual; (ii) stipulating that virtual currency issued by game operators can only be used for purchasing virtual products and services within the online games and not for purchasing tangible or physical products; (iii) requiring that the price for redemption of virtual currency shall not exceed the respective original purchase price; and (iv) banning the trading of virtual currency.

On June 4, 2009, the MOC and the MOFCOM jointly issued a notice regarding strengthening the administration of online game virtual currency, or the Virtual Currency Notice. The notice requires businesses that (i) issue online game virtual currency (in the form of prepaid cards or prepayment or prepaid card points) or (ii) offer online game virtual currency transaction services, to apply for approval from the MOC through its provincial branches within three months after the issuance of the notice. The notice also prohibits businesses that issue online game virtual currency from providing services that would enable the trading of such virtual currency. The notice further requires an online game operator engage in the provision of virtual currency transaction service to comply with relevant e-commerce regulations issued by the MOFCOM. On June 3, 2010, the MOC issued the Online Game Measures, which became effective August 1, 2010, according to which (i) companies that plan to engage in the operation of online games, issuance of virtual currency and provision of virtual currency transaction services shall obtain a license from the provincial counterpart of the MOC; (ii) virtual currency may only be used to purchase services and products provided by the online game operator that issues the currency; (iii) the purpose of issuing virtual currency shall not be malicious appropriation of the user’s advance payment; (iv) the storage period of online gamers’ purchase record shall not be shorter than 180 days; and (v) the types, price and total amount of virtual currency shall be filed with the provincial counterpart of MOC.

The business scope in the Internet Cultural Operation Licenses of Shenzhen iDreamSky and Shenzhen Mengyu includes the issuance of virtual currency. While we do not believe we offer in-game virtual currency trading services, in some mobile games the players are allowed to purchase in-game virtual currency or credits with RMB for use in these games. We cannot assure you that the PRC regulatory authorities will not take a view contrary to ours or will deem that we are not in full compliance with the regulations on virtual currency. In that event, we may be required to cease either our game credit issuance activities or such deemed “trading service” activities and may be subject to certain penalties, including but not limited to mandatory corrective measures and fines. The occurrence of any of the foregoing could have a material adverse effect on our business and results of operations.

In addition, the Virtual Currency Notice prohibits online game operators from setting game features that involve the direct payment of cash or virtual currency by players for the chance to win virtual items or virtual currency based on random selection through a lucky draw, wager or lottery. It is unclear whether these restrictions would apply to certain aspects of our mobile games. If the PRC regulatory authorities take a view that

 

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certain of our game features are prohibited by the Virtual Currency Notice, we may be subject to penalties, including mandatory corrective measures and fines.

Currently there is no law or regulation specifically governing virtual asset property rights and therefore, it is unclear what liabilities, if any, mobile game operators may have for virtual assets.

During the course of playing mobile games, some virtual assets, such as special equipment, user experience grades and other features of our users’ game characters, are acquired and accumulated. Such virtual assets can be important to users and have monetary value and in some cases are sold among users for actual money. In practice, virtual assets can be lost for various reasons, often through unauthorized use of the game account of one user by other users and occasionally through data loss caused by a delay of network service, a network crash or hacking activities. Currently, there is no PRC law or regulation specifically governing virtual asset property rights. As a result, there is uncertainty as to who is the legal owner of virtual assets, whether and how the ownership of virtual assets is protected by law, and whether an operator of mobile games such as us would have any liability to users or other interested parties (whether in contract, tort or otherwise) for the loss of virtual assets. In case of a loss of virtual assets, we may be sued by our users and held liable for damages, which may negatively affect our reputation and business, financial condition and results of operations. We have not been involved in any virtual assets related law suits. However, we cannot assure you that such law suits will not be brought against us in the future.

Based on several judgments by PRC courts regarding the liabilities of game operators for loss of virtual assets by users, the courts have generally required the game operators to provide well-developed securities systems to protect such virtual assets owned by users and have required some game operators to return the virtual items or be liable for the loss and damage incurred therefrom if the online game operators have been determined to be in default or held liable for infringement of users’ rights.

Concerns about the use of personal data in compliance with PRC law could damage our reputation and deter current and potential users from using our services.

Pursuant to the applicable PRC laws and regulations concerning the use and sharing of personal data, our PRC subsidiaries and consolidated affiliated entities are required to keep our users’ personal information confidential and are prohibited from disclosing such information to any third parties without the users’ consent. We apply strict management and protection to any information provided by users, and under our privacy policy, without our users’ prior consent, we will not provide any of our users’ personal information to any unrelated third party. In December 2012 and July 2013, new laws and regulations were issued by the standing committee of the PRC National People’s Congress and the MIIT to enhance the legal protection of information security and privacy on the Internet. The laws and regulations also require Internet operators to take measures to ensure confidentiality of information of users. While we strive to comply with our privacy guidelines as well as all applicable data protection laws and regulations, any failure or perceived failure to comply may result in proceedings or actions against us by government entities or others, and could damage our reputation. User and regulatory attitudes towards privacy are evolving, and future regulatory or user concerns about the extent to which personal information is shared with merchants or others may adversely affect our ability to share certain data with merchants, which may limit certain methods of targeted marketing. Concerns about the security of personal data could also lead to a decline in general Internet usage, which could lead to lower user traffic on our website. A significant reduction in user traffic could lead to lower revenues from paying users, which could have a material adverse effect on our business, financial condition and results of operations.

Our mobile game operations may be adversely affected by implementation of new regulations related to the PRC government’s anti-fatigue policies.

The PRC government may decide to adopt more stringent policies to monitor the online game industry as a result of adverse public reaction to perceived addiction to online games, particularly by minors. Our online

 

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mobile games may be subject to these policies. On April 15, 2007, eight PRC government authorities, including GAPP, the Ministry of Education and the MIIT, jointly issued a notice, or the Anti-Fatigue Notice, requiring all Chinese online game operators to adopt an “anti-fatigue system” in an effort to curb addiction to online games by minors. Under the anti-fatigue system, game operators are required to reduce the value of game benefits for minor users by half when those users reach the “fatigue” level, and to zero when they reach the “unhealthy” level. In addition, online game users in China are now required to register their identity card numbers before they can play an online game. The anti-fatigue system allows game operators to identify which users are minors. These restrictions could limit our ability to increase our business among minors. Furthermore, if these restrictions were expanded to apply to adult users in the future, our business could be materially and adversely affected. On July 1, 2011, eight PRC government authorities, including GAPP, the Ministry of Education, the MIIT and five others, jointly promulgated a further notice to strengthen the implementation of the anti-fatigue system and real-name registration, entitled the Notice on Initializing the Verification of Real-name Registration for Anti-Fatigue System on Online Games, or the Real-name Registration Notice, which took effect on October 1, 2011. The Real-name Registration Notice’s main focus is to prevent minors from using an adult’s ID to play Internet games. Accordingly, the notice provides more stringent punishment for online game operators for not implementing the anti-fatigue and real name registration measures properly and effectively. The most severe punishment contemplated by the Real-name Registration Notice requires the termination of the operation of the online game if it is found to be in violation of the Anti-Fatigue Notice, the Parental Guardianship Project Circular, or the Real-name Registration Notice. The Realname Registration Notice further increases our operational risks, as we will be required to spend more resources on real-name verification and anti-fatigue systems, which will lead to an increase in operation costs. In addition, the amount of time that minors will be able to spend playing online games such as ours will be further limited, which can be expected to lead to a reduction in our revenues. Furthermore, if we are found to be in violation of the Real-name Registration Notice, we may be required to suspend or discontinue our online game operations.

Regulation and censorship of information disseminated over the Internet in China may adversely affect our business, and we may be liable for information displayed on, retrieved from or linked to our applications.

China has enacted laws and regulations governing Internet access and the distribution of news and other content, as well as products and services, through the Internet. The PRC government prohibits information that it believes to be in violations of PRC laws from being distributed through the Internet. The MIIT, MOC and other competent government authorities have promulgated regulations that prohibit games from being distributed through the Internet if the games contain content that is found to, among other things, propagate obscenity, gambling or violence, instigate crimes, undermine public morality or the cultural traditions of China, or compromise state security or secrets. If any of the games we offer were deemed to violate any such content restrictions, we would not be able to obtain the necessary government approval to continue such offerings and/or could be subject to penalties, including confiscation of income, fines, suspension of business and revocation of our licenses for operating mobile games, which would materially and adversely affect our business, financial condition and results of operations. We may also be subject to potential liability for unlawful actions of our users or for content we distribute that is deemed inappropriate. We may be required to delete content that violates PRC laws and report content that we suspect may violate PRC laws, which may reduce our user base, the amount of time our games are played or the purchases of virtual items in our games. It may be difficult to determine the type of content that may result in liability for us, and if we are found to be liable, we may be prevented from operating our games or offering other services in China.

Adverse changes in economic and political policies of the PRC government could negatively impact China’s overall economic growth, which could materially and adversely affect our business.

We conduct substantially all of our operations in China. Accordingly, our business, financial condition, results of operations and prospects depend significantly on economic developments in China. China’s economy differs from the economies of most other countries in many respects, including the amount of government involvement in the economy, the general level of economic development, growth rates and government control of

 

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foreign exchange and the allocation of resources. While the PRC economy has grown significantly over the past few decades, this growth has remained uneven across different periods, regions and economic sectors.

The PRC government also exercises significant control over China’s economic growth by allocating resources, controlling the payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Between late 2003 and 2008, the PRC government implemented a number of measures, such as increasing the PBOC’s statutory deposit reserve ratio and imposing commercial bank lending guidelines, which slowed the growth of credit. In 2008 and 2009, however, in response to the global financial crisis, the PRC government loosened such requirements. Any actions and policies adopted by the PRC government or any prolonged slowdown in China’s economy, in particular the mobile applications industry, could have a negative impact on our business, operating results and financial condition in a number of ways. For example, our users may decrease spending on our offerings, while we may have difficulty expanding our user base fast enough, or at all, to offset the impact of decreased spending by our existing users.

We may rely on dividends and other distributions from our PRC subsidiary to fund our cash and financing requirements, and any limitation on the ability of our subsidiary to make payments to us could materially and adversely affect our ability to conduct our business.

As an offshore holding company, we may rely principally on dividends from our PRC subsidiary for our cash requirements, dividends payments and other distributions to our shareholders, and to service any debt that we may incur and pay our operating expenses. The payment of dividends by entities organized in China is subject to limitations. In particular, PRC regulations permit our subsidiary to pay dividends only out of their accumulated profits, if any, as determined in accordance with Chinese accounting standards and regulations. In addition, our PRC subsidiary is required each year to set aside at least 10% of its annual after-tax profits (as determined under PRC accounting standards) into its statutory reserve fund until the aggregate amount of that reserve reaches 50% of such entity’s registered capital. These reserves are not distributable as cash dividends.

If our PRC subsidiary incurs debt on their own behalf, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us. Any limitation on the ability of our subsidiary to distribute dividends or other payments to us could materially and adversely limit our ability to grow, make investments or acquisitions, pay dividends and otherwise fund and conduct our business.

PRC regulation of loans to and direct investments in PRC entities by offshore holding companies may delay or prevent us from using the proceeds of any offering to make loans or capital contributions to our PRC operating subsidiary, which could materially and adversely affect our liquidity and ability to fund and expand our business.

We may transfer funds to our PRC subsidiary or finance our PRC subsidiary by means of shareholder’s loans or capital contributions upon completion of an offering. Any loans to our PRC subsidiary, which is a foreign-invested enterprise, cannot exceed statutory limits based on the amount of our investments in such subsidiary, and shall be registered with the State Administration of Foreign Exchange, or SAFE, or its local counterparts. Furthermore, any capital contributions we make to our PRC subsidiary shall be approved by MOFCOM or its local counterparts. We may not be able to obtain these government registrations or approvals on a timely basis, if at all. If we fail to receive such registrations or approvals, our ability to provide loans or capital contributions to our PRC subsidiary may be negatively affected, which could adversely affect our liquidity and our ability to fund and expand our business.

In addition, SAFE promulgated the Circular on the Relevant Operating Issues concerning Administration Improvement of Payment and Settlement of Foreign Currency Capital of Foreign-invested Enterprises, or SAFE Circular No. 142, on August 29, 2008. Under SAFE Circular No. 142, registered capital of a foreign invested company settled in Renminbi converted from foreign currencies may only be used within the business scope

 

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approved by the applicable governmental authority and may not be used for equity investments in the PRC, unless otherwise provided by PRC laws. In addition, foreign invested companies may not change how they use such capital without SAFE’s approval, and may not in any case use such capital to repay Renminbi loans if they have not used the proceeds of such loans. Furthermore, SAFE promulgated a circular on November 9, 2010, or SAFE Circular No. 59, which requires the authenticity of settlement of net proceeds from offshore offerings to be closely examined and the net proceeds to be settled in the manner described in the prospectus for the offering. SAFE further promulgated the Circular on Further Clarification and Regulation of the Issues Concerning the Administration of Certain Capital Account Foreign Exchange Businesses, or SAFE Circular No. 45, on November 16, 2011, which expressly prohibits foreign-invested enterprises from using the registered capital settled in Renminbi converted from foreign currencies to grant loans through entrustment arrangements with a bank, repay inter-company loans or repay bank loans that have been transferred to a third party. SAFE Circular No. 142, SAFE Circular No. 59 and SAFE Circular No. 45 may significantly limit our ability to transfer the net proceeds from an offering to our PRC subsidiary and convert the net proceeds into Renminbi to invest in or acquire any other PRC companies, which may adversely affect our liquidity and our ability to fund and expand our business in the PRC.

Fluctuations in exchange rates could have a material and adverse effect on our results of operations and the value of your investment.

The value of the RMB against the U.S. dollar and other currencies is affected by changes in China’s political and economic conditions and China’s foreign exchange policies, among other things. On July 21, 2005, the PRC government changed its decades-old policy of pegging the value of the RMB to the U.S. dollar, and the RMB appreciated more than 20% against the U.S. dollar over the following three years. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the RMB and the U.S. dollar remained within a narrow band. The PRC government has allowed the RMB to appreciate slowly against the U.S. dollar again, and it has appreciated more than 10% since June 2010, although this trend reversed slightly in early 2014 when the RMB depreciated against the US dollar. 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. In addition, there remains significant international pressure on the PRC government to adopt a substantial liberalization of its currency policy, which could result in further fluctuation in the value of the RMB against the U.S. dollar.

Significant revaluation of the RMB may have a material and adverse effect on your investment. For example, to the extent that we need to convert U.S. dollars we receive from this initial public offering into RMB for our operations, appreciation of the RMB against the U.S. dollar would have an adverse effect on the RMB amount we would receive from the conversion. Conversely, if we decide to convert our RMB into U.S. dollars for the purpose of paying dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect on the U.S. dollar amount available to us. In addition, appreciation or depreciation in the value of the RMB relative to U.S. dollars would affect our financial results reported in U.S. dollar terms regardless of any underlying change in our business or results of operations.

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.

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

The PRC government imposes controls on the convertibility of the Renminbi into foreign currencies and, in certain cases, the remittance of currency out of China. We receive substantially all of our revenues in Renminbi.

 

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Under our current corporate structure, our Cayman Islands holding company primarily relies on dividend payments from our wholly owned PRC subsidiary in China, Chuangmeng Wuxian, to fund any cash and financing requirements we may have. See “Our History and Corporate Structure.”

Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior SAFE approval by complying with certain procedural requirements. Therefore, Chuangmeng Wuxian may pay dividends in foreign currency to us without pre-approval from SAFE. However, approval from or registration with competent government authorities is required where the Renminbi is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of loans denominated in foreign currencies. With the prior approval from SAFE, cash generated from the operations of our PRC subsidiary may be used to pay off debt owed to entities outside China in a currency other than Renminbi. The PRC government may at its discretion restrict access to foreign currencies for current account transactions in the future. If the foreign exchange control system prevents us from obtaining sufficient foreign currencies to satisfy our foreign currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of the ADSs.

Uncertainties and changes in the PRC legal system could materially and adversely affect our business.

We conduct our business primarily through our PRC subsidiary and affiliated entities in China. Our operations in China are governed by PRC laws and regulations. The PRC legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value.

In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general, and forms of foreign investment (including wholly foreign-owned enterprises and joint ventures) in particular. These laws, regulations and legal requirements, including those governing PRC tax matters, are relatively new and amended frequently, and their interpretation and enforcement often raise uncertainties that could limit the reliability of the legal protections available to us. In addition, the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violations of these policies and rules until the violations have occurred. Furthermore, the PRC administrative and court authorities have significant discretions in interpreting and implementing or enforcing statutory rules and contractual terms, and it may be more difficult to predict the outcome of administrative and court proceedings and the level of legal protection we may enjoy in the PRC versus other more developed legal systems. These uncertainties may affect our judgment on the relevance of legal requirements and our decisions on the measures and actions to be taken to fully comply therewith, and may affect our ability to enforce our contractual or tort rights. Such uncertainties may result in substantial operating expenses and costs, and any litigation in China may result in diversion of resources and management’s attention, and therefore materially and adversely affect our business and results of operations We cannot predict future developments in the PRC legal system. We may be required to procure additional permits, authorizations and approvals for our operations, which we may not be able to obtain. Our inability to obtain such permits or authorizations may materially and adversely affect our business, financial condition and results of operations.

The PRC government extensively regulates the Internet industry, including the foreign ownership of, and the licensing and permit requirements pertaining to, companies in the Internet industry. These Internet-related laws and regulations are relatively new and evolving, and their interpretation and enforcement involve significant uncertainty. With regard to the mobile game industry in China, various regulatory authorities of the PRC central government, such as the State Council, the MIIT, SAIC, MOC, the SAPPRFT, and the Ministry of Public Security, are empowered to promulgate and implement regulations governing various aspects of the Internet and the mobile game industries. There exist inconsistencies and ambiguities in the regulations promulgated by different government authorities. We are required to obtain applicable permits or approvals from different regulatory authorities in order to provide mobile game services. As a result, it may be difficult to determine what

 

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actions or omissions may be deemed to be in violation of applicable laws and regulations. Risks and uncertainties relating to PRC regulation of Internet businesses include, but are not limited to, the following: (1) new laws, regulations or policies may be promulgated or announced that will regulate Internet activities, including mobile game businesses. If these new laws, regulations or policies are promulgated, additional licenses may be required for our operations. If our operations do not comply with these new regulations after they become effective, or if we fail to obtain any licenses required under these new laws and regulations, we could be subject to penalties and our business operations could be disrupted; (2) there are uncertainties relating to the regulation of the Internet industry in China, including evolving licensing requirements. This means that permits, licenses or operations of some of our companies may be subject to challenge, or we may fail to obtain or renew permits or licenses that applicable regulators may deem necessary for our operations. If we fail to maintain or obtain the required permits or licenses, we may be subject to various penalties, including fines and discontinuation of, or restriction on, our operations. Any penalty may disrupt our business operations and may have a material adverse effect on our results of operations; (3) the interpretation and application of existing or future PRC laws, regulations and policies relating to the Internet industry have created substantial uncertainties regarding the legality of existing and future foreign investments in, and the businesses and activities of, Internet businesses in China, including our business. We cannot assure you that we will be able to maintain our existing licenses or obtain any new licenses required under any existing or new laws or regulations. There are also risks that we may be found to be in violation of existing or future laws and regulations given the uncertainty and complexity of China’s regulation of Internet businesses. If current or future laws, rules or regulations regarding Internet-related activities are interpreted in such a way as to render our ownership structure and/or business operations illegal or non-compliant, our business could be severely impaired and we could be subject to severe penalties.

We may be required to obtain approval of the CSRC before listing and trading the ADSs on the NASDAQ Global Select Market.

Pursuant to the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the New M&A Rules, which became effective in September 2006, and were amended on in June, 2009, an offshore special purpose vehicle, or SPV, formed for purposes of seeking overseas listing of the interest in PRC companies via acquisition and controlled directly or indirectly by PRC companies or individuals shall obtain CSRC approval prior to listing and trading of the SPV’s securities on an overseas stock exchange. On December 14, 2006, the CSRC published procedures for special purpose vehicles to obtain approval of overseas listings. The procedures include filing documents with the CSRC and take several months to complete. The application of this new PRC regulation remains unclear.

While the application of the New M&A Rules remains unclear, we believe, based on the advice of our PRC legal counsel that CSRC’s approval is not required given the fact that (i) Chuangmeng Wuxian was incorporated as a wholly foreign-owned enterprise by means of direct investment, rather than by acquisition of the equity interests or assets of a PRC domestic company owned by PRC companies or individuals as defined in the New M&A Rules, and (ii) no provision in the New M&A Rules explicitly classifies the contractual arrangements among Chuangmeng Wuxian, each of Shenzhen Mengyu, Shenzhen iDreamSky and Beijing Chuangmeng and their respective shareholders as a type of transaction subject to the New M&A Rules. However, our PRC legal counsel further advised us that since there has been no official interpretation or clarification of the New M&A Rules, there remains some uncertainty as to how the New M&A Rules will be interpreted or implemented in the context of an overseas offering and the opinions summarized above are subject to any new laws and regulations or further implementations and interpretations of competent government authorities in any form relating to the New M&A Rules. However, we cannot assure you that PRC government authorities, including the CSRC, will reach the same conclusion as our PRC legal counsel. If the CSRC or other PRC government authorities determine that prior CSRC approval is required, any future registered offering will be delayed until we obtain the approval from the CSRC, which may take several months or longer. If a prior approval from the CSRC is required but not obtained, we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory authorities.

 

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These regulatory authorities may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, delay or restrict the repatriation of the proceeds from future offerings into the PRC, or take other actions that could materially and adversely affect our business or the trading price of the ADSs. The CSRC or other PRC regulatory authorities may also require us, or make it advisable for us, to halt an offering before settlement and delivery of the ADSs offered. Consequently, if you engage in market trading or other activities in anticipation of and prior to settlement and delivery, you do so at the risk that settlement and delivery may not occur.

A failure by the beneficial owners of our shares who are PRC residents to comply with certain PRC foreign exchange regulations could restrict our ability to distribute profits, restrict our overseas and cross-border investment activities and subject us to liability under PRC law.

SAFE has promulgated a series of rules, guidance and several regulations, including the Notice on Relevant Issues Concerning Foreign Exchange Administration for PRC Residents to Engage in Financing and Inbound Investment via Overseas Special Purpose Vehicles, or SAFE Circular No. 75, effective on November 1, 2005. These regulations require PRC residents, including natural persons and legal entities, to register with local branches of SAFE in connection with their direct or indirect offshore investment activities before establishing or controlling an overseas company for the purpose of equity financing from overseas with the assets or equities of PRC companies, referred to in SAFE Circular No. 75 as an “offshore special purpose company.” SAFE Circular No. 75 further requires amendment to the registration in the event of any significant changes with respect to the offshore special purpose company, such as increase or decrease of capital, equity investment or, including an initial public offering by such company. In the event that a PRC shareholder with a direct or indirect stake in an offshore special purpose company fails to fulfill the required SAFE registration, the PRC subsidiaries of that offshore special purpose company may be prohibited from making profit distributions to the offshore parent and from paying the offshore parent proceeds from any reduction in capital, share transfer or liquidation in respect of the PRC subsidiaries, and the offshore special purpose company may be restricted in their ability to contribute additional capital into its PRC subsidiary. Further, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for foreign exchange evasion.

These regulations apply to our direct and indirect shareholders who are PRC residents and may apply to any offshore acquisitions or share transfers that we make in the future if our shares are issued to PRC residents. We have requested PRC residents who we know currently hold direct or indirect interests in our company to make the necessary applications, filings and amendments as required under SAFE Circular No. 75 and other related rules. To the best of our knowledge, all of our shareholders who are PRC citizens and who hold interest in us are preparing to file with local SAFE branches for SAFE registration and/or amendment in connection with their overseas investment and shareholding in our company according to SAFE Circular No. 75. However, in practice, different local SAFE branches may have different views and procedures on the application and implementation of SAFE regulations, and we cannot assure you that these individuals or any other direct or indirect shareholders or beneficial owners of our company who are PRC residents will be able to successfully complete the registration or update the registration of their direct and indirect equity interest as required. If they fail to make or update the registration, our PRC subsidiary could be subject to fines and legal penalties, and SAFE could restrict our cross-border investment activities and our foreign exchange activities, including restricting our PRC subsidiary’s ability to distribute dividends to, or obtain loans denominated in foreign currencies from, our company, or prevent us from paying dividends. As a result, our business operations and our ability to make distributions to you could be materially and adversely affected.

Failure to comply with the registration requirements for employee share option plans may subject our PRC equity incentive plan participants or us to fines and other legal or administrative sanctions.

On February 15, 2012, SAFE promulgated the Circular of the SAFE on Relevant Issues Concerning the Foreign Exchange Administration for Domestic Individuals’ Participating in the Share Incentive Schemes of

 

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Overseas-Listed Companies, or SAFE Circular No. 7, to replace the previous Operating Procedures for Administration of Domestic Individuals Participating in the Employee Stock Ownership Plan or Stock Option Plan of Offshore Listed Companies issued by SAFE in March 2007. SAFE Circular No. 7 regulates foreign exchange matters associated with employee stock option incentives or similar incentives permitted under applicable laws and regulations granted to PRC residents by companies whose shares are listed on offshore stock exchanges.

In accordance with SAFE Circular No. 7, all PRC residents who participate in share incentive plans of an overseas publicly-listed company are required, through the PRC subsidiary of the overseas publicly-listed company, to jointly entrust a PRC agent to handle foreign exchange registration with SAFE or its local office and complete procedures relating to the share incentive schemes such as opening accounts and capital transfers. PRC residents include PRC nationals or foreign citizens having been consecutively residing in PRC for not less than one year, acting as directors, supervisors, senior management personnel or other employees of PRC companies affiliated with such offshore listed company. A PRC agent can be one of the PRC subsidiaries of the offshore listed company participating in the share incentive scheme or another PRC institution qualified for asset trusteeship s as designated by the PRC subsidiary and in accordance with PRC laws. The foreign exchange proceeds received by the PRC residents from sale of shares under share incentive plans granted by offshore listed companies must be remitted to bank accounts in China opened by the PRC agents. Further, a Notice Concerning Individual Income Tax on Earnings from Employee Stock Options, jointly issued by the Ministry of Finance and the State Administration of Taxation, or the SAT, provides that domestic companies that implement employee share option programs must file the employee share option plans and other relevant documents with local tax authorities having jurisdiction over the companies before implementing such plans, and must file share option exercise notices and other relevant documents with local tax authorities before their employees exercise any share options.

Following the completion of this offering, we and our PRC employees who have been granted shares or share options under our share option incentive plan will be subject to these regulations. If we or any of our PRC optionees fail to comply with these regulations, we or our PRC optionees may be subject to fines and other legal or administrative sanctions.

We may be classified as a “resident enterprise” for PRC enterprise income tax purposes, which could result in unfavorable tax consequences to us and our non-PRC shareholders.

Under the PRC Enterprise Income Tax Law, or the New EIT Law, and its implementation rules, both effective from January 1, 2008, an enterprise established outside of the PRC with “de facto management bodies” within the PRC is considered a PRC resident enterprise and is subject to a 25% enterprise income tax on its global income. The implementation rules further define the term “de facto management bodies” as establishments that carry out substantial and overall management and control over the manufacturing and business operations, personnel, accounting and properties of an enterprise. The SAT issued the Notice Regarding the Determination of Chinese-Controlled Offshore Incorporated Enterprises as PRC Tax Resident Enterprises on the Basis of De Facto Management Bodies, or Circular No. 82, which sets out certain specific criteria for determining whether the “de facto management body” of a Chinese-controlled offshore incorporated enterprise is located in China.

Although Circular No. 82 only applies to offshore enterprises controlled by PRC enterprises or PRC enterprise groups, not those controlled by PRC individuals or foreign individuals, the determining criteria set forth in Circular No. 82 may reflect the SAT’s general position on how the “de facto management body” test should be applied in determining the tax resident status of offshore enterprises, regardless of whether they are controlled by PRC enterprises, PRC enterprise groups or by PRC or foreign individuals. As a result, we cannot assure you that the SAT will not implement Circular No. 82 or amend the rules in the future to the effect that

 

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such rules will apply to us or our overseas subsidiary. Therefore, although we currently take the position that we and our overseas subsidiary are not PRC resident enterprises, there is no assurance that we or our overseas subsidiary will not be so treated. The SAT issued the Administrative Measures on Enterprise Income Tax of Foreign-Incorporated Chinese-Controlled Resident Enterprises (Trial) on July 27, 2011, which took effect from September 1, 2011. According to these measures, in the event that the PRC authorities subsequently determine that we should be treated as a resident enterprise and decide to issue the Resident Enterprise Recognition Letter for Foreign-Incorporated Chinese-Controlled Enterprises to us, we may be required to handle all tax matters according to the rules governing PRC resident enterprises for the enterprise income tax purpose from the year when such letter is issued to us. If the competent PRC tax authorities determine that our legal entities organized outside of the PRC constitute PRC resident enterprises, we may be considered a PRC resident enterprise and may therefore be subject to enterprise income tax at a rate of 25% on our global income. If we are considered a PRC 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. Dividends paid to us from our PRC subsidiary would qualify as “tax-exempted income.”

If we are treated as a PRC tax resident enterprise, dividends paid by us to our investors and gains on the sale of our shares may be subject to PRC withholding tax. Under the New EIT Law and related implementation regulations, PRC EIT withholding tax at the rate of 10% is applicable to dividends from PRC source paid to investors that are “non-resident enterprises,” that do not have an establishment or place of business in the PRC, or that have an establishment or place of business in the PRC but the relevant income is not effectively connected with the establishment or place of business. In addition, any gain realized on the transfer of ADSs or shares by such investors is subject to 10% PRC income tax if such gain is regarded as income derived from sources within the PRC unless an applicable treaty provides otherwise. Individual non-PRC investors may be subject to such PRC taxes on dividends and gains of a rate of 20% unless an applicable treaty provides otherwise. If we are considered a PRC “resident enterprise,” it is unclear whether dividends we pay with respect to our ordinary shares or ADSs, or the gain you may realize from the transfer of our ordinary shares or ADSs, would be treated as income derived from sources within the PRC and be subject to such PRC tax. If we are required under the New EIT Law to withhold PRC income tax on dividends payable to our non-PRC investors, or if you are required to pay PRC income tax on the transfer of our ordinary shares or ADSs, the value of your investment in our Class A ordinary shares or ADSs may be materially and adversely affected.

Any change in the tax treatment we currently enjoy in the PRC may materially and adversely impact our net income.

Our PRC subsidiary is incorporated in the PRC and is governed by applicable PRC income tax laws and regulations. The New EIT Law and its implementing rules, both of which came into effect on January 1, 2008, impose a statutory rate of 25% on PRC enterprises. However, the New EIT Law also permits enterprises to continue to enjoy their existing tax incentives, adjusted by certain transitional phase-out rules, under which enterprises established before the promulgation date of the New EIT Law that were granted tax holidays under the then effective tax laws or regulations may continue to enjoy their tax holidays until their expiration. Under the New EIT Law, its implementation regulations and other relevant rules, newly established software enterprises such as Shenzhen iDreamSky may be entitled to a two-year exemption followed by a three-year 50% enterprise income tax rate reduction from its first profit-making year. Shenzhen iDreamSky qualifies as a newly established software enterprise and is currently applying for such preferential tax treatments with the relevant PRC tax authority. Preferential tax treatments and incentives granted to us by PRC governmental authorities are subject to review and may be adjusted or revoked at any time in the future. While the PRC enterprise income tax is generally imposed based on actual taxable income, some of our subsidiaries pay enterprise income tax based on a deemed profit calculation. We cannot assure you that the local tax authorities will not, in the future, change their position and discontinue any of our current tax treatments, potentially with retroactive effect. The discontinuation of any of our current tax treatments could materially increase our tax obligations and adversely impact our net income.

 

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The New EIT Law will affect tax exemptions on dividends to be paid by our PRC subsidiary to us through our Hong Kong subsidiary and we may not be able to obtain certain treaty benefits under the relevant tax treaty.

We are a holding company incorporated under the laws of the Cayman Islands. We conduct substantially all of our business through our PRC subsidiary and we derive all of our income from it. Under the New EIT Law and its implementation rules, dividends generated after January 1, 2008 payable by a foreign-invested enterprise in the PRC to its shareholders that are “non-resident enterprises” are subject to a 10% withholding tax, unless such shareholders’ jurisdiction of incorporation has a tax treaty with the PRC that provides for a preferential arrangement.

Pursuant to the Notice of the SAT on Issuing the Table of Tax Rates on Dividends in Treatises, or Notice 112, which was issued on January 29, 2008, the Arrangement between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion, or the Double Taxation Arrangement (Hong Kong), which became effective on December 8, 2006, such withholding tax may be lowered to 5% if the PRC enterprise is at least 25% directly held by a Hong Kong enterprise. In October 2009, the SAT further issued the Notice on How to Understand and Determine the “Beneficial Owners” in Tax Treaties, or Circular No. 601. According to Circular No. 601, non-resident enterprises that cannot provide valid supporting documents as “beneficial owners,” who are generally individuals, companies or other organizations which are normally engaged in substantive operations, may not be approved to enjoy tax treaty benefits. These rules also set forth certain criteria for determining whether, for treaty purposes, a person is a “beneficial owner.” Specifically, they expressly exclude a “conduit company” from qualifying as a “beneficial owner” if it is established for the purposes of avoiding or reducing tax obligations or transferring or accumulating profits and not engaged in substantive operations such as manufacturing, sales or management. As a result, dividends from our PRC subsidiary paid to us through our Hong Kong subsidiary may be subject to a reduced withholding tax at a rate of 5% only if our Hong Kong subsidiary is determined to be a Hong Kong tax resident and is considered to be a “beneficial owner” that is generally engaged in substantive business activities and entitled to treaty benefits under the Double Taxation Arrangement (Hong Kong). Otherwise, we may not be able to enjoy the preferential withholding tax rate of 5% under the tax arrangement and may therefore be subject to withholding tax at a rate of 10% with respect to dividends to be paid by our PRC subsidiary to us through our Hong Kong subsidiary.

We face uncertainties with respect to the application of the Circular on Strengthening the Administration of Enterprise Income Tax for Share Transfer by Non-PRC Resident Enterprises.

Pursuant to the Circular on Strengthening the Administration of Enterprise Income Tax for Share Transfers by Non-PRC Resident Enterprises, or SAT Circular No. 698, issued by SAT, in December 2009, with retroactive effect from January 1, 2008, if a non-resident enterprise indirectly transfers the equity interests of a PRC resident enterprise by transferring 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 of less than 12.5% or (ii) does not impose income tax on foreign income of its residents, the transferring nonresident enterprise must report this Indirect Transfer to the competent PRC tax authority of the PRC resident enterprise. The PRC tax authority will apply the “substance over form” principle, and as a result may disregard the existence of the overseas holding company if such overseas holding company 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 an Indirect Transfer may be subject to PRC withholding tax at a rate of up to 10%. SAT Circular No. 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. In addition, SAT released the SAT Public Notice (2011) No. 24, or SAT Public Notice 24, which took effect on April 1, 2011, to clarify several issues related to SAT Circular No. 698. Under SAT Public Notice 24, the term “effective tax” refers to the effective tax on the gain derived from a disposition of any equity interests of an overseas holding company. There is uncertainty as to

 

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the application of SAT Circular No. 698. While the term “Indirect Transfer” is not clearly defined, it is understood that the relevant PRC tax authorities have broad jurisdiction over requests for information regarding foreign companies having remote contact with the PRC. Moreover, the relevant authority has not yet promulgated any formal provisions or made any formal interpretation as to the procedures or format for reporting an Indirect Transfer. In addition, there have not been any formal declarations concerning how to determine whether a foreign investor has adopted an arrangement for the purpose of reducing, avoiding or deferring PRC tax. SAT Circular No. 698 may be determined by the tax authorities to be applicable to our private equity financing and restructuring prior to this offering where non-resident investors and non-resident enterprise shareholders were involved. In addition, although it appears that SAT Circular No. 698 was not intended to apply to purchase and sale of shares of publicly traded companies in the open market, the PRC tax authorities may determine that SAT Circular No. 698 is applicable to our non-resident shareholders who acquired our shares outside of the open market and subsequently sell our shares in our private financing transactions or in the open market if any of such transactions were determined by the tax authorities to lack reasonable commercial purpose. As a result, we and our non-resident investors or non-resident enterprise shareholders may be at risk of being taxed under SAT Circular No. 698 and may be required to expend valuable resources to comply with SAT Circular No. 698 or to establish that we and our non-resident enterprise investors or non-resident enterprise shareholders should not be taxed under SAT Circular No. 698, which may have a material adverse effect on our financial condition and results of operations or such non-resident investors’ or such non-resident enterprise shareholders’ investments in us.

The enforcement of labor contract law and increase in labor costs in the PRC may adversely affect our business and our profitability.

China adopted a labor contract law and its implementation rules effective on January 1, 2008 and September 18, 2008, respectively. The labor contract law and its implementation rules impose more stringent requirements on employers with regard to, among others, minimum wages, severance payment upon permitted termination of the employment by an employer and non-fixed term employment contracts, time limits for probation period as well as the duration and the times that an employee can be placed on a fixed term employment contract. Due to the limited period of effectiveness of the labor contract law and its implementation rules, and the lack of clarity with respect to their implementation, potential penalties and fines, it is uncertain how they will impact our current employment policies and practices. Our employment policies and practices may violate the labor contract law or its implementation rules and we may be subject to related penalties, fines or legal fees. Compliance with the labor contract law and its implementation rules may increase our operating expenses, in particular our personnel expenses, as the continued success of our business depends significantly on our ability to attract and retain qualified personnel. In the event that we decide to terminate some of our employees or otherwise change our employment or labor practices, the labor contract law and its implementation rules may also limit our ability to effect those changes in a manner that we believe to be cost-effective or desirable, which could adversely affect our business and results of operations.

Additionally, PRC companies are subject to various laws and regulations regarding social insurance and housing funds, under which our PRC subsidiary and affiliates are required to pay employees’ pension contributions, housing funds, medical insurance premiums and other welfare-oriented payments. Shenzhen iDreamSky and Shenzhen Mengyu have not contributed social insurance premiums and housing funds for their employees in compliance with applicable PRC laws. As such, they may be ordered to compensate the cumulative amount of the under-contributed social insurance premiums and housing fund contributions and be subject to administrative penalties, including fines. In the event that we fail to comply with the social insurance and housing funds contribution requirements, we may be subject to administrative penalties, and our business and reputation may be adversely affected.

 

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Certain of our leased property interests may be defective and our right to lease the properties affected by such defects may be challenged, which could cause significant disruption to our business.

Our primary office premises is located within the High and New Technology Industry Area of Shenzhen Special Economic Zone, or the High-Tech Area. According to the relevant administrative measures of the High-Tech Area, the properties located in the High-Tech Area can only be used by the owners of the properties for their own purposes. When an owner has used 50% or more of the construction area of its property located in the High-Tech Area for its own purposes, the owner may apply to the administrative authority of the High-Tech Area for an approval for leasing the remaining vacant property to third parties. If an owner leases its property within the High-Tech Area to third parties without obtaining the approval from the administrative authority, it may be ordered to terminate the lease and be subject to certain penalties. The landlord of our office premises has not obtained the approval from the administrative authority of the High-Tech Area prior to its leasing of the premises to us. Therefore, the landlord may be deemed by relevant authorities to lack the right to lease, and its lease agreements with us may not be valid or enforceable under PRC laws and regulations. Our lease agreements may also be challenged by relevant administrative authorities. Our landlord has filed an application to the administrative authority of the High-Tech Area for the approval for leasing the office premises to us, but it cannot be assured that the landlord will obtain the approval and the relevant administrative authorities will not challenge our lease agreements. Our business may be interrupted if we are required to relocate our office as a result of such defects, and we may incur substantial costs in connection with such relocation.

Further, according to the guidelines of the administrative authority of the High-Tech Area regarding the relocation within the High-Tech Area, a tenant must obtain relocation approval prior to the tenant’s entering into a lease agreement with a new landlord. We moved from our former office to our current office, both of which are located in the High-Tech Area in 2013. However, we did not obtain the approval from the administrative authority of the High-Tech Area for the relocation. We are unable to apply to the administrative authority of the High-Tech Area for approval of our relocation until our landlord has obtained approval for leasing us our current office premises.

In addition, the lease agreements of our PRC operating entities have not been registered with competent governmental authority. Further, if a landlord has not obtained the consent from the administrative authority for lease of its property in the High-Tech Area, the lease agreement of a landlord cannot be registered with the competent government authority. According to PRC laws and regulations, the failure to register a lease agreement will not affect its effectiveness between the tenant and the landlord, however, the landlord or the tenant may be subject to fines for such failure to register the lease agreements.

If the custodians or authorized users of our corporate chops and seals, fail to fulfill their responsibilities, or misappropriate or misuse these corporate instruments, our business and operations could be materially and adversely affected.

In China, legal documents are generally executed using corporate chops. The corporate chops and seals of our PRC entities are essential to our ability to enter into contracts, conduct banking business and take certain corporate actions, including filing with the relevant PRC authorities. In order to maintain the physical security of our corporate chops and seals, we store them in secure location accessible only to authorized personnel, who are usually members of our senior management. Although we monitor such authorized personnel, there is no assurance these procedures will prevent all instances of abuse or negligence. Accordingly, if any of our authorized personnel misuse or misappropriate our corporate chops or seals, we could experience significant disruption to our operations. Attempts to remedy such disruption may involve expensive legal or other proceedings, and we may not prevail for a long time or at all. In particular, during any period we lose effective control of an entity as a result of such misuse or misappropriation, the business activities and economic contribution of the affected entity could be severely disrupted, or our auditor may be unable to access documents and information from such entities that may be necessary for them to complete an audit of the consolidated financial statements of our group.

 

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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 H1N1, or swine influenza, avian influenza, severe acute respiratory syndrome, or SARS, or another epidemic. Any adverse public health developments in China could 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, earthquakes, fire, floods, environmental accidents, power loss, communications failures and similar events, all of which may disrupt our business. If any significant man-made or natural disaster were to occur in the future, our ability to operate our business could be seriously impaired.

Risks Related to this Offering

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

Prior to this initial public offering, there has not been a public market for our ordinary shares or the ADSs. [The ADSs have been approved for listing on the NASDAQ Global Select Market. Our ordinary shares will not be listed or quoted for trading on any exchange.] If an active trading market for the ADSs does not develop after this offering, the market price and liquidity of the ADSs will be materially and adversely affected. The initial public offering price for the ADSs will be determined by negotiations between us and the underwriters and may bear no relationship to the market price for the ADSs after the initial public offering. We cannot assure you that an active trading market for the ADSs will develop or that the market price of the ADSs will not decline below the initial public offering price.

The market price for the ADSs may be volatile.

In addition to the volatility in the price of the ADSs which could be caused by the materialization of any of the risks described in this section, the securities markets in the United States, China and elsewhere have from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of the ADSs.

You will experience immediate dilution in the net tangible book value of ADSs purchased.

When you purchase ADSs in the offering at the public offering price of US$             per ADS, you will incur immediate dilution of approximately US$             per ADS, representing the difference between the purchase price per ADS in this offering of US$            , being the mid-point of the estimated range of the initial public offering price shown on the front cover of this prospectus, and our pro forma as adjusted net tangible book value per ADS as of             , 2014 after giving effect to the conversion of our preferred shares into ordinary shares immediately upon the completion of this offering. See “Dilution.” In addition, you may experience further dilution in the net tangible book value of the ADSs purchased to the extent that additional Class A ordinary shares are issued upon exercise of outstanding options and options that we may grant from time to time. See “Dilution.”

We may need additional capital, and the sale of additional ADSs or other equity securities or incurrence of additional indebtedness could result in additional dilution to our shareholders or increase our debt service obligations.

Historically, we have relied principally on external sources of financing to fund our operations and capital expansion needs. We may require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may pursue. If our resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity, equity-linked or debt securities or enter into

 

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a credit facility. The sale of additional equity securities could result in additional dilution to our shareholders. Debt financing would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. It is uncertain whether financing will be available in amounts or on terms acceptable to us, if at all.

Substantial future sales of the ADSs in the public market, or the perception that these sales could occur, could cause the price of the ADSs to decline.

Additional sales of our Class A ordinary shares in the public market after this offering, or the perception that these sales could occur, could cause the market price of the ADSs to decline. Upon completion of this offering, we will have              ordinary shares outstanding, including              Class A ordinary shares (or              Class A ordinary shares if the underwriters exercise their option to purchase additional ADS in full) and              Class B ordinary shares. All shares sold in this offering will be freely transferable without restriction or additional registration under the Securities Act. Ordinary shares outstanding after this offering will be available for sale, upon the expiration of the applicable lock-up period, subject to volume and other restrictions as applicable under Rule 144 under the Securities Act. Any or all of these shares can be released prior to expiration of the lock-up period at the discretion of the representatives of the underwriters for this offering. To the extent shares are released before the expiration of the lock-up period and these shares are sold into the market, the market price of the ADSs could decline.

In addition, certain holders of our ordinary shares after the completion of this offering will have the right to cause us to register the sale of those shares under the Securities Act. Registration of these shares under the Securities Act would result in these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the registration. Sales of these registered shares in the public market could cause the price of the ADSs to decline.

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

We have adopted a dual-class ordinary share structure in July 2014 that will become effective immediately upon the completion of this offering. Our ordinary shares are divided into Class A ordinary shares and Class B ordinary shares. Holders of Class A ordinary shares will be entitled to one vote per share, while holders of Class B ordinary shares will be entitled to ten votes per share. We will issue Class A ordinary shares represented by our ADSs in this offering. Dream Data Services Limited, wholly owned and controlled by Michael Xiangyu Chen, our co-founder, chairman and chief executive officer, will hold 28,873,610 Class B ordinary shares, and DT01 Holding International Limited, 50% owned and controlled by Jeffrey Lyndon Ko, our co-founder, director and executive vice president, and 50% owned and controlled by Anfernee Song Guan, our co-founder, director and chief technology officer, will hold 7,308,860 Class B ordinary shares. Immediately upon the completion of this offering, all the remaining ordinary shares will convert into Class A ordinary shares, 50% of our preferred shares will automatically convert into Class A ordinary shares at a conversion ratio of one preferred share to one Class A ordinary share and 50% of our preferred shares will automatically convert into Class B ordinary shares at a conversion ratio of one preferred share to one Class B ordinary share. Class A ordinary shares will not be convertible to Class B ordinary shares under any circumstances. Upon any sale, pledge, transfer, assignment or disposition of Class B ordinary shares by a holder thereof to any person or entity which is not an affiliate of such holder, such Class B ordinary shares shall be automatically and immediately converted into the equal number of Class A ordinary shares.

Due to the disparate voting powers attached to these two classes of shares, we anticipate that our founders, Michael Xiangyu Chen, Jeffrey Lyndon Ko and Anfernee Song Guan will collectively own approximately             % of the voting power of our outstanding ordinary shares after this offering, and will have considerable influence over matters requiring shareholder approval, including election of directors and significant corporate

 

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transactions, such as a merger or sale of our company or our assets. This concentrated control will limit your ability to influence corporate matters and could discourage others from pursuing any potential merger, takeover or other change of control transactions that holders of our Class A ordinary shares and ADSs may view as beneficial.

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

Except as described in this prospectus and in the deposit agreement, holders of the ADSs will not be able to exercise voting rights attaching to the shares represented by the ADSs. You will have a right to instruct the depositary how to exercise those voting rights. However, the depository or its nominee may not successfully comply with your instructions or intentions. 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.

The depositary may give us a discretionary proxy to vote the Class A ordinary shares underlying your ADSs if you do not give voting instructions, which could adversely affect your interests.

Under the deposit agreement for the ADSs, if we timely asked for your instructions but the depositary does not receive your instructions by the cutoff date it sets, the depositary will give us a discretionary proxy to vote the Class A ordinary shares underlying your ADSs as to all matters at the shareholders’ meeting unless:

 

    we instructed the depositary we do not wish to receive a discretionary proxy;

 

    we informed the depositary that there is substantial opposition to the particular matter; or

 

    the particular matter would have a material adverse impact on shareholders.

The effect of this discretionary proxy is that if you do not give voting instructions, you cannot prevent the Class A ordinary shares underlying your ADSs from being voted, except in the circumstances described above. This may make it more difficult for shareholders to influence the management of our company. Holders of our ordinary shares are not subject to this discretionary proxy.

You may not be able to participate in rights offerings and may experience dilution of your holdings as a result.

We may from time to time distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement for the ADSs, the depositary will not offer those rights to ADS holders unless both the rights and the underlying securities to be distributed to ADS holders are either registered under the Securities Act, or exempt from registration under the Securities Act with respect to all holders of ADSs. We are under no obligation to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared effective. In addition, we may not be able to take advantage of any exemptions from registration under the Securities Act. Accordingly, holders of the ADSs may be unable to participate in our rights offerings and may experience dilution in their holdings as a result.

You may be subject to limitations in transferring 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 deem 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.

 

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Our post-offering memorandum and articles of association contain anti-takeover provisions that could discourage, delay or prevent a third party from acquiring us, which could limit our shareholders’ opportunity to sell their shares, including Class A ordinary shares represented by our ADSs, at a premium.

Our post-offering memorandum and articles of association, which will become effective immediately upon the completion of this offering, contain provisions that limit the ability of others to acquire control of our company or cause us to engage in change-of-control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or a similar transaction. For example, our board of directors has the authority to issue preferred shares in one or more series and to designate the price, rights, preferences, privileges and restrictions of such preferred shares without any further vote or action by our shareholders. These preferred shares may have better voting rights than our ordinary shares, in the form of ADSs or otherwise, and could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preferred shares, the price of our ADSs may fall and the voting rights of the holders of our ordinary shares and ADSs may be diluted.

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, operate all of our business from mainland China and Hong Kong and all of our officers reside outside the United States.

We are incorporated in the Cayman Islands and primarily conduct our operations through our subsidiaries in Hong Kong and mainland China and through our VIEs, Shenzhen Mengyu, Shenzhen iDreamSky and Beijing Chuangmeng, in China. Most of our directors and officers reside outside the United States and all or 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 original action against us or against these individuals in the United States in the event that you believe that your rights have been infringed under the U.S. federal securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and 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. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities.”

Our corporate affairs are governed by our memorandum and articles of association and by the Companies Law (2013 Revision) and common law of the Cayman Islands. The rights of shareholders to take legal action against our directors and us, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands have a less developed body of securities laws as compared to the United States, and provide significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before the federal courts of the United States. As a result, your ability to protect your interests if you are harmed in a manner that would otherwise enable you to sue in a United States federal court may be limited to direct shareholder lawsuits.

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

 

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Our management will have considerable discretion as to the use of the net proceeds from this offer and you may not agree with our management on these uses.

We intend to use the net proceeds of this offering for mergers and acquisitions, acquiring game titles and other intellectual property rights related to mobile games, and for working capital and general corporate purposes. However, our management will have considerable discretion in the application of the net proceeds received by us. You will not have the opportunity, as part of your investment decision, to assess whether proceeds are being used appropriately. You must rely on the judgment of our management regarding the application of the net proceeds of this offering. The net proceeds may be used for corporate purposes that do not improve our efforts to maintain profitability or increase our share price. The net proceeds from this offering may be placed in investments that do not produce income or that lose value.

We are an “emerging growth company” and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our ADSs less attractive to investors.

We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act for up to five fiscal years after the date of this offering. Section 404(b) of the Sarbanes-Oxley Act requires our independent registered public accounting firm to attest to and report on the effectiveness of the internal control structure and procedures for financial reporting.

We will cease to be an “emerging growth company” upon the earliest of: (i) the last day of the fiscal year during which we have gross revenues of US$1 billion or more, (ii) the last day of the fiscal year following the fifth anniversary of the date of this offering, (iii) the date on which we have issued more than US$1.0 billion in non-convertible debt during the previous three-year period, or (iv) when we become a “large accelerated filer,” as defined in Rule 12b-2 under the Exchange Act.

We cannot predict if investors will find our ADSs less attractive because we may rely on these exemptions. If some investors find our ADSs less attractive as a result, there may be a less active trading market for our ADSs and the trading price of our ADSs may be more volatile.

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

Because we qualify as a foreign private issuer under the Exchange Act, we are exempt from certain provisions of the securities rules and regulations in the United States that are applicable to U.S. domestic issuers, including:

 

    the rules under the Exchange Act requiring filings with the U.S. Securities and Exchange Commission, or the SEC, of quarterly reports on Form 10-Q or current reports on Form 8-K;

 

    the sections of the Exchange Act regulating the solicitation of proxies, consents or authorizations in respect of a security registered under the Exchange Act;

 

    the sections of the Exchange Act requiring insiders to file public reports of their share ownership and trading activities and liability for insiders who profit from trades made in a short period of time; and

 

    the selective disclosure rules by issuers of material non-public information under Regulation FD.

We will be required to file an annual report on Form 20-F within four months of the end of each fiscal year. In addition, we intend to publish our results on a quarterly basis as press releases, distributed pursuant to the rules and regulations of the NASDAQ Global Select Market. Press releases relating to financial results and material events will also be furnished to the SEC on Form 6-K. However, the information we are required to file with or furnish to the SEC will be less extensive and less timely as compared to that required to be filed with the SEC by

 

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U.S. domestic issuers. As a Cayman Islands company listed on the NASDAQ Global Select Market, we are subject to the NASDAQ Global Select Market corporate governance listing standards. However, NASDAQ Global Select Market rules permit a foreign private issuer like us to follow the corporate governance practices of its home country. Certain corporate governance practices in the Cayman Islands, which is our home country, may differ significantly from the NASDAQ Global Select Market corporate governance listing standards. Although we do not currently plan to utilize the home country exemption for corporate governance matters, to the extent that we choose to do so in the future, our shareholders may be afforded less protection than they otherwise would under the NASDAQ Global Select Market corporate governance listing standards applicable to U.S. domestic issuers. As a result, you may not be afforded the same protections or information, which would be made available to you, were you investing in a U.S. domestic issuer.

We will incur additional costs as a result of becoming a public company.

As a public company, we will incur a significantly higher level of legal, accounting and other expenses than we do as a private company. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by the SEC and the NASDAQ Global Select Market, require changes in the corporate governance practices of public companies.

When we become a public company, we will establish additional board committees and will adopt and implement additional policies regarding internal controls over financial reporting and disclosure controls and procedures. In particular, compliance with Section 404 of the Sarbanes-Oxley Act, which requires public companies to include a report of management on the effectiveness of their internal control over financial reporting, will increase our costs. In addition, we will incur costs associated with public company reporting requirements, such as the requirements to file an annual report and other reports with the SEC. We expect these rules and regulations to increase our legal and financial compliance costs, but we cannot predict or estimate the additional costs or the timing of initially additional costs we may incur.

There can be no assurance that we will not be a passive foreign investment company for United States federal income tax purposes for any taxable year, which could result in adverse United States federal income tax consequences to United States Holders of the ADSs or ordinary shares.

A non-United States corporation will be a passive foreign investment company, or PFIC, for United States federal income tax purposes, for any taxable year if either (i) at least 75% of its gross income for such year is passive income or (ii) at least 50% of the value of its assets (based on an average of the quarterly values of the assets) during such year is attributable to assets that produce passive income or are held for the production of passive income. A separate determination must be made after the close of each taxable year as to whether we were a PFIC for that year. If we are a PFIC for any taxable year during which a United States Holder (as defined in “Taxation—United States Federal Income Taxation”) holds an ADS or ordinary share, certain adverse United States federal income tax consequences could apply to such United States Holder.

We will be treated as owning a proportionate share of the assets and earning a proportionate share of the income of any other corporation in which we own, directly or indirectly, more than 25% by value of the stock. Although the law in this regard is unclear, we are treating Shenzhen Mengyu, Beijing Chuangmeng and Shenzhen iDreamSky, our VIEs, as being owned by us for United States federal income tax purposes, not only because we control their management decisions, but also because we are entitled to substantially all of the economic benefits associated with these entities, and as a result, we consolidate these entities’ operating results in our consolidated GAAP financial statements. If it were determined, however, that we are not the owner of any of our VIEs for United States federal income tax purposes, the composition of our income and assets would change and we likely would be treated as a PFIC for the current taxable year ending on December 31, 2014 or any subsequent taxable year.

 

 

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Assuming that we are the owner of our VIEs and their subsidiaries for United States federal income tax purposes, and based on the anticipated value of our assets (which is based on the expected price of our shares in this offering) and the current and anticipated composition of our income and assets, we do not expect to be a PFIC for our current taxable year ending December 31, 2014. However, the application of the PFIC rules is subject to uncertainty in several respects, and we cannot assure you the United States Internal Revenue Service, or the IRS, will not take a contrary position.

Changes in the composition of our income and assets or value of our assets may cause us to become a PFIC for the current or any subsequent taxable year. The determination of whether we are or will become a PFIC for any taxable year may depend, in part, upon the value of our goodwill and other intangibles not reflected on our balance sheet (which may be determined based upon the market value of our ADSs or ordinary shares from time to time, which may be volatile) and may also be affected by how, and how quickly, we spend our liquid assets and the cash raised in this offering. Among other matters, if our market capitalization is less than anticipated or subsequently declines, we may be or become a PFIC for the current or future taxable years because our cash and other passive assets would then comprise a greater percentage of our overall assets. Further, while we believe our classification methodology and valuation approach is reasonable, it is possible that the IRS may challenge our classification or valuation of our goodwill and other intangibles, which may result in our company being or becoming classified as a PFIC for the current or one or more future taxable years.

See “Taxation—United States Federal Income Taxation—Passive Foreign Investment Company.” Each United States Holder is urged to consult with its tax advisors regarding the impact of the PFIC rules on an investment in our ADSs or ordinary shares.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available to us. These statements involve known and unknown risks, uncertainties and other factors which 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,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “potential,” “continue,” “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, among other things, statements relating to:

 

    our business strategies and initiatives as well as our business plans;

 

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

 

    expected changes in our revenue and certain cost or expense items;

 

    our ability to continue to offer new and attractive games and services;

 

    our ability to continue to develop new technologies and/or upgrade our existing technologies;

 

    our ability to attract, retain and monetize users;

 

    our expectation regarding the use of proceeds from this offering;

 

    growth of and trends and competition in the mobile game industry in China;

 

    PRC governmental policies and regulations relating to the mobile game industry in China; and

 

    general economic and business conditions in China.

You should thoroughly read this prospectus and the documents that we refer to in this prospectus with the understanding that our actual results in the future may be materially different from or worse than what we expect. We qualify all of our forward-looking statements by these cautionary statements. Other sections of this prospectus include additional factors which could adversely affect our business and financial performance. Moreover, we operate in an evolving environment. New risk factors and uncertainties emerge from time to time and it is not possible for our management to predict all risk factors and uncertainties, 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. Important risks and factors that could cause our actual results to be materially different from our expectations are generally set forth in the “Prospectus Summary,” “Risk Factors,” “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Industry,” “Business” and elsewhere in this prospectus.

This prospectus also contains third-party data related to macroeconomic data and the mobile game industry as well as related projections and analyses based on a number of assumptions. These market data, including statistical data extracted from the Analysys Report, include projections that are based on a number of assumptions. The projected growth may not materialize at the rates suggested by the market data, or at all. The failure of these markets to grow at the projected rates may have a material adverse effect on our business and the market price of our ADSs. In addition, the changing nature of the mobile game industry subjects any projections or estimates relating to the growth prospects or future condition of our market to significant uncertainties. If any one or more of the assumptions underlying the market data turns out to be incorrect, our actual results may differ from the projections based on these assumptions. Although we believe that the publications, reports and surveys are reliable, we have not independently verified the data. You should not place undue reliance on these forward-looking statements.

 

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The forward-looking statements made in this prospectus relate only to events or information as of the date on which these statements are made in this prospectus. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this prospectus. You should not rely upon forward-looking statements as predictions of future events.

 

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USE OF PROCEEDS

We estimate that we will receive net proceeds from this offering of approximately US$            million, or approximately US$            million if the underwriters exercise their option to purchase additional ADSs in full, after deducting underwriting discounts and the estimated offering expenses payable by us. These estimates are based upon an assumed initial offering price of US$            per ADS, the mid-point of the estimated range of the initial public offering price shown on the cover page of this prospectus. Assuming the number of ADSs offered by us as set forth on the cover page of this prospectus remains the same, and after deduction of underwriting discounts and estimated offering expenses payable by us, a US$1.00 increase (decrease) in the assumed initial public offering price of US$            per ADS, the mid-point of the estimated range of the initial public offering price shown on the cover page of this prospectus, would increase (decrease) the net proceeds of this offering by approximately US$            million.

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

 

    US$            million for the acquisitions of game licenses and other intellectual properties rights related to mobile games;

 

    US$            million for mergers and acquisitions; and

 

    US$            million for working capital and other general corporate purposes.

The foregoing represents our current intentions based upon our present plans and business conditions to use and allocate the net proceeds of this offering. Our management, however, will have significant flexibility and discretion to apply the net proceeds of this offering. If an unforeseen event occurs or business conditions change, we may use the proceeds of this offering differently than as described in this prospectus. To the extent that the net proceeds we receive from this offering are not immediately used for the above purposes, we intend to invest our net proceeds in short-term, interest-bearing bank deposits or debt instruments.

As an offshore holding company, under PRC laws and regulations we will be permitted to transfer the net proceeds of this offering to our PRC subsidiary only through loans or capital contributions. Subject to satisfaction of applicable PRC governmental registration and approval requirements, we may extend loans to our PRC subsidiary or make capital contributions to our PRC subsidiary to fund its capital expenditures or working capital. We intend to contribute or loan some or all of the net proceeds of this offering to our PRC subsidiary, and to convert the contributed net proceeds into RMB after we complete applicable PRC governmental registration requirements and receive required approvals. If we provide funding to our PRC subsidiary through capital contributions or loans, we will need to increase our PRC subsidiary’s approved registered capital and/or total investment amount, which requires approval from MOFCOM or its local counterparts. If we provide funding to our PRC subsidiary through loans, we will also need to register such loans with the SAFE, which the completion of which generally requires 20 business days or longer. We may not be able to complete applicable governmental registrations or obtain the required approvals on a timely basis, if at all. See “Risk Factors—Risks Related to Doing Business in China—PRC regulation of loans to and direct investments in PRC entities by offshore holding companies may delay or prevent us from using the proceeds of any offering to make loans or capital contributions to our PRC operating subsidiary, which could materially and adversely affect our liquidity and ability to fund and expand our business.”

 

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DIVIDEND POLICY

We do not have any present plan to pay any cash dividends on our ordinary shares in the foreseeable future. We currently intend to retain future earnings, if any, to operate our business and finance future growth strategies. Any determination to pay dividends in the future will be made at the discretion of our board of directors and will depend on our results of operations, financial conditions, contractual restrictions, restrictions imposed by applicable law and other factors our board of directors deems relevant.

Our board of directors has discretion on whether to pay dividends, subject to applicable laws. In addition, our shareholders may by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended by our directors. Under Cayman Islands law, a Cayman Islands company may pay a dividend on its shares out of either profit or share premium amount, provided that in no circumstances may a dividend be paid if this would result in the company being unable to pay its debts due in the ordinary course of business. Even if our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant. If we pay any dividends, ADS holders will receive payment to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares.” Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars.

We are a holding company, and we rely on dividends paid by our subsidiary in China for our cash needs, including the funds necessary to pay dividends and other cash distributions to our shareholders, service any debt we may incur and pay our expenses. The payment of dividends in China is subject to limitations. Regulations in China currently permit payment of dividends by our PRC subsidiary only out of accumulated profits as determined in accordance with accounting standards and regulations in China. In addition, our PRC subsidiary is required to set aside at least 10% of its after-tax profits each year to contribute to its statutory reserve fund until the accumulated balance of the statutory reserve funds reach 50% of its registered capital. Our PRC subsidiary is also required to reserve a portion of its after-tax profits to its discretionary fund, the amount of which is determined by its shareholders in accordance with PRC law. These funds are not distributable in cash dividends.

 

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CAPITALIZATION

The following table sets forth our capitalization as of March 31, 2014:

 

    on an actual basis;

 

    on a pro forma basis to give effect to the automatic conversion of 50% of our outstanding Series A, Series A-1, Series B, Series B-1 and Series C preferred shares into 45,263,650 Class A ordinary shares at a conversion ratio of one preferred share to one Class A ordinary share and the remaining 50% into 45,263,650 Class B ordinary shares at a conversion ratio of one preferred share to one Class B ordinary share immediately upon the completion of this offering; and

 

    on a pro forma as adjusted basis to give effect to (i) the automatic conversion of 50% of our outstanding Series A, Series A-1, Series B, Series B-1 and Series C preferred shares into 45,263,650 Class A ordinary shares at a conversion ratio of one preferred share to one Class A ordinary share and the remaining 50% into 45,263,650 Class B ordinary shares at a conversion ratio of one preferred share to one Class B ordinary share immediately upon the completion of this offering; and (ii) the issuance and sale of                    Class A ordinary shares in the form of ADSs by us in this offering, assuming an initial public offering price of US$            per ADS, being the mid-point of the estimated range of the initial public offering price shown on the cover page of this prospectus, after deducting underwriting discounts, commissions and estimated offering expenses payable by us and assuming no exercise of the underwriters’ option to purchase additional ADSs.

 

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The as adjusted adjustments reflected below are subject to change and are based upon available information and certain assumptions that we believe are reasonable. Our additional paid-in capital, total shareholders’ equity and total capitalization following the completion of this offering are subject to adjustment based on the actual initial public offering price and other terms of this offering determined at pricing. You should read this capitalization table in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes appearing elsewhere in this prospectus.

 

     As of March 31, 2014(1)
     Actual     Pro Forma     Pro Forma
As Adjusted
     (in thousands of US$, except share
numbers)

Mezzanine equity:

      

Series A convertible redeemable preferred shares (US$0.0001 par value, 6,750,000 shares authorized, issued and outstanding and none outstanding on a pro forma basis and pro forma as adjusted basis)

     526            

Series A-1 convertible redeemable preferred shares (US$0.0001 par value, 19,717,880 shares authorized, issued and outstanding and none outstanding on a pro forma basis and pro forma as adjusted basis)

     8,277            

Series B convertible redeemable preferred shares (US$0.0001 par value, 25,000,000 shares authorized, issued and outstanding and none outstanding on a pro forma basis and pro forma as adjusted basis)

     79,459            

Series B-1 convertible redeemable preferred shares (US$0.0001 par value, 11,111,100 shares authorized, issued and outstanding and none outstanding on a pro forma basis and pro forma as adjusted basis)

     35,383            

Series C convertible redeemable preferred shares (US$0.0001 par value, 27,948,320 shares authorized, issued and outstanding and none outstanding on a pro forma basis and pro forma as adjusted basis)

     89,181            

Shareholders’ equity:

      

Ordinary shares (US$0.0001 par value; 409,472,700 shares authorized and 41,032,120 unclassified shares issued and outstanding as of December 31, 2013 and March 31, 2014, and 50,113,300 Class A ordinary shares issued and outstanding and 81,446,120 Class B ordinary shares issued and outstanding on a pro forma basis as of March 31, 2014

     4        13     

Additional paid-in capital(1)

            212,817     

Statutory reserves

     434        434     

Accumulated deficit

     (182,560     (182,560  

Accumulated other comprehensive income

     (194     (194  
  

 

 

   

 

 

   

Total iDreamSky Technology Limited shareholders’ (deficit)/equity

     (182,316     30,510     
  

 

 

   

 

 

   

Non controlling interest

     89        89     
  

 

 

   

 

 

   

Total shareholders’ (deficit)(1)/equity

     (182,227     30,599     
  

 

 

   

 

 

   

Total capitalization(1)

     56,850        56,850     
  

 

 

   

 

 

   

 

(1)  A US$1.00 increase (decrease) in the assumed initial public offering price of US$            per ADS, the mid-point of the estimated range of the initial public offering price shown on the cover page of this prospectus, would increase (decrease) each of additional paid-in capital, total shareholders’ equity and total capitalization by US$            million, assuming the number of ADSs offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated expenses payable by us.

 

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DILUTION

If you invest in our ADSs, your interest will be diluted for each ADS you purchase to the extent of the difference between the initial public offering price per ADS and our net tangible book value per ADS after this offering. Dilution results from the fact that the initial public offering price per Class A ordinary share is substantially in excess of the net tangible book value per ordinary share attributable to the existing shareholders for our presently outstanding ordinary shares.

Our net tangible book value as of March 31, 2014 on actual basis was approximately negative US$182.2 million, or negative US$4.44 per ordinary share and              per ADS. Net tangible book value represents the amount of our total consolidated tangible assets, less the amount of our total consolidated liabilities. Dilution is determined by subtracting the pro forma as adjusted net tangible book value per ordinary share from the assumed initial public offering price per Class A ordinary share and ADS.

Without taking into account any other changes in net tangible book value after March 31, 2014, other than to give effect to (i) the automatic conversion of 50% of our outstanding Series A, Series A-1, Series B, Series B-1 and Series C preferred shares into 45,263,650 Class A ordinary shares at a conversion ratio of one preferred share to one Class A ordinary share and the remaining 50% into 45,263,650 Class B ordinary shares at a conversion ratio of one preferred share to one Class B ordinary share immediately upon the completion of this offering; and (ii) our sale of            ADSs offered in this offering based on the assumed initial public offering price of US$            per ADS, the mid-point of the estimated initial public offering price range, after deduction of the underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of March 31, 2014 would have been US$            million, or US$            per outstanding ordinary share and US$            per ADS. This represents an immediate increase in net tangible book value of US$            per ordinary share and US$            per ADS to the existing shareholders, and an immediate dilution in net tangible book value of US$            per ordinary share and US$            per ADS to investors purchasing ADSs in this offering. The pro forma as adjusted information discussed above is illustrative only. Our net tangible book value following the completion of this offering is subject to adjustment based on the actual initial public offering price of our ADSs and other terms of this offering determined at pricing. The following table illustrates such dilution, assuming no exercise of the underwriters’ option to purchase additional shares:

 

     Per Ordinary Share      Per ADS  

Assumed initial public offering price

   US$            US$                

Net tangible book value as of March 31, 2014

   US$ (4.44)       US$                

Pro forma as adjusted net tangible book value after giving effect to the automatic conversion of all of our outstanding preferred shares

   US$            US$                

Pro forma as adjusted net tangible book value after giving effect to the automatic conversion of all of our outstanding preferred shares and this offering

   US$            US$                

Increase in net tangible book value attributable to the automatic conversion of all of our outstanding preferred shares and this offering

   US$                US$                

Amount of dilution in net tangible book value to new investors in the offering

   US$                US$                

A US$1.00 change in the assumed initial public offering price of US$             per ADS would, in the case of an increase, increase and, in the case of a decrease, decrease our pro forma as adjusted net tangible book value as described above by US$             million, the pro forma as adjusted net tangible book value per ordinary share and per ADS by US$             per ordinary share and by US$             per ADS, and the dilution per ordinary share and per ADS to new investors in this offering by US$             per ordinary share and US$             per ADS, respectively, assuming no change to the number of ADSs offered by us as set forth on the cover page of this prospectus and after deducting underwriting discounts and commissions and estimated offering expenses.

Assuming the underwriters’ option to purchase additional ADSs is exercised in full, our pro forma as adjusted net tangible book value as of March 31, 2014 would have been US$             per outstanding ordinary

 

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share, or US$             per ADS. This represents an immediate increase in net tangible book value of US$             or         % per ordinary share, or US$             or         % per ADS, to our existing shareholders and an immediate dilution in net tangible book value of US$             or         % per ordinary share, or US$             or         % per ADS, to new investors of ADSs in this offering.

The following table summarizes, on a pro forma as adjusted basis as of March 31, 2014, the differences between existing shareholders and the new investors with respect to the number of ordinary shares (in the form of ADSs or shares) purchased from us, the total consideration paid and the average price per ordinary share and ADS paid before deducting the underwriting discounts and commissions and estimated offering expenses. The total number of ordinary shares does not include Class A ordinary shares underlying the ADSs issuable upon the exercise of the underwriters’ option to purchase additional ADSs.

 

     Ordinary shares
purchased
    Total consideration     Average
price per

ordinary
share
     Average
price per
ADS
 
     Number    Percent     Amount      Percent       

Existing shareholders

                   US$                                 US$                    US$                

New investors

                   US$                                 US$                    US$                
  

 

  

 

 

   

 

 

    

 

 

      

Total

        100.0   US$                      100.0     
  

 

  

 

 

   

 

 

    

 

 

      

A US$1.00 increase (decrease) in the assumed initial public offering price per ADS would increase (decrease) our pro forma as adjusted net tangible book value after giving effect to the offering by US$             million, the pro forma as adjusted net tangible book value per ordinary share and per ADS after giving effect to this offering by US$             per Class A ordinary share and US$             per ADS and the dilution in pro forma as adjusted net tangible book value per ordinary share and per ADS to new investors in this offering by US$             per ordinary share and US$             per ADS, assuming no exercise of the underwriters’ option to purchase additional ADSs and no change to the number of ADSs offered by us as set forth on the cover page of this prospectus, and after deducting the estimated underwriting discounts and commissions and the estimated offering expenses payable by us.

The discussion and tables above also do not take into consideration any outstanding share options. As of March 31, 2014, there were 2,690,000 ordinary shares issuable upon the exercise of outstanding share options granted to our employees at a weighted average exercise price of US$0.04 per ordinary share. See “Management—Share Incentive Plans.” To the extent that any of these options are exercised, there will be further dilution to new investors.

 

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EXCHANGE RATE INFORMATION

We conduct substantially all of our operations in China. All of our revenues, costs and expenses are denominated in Renminbi. This prospectus contains translations of certain Renminbi amounts into U.S. dollars at specified rates, which is based on the rate certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise stated, all translations from Renminbi to U.S. dollars has been made at a rate as of the period end of the applicable periods, that is, RMB6.0537 to US$1.00, the noon buying rate in effect as of December 31, 2013 or RMB6.2164 to US$1.00, the noon buying rate in effect as of March 31, 2014, as applicable. We make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any particular rate, the rates stated below, or at all. The PRC government imposes controls over its foreign currency reserves in part through direct regulation of the conversion of Renminbi into foreign exchange and through restrictions on foreign trade. On June 27, 2014, the noon buying rate was RMB6.2180 to US$1.00.

The following table sets forth information concerning the rates of exchange of US$1.00 into RMB for the periods indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this prospectus or willuse in the preparation of our periodic reports or any other information to be provided to you.

 

     Noon buying rate  

Period

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

2009

     6.8259         6.8295         6.8176         6.8470   

2010

     6.6000         6.7603         6.6000         6.8330   

2011

     6.2939         6.4475         6.2939         6.6364   

2012

     6.2301         6.2990         6.2221         6.3879   

2013

     6.0537         6.1412         6.0537         6.2438   

December 2013

     6.0537         6.0738         6.0537         6.0927   

2014

           

January 2014

     6.0590         6.0509         6.0402         6.0600   

February 2014

     6.1448         6.0816         6.0591         6.1448   

March 2014

     6.2164         6.1729         6.1183         6.2273   

April 2014

     6.2591         6.2246         6.1966         6.2591   

May 2014

     6.2471         6.2380         6.2255         6.2591   

June 2014 (through June 27, 2014)

     6.2180         6.2320         6.2090         6.2548   

 

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

 

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ENFORCEABILITY OF CIVIL LIABILITIES

We are incorporated in the Cayman Islands to take advantage of certain benefits associated with being a Cayman Islands exempted company, such as political and economic stability; an effective judicial system; a favorable tax system; the absence of exchange control or currency restrictions; and the availability of professional and support services. However, certain disadvantages accompany incorporation in the Cayman Islands. These disadvantages include, but are not limited to: the Cayman Islands has a less developed body of securities laws as compared to that of the United States and these securities laws provide significantly less protection to investors; and the potential lack of standing by Cayman Islands companies to sue before the federal courts of the United States.

Our organizational documents do not contain provisions requiring that disputes, including those arising under the securities laws of the United States, between us, our officers, directors and shareholders, be subject to arbitration.

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

We have appointed Law Debenture Corporate Services Inc. as our agent upon whom process may be served in any action brought against us under the securities laws of the United States.

Maples and Calder, our counsel as to Cayman Islands law, has advised us that there is uncertainty as to whether the courts of the Cayman Islands would:

 

    recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States; or

 

    entertain original actions brought in the Cayman Islands against us or our directors or officers predicated upon the civil liability provision of the securities laws of the United States or any state in the United States.

Maples and Calder has further advised us that although there is no statutory enforcement in the Cayman Islands of judgments obtained in the federal or state courts of the United States (and the Cayman Islands are not a party to any treaties for the reciprocal enforcement or recognition of such judgments), a judgment obtained in such jurisdiction will be recognized and enforced in the courts of the Cayman Islands at common law, without any re-examination of the merits of the underlying dispute, by an action commenced on the foreign judgment debt in the Grand Court of the Cayman Islands, provided that such judgment: (a) is given by a foreign court of competent jurisdiction; (b) imposes on the judgment debtor a liability to pay a liquidated sum for which the judgment has been given; (c) is final; (d) is not in respect of taxes, a fine or a penalty; and (e) was not obtained in a manner and is not of a kind the enforcement of which is contrary to natural justice or the public policy of the Cayman Islands. However, the Cayman Islands courts are unlikely to enforce a punitive judgment of a United States court predicated upon the liabilities provision of the federal securities laws in the United States without retrial on the merits if such judgment gives rise to obligations to make payments that may be regarded as fines, penalties or similar charges. Our shareholders can, under certain circumstances, originate actions against us. See “Description of Share Capital—Differences in Corporate Law—Shareholders’ Suits.”

We have been advised by Han Kun Law Offices, our PRC counsel, that there is uncertainty as to whether the courts of the PRC would enforce judgments of United States courts or Cayman courts obtained against us or these persons predicated upon the civil liability provisions of the United States federal and state securities laws.

 

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Our PRC counsel, Han Kun Law Offices, has further advised us that PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based either on treaties between the PRC and the jurisdiction where the judgment is made or on reciprocity arrangements between jurisdictions. If there are no treaties or reciprocity arrangements between the PRC and a foreign jurisdiction where a judgment is rendered, according to the PRC Civil Procedures Law, matters relating to the recognition and enforcement of the foreign judgment in the PRC may be resolved through diplomatic channels. The PRC does not have any treaties or other arrangements with the United States or the Cayman Islands that provide for the reciprocal recognition and enforcement of foreign civil judgments. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC law or national sovereignty, security or public interest. As a result, it is generally difficult to enforce in the PRC a judgment rendered by a U.S. or Cayman Islands court.

 

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OUR HISTORY AND CORPORATE STRUCTURE

Our History

We commenced operations in November 2009 with the establishment of Shenzhen Mengyu Technology Co., Ltd., or Shenzhen Mengyu, in China, focusing on mobile game development outsourcing services for overseas game developers. In February 2011, we incorporated Shenzhen iDreamSky Technology Co., Ltd., or Shenzhen iDreamSky, which became the primary entity through which we operate our business. In January 2012, we established Beijing Chuangmeng Wuxian Technology Co., Ltd., or Beijing Chuangmeng, in China. Shenzhen Mengyu, Shenzhen iDreamSky and Beijing Chuangmeng, or collectively, our variable interest entities or VIEs, later became our PRC consolidated affiliated entities through the contractual arrangements described below. We hold licenses required for our business under PRC law through our VIEs.

In December 2010, Shenzhen Huaxiu Investment Co., Ltd., or Shenzhen Huaxiu, an investment company controlled by Meiping Li, an independent third party and a former investor in our company, became a shareholder of Shenzhen Mengyu, by acquiring an equity interest from Michael Xiangyu Chen, or Mr. Chen, our co-founder, chairman and chief executive officer and the then 100% shareholder of Shenzhen Mengyu. In February 2011, Shenzhen Mengyu and Shenzhen Huaxiu jointly established Shenzhen iDreamSky. In April 2011, Shenzhen iDreamSky received an investment from Legend Star Incubator Investment Co., Ltd., or Legend Star, a venture capital fund controlled by Legend Holdings Corporation, an investment holding company. Between July 2011 and September 2013, Shenzhen Huaxiu and Legend Star transferred their respective equity interests in Shenzhen Mengyu and Shenzhen iDreamSky to Mr. Chen, who is holding equity interests in Shenzhen Mengyu and Shenzhen iDreamSky on behalf of us pursuant to contractual arrangements, for a consideration of RMB3,000,000 and RMB6,027,220, respectively. Following the transfers, Shenzhen Huaxiu and Legend Star no longer hold any interests or claims on the shares held by Mr. Chen in Shenzhen Mengyu and Shenzhen iDreamSky. Affiliates of Shenzhen Huaxiu and Legend Star later acquired equity interest in our current holding company iDreamSky, as part of our restructuring for international financing purposes.

On February 23, 2012, we incorporated iDreamSky as a limited liability company in the Cayman Islands, for purpose of international financing. Upon our incorporation, we issued ten ordinary shares to the incorporation agent, which transferred such shares to Dream Data Services Limited, or Dream Data, a limited liability company incorporated under the laws of the British Virgin Islands and wholly owned by Mr. Chen, 39,764,000 ordinary shares to Dream Data, 11,260,000 ordinary shares to Huaxiu Investment Limited, or Huaxiu Investment, a limited liability company incorporated under the laws of the British Virgin Islands and wholly owned by Meiping Li, and 2,976,000 ordinary shares to Dream Soft Services Limited, or Dream Soft, a limited liability company incorporated under the laws of the British Virgin Islands the entire equity interest of which was then held by Jeffrey Lyndon Ko, or Mr. Ko, our co-founder, director and executive vice president, on behalf of Mr. Chen. In March 2012, iDreamSky established its wholly owned subsidiary, iDreamSky Technology (HK) Limited, or iDreamSky HK, in Hong Kong. In April 2012, iDreamSky HK established its wholly owned subsidiary, Chuangmeng Wuxian (Beijing) Information & Technology Co., Ltd., or Chuangmeng Wuxian, in China. Chuangmeng Wuxian is currently engaged in the business of software development which is a foreign investment industry encouraged under the latest version of Guiding Catalog for Foreign Investment Industries.

In August 2012, we established Shenzhen Yiyou Technology Co., Ltd., or Shenzhen Yiyou, in China jointly with Wenhao Fan and Qiyang Deng, both of whom are independent third parties. Shenzhen Yiyou is primarily engaged in the development of mobile games and is currently 86.5% held by Shenzhen iDreamSky. In December 2013, we established Shenzhen Zhuoyou Technology Co., Ltd., or Shenzhen Zhuoyou, in China jointly with Yang Wang, an independent third party. Shenzhen Zhuoyou is primarily engaged in the development of mobile games and is currently 90.9% held by Shenzhen iDreamSky. The purpose of setting up Shenzhen Yiyou and Shenzhen Zhuoyou is to obtain licenses to games developed by them on favorable commercial terms. In March 2014, we established Nanjing Zhuochuang Huyu Information Technology Co., Ltd., through which we plan to conduct certain game publishing business.

 

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On April 13, 2012, iDreamSky entered into a preferred share subscription agreement with Prime Express Investments Limited, or Prime Express, Ultimate Lenovo Limited, or Ultimate Lenovo (together with Prime Express, the “Series A Investors,” both of which are affiliates of Legend Star), LC Fund V, L.P., or LC Fund, LC Parallel Fund V, L.P., or LC Parallel, Redpoint Ventures IV, L.P., or Redpoint Ventures, and Redpoint Associates IV, L.L.C., or Redpoint Associates (together with LC Fund, LC Parallel and Redpoint Ventures, the “Series B Investors”), and certain other parties thereto, pursuant to which iDreamSky issued 13,500,000 Series A preferred shares for an aggregate purchase price of US$950,254 to the Series A Investors, 25,000,000 Series B preferred shares for an aggregate purchase price of US$6,000,000 to the Series B Investors, and warrants to subscribe a certain number of Series B-1 preferred shares, or the Series B-1 Warrants, to each of the Series B Investors.

On April 19, 2013, Halfbrick International Holdings Pty Ltd. or Halfbrick, acquired the entire equity interest in Dream Soft from Mr. Ko, who was holding such interest on behalf of Mr. Chen, and became the 100% shareholder of Dream Soft. On February 6, 2014, Dream Soft acquired an additional 24,000 ordinary shares in iDreamSky held by Dream Data. The aggregate consideration paid by Halfbrick in connection with its acquisition of our ordinary shares is US$900,000.

On July 4, 2013, the Series B Investors exercised their respective rights under the Series B-1 Warrants. Pursuant to the exercise of the warrants, the Series B Investors subscribed for 11,111,100 Series B-1 preferred shares for an aggregate price of US$4,000,000.

On September 3, 2013, iDreamSky entered into a preferred share subscription agreement with the Series B Investors, certain other parties thereto and THL A19 Limited, or THL A19, pursuant to which iDreamSky issued 8,457,880 Series A-1 preferred shares for an aggregate purchase price of US$3,565,643 and 4,167,340 Series C preferred shares for an aggregate purchase price of US$2,000,000 to the Series B Investors, and 11,260,000 Series A-1 preferred shares for an aggregate purchase price of US$4,746,950 and 23,780,980 Series C preferred shares for an aggregate purchase price of US$11,413,050 to THL A19.

On September 9, 2013, iDreamSky entered into a number of repurchase agreements with some existing shareholders to repurchase a certain number of its shares. Pursuant to the repurchase agreements, iDreamSky repurchased 1,707,880 ordinary shares at an aggregate price of US$720,002 from Dream Data, 11,260,000 ordinary shares, representing the entire equity interest held by Huaxiu Investment in our company, at an aggregate price of US$4,746,950 from Huaxiu Investment, 3,375,000 Series A preferred shares at an aggregate price of US$1,422,820.5 from Prime Express, and 3,375,000 Series A preferred shares at an aggregate price of US$1,422,820.5 from Ultimate Lenovo.

On January 22, 2014, Dream Data entered into a share transfer agreement with Prometheus Capital (International) Co, Ltd, or Prometheus Capital, to transfer 1,849,650 ordinary shares in iDreamSky to Prometheus Capital for an aggregate consideration of US$5.9 million.

On April 11, 2014, Dream Data executed an instrument of transfer to transfer 7,308,860 ordinary shares in iDreamSky to DT01 Holding International Limited, a British Virgin Islands company jointly owned by Jeffrey Lyndon Ko, our co-founder, director and executive vice president, and Anfernee Song Guan, our co-founder, director and chief technology officer, as compensation for their contribution to our company, without any cash consideration.

 

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Our Corporate Structure

The following diagram illustrates our shareholding and corporate structure and the place of incorporation of each of our significant subsidiaries and significant VIEs as of the date of this prospectus:

 

LOGO

 

LOGO Direct equity interest
LOGO Contractual arrangements. See “—Contractual Arrangements Among Chuangmeng Wuxian, our VIEs and the Respective Shareholders of our VIEs.”
(1)  Beijing Chuangmeng is 99% owned by Michael Xiangyu Chen, our co-founder, chairman and chief executive officer, and 1% owned by Anfernee Song Guan, our co-founder, director and chief technology officer. Beijing Chuangmeng currently does not have any business operations.
(2)  Shenzhen iDreamSky is 100% owned by Michael Xiangyu Chen, our co-founder, chairman and chief executive officer. Shenzhen iDreamSky is the primary entity through which we operate our mobile game publishing business.
(3)  Shenzhen Mengyu is 99% owned by Michael Xiangyu Chen, our co-founder, chairman and chief executive officer, and 1% owned by Anfernee Song Guan, our co-founder, director and chief technology officer. Shenzhen Mengyu operates some of our mobile game publishing business.
(4)  Shenzhen Yiyou is 86.5% owned by Shenzhen iDreamSky, 9.7% owned by Qiyang Deng, an independent third party, and 3.8% owned by Wenhao Fan, an independent third party. We invested in Shenzhen Yiyou, which is engaged in the business of mobile game development, in order to obtain licenses to its games on favorable commercial terms.
(5)  Shenzhen Zhuoyou is 90.9% owned by Shenzhen iDreamSky and 9.1% owned by Yang Wang, an independent third party. We invested in Shenzhen Zhuoyou, which is engaged in the business of mobile game development, in order to obtain licenses to its games on favorable commercial terms.
(6)  We plan to conduct certain of our game publishing business through Nanjing Zhuochuang Huyu Information Technology Co., Ltd.

Contractual Arrangements among Chuangmeng Wuxian, our VIEs and the Respective Shareholders of our VIEs

Foreign ownership of mobile and Internet-based businesses is subject to significant restrictions under current PRC laws and regulations. For a discussion of these restrictions, see “Regulations.” To comply with PRC

 

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laws, rules and regulations, we operate our business through our VIEs, Shenzhen Mengyu, Shenzhen iDreamSky and Beijing Chuangmeng. On April 19, 2012, through Chuangmeng Wuxian, we entered into certain contractual arrangements with Shenzhen Mengyu, Shenzhen iDreamSky and Beijing Chuangmeng and their respective shareholders, which enable us to:

 

    exercise effective control over the operations of our VIEs;

 

    receive substantially all of the economic benefits from our VIEs; and

 

    have an exclusive option to purchase all or part of the equity interest in our VIEs when and to the extent permitted by PRC law.

As a result of our ownership of Chuangmeng Wuxian, we became the primary beneficiary of the VIEs, and we treat them as our variable interest entities under U.S. GAAP. We have consolidated the financial results of our VIEs in our consolidated financial statements in accordance with U.S. GAAP. Our VIEs collectively contributed substantially all of our consolidated total revenues for the years ended December 31, 2012 and 2013 and the three months ended March 31, 2014, respectively.

However, these contractual arrangements may not be as effective in providing us with control over the VIEs as direct ownership of them. In addition, each of our VIEs or its shareholders may breach the contractual arrangements with us. In such cases, we would have to rely on legal remedies under PRC law, which may not always be effective, particularly in light of uncertainties in the PRC legal system. See “Risk Factors—Risks Related to Our Corporate Structure—Our contractual arrangements with our VIEs and their respective shareholders may not be as effective in providing control as direct ownership. Our VIEs and their shareholders may fail to perform their obligations under these contractual arrangements.” and “Risk Factors—Risks Related to Our Corporate Structure—If the PRC government determines that our ownership structure does not comply with the restrictions contained in the GAPP Notice, we could be subject to severe penalties.”

The following is a summary of the currently effective contractual arrangements among Chuangmeng Wuxian, our VIEs, and the shareholders of our VIEs:

Contractual Arrangements with Shenzhen iDreamSky and its Shareholders

Exclusive Business Cooperation Agreement. Under the exclusive business cooperation agreement dated April 19, 2012 and amended on November 29, 2013 between Chuangmeng Wuxian and Shenzhen iDreamSky, Shenzhen iDreamSky has agreed to accept all consultations and services provided by Chuangmeng Wuxian and, without the consent of Chuangmeng Wuxian, not to accept the same or any similar consultations and/or services by, or establish similar cooperation relationship with, any third party. In consideration of the services provided by Chuangmeng Wuxian, 100% of Shenzhen iDreamSky’s net income shall be regarded as services fees to be paid upon request by Chuangmeng Wuxian. The rate of such service fees may be adjusted upon written consent of Chuangmeng Wuxian pursuant to the operational needs of Shenzhen iDreamSky. In addition, Shenzhen iDreamSky grants to Chuangmeng Wuxian an irrevocable and exclusive option to purchase from it any or all of its assets at the lowest purchase price, to the extent permitted by PRC laws. Chuangmeng Wuxian shall have exclusive and proprietary rights and interests in all rights, ownership, interests and intellectual properties arising out of or created during the performance of the agreement. The agreement shall remain effective until being terminated in accordance with the agreement or terminated in writing by Chuangmeng Wuxian.

Power of Attorney. On November 29, 2013, the shareholder of Shenzhen iDreamSky granted an irrevocable power of attorney to Chuangmeng Wuxian, which replaced the previous irrevocable powers of attorney, the earliest of which was granted to Chuangmeng Wuxian on April 19, 2012. Pursuant to the irrevocable power of attorney, the shareholder appointed Chuangmeng Wuxian as his exclusive attorney-in-fact to attend shareholders’ meetings of Shenzhen iDreamSky, to exercise his shareholder’s rights and voting rights under PRC laws and under articles of association of Shenzhen iDreamSky, including but not limited to, to sell, transfer, pledge or

 

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dispose of his shares in Shenzhen iDreamSky, and to designate and appoint the legal representative, director, supervisor, chief executive officer and other senior management members of Shenzhen iDreamSky. The power of attorney shall remain in force until the shareholder ceases to hold any equity interest in Shenzhen iDreamSky.

Exclusive Option Agreement. On March 12, 2014, Chuangmeng Wuxian, Shenzhen iDreamSky and its shareholders entered into an exclusive option agreement, which replaced the previous exclusive option agreements, the earliest of which was entered into on April 19, 2012. Pursuant to the latest exclusive option agreement, the shareholder irrevocably granted Chuangmeng Wuxian or its designated representative(s) an irrevocable and exclusive right to purchase, to the extent permitted under PRC laws, at any time all or part of his equity interests in Shenzhen iDreamSky. The purchase price should be equal to the amount that the shareholders contributed to Shenzhen iDreamSky as registered capital for the equity interest purchased, or, if a higher purchase price is required by PRC Law, the lowest price permitted by such applicable PRC law. If Chuangmeng Wuxian exercises its exclusive option to purchase, it may elect to pay the purchase price by cancelling the outstanding amount of the loan owed to it by the shareholder of Shenzhen iDreamSky. Without the prior written consent of Chuangmeng Wuxian, the shareholder of Shenzhen iDreamSky shall not sell, transfer, mortgage or dispose of any legal or beneficial interest in the equity interests in Shenzhen iDreamSky or allow the encumbrance thereon of any security interest. The shareholder of Shenzhen iDreamSky shall promptly donate any profits, interest, dividend or proceeds of liquidation he gains from Shenzhen iDreamSky to Chuangmeng Wuxian to the extent permitted under applicable PRC laws. Upon request by Chuangmeng Wuxian, the shareholder of Shenzhen iDreamSky shall appoint any designee of Chuangmeng Wuxian as the director of Shenzhen iDreamSky. Without prior written consent of Chuangmeng Wuxian, Shenzhen iDreamSky shall not: (i) sell, transfer, mortgage or dispose of any material assets or beneficial interest in its business or revenue, (ii) incur, inherit, guarantee or suffer the existence of any debt except for the debts incurred in the ordinary course of business other than through loans, (iii) provide any person with any loan or credit, (iv) merge, consolidate with, acquire or invest in any person, (v) in any manner distribute dividends to its shareholders, (vi) engage in any business in competition with Chuangmeng Wuxian or its affiliates, or (vii) be dissolved or liquated, except as required by PRC laws. The agreements shall remain effective until all equity interests held by the shareholders in Shenzhen iDreamSky have been transferred or assigned to Chuangmeng Wuxian and/or its designated representative(s).

Loan Agreement. On March 12, 2014, Chuangmeng Wuxian and the shareholder of Shenzhen iDreamSky entered into a loan agreement, pursuant to which the parties confirmed that a loan in an aggregate amount of RMB10.0 million (US$1.6 million) have been made by Chuangmeng Wuxian to the shareholder of Shenzhen iDreamSky to be used solely for the purpose of making capital contribution to the registered capital of Shenzhen iDreamSky. The method of repayment of the loan shall be at the sole discretion of Chuangmeng Wuxian, and may take the form of the transferring of all equity interest in Shenzhen iDreamSky by its shareholder to Chuangmeng Wuxian or its designated persons pursuant to Chuangmeng Wuxian’s exercise of its exclusive purchase right under the exclusive option agreement, and any proceeds from the transfer of the equity interest shall be used to repay the loan to Chuangmeng Wuxian. In the event that the shareholder sells his equity interests to Chuangmeng Wuxian or its designated persons at a price which is equal to or lower than the principal amount of the loan, the loan will be interest-free. If the price is higher than the principal amount of the loan, the excess amount will be paid to Chuangmeng Wuxian as the loan interests to the extent permitted by PRC law. The terms of the loan are ten years from the effective date of the loan agreement and may be extended upon mutual written consent of Chuangmeng Wuxian and the shareholder of Shenzhen iDreamSky. The loan must be repaid immediately under certain circumstances, including, among other things (i) 30 days elapse after receiving a written notice from Chuangmeng Wuxian requesting repayment, (ii) the shareholder ceasing to be an employee of us, (iii) if foreign investors are permitted to invest in Shenzhen iDreamSky with a controlling stake or in the form of wholly foreign-owned enterprises, the relevant authorities of China begin to approve such investments, and Chuangmeng Wuxian exercises its exclusive option to purchase the equity interests in Shenzhen iDreamSky. The loan may later offset the purchase price payable by Chuangmeng Wuxian to the shareholder upon exercise of the purchase option by Chuangmeng Wuxian.

 

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Equity Interest Pledge Agreement. On March 12, 2014, Chuangmeng Wuxian, Shenzhen iDreamSky and its shareholder entered into an equity interest pledge agreement, which replaced the previous equity interest pledge agreements, the earliest of which was entered into on April 19, 2012. Pursuant to the latest equity interest pledge agreement, the shareholder of Shenzhen iDreamSky have agreed to pledge all of the equity interests in Shenzhen iDreamSky (including any equity interest in Shenzhen iDreamSky subsequently acquired by the shareholders) to Chuangmeng Wuxian as a security for the performance by Shenzhen iDreamSky and its shareholder of their respective obligations under the exclusive business cooperation agreement, exclusive option agreements, loan agreement, power of attorney, equity interest pledge agreement, as well as for payment of all the direct, indirect and derivative losses and losses of anticipated profits that may be suffered by Chuangmeng Wuxian as a result of a breach of the abovementioned agreements by Shenzhen iDreamSky and/or its shareholder. If Shenzhen iDreamSky or any of its shareholder fails to perform any obligations under those agreements, Chuangmeng Wuxian will be entitled to enforce the pledge and to seek any remedial measure under applicable PRC laws, including to be paid in priority with the equity interest in Shenzhen iDreamSky. The pledge will remain effective until the fulfillment of all the obligations under the exclusive business cooperation agreement, exclusive option agreement, loan agreement, powers of attorney, equity interest pledge agreement and the full payment of losses resulted from a breach of those agreements by Shenzhen iDreamSky and/or its shareholder.

Spouse Consent Letter. On March 12, 2014, the spouse of the shareholder of Shenzhen iDreamSky executed a spouse consent letter, which replaced the spouse consent letter executed on November 29, 2013. Pursuant to the spouse consent letter, the shareholder’s spouse has agreed to the execution of the exclusive option agreement, equity interest pledge agreement, power of attorney, loan agreement and the disposal of the equity interests held by the shareholder in Shenzhen iDreamSky pursuant to those agreements. The spouse of the shareholder agreed that she shall not assert any interests in such equity interests in Shenzhen iDreamSky held by the shareholder, and if she obtains any such equity interests, she shall be bound by the exclusive option agreement, equity interest pledge agreement, loan agreement, power of attorney and the exclusive business cooperation agreement.

Contractual Arrangements with Shenzhen Mengyu and its Shareholders

Exclusive Business Cooperation Agreement. Under the exclusive business cooperation agreement dated April 19, 2012 and amended on November 29, 2013 between Chuangmeng Wuxian and Shenzhen Mengyu, Shenzhen Mengyu has agreed to accept all consultations and services provided by Chuangmeng Wuxian, and without the consent of Chuangmeng Wuxian, not to accept the same or any similar consultations and/or services by, or establish similar cooperation relationship with, any third party. In consideration of the services provided by Chuangmeng Wuxian, 100% of Shenzhen Mengyu’s net income shall be regarded as services fees to be paid upon request by Chuangmeng Wuxian. The rate of such service fees may be adjusted upon written consent of Chuangmeng Wuxian pursuant to the operational needs of Shenzhen Mengyu. In addition, Shenzhen Mengyu grants to Chuangmeng Wuxian an irrevocable and exclusive option to purchase from it any or all of its assets at the lowest purchase price, to the extent permitted by PRC laws. Chuangmeng Wuxian shall have exclusive and proprietary rights and interests in all rights, ownership, interests and intellectual properties arising out of or created during the performance of the agreement. The agreement shall remain effective until being terminated in accordance with the agreement or terminated in writing by Chuangmeng Wuxian.

Power of Attorney. On November 29, 2013, each shareholder of Shenzhen Mengyu granted an irrevocable power of attorney to Chuangmeng Wuxian, which replaced the irrevocable power of attorney previously granted to Chuangmeng Wuxian on April 19, 2012. Pursuant to the irrevocable power of attorney, each of such shareholders appointed Chuangmeng Wuxian as his exclusive attorney-in-fact to attend shareholders’ meetings of Shenzhen Mengyu, to exercise his shareholder’s rights and voting rights under PRC laws and under articles of association of Shenzhen Mengyu, including but not limited to, to sell, transfer, pledge or dispose of his shares in Shenzhen Mengyu, and to designate and appoint the legal representative, director, supervisor, chief executive

 

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officer and other senior management members of Shenzhen Mengyu. Each power of attorney shall remain in force until the shareholder ceases to hold any equity interest in Shenzhen Mengyu.

Exclusive Option Agreement. On March 5, 2014, Chuangmeng Wuxian, Shenzhen Mengyu and its shareholders entered into exclusive option agreements, which replaced the previous exclusive option agreements, the earliest of which was entered into on April 19, 2012. Pursuant to the latest exclusive option agreements, each of the shareholders irrevocably granted Chuangmeng Wuxian or its designated representative(s) an irrevocable and exclusive right to purchase, to the extent permitted under PRC laws, at any time all or part of his equity interests in Shenzhen Mengyu. The purchase price should be equal to the amount that the shareholders contributed to Shenzhen Mengyu as registered capital for the equity interest purchased, or, if a higher purchase price is required by PRC Law, the lowest price permitted by such applicable PRC law. If Chuangmeng Wuxian exercises its exclusive option to purchase, it may elect to pay the purchase price by cancelling the outstanding amount of the loans owed to it by the shareholders of Shenzhen Mengyu. Without the prior written consent of Chuangmeng Wuxian, each of the shareholders of Shenzhen Mengyu shall not sell, transfer, mortgage or dispose of any legal or beneficial interest in the equity interests in Shenzhen Mengyu or allow the encumbrance thereon of any security interest. Each of shareholders of Shenzhen Mengyu shall promptly donate any profits, interest, dividend or proceeds of liquidation he gains from Shenzhen Mengyu to Chuangmeng Wuxian to the extent permitted under applicable PRC laws. Upon request by Chuangmeng Wuxian, each of the shareholders of Shenzhen Mengyu shall appoint any designee of Chuangmeng Wuxian as the director of Shenzhen Mengyu. Without prior written consent of Chuangmeng Wuxian, Shenzhen Mengyu shall not: (i) sell, transfer, mortgage or dispose of any material assets or beneficial interest in its business or revenue, (ii) incur, inherit, guarantee or suffer the existence of any debt except for the debts incurred in the ordinary course of business other than through loans, (iii) provide any person with any loan or credit, (iv) merge, consolidate with, acquire or invest in any person, (v) in any manner distribute dividends to its shareholders, (vi) engage in any business in competition with Chuangmeng Wuxian or its affiliates, or (vii) be dissolved or liquated, except as required by PRC laws. The agreements shall remain effective until all equity interests held by the shareholders in Shenzhen Mengyu have been transferred or assigned to Chuangmeng Wuxian and/or its designated representative(s).

Loan Agreement. On March 5, 2014, Chuangmeng Wuxian and the shareholders of Shenzhen Mengyu entered into loan agreements, pursuant to which the parties confirmed that loans in an aggregate amount of RMB10.0 million (US$1.6 million) have been made by Chuangmeng Wuxian to the shareholders of Shenzhen Mengyu to be used solely for the purpose of making capital contribution to the registered capital of Shenzhen Mengyu. The method of repayment of the loans shall be at the sole discretion of Chuangmeng Wuxian, and may take the form of the transferring of all equity interest in Shenzhen Mengyu by its shareholders to Chuangmeng Wuxian or its designated persons pursuant to Chuangmeng Wuxian’s exercise of its exclusive purchase right under the exclusive option agreements, and any proceeds from the transfer of the equity interest shall be used to repay the loans to Chuangmeng Wuxian. In the event that the shareholders sell their equity interests to Chuangmeng Wuxian or its designated persons at a price which is equal to or lower than the principal amount of the loans, the loans will be interest-free. If the price is higher than the principal amount of the loans, the excess amount will be paid to Chuangmeng Wuxian as the loan interests to the extent permitted by PRC law. The terms of the loans are ten years from the effective date of the loan agreements and may be extended upon mutual written consent of Chuangmeng Wuxian and the shareholders of Shenzhen Mengyu. The loans must be repaid immediately under certain circumstances, including, among other things (i) 30 days elapse after receiving a written notice from Chuangmeng Wuxian requesting repayment, (ii) the shareholders ceasing to be employees of us, (iii) if foreign investors are permitted to invest in Shenzhen Mengyu with a controlling stake or in the form of wholly foreign-owned enterprises, the relevant authorities of China begin to approve such investments, and Chuangmeng Wuxian exercises its exclusive option to purchase the equity interests in Shenzhen Mengyu. The loan may later offset the purchase price payable by Chuangmeng Wuxian to the shareholder upon exercise of the purchase option by Chuangmeng Wuxian.

Equity Interest Pledge Agreement. On March 5, 2014, Chuangmeng Wuxian, Shenzhen Mengyu and its shareholders entered into equity interest pledge agreements, which replaced the previous equity interest pledge

 

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agreements, the earliest of which was entered into on April 19, 2012. Pursuant to the latest equity interest pledge agreements, the shareholders of Shenzhen Mengyu have agreed to pledge all of their equity interests in Shenzhen Mengyu (including any equity interest in Shenzhen Mengyu subsequently acquired by the shareholders) to Chuangmeng Wuxian as a security for the performance by Shenzhen Mengyu and its shareholders of their respective obligations under the exclusive business cooperation agreements, exclusive option agreements, loan agreements, powers of attorney, equity interest pledge agreements, as well as for payment of all the direct, indirect and derivative losses and losses of anticipated profits that may be suffered by Chuangmeng Wuxian as a result of a breach of the abovementioned agreements by Shenzhen Mengyu and/or its shareholders. If Shenzhen Mengyu or any of its shareholders fails to perform any obligations under those agreements, Chuangmeng Wuxian will be entitled to enforce the pledge and to seek any remedial measure under applicable PRC laws, including to be paid in priority with the equity interest in Shenzhen Mengyu. The pledge shall remain effective until the fulfillment of all the obligations under the exclusive business cooperation agreements, exclusive option agreements, loan agreements, powers of attorney, equity interest pledge agreements and the full payment of losses resulted from a breach of those agreements by Shenzhen Mengyu and/or its shareholders.

Spouse Consent Letter. On March 5, 2014, the spouse of each of the shareholders of Shenzhen Mengyu executed a spouse consent letter, which replaced the spouse consent letter executed on November 29, 2013. Pursuant to the spouse consent letter, each shareholder’s spouse has agreed to the execution of the exclusive option agreements, equity interest pledge agreements, powers of attorney, loan agreements and the disposal of the equity interests held by the shareholder in Shenzhen Mengyu pursuant to those agreements. The spouse of each of the shareholders agreed that she shall not assert any interests in such equity interests in Shenzhen Mengyu held by the shareholder, and if she obtains any such equity interests, she shall be bound by the exclusive option agreements, equity interest pledge agreements, loan agreements, power of attorney and the exclusive business cooperation agreement.

Contractual Arrangements with Beijing Chuangmeng and its Shareholders

Exclusive Business Cooperation Agreement. Under the exclusive business cooperation agreement dated April 19, 2012 and amended on November 29, 2013 between Chuangmeng Wuxian and Beijing Chuangmeng, Beijing Chuangmeng agrees to accept all consultations and services provided by Chuangmeng Wuxian and without the consent of Chuangmeng Wuxian, shall not accept the same or any similar consultations and/or services by, or establish similar cooperation relationship with, any third party. In consideration of the services provided by Chuangmeng Wuxian, 100% of Beijing Chuangmeng’s net income shall be regarded as the services fees, to be paid upon request by Chuangmeng Wuxian. The rate of such service fees may be adjusted upon written consent of Chuangmeng Wuxian pursuant to the operational needs of Beijing Chuangmeng. In addition, Beijing Chuangmeng grants to Chuangmeng Wuxian an irrevocable and exclusive option to purchase from it any or all of its assets at the lowest purchase price, to the extent permitted by PRC laws. Chuangmeng Wuxian shall have exclusive and proprietary rights and interests in all rights, ownership, interests and intellectual properties arising out of or created during the performance of the agreement. The agreement shall remain effective until being terminated in accordance with the agreement or terminated in writing by Chuangmeng Wuxian.

Power of Attorney. On November 29, 2013, each shareholder of Beijing Chuangmeng granted an irrevocable power of attorney to Chuangmeng Wuxian, which replaced the irrevocable power of attorney previously granted to Chuangmeng Wuxian on April 19, 2012. Pursuant to the irrevocable power of attorney, each of such shareholders appointed Chuangmeng Wuxian as his exclusive attorney-in-fact to attend shareholders’ meetings of Beijing Chuangmeng, to exercise his shareholder’s rights and voting rights under PRC law and under articles of association of Beijing Chuangmeng, including but not limited to, to sell, transfer, pledge or dispose of his shares in Beijing Chuangmeng, and to designate and appoint the legal representative, director, supervisor, chief executive officer and other senior management members of Beijing Chuangmeng. Each power of attorney shall remain in force until the shareholder ceases to hold any equity interest in Beijing Chuangmeng.

 

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Exclusive Option Agreement. On November 29, 2013, Chuangmeng Wuxian, Beijing Chuangmeng and its shareholders entered into exclusive option agreements, which replaced the previous exclusive option agreements entered into on April 19, 2012. Pursuant to the latest exclusive option agreements, each of the shareholders irrevocably granted Chuangmeng Wuxian or its designated representative(s) an irrevocable and exclusive right to purchase, to the extent permitted under PRC laws, at any time all or part of his equity interests in Beijing Chuangmeng. Without the prior written consent of Chuangmeng Wuxian, each of the shareholders of Beijing Chuangmeng shall not sell, transfer, mortgage or dispose of any legal or beneficial interest in the equity interests in Beijing Chuangmeng or allow the encumbrance thereon of any security interest. Each of shareholders of Beijing Chuangmeng shall promptly donate any profits, interest, dividend or proceeds of liquidation he gains from Beijing Chuangmeng to Chuangmeng Wuxian to the extent permitted under applicable PRC laws. Upon request by Chuangmeng Wuxian, each of the shareholders of Beijing Chuangmeng shall appoint any designee of Chuangmeng Wuxian as the director of Beijing Chuangmeng. Without prior written consent of Chuangmeng Wuxian, Beijing Chuangmeng shall not: (i) sell, transfer, mortgage or dispose of any material assets or beneficial interest in its business or revenue, (ii) incur, inherit, guarantee or suffer the existence of any debt except for the debts incurred in the ordinary course of business other than through loans, (iii) provide any person with any loan or credit, (iv) merge, consolidate with, acquire or invest in any person, (v) in any manner distribute dividends to its shareholders, (vi) engage in any business in competition with Chuangmeng Wuxian or its affiliates, or (vii) be dissolved or liquated, except as required by PRC laws. The agreements shall remain effective until all equity interests held by the shareholders in Beijing Chuangmeng have been transferred or assigned to Chuangmeng Wuxian and/or its designated representative(s).

Equity Interest Pledge Agreement. On November 29, 2013, Chuangmeng Wuxian, Beijing Chuangmeng and its shareholders entered into equity interest pledge agreements, which replaced the previous equity interest pledge agreements entered into on April 19, 2012. Pursuant to the latest equity interest pledge agreements, the shareholders of Beijing Chuangmeng have agreed to pledge all of their equity interests in Beijing Chuangmeng (including any equity interest in Beijing Chuangmeng subsequently acquired by the shareholders) to Chuangmeng Wuxian as a security for the performance by Beijing Chuangmeng and its shareholders of their respective obligations under the exclusive business cooperation agreement, exclusive option agreements, powers of attorney, equity interest pledge agreements, as well as for payment of all the direct, indirect and derivative losses and losses of anticipated profits that may be suffered by Chuangmeng Wuxian as a result of a breach of the abovementioned agreements by Beijing Chuangmeng and/or its shareholders. If Beijing Chuangmeng or any of its shareholders fails to perform any obligations under those agreements, Chuangmeng Wuxian will be entitled to enforce the pledge and to seek any remedial measure under applicable PRC laws, including to be paid in priority with the equity interest in Beijing Chuangmeng. The pledge shall remain effective until the fulfillment of all the obligations under the exclusive business cooperation agreements, exclusive option agreements, powers of attorney, equity interest pledge agreements and the full payment of losses resulted from a breach of those agreements by Beijing Chuangmeng and/or its shareholders.

Spouse Consent Letter. On November 29, 2013, the spouse of each of the shareholders of Beijing Chuangmeng executed a spouse consent letter, pursuant to which each shareholder’s spouse has agreed to the execution of the exclusive option agreements, equity interest pledge agreements, powers of attorney and the disposal of the equity interests held by the shareholder in Beijing Chuangmeng pursuant to those agreements. The spouse of each of the shareholders agreed that she shall not assert any interests in such equity interests in Beijing Chuangmeng held by the shareholder, and if she obtains any such equity interests, she shall be bound by the exclusive option agreements, equity interest pledge agreements, power of attorney and the exclusive business cooperation agreement.

In the opinion of Han Kun Law Offices, our PRC legal counsel:

 

    the ownership structures of each of our VIEs and Chuangmeng Wuxian, both currently and immediately after giving effect to this offering, will not result in any violation of PRC laws or regulations currently in effect; and

 

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    each of the contractual arrangements among Chuangmeng Wuxian, our VIEs and their respective shareholders governed by PRC law both currently and immediately after giving effect to this offering are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect.

However, we have been further advised by our PRC legal counsel that there are substantial uncertainties regarding the interpretation and application of current and future PRC laws, regulations and rules. Accordingly, the PRC regulatory authorities may in the future take a view that is contrary to the above opinion of our PRC legal counsel. We have been further advised by our PRC counsel that if the PRC government finds that the agreements that establish the structure for operating our mobile games business do not comply with PRC government restrictions on foreign investment in the aforesaid business we engage in, we could be subject to severe penalties including being prohibited from continuing operations. See “Risk Factors—Risks Related to Our Corporate Structure—We conduct certain aspects of our businesses in China through our VIEs by means of contractual arrangements. If the PRC government determines that these contractual arrangements do not comply with applicable regulations, our business could be materially and adversely affected.” and “Risk Factors—Risks Related to Doing Business in China—Uncertainties and changes in the PRC legal system could materially and adversely affect our business.”

 

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SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OPERATING DATA

The selected consolidated financial information and operating data should be read in conjunction with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

The following tables present our selected consolidated statement of operations data for the years ended December 31, 2012 and 2013 and the consolidated balance sheet data as of December 31, 2012 and 2013. All share and per share data in the tables below give effect to a share split effected on July 1, 2014, following which each of our previously issued ordinary shares and preferred shares was subdivided into ten ordinary shares and preferred shares, respectively. The data presented in these tables derived from our audited consolidated financial statements included elsewhere in this prospectus. The consolidated financial statements are prepared and presented in accordance with U.S. GAAP. The selected consolidated statements of operations data for the three months ended March 31, 2013 and 2014 and selected consolidated balance sheet data as of March 31, 2014 have been derived from our unaudited interim consolidated financial statements included elsewhere in this prospectus. The unaudited interim consolidated financial statements have been prepared on the same basis as our audited consolidated financial statements and include all adjustments, consisting of normal recurring adjustments, that we consider necessary for a fair statement of our financial position and operating results for the periods presented. Our historical results are not necessarily indicative of our results for any future periods.

 

     For the Year Ended December 31,     For the Three Months Ended
March 31,
 
     2012     2013     2013     2014  
     RMB     RMB     US$     RMB     RMB     US$  
     (in thousands, except share and per share data)  

Consolidated Statement of Operations Data:

            

Revenues:

            

Game revenues

     18,059        244,806        40,439        21,891        173,968        27,985   

Other revenues

     1,319        1,762        292        184        134        22   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     19,378        246,568        40,731        22,075        174,102        28,007   

Cost of revenues

     (14,593     (155,898     (25,753     (13,487     (101,268     (16,290
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     4,785        90,670        14,978        8,588        72,834        11,717   

Operating expenses:

            

Research and development expenses

     (7,501     (14,214     (2,348     (2,343     (6,799     (1,094

Sales and marketing expenses

     (2,797     (27,940     (4,615     (4,698     (12,460     (2,004

General and administrative expenses

     (4,713     (14,780     (2,442     (2,263     (11,281     (1,816
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     (15,011     (56,934     (9,405     (9,304     (30,540     (4,914

Other gains, net

     946        106        17        46        1,194        192   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (loss)/profit

     (9,280     33,842        5,590        (670     43,488        6,995   

Interest income

     20        81        13        7        39        6   

Foreign exchange (loss)/gain and others

     (63     266        44        (19     (598     (96

Share of loss from an equity investment

            (170     (28            (29     (4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/income before income tax

     (9,323     34,019        5,619        (682     42,900        6,901   

Income tax expense

            (6,174     (1,020            (9,735     (1,566
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income

     (9,323     27,845        4,599        (682     33,165        5,335   

Less: Net loss attributable to the noncontrolling interest

     32        287        47        87        (502     (81
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income attributable to iDreamSky Technology Limited

     (9,291     28,132        4,646        (595     32,663        5,254   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Accretion to convertible redeemable preferred shares redemption value

     (22,870     (262,782     (43,408     (3,349     (845,001     (135,931

Deemed dividend to series A convertible redeemable preferred shares

     (540     (14,402     (2,379                     

Deemed dividend to Li Meiping ordinary shares

     (300     (29,075     (4,803                     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to ordinary shareholders

     (33,001     (278,127     (45,944     (3,944     (812,338     (130,677
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per ordinary share—basic

     (0.77     (6.97     (1.15     (0.09     (19.8     (3.18

Net loss per ordinary share—diluted

     (0.77     (6.97     (1.15     (0.09     (19.8     (3.18

Weighted average number of ordinary shares attributable to iDreamSky Technology Limited—basic (thousands)

     42,740        39,930        39,930        42,740        41,030        41,030   

Weighted average number of ordinary shares attributable to iDreamSky Technology Limited—diluted (thousands)

     42,740        39,930        39,930        42,740        41,030        41,030   

 

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     As of December 31,     As of March 31,  
     2012     2013     2014  
     RMB     RMB     US$     RMB     US$  
    

(in thousands, except share and per share data)

 

Consolidated Balance Sheet Data:

          

Cash and cash equivalents

     31,365        179,658        29,677        158,502        25,497   

Accounts receivable, net

     5,052        76,900        12,703        125,496        20,188   

Prepayments and other current assets

     1,324        7,078        1,171        49,589        7,977   

Total current assets

     43,458        264,954        43,768        333,703        53,681   

Property and equipment, net

     2,207        8,684        1,434        10,126        1,629   

Total assets

     46,895        278,638        46,028        353,406        56,850   

Total liabilities

     23,242        123,153        20,344        163,199        26,251   

Total mezzanine equity

     61,085        470,664        77,748        1,323,008        212,826   

Ordinary shares (US$0.0001 par value; 461,500,000, 409,472,700 and 409,472,700 shares authorized, 42,740,000, 41,032,120 and 41,032,120 shares issued and outstanding as of December 31, 2012 and 2013 and March 31, 2014, respectively)

     27        26        4        26        4   

Additional paid-in capital

                                   

Statutory reserves

            2,701        446        2,701        434   

Accumulated deficit

     (37,664     (322,619     (53,293     (1,134,875     (182,560

Accumulated other comprehensive income

     102        4,661        770        (1,207     (194

Total shareholders’ deficit

     (37,432     (315,179     (52,064     (1,132,801 )      (182,227 ) 

Total liabilities, mezzanine equity and shareholders’ equity

     46,895        278,638        46,028        353,406        56,850   

Operating Data:

 

     As of December 31,      As of March 31,  
     2012      2013      2014  
     (in millions)  

Registered users

     127.5         398.8         472.7   

 

     For the Year Ended
December 31,
     For the Quarter Ended
March 31,
 
     2012      2013      2013      2014  
     (in millions)  

Downloads and activations

     111.6         271.3         63.0         73.9   

 

    For the Quarter Ended  
    March 31,
2012
    June 30,
2012
    September 30,
2012
    December 31,
2012
    March 31,
2013
    June 30,
2013
    September 30,
2013
    December 31,
2013
    March 31,
2014
 
    (in millions)        

Average MAUs

    5.6        11.6        22.0        34.0        56.7        70.3        81.3        91.0        98.3   

Average MPUs

    0.0        0.1        0.2        0.3        1.1        1.4        4.6        5.1        5.1   

Average DAUs

    1.9        4.6        7.6        10.6        16.8        21.8        25.0        25.4        25.8   

Paying ratio

    0.0     0.8     0.8     0.9     1.9     2.1     5.6     5.7     5.2

 

Note: Paying ratio for a given quarter equals to average MPUs divided by average MAUs for that quarter.

 

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Non-GAAP Measures

Adjusted EBITDA and Adjusted Net Loss or Income

To provide investors with additional information about our financial results, we disclose in this prospectus non-GAAP financial measures, adjusted EBITDA and adjusted net (loss)/income. We have provided below a reconciliation between each adjusted EBITDA and adjusted net (loss)/income to net (loss)/income, the most directly comparable GAAP financial measure.

We have included adjusted EBITDA and adjusted net (loss)/income in this prospectus because they are key measures we use to evaluate our operating performance, generate future operating plans and make strategic decisions for the allocation of capital. Accordingly, we believe that adjusted EBITDA and adjusted net (loss)/income provide useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors. These non-GAAP financial measures enable our management to assess our operating results without considering the impact of non-cash charges, including share-based compensation, fair value change of preferred share warrant liability and share of loss from an equity investment. Furthermore, these non-GAAP financial measures eliminate the impact of items that we do not consider indicative of the performance of our business. While we believe that these non-GAAP financial measures are useful in evaluating our business, this information should be considered as supplemental in nature and is not meant as a substitute for the related financial information prepared in accordance with U.S. GAAP.

The following tables present a reconciliation of each adjusted EBITDA and adjusted net (loss)/income to net (loss)/income, the most directly comparable GAAP financial measure.

 

     For the Year Ended
December 31,
    For the Three Months Ended
March 31,
 
     2012     2013     2013     2014  
     RMB     RMB     US$     RMB     RMB     US$  
     (in thousands)  

Reconciliation of Net (Loss)/Income to Adjusted Net (Loss)/Income and Adjusted EBITDA:

            

Net (loss)/income

     (9,323     27,845        4,599        (682     33,165        5,335   

Share-based compensation

     1,415        329        54        82        82        14   

Fair value change of preferred share warrant liability

     564        514        85        111                 

Share of loss from an equity investment

            170        28               29        4   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net (loss)/income

     (7,344     28,858        4,766        (489     33,276        5,353   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Depreciation of property and equipment

     428        1,788        296        383        736        118   

Amortization of intangible assets

     1,151        1,990        329        235        955        154   

Income tax expense

            6,174        1,020               9,735        1,566   

Interest income

     (20     (81     (13     (7     (39     (6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

     (5,785     38,729        6,398        122        44,663        7,185   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The use of adjusted EBITDA and adjusted net (loss)/income has material limitations as an analytical tool, as adjusted EBITDA and adjusted net (loss)/income do not include all items that impact our net loss or income for the period. In addition, because these non-GAAP measures may not be calculated in the same manner by all companies, they may not be comparable to other similar titled measures used by other companies.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our audited consolidated financial statements and the related notes, which are included elsewhere in this prospectus. 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 prospectus.

Overview

We are the largest independent mobile game publishing platform in China based on the number of active users in 2013, according to the Analysys Report. In the first quarter of 2014, we had average MAUs of 98.3 million. We redesign and optimize third-party games and deliver them to users through our proprietary distribution channels as part of our broader publishing solution. We also selectively acquire and develop certain games to obtain games for our portfolio on more favorable commercial terms. Our proprietary distribution channels include in-game cross promotions and our self-operated iDreamSky Game Center and www.uu.cc. We also operate games as a service, where we offer live game services and gain user insights through our multi-dimensional data analysis engine to drive ongoing game optimization and monetization. We currently offer 40 casual and mid- and hardcore mobile games of various genres.

Our platform offers a one-stop solution, including game redesign and porting, ongoing optimization, marketing, distribution, monetization, payment support and user-related services. In addition to our proprietary distribution channels, we also partner with major app stores and mobile browsers in China, such as Tencent App Store, Qihoo 360 Mobile, 91 Wireless and UCWeb, mobile device makers and retailers such as Lenovo, Huawei, ZTE and Suning, mobile carriers and mobile advertising agents to distribute our games. We also partner with almost all major payment service providers in China, including all three mobile carriers and major third-party payment service providers such as Alipay, Weixin Payments, China UnionPay and Yeepay.

We have grown significantly since our inception in 2009. Our total revenues increased from RMB19.4 million in 2012 to RMB246.6 million (US$40.7 million) in 2013, and from RMB22.1 million in the three months ended March 31, 2013 to RMB174.1 million (US$28.0 million) in the three months ended March 31, 2014. We had net loss of RMB9.3 million in 2012 and net income of RMB27.8 million (US$4.6 million) in 2013. We had net loss of RMB0.7 million in the three months ended March 31, 2013, and net income of RMB33.2 million (US$5.3 million) in the corresponding period in 2014. We had adjusted net loss of RMB7.3 million in 2012, compared to adjusted net income of RMB28.9 million (US$4.8 million) in 2013. We had adjusted net loss of RMB0.5 million in the three months ended March 31, 2013, compared to adjusted net income of RMB33.3 million (US$5.4 million) in the corresponding period in 2014. For information regarding adjusted net (loss)/income and a reconciliation of adjusted net (loss)/income to net (loss)/income, see “Selected Consolidated Financial Information and Operating Data—Non-GAAP Measures.”

Significant Factors Affecting Our Results of Operations

Our results of operations and financial condition are affected by the general factors driving China’s mobile game industry, including China’s overall economic growth, growth of the smartphone and mobile communications industries, demand for mobile games and entertainment, government policies for telecommunications and competition in China’s mobile game industry.

 

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Our results of operations are also directly affected by the following factors specific to our company:

 

    Our ability to grow our active user base and retain our users. Our results of operations depend on our ability to maintain and grow our active user base. We attract new users by expanding our game portfolio, offering diversified platform services and the increasing network effect of our platform. We retain users through measures such as offering new and improved game functions to maintain user interest, cross-promotion to enhance user engagement and promotional events to reward user loyalty.

 

    Our ability to monetize our use base. Our results of operations depend on our ability to convert our active users into paying users and subsequently retain these paying users. We convert active users to paying users by offering suitably-priced virtual items and functions that can be conveniently paid for, thereby cultivating a habit of paying for virtual goods. We increase our average revenue per paying user, or ARPPU, through identifying and implementing new monetization points suitable for PRC users and continuously optimizing our virtual goods merchandising strategy through data analysis, and maintaining user engagement.

 

    The popularity of our game portfolio. The popularity of both our existing games and any new games we offer is another major factor that affects our results of operations. As of March 31, 2014, we had a large and diversified portfolio of 18 casual games and 20 mid- and hardcore games. We published two of the top three and three of the top ten casual games by active users in China in the first quarter of 2014, according to the Analysys Report. Our reputation as a reliable and trusted partner for game developers allows us to continue to license top-ranked games for the PRC market. Additionally, our results of operations are affected by the life cycles of the games we offer, which can be extended through our strong game operations and offering new content and functions to users. Our ability to continue to expand our portfolio with games popular with a wide user demographic and longer life cycles will be critical to the growth of our user base.

 

    Our relationships with game developers. Our relationships with game developers affect our ability to expand our game portfolio, which in turn contributes to our ability to acquire new users. Additionally, the strength of our relationships with game developers may determine the terms under which we are able to license their games, which affects our revenue since our revenue is net of payments to our game developer partners. Under our distribution agreements with game developer partners, our game developer partners generally receive a prescribed percentage of either the gross billings or gross billings after deduction of certain expenses and tax, depending on the terms of the agreements, based on monthly report of gross billings generated from the games. We believe that we have established a reputation as a reliable and trusted partner within the global mobile game developer community, which has allowed us to gain access to the source code of certain of our games and improved our ability to control the operation of our games and engage and monetize our users.

 

    Our revenue mix. Our results of operations are affected by our revenue mix, which may alter our margin profile. We currently offer casual games and mid- and hardcore games. Casual games are games that are simple and easy to play, and typically serve as a gateway to introduce users to the idea of making in-game purchases of virtual items due to their relatively low prices in comparison to purchases in mid- and hardcore games. As such, casual games typically have a relatively higher active and paying user base and have relatively lower cost of virtual items that results in lower ARPPU. In contrast, mid- and hardcore games are games that are more complex to play, require more time commitment and offer the users a more immersive experience. As a result, users of mid- and hardcore games are typically more willing to pay for more virtual items and higher priced virtual items. As such, mid- and hardcore games typically have a relatively smaller active and paying user base and have relatively higher cost of virtual items that results in higher ARPPU. Casual games and mid- and hardcore games also have different levels of payment processing and distribution channel costs, all of which may affect our profitability.

 

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    Costs of our payment channels. Our payment channel providers include China’s three mobile carriers, namely China Mobile, China Unicom and China Telecom, and third-party payment platforms such as Alipay, Weixin Payments, China UnionPay and Yeepay. The mobile carriers and third-party payment platforms are generally entitled to a prescribed percentage of the gross billings, which is charged by the mobile carriers or third-party payment platforms to the mobile game players. We rely in part on these three mobile carriers as our payment processing and distribution channels. These mobile carriers account for a majority of our payment processing costs due to that most of our casual game purchases are paid through SMS billings, where mobile carrier charges the payment directly to users’ mobile phone bills or deduct the amount directly from the users’ remaining mobile balance. The percentage of payment processing fees charged by mobile carriers are relatively higher than those charged by third-party payment platforms. Additionally, due to their dominant position in China’s telecommunications industry, our ability to negotiate more favorable terms with mobile carriers is limited. Our relationships with and ability to negotiate favorable terms with these mobile carriers and third-party payment channels directly affect our costs and profitability.

 

    Costs of our distribution channels. Our results of operations are directly affected by the costs of our distribution channels. Our ability to self-distribute our games and generate game activations can reduce our distribution costs and marketing expenses. In 2013, 36.0% of our game activations were organically generated with no direct marketing expenses. Our proprietary distribution capabilities depend on our ability to cross-promote our games with other games in our portfolio, as well as with third-party applications of our business partners. Additionally, our proprietary distribution capabilities also depend on the success of our self-operated game distribution channels, such as iDreamSky Game Center and uu.cc. We also enter into distribution agreements with these third-party distributors, pursuant to which we pay a portion of the gross billings from games downloaded through their platforms. Our relationships with third-party distribution channels, particularly our ability to negotiate favorable terms with them, directly affect our costs and profitability.

Description of Certain Statement of Operations Items

Revenues

We generate revenues from games and other sources. The following table sets forth revenues generated from each source, both in absolute amount and as a percentage of total revenues for the years indicated:

 

     For the Year Ended December 31,      For the Three Months Ended March 31,  
     2012      2013      2013      2014  
     RMB      %      RMB      US$      %      RMB      %      RMB      US$      %  
     (in thousands, except percentages)  

Game revenues

     18,059         93.2         244,806         40,439         99.3         21,891         99.2         173,968         27,985         99.9   

Other revenues

     1,319         6.8         1,762         292         0.7         184         0.8         134         22         0.1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     19,378         100.0         246,568         40,731         100.0         22,075         100.0         174,102         28,007         100.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Games

Game revenues constituted almost all of our total revenues in 2012 and 2013, accounting for 93.2% and 99.3% of our total revenues, respectively. For the three months ended March 31, 2014, game revenues accounted for 99.9% of our total revenues. All of our games are free to play, and therefore game revenues are primarily derived from sales of in-game virtual items, including items, avatars, skills, privileges or other in-game consumables, features or functionality, within our games. Gross billings is the total monetary value of virtual items sold in our games. We record revenues based on gross or net basis, depending on whether we are a principal or an agent with respect to the games played. Our gross billings increased by 1,035.5% from 2012 to 2013 and by 520.0% from the three months ended March 31, 2013 to the three months ended March 31, 2014.

 

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For games for which we have content distribution agreements with game developers, we record revenues on a gross or net basis depending on whether we are considered a principal or an agent in these arrangements. To make such determination, we consider whether we take primary responsibilities for game operation, including determining distribution and payment channels, providing customer services, hosting game servers, controlling game and service specifications and pricing. Under the arrangements where we are considered an agent, we record revenues from licensed games only after deducting payments to game developers. Commission fees paid to distribution channels and payment channels are recorded as cost of revenues. Under the arrangements where we are considered as a principal, we record revenue on a gross basis. Content fees paid to third-party game developers and commission fees paid to distribution channels and payment channels are recorded as cost of revenues.

Revenues generated from third-party licensed games in which we are considered an agent amounted to 100.0%, 100.0% and 69.3% of our total game revenues for the year ended December 31, 2012, and 2013 and for the three months ended March 31, 2014, respectively. Revenues generated from third-party licensed games where we are considered a principal amounted to 4.7% of our total game revenues for the three months ended March 31, 2014; and no revenues were generated from these third-party licensed games in the years ended December 31, 2012 and 2013.

In the first quarter of 2014, we also began to publish games developed by Shenzhen Zhuoyou and Shenzhen Yiyou, subsidiaries of our VIE. We established with third parties these entities in order to license games developed by these entities on favorable commercial terms. Additionally, in 2014, we also published a game developed by a third party for which we have acquired intellectual property rights under a game acquisition agreement. Under this agreement, we acquired intellectual property rights to the game for a fixed consideration and do not share the gross billings. We generally record game revenues derived from these self-developed and acquired games on a gross basis, as we act as a principal to fulfil most obligations related to the operation of the games. Commission fees paid to distribution channels and payment channels are recorded as cost of revenues. We typically select games that are initially developed by smaller game developers that do not have the resources and platform to market and monetize the games effectively. We utilize our existing platform, know-how and resources for further development, refinement, monetization and marketing of these games. Revenues from these games amounted to 26.0% of our total game revenues for the three months ended March 31, 2014.

We operated 22 casual games and 6 mid- and hardcore games as of December 31, 2012, 18 casual games and 28 mid- and hardcore games as of December 31, 2013 and 18 casual games and 20 mid- and hardcore games as of March 31, 2014. The decrease in the number of mid- and hardcore games we operated from December 31, 2013 to March 31, 2014 is due to the fact that we focus on publishing highly popular games and therefore may retire in the ordinary course of our business certain games that are at the end of their life cycle. We license and operate mid- and hardcore mobile games that are developed by domestic mobile game developers. Most of such games are turn-based role-playing games, action role-playing games, strategy games and action fighting games with themes focusing on Chinese mythology, fantasy and history. After these games are launched, we continue to work with these developers to enhance features in the games, such as better visual effects and user experience, in order to better engage, retain and monetize our more dedicated users. We will monitor and retire games that are at the end of their life cycle.

Although we have retired certain mid- and hardcore games in the three months ended March 31, 2014, we generated revenues from mid- and hardcore games of RMB23.9 million (US$3.8 million) during this period, compared to RMB29.4 million (US$4.9 million) for all of 2013. Our average MAUs and MPUs from mid- and hardcore games increased to 2.8 million and approximately 133,000, respectively, in the three months ended March 31, 2014, compared to 0.9 million and approximately 17,800, respectively, in 2013. However, our ARPPU for mid- and hardcore games decreased to RMB59.9 (US$9.6) in the three months ended March 31, 2014 from RMB137.9 (US$22.8) in 2013 primarily because: (i) we began to support direct billing through mobile carriers in our mid and hardcore games in February 2014, as opposed to payments made through third-party payment

 

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channels, which resulted in more users, with smaller purchases during the initial ramp-up period, and (ii) a change in our mid- and hardcore game mix, which included a greater number of relatively simpler games with generally lower user spending. We believe that by focusing on promoting relatively popular games and enhancing the features of these games, our users enjoy a more immersive experience in these games and tend to play them for longer and more frequent sessions and spend more money on in-game purchases.

The following table sets forth revenues generated from casual games and mid- and hardcore games, both in absolute amounts and as a percentage of total game revenues for the years indicated:

 

     For the Year Ended December 31,      For the Three Months Ended March 31,  
     2012      2013      2013      2014  
     RMB      %      RMB      US$      %      RMB      %      RMB      US$      %  
     (in thousands, except percentages)  

Casual games

     10,803         60.0         215,364         35,576         88.0         15,471         70.7         150,041         24,136         86.2   

Mid- and hardcore games

     7,256         40.0         29,442         4,863         12.0         6,420         29.3         23,927         3,849         13.8   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total game revenues

     18,059         100.0         244,806         40,439         100.0         21,891         100.0         173,968         27,985         100.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Our game revenues are directly affected by the following key metrics:

 

    Monthly active users. MAUs refer to the number of unique user accounts that interacted with our SDK network in a particular month. Our average MAUs increased from 18.3 million in 2012 to 74.8 million in 2013 and to 98.3 million in the first quarter of 2014, and are directly affected by (i) the number of mobile games that we offer as of a certain date and (ii) the popularity of these games. Our MAUs are also affected by our level of user engagement and user retention. We evaluate user engagement by daily active users, or DAUs, and total game sessions, which are the total number of sessions played on our platform during a given period. We evaluate our user retention by user retention rate, which is the number of active users of the current month who were also active users of the previous month divided by the number of active users of the previous month. Our average DAUs in the first quarter of 2013 and the first quarter of 2014 was 16.8 million and 25.8 million, respectively. Our total game sessions in 2013 were 7.9 billion. Our total game sessions for the first quarter of 2013 and the first quarter of 2014 were 1.4 billion and 2.6 billion, respectively. Our user retention rate for the first quarter of 2013 and the first quarter of 2014 was 46.9% and 47.8%, respectively.

 

    Monthly paying users. MPUs refer to the number of unique user accounts through which a payment is made in our mobile games in a particular month. Our average MPUs increased from 0.1 million in 2012 to 3.1 million in 2013 and to 5.1 million in the first quarter of 2014, and are directly affected by, in addition to the factors that affect our MAUs, (i) the diversity of our virtual item offerings and (ii) the popularity and desirability of our virtual item offerings.

 

    Average revenue per monthly paying user. ARPPU for a certain month is calculated as game revenues in a particular month divided by the number of MPUs in that month. ARPPU for the year is calculated using game revenues for the entire year divided by the MPUs over the twelve-month period. Our ARPPU decreased from RMB10.5 in 2012 to RMB6.7 (US$1.1) in 2013 primarily due to a change in the mix of games as our casual games, which have larger paying user base and lower ARPPU. Our ARPPU increased to RMB11.3 (US$1.9) in the first quarter of 2014 from RMB6.9 in the first quarter of 2013, primarily due to our efforts to develop stronger purchasing habits in our users and increased purchases in our new mid- and hardcore games, which generally have higher ARPPU than our casual games.

Others

Other revenues primarily consist of revenues from advertising placements that third parties place on the interface of our mobile games and software outsourcing services that we provide to third parties.

 

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Cost of Revenues

Cost of revenues primarily consists of (i) payment processing costs, (ii) distribution channel costs, (iii) salary and welfare costs and (iv) other costs.

Payment processing costs are payment processing fees from the sales of in-game virtual items that are retained by payment channel providers in accordance with our agreements with them. Our payment channel providers include China’s three mobile carriers, namely China Mobile, China Unicom and China Telecom, and third-party payment platforms such as Alipay, Weixin Payments, China UnionPay and Yeepay. The mobile carriers and third-party payment platforms are generally entitled to a prescribed percentage of the gross billings, which is charged by the mobile carriers or third-party payment platforms to the mobile game players. The percentage retained by payment channel providers varies, with mobile carriers charging a relatively higher rate in comparison to third-party payment platforms. China’s three mobile carriers accounted for a majority of our payment processing costs. As payments for casual games are typically made through mobile carriers using SMS billings, and payments for mid- and hardcore games are typically made through third-party payment platforms, our payment processing costs as a percentage of our total revenues may fluctuate based on our revenue mix.

Distribution channel costs are fees that we pay to third-party distributors to allow downloads of our games through their platforms. Third-party distributors include (i) web stores and mobile app stores of China’s three major mobile carriers, (ii) other web and mobile distribution platforms, such as Tencent App Store, Qihoo 360 Mobile and 91 Wireless and (iii) mobile device makers who preinstall our games with their devices, such as Lenovo, Huawei and ZTE. We enter into distribution agreements with these third-party distributors, pursuant to which we pay a portion of the gross billings, net of payment processing costs, from games downloaded through their platforms.

Salary and welfare consists of salary and benefits (including share-based compensation) for game operations personnel. Other costs include outsourcing costs, bandwidth costs, business tax and surcharges, depreciation and amortization, office rentals and other cost of revenues. Other costs for the three months ended March 31, 2014 also include content fees paid to a third party game developer in an arrangement where we act as principal.

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

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2012     2013                 2013                                      2014                   
    RMB     % of revenues     RMB     US$     % of revenues     RMB     % of revenues     RMB     US$     % of revenues  
    (in thousands, except percentages)  

Payment processing costs

    4,641        23.9        92,738        15,320        37.6        6,510        29.5        61,506        9,894        35.3   

Distribution channel costs

    1,623        8.4        31,317        5,173        12.7        2,108        9.6        25,186        4,051        14.5   

Salary and welfare costs

    2,944        15.2        9,379        1,549        3.8        1,289        5.8        4,225        680        2.4   

Other costs

    5,385        27.8        22,464        3,711        9.1        3,580        16.2        10,351        1,665        6.0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    14,593        75.3        155,898        25,753        63.2        13,487        61.1        101,268        16,290        58.2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating Expenses

Our operating expenses consist of research and development expenses, sales and marketing expenses and general and administrative expenses.

 

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The following table sets forth the components of our operating expenses in absolute amounts and as a percentage of revenues for the periods indicated.

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2012     2013                 2013                                          2014                   
    RMB     % of revenues     RMB     US$     % of revenues     RMB     % of revenues     RMB     US$     % of revenues  
    (in thousands, except percentages)  

Research and development expenses

    7,501        38.7        14,214        2,348        5.8     

 

2,343

  

 

 

10.6

  

    6,799        1,094        3.9   

Sales and marketing expenses

    2,797        14.4        27,940        4,615        11.3     

 

4,698

  

 

 

21.2

  

    12,460        2,004        7.1   

General and administrative expenses

    4,713        24.3        14,780        2,442        6.0     

 

2,263

  

 

 

10.3

  

    11,281        1,816        6.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    15,011        77.5        56,934        9,405        23.1        9,304        42.1        30,540        4,914        17.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Research and development expenses primarily consist of (i) salary and welfare (including share-based compensation) for our R&D personnel and (ii) rental and depreciation of office premises and servers utilized by our R&D personnel.

Selling and marketing expenses primarily consist of (i) promotional expenses, (ii) expenses for attending industry trade shows and conferences and (iii) advertising expenses.

General and administrative expenses primarily consist of (i) salary and welfare (including share-based compensation) for our general and administrative personnel, (ii) traveling and entertainment expenses and (iii) office expenses.

Taxation

Cayman Islands

We are incorporated in the Cayman Islands. Under the current law of the Cayman Islands, we are not subject to income or capital gains tax. In addition, dividend payments are not subject to withholding tax in the Cayman Islands.

Hong Kong

Our subsidiary incorporated in Hong Kong is subject to Hong Kong profits tax at a rate of 16.5%.

China

Under the EIT Law, domestic enterprises and foreign investment enterprises, such as our WFOE and VIEs, are subject to a unified 25% enterprise income tax rate, except for certain entities that benefit from tax holidays or other types of preferential tax treatment.

Shenzhen iDreamSky is qualified as a “software enterprise” and is entitled to tax exemption for two years beginning from 2013 and 50% enterprise income tax rate reduction for the subsequent three years. Shenzhen iDreamSky is also qualified as a High and New Technology Enterprise and is entitled to a reduced enterprise income tax rate of 15% for years 2013, 2014 and 2015. Shenzhen iDreamSky has applied for and is approved to enjoy the preferential tax treatment for software enterprises.

 

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Under the EIT Law, dividends paid by foreign invested enterprises out of profits earned after January 1, 2008 to non-PRC tax resident enterprises are subject to a PRC withholding tax of 10%. Pursuant to the Arrangement between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income entered into between Hong Kong and the PRC and other related PRC laws and regulations, such rate is lowered to 5% if a Hong Kong resident enterprise owns over 25% of the equity interest of a PRC resident enterprise during the 12 consecutive months preceding the receipt of the dividends. Our PRC subsidiary is currently wholly-owned by our Hong Kong subsidiary. However, there is no assurance that PRC tax authorities will treat our Hong Kong subsidiary as the beneficial owner of the dividends paid by our PRC subsidiary and grant approvals for the 5% withholding tax rate on dividends received by our Hong Kong subsidiary from our PRC subsidiary.

The EIT Law also provides that enterprises established under the laws of foreign countries or regions and whose “de facto management body” is located within the PRC are considered PRC tax resident enterprises and subject to PRC income tax at the rate of 25% on worldwide income. The term “de facto management body” means an establishment that exercises, in substance, overall management and control over the production and business, personnel, accounting, properties and other aspects of an enterprise. We do not believe we are currently a PRC tax resident. However, it remains unclear how PRC tax authorities will determine the tax residency status of companies like us. If we are deemed as a PRC tax resident, we would be subject to 25% PRC enterprise income tax on our global income under the EIT Law. See “Risk Factors—Risk Related to Doing Business in China—We may be classified as a ‘resident enterprise’ for PRC enterprise income tax purposes, which could result in unfavorable tax consequences to us and our non-PRC Shareholders.”

Critical Accounting Policies and Estimates

We prepare our financial statements in conformity with U.S. GAAP, which requires us to make estimates and assumptions that affect our reporting of, among other things, assets and liabilities, contingent assets and liabilities and revenues and expenses. We regularly evaluate these estimates and assumptions based on the most recently available information, our own historical experiences and other factors that we believe to be relevant under the circumstances. Since our financial reporting process inherently relies on the use of estimates and assumptions, our actual results could differ from what we expect. This is especially true with some accounting policies that require higher degrees of judgment than others in their application. We consider the policies discussed below to be critical to an understanding of our audited consolidated financial statements because they involve the greatest reliance on our management’s judgment.

Revenue recognition

Game revenues

During the periods before to January 1, 2014, we were exclusively a publisher of mobile games developed by third-party game developers. We license mobile games from game developers and earn game publishing service revenue by making a localized version of the licensed games and publishing them to the game players through distribution channels, including various mobile application stores and software websites (collectively referred to as “distribution channels”), including our websites. Through the distribution channels, game players can download the mobile games to their mobile devices. The mobile games licensed by us include casual mobile games (also known as single-player offline mobile games) and mid- and hardcore mobile games (also known as multi-player online mobile games) which are operated under a free to-play model whereby game players can download the games free of charge and are charged for the purchase of in-game virtual items via payment channels, such as various mobile carriers and third-party internet payment systems (collectively referred to as “payment channels”).

Since January 1, 2014, in addition to publishing licensed mobile games, we also have published mobile games we developed and mobile games we acquired from third parties, through the distribution channels. These games are also operated under a free to-play model as noted above.

 

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Casual mobile games

For casual mobile games, game players play the games on their own. Upon the completion of download and installation of the games to the game players’ mobile device, all functionalities of the games have been fully delivered to the devices. Players can then play the games on their device without real time connection to the Internet. At game players’ discretion, in-game virtual items may be purchased to enhance game players’ game experience. The fulfillment of in-game purchase requires connection to the mobile carriers’ network or Internet connection to the servers of payment channels at the time of purchase. Once the game players confirm their purchase requests, the payment channels send an “unlock code” to the device of the game players and then the purchased virtual items are automatically unlocked in the downloaded game. Therefore, future play and use of the purchased features do not require ongoing online connectivity or involvement of us and game servers are not necessary for game players to player the game or utilize the purchased in-game features or items. We do not have a practice or history of replacing lost games or data of offline mobile games for game players.

Mid- and hardcore mobile games

For mid- and hardcore mobile games, game players interact with other online players to collaborate or to compete among themselves to complete certain tasks of the games within a virtual social environment. Playing of the online mobile games requires real time internet connection to game servers, where all in-game user information is stored, including game playing contents and player’s in-game purchase data. The game application downloaded on game players’ device is similar to a portal to access the online game servers which are hosted by the game developers. Game players may purchase in-game virtual items or features via the payment channels to enhance their game-playing experience similar to offline mobile games.

Principal Agent Consideration

Third party licensed mobile games

Proceeds earned from selling in-game virtual items, in both of the licensed casual and mid- and hardcore mobile games, are shared between us and the game developers, with the amount paid to the developers generally calculated based on amounts paid by players, after deducting for the fees paid to the payment channels and the distribution channels including the credit allowable for deduction for games that were downloaded through the our owned platforms, multiplied by a predetermined percentage for each game.

In accordance with ASC 605-45, Revenue Recognition: Principal Agent Considerations, we evaluate agreements with the game developers, distribution channels and payment channels in order to determine whether or not we act as the principal or as an agent in the arrangement with each party respectively, which we consider in determining if relevant revenues should be reported gross or net of the pre-determined amount of the proceeds shared with the other parties. The determination of whether to record the revenue gross or net is based on an assessment of various factors, including but not limited to whether we (i) are the primary obligor in the arrangement; (ii) have general inventory risk; (iii) change the product or perform part of the services; (iv) have latitude in establishing the selling price; (v) have involvement in the determination of product and service specifications. The assessment is performed for all of our licensed mobile games, including offline and online mobile games.

With respect to our game license arrangements entered into during the years ended December 31, 2012 and 2013, we considered that the (i) developers are responsible for providing the game product desired by the game players; (ii) the costs incurred by the developers to develop the games are more than the licensing costs and game localizations costs incurred by us; (iii) the hosting and maintenance of game servers for running the online mobile games is the responsibility of the developers; (iv and v) the developers have the right to review and approve the pricing of in-game virtual items and the specification, modification or update of the game made by us. Our responsibilities are publishing, providing payment solution and market promotion service, and thus we view the game developers to be our customers and consider us as the agent of the game developers in the arrangements with game players. Accordingly, we record the game publishing service revenue from these licensed games, net of amounts paid to the game developers.

 

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As we are responsible for identifying, contracting with and maintaining the relationships of the distribution and payment channels, commission fees paid to the distribution channels and payment channels are included in cost of revenues and presented on a gross basis. We consider us to be the primary obligor to the game developers for the reasons identified above as we have been given latitude by the game developers in selecting distribution and payment channels for our service to the game developers.

With respect to our game license arrangements entered into during the period ended March 31, 2014, there are new game license arrangements under which we take primary responsibilities of game operation, including determining distribution and payment channels, providing customer services, hosting game servers, if needed, and controlling game and services specifications and pricing. Under this type of game license arrangement, we considered us to be a principal in these arrangements. Accordingly, we record the mobile game revenues from these third-party licensed games on a gross basis. Commission fees paid to distribution channels and payment channels and content fees paid to third party game developers are recorded as cost of revenues.

Self-developed and acquired mobile games

Game revenues derived from self-developed and acquired mobile games are recorded on a gross basis as we act as a principal to fulfill most obligations related to the mobile game operation. Commission fees paid to distribution channels and payment channels are recorded as cost of revenues.

Timing of revenue recognition

We evaluate revenue recognition based on the criteria set forth in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605, Revenue Recognition and ASC 985-605, Software: Revenue Recognition. We recognize the service revenue when all four of the following criteria are met (i) persuasive evidence of an arrangement exists, (ii) service has been rendered, (iii) the selling price is fixed or determinable and (iv) the collection of the resulting receivable is reasonably assured.

Casual mobile games

For casual mobile games, we have determined that all revenue recognition criteria are met upon players’ confirmation of the purchase request and the unlocking of the purchased virtual items. This is because the service fee earned by us from the developers is fixed or determinable, the fee is considered collectible and the performance by us has occurred once the game players purchase virtual items. We have no additional performance obligations to the developers or game players in order to earn the service fee upon the completion of the corresponding in-game purchases. Therefore, we recognize revenue from providing services to casual mobile game developers upon the purchase of in-game virtual items by the game players.

Mid- and hardcore mobile games

For games where we are acting as an agent in selling the mid- and hardcore mobile games to game players, we have determined that all revenue recognition criteria are met upon players’ confirmation of the purchase request although the utilization of the purchased virtual items require connection to the game servers. The fact that the operation of these mobile games requires hosting and maintenance of online game servers would not affect the timing of revenue recognition by us because those obligations are the responsibilities of the game developers as the primary obligor. Therefore, we recognize revenue from providing services to mid- and hardcore mobile game developers upon the purchase of in-game virtual items by the game players as we have no further obligations to the developers in order to earn the service fee upon the completion of the corresponding in-game purchases.

For mid- and hardcore mobile games where we are acting as a principal, we have determined that we are obligated to provide on-going services to the game players who purchased virtual items to gain an enhanced

 

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game-playing experience over an average playing period of the paying players, and accordingly, we recognize the revenues ratably over the estimated average playing period of these paying players, starting from the point in time when virtual items are delivered to the players’ accounts, and all other revenue recognition criteria are met.

As the mid- and hardcore games are under a free-to-play model and revenue is generated from game paying players when they purchase game points for in-game virtual items, we focus on the playing period of paying players when estimating the period over which revenue is being recognized. We track each of the paying players’ purchases and log in history for each significant game to estimate the average playing period of the paying players (“estimated player play life”), which is the average playing period of all paying players between the first time the players charge game points into their accounts and the last log in. If a new game is launched and only a limited period of paying player data is available, then we consider other qualitative factors, such as the playing patterns for paying users for other games with similar characteristics.

For the three months ended March 31, 2014, the estimated player play life of three months is based on two games that have sufficient historical operating data. The same estimated player play life was applied to the other games due to the lack of sufficient historical operating data, as well as the similarity in game characteristics and playing patterns of paying players, such as targeted players and purchasing frequency. While we believe our estimates to be reasonable based on available game player information, we may revise such estimates in the future as the games’ operation periods change, sufficient individual game data become available, or there is indication that the similarities in characteristics and playing patterns of paying players of the games change. Any adjustments arising from changes in the estimates of player pay life would be applied prospectively on the basis that such changes are caused by new information indicating a change in game player behavior patterns. Any changes in our estimates of player pay life may result in revenues being recognized on a basis different from prior periods’ and may cause our operating results to fluctuate.

We also hosted and maintained certain servers to collect and analyze user location, type and number of games downloaded, playing frequency and time and purchasing habits of the users of our casual and mid- and hardcore games. However, the hosting and maintaining of these servers for internal data analysis does not affect the timing of revenue recognition by us.

Share-based compensation

We awarded a number of share-based compensation options to our employees and officers. The details of these share-based awards and the respective terms and conditions are described in “Share-based payments” in note 15 to our audited consolidated financial statements for the years ended December 31, 2012 and 2013.

Options are accounted for as equity-classified awards because we currently have no intention to exercise our call right to repurchase our ordinary shares acquired by the employees through the aforesaid share options and the number of shares of our ordinary shares issued under these awards are fixed and determined at the time of grants. All options are measured based on the fair value of the award on the grant date and recognized as compensation expenses based on the straight-line vesting method, net of estimated forfeitures, over the requisite service period, which is generally the vesting period.

The following table sets forth the options granted that were outstanding as of March 31, 2014:

 

Date of option grant

   Options
outstanding
     Average exercise
price
     Average fair value
of options as of
grant date
     Fair value of
ordinary shares
as of grant date
 
            (US$)      (US$)      (US$)  

July 31, 2012

     2,690,000         0.04         0.162         0.198   

 

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We estimate the fair value of share options granted using the binominal option pricing model. The key assumptions used to determine the fair value of the options at the relevant grant dates were as follows:

 

     Grant date  

Risk-free interest rate

     1.57

Volatility

     58.97

Dividend yield

       
  

 

 

 

Total share-based compensation costs recognized for the years ended December 31, 2012 and 2013 and for the three months ended March 31, 2013 and 2014 are as follows:

 

     For the Year Ended
December 31,
     For the Three Months
Ended March 31,
 
     2012      2013      2013      2014  
     RMB      RMB      US$      RMB      RMB      US$  
     (in thousands)  

Cost of revenues

     381         89         15         22         22         4   

Research and development expenses

     744         174         29         43         43         7   

General and administrative expenses

     290         66         10         17         17         3   

Fair value of our ordinary shares

Prior to the completion of this offering, we are a private company with no quoted market prices for our ordinary shares. We have therefore estimated, with assistance from an independent valuation firm, the fair value of our ordinary shares at certain dates in 2012 and 2013.

The following table sets forth the fair values of our ordinary shares estimated from January 1, 2012 to March 31, 2014:

 

Date

   Fair value per
ordinary share
(US$)
    

Type of methodology

  

Type of valuation

  

Purpose of
valuation

April 13, 2012

     0.1443       Income Approach    Contemporaneous    Series A, Series B valuation

July 31, 2012

    
0.1980
  
   Income Approach    Contemporaneous    Valuation of ESOP

June 30, 2013

     0.3526       Income Approach    Contemporaneous    Series B-1 valuation

September 3, 2013

     0.4273       Income Approach    Contemporaneous    Series A-1, Series C valuation

We estimated the fair value of our ordinary shares based on valuations performed by our management with the assistance of an independent valuer for options granted after January 1, 2011. Determining the fair values of our ordinary shares requires our management to make complex and subjective judgments regarding our projected financial and operating results, the unique business risks, the liquidity of our ordinary shares and operating history and prospects at the time of each grant. Therefore, these fair values are inherently uncertain and highly subjective.

In determining the fair values of our ordinary shares as of each award grant date, we consider a number of objective and subjective factors that we believe market participants would consider, including (a) our business,

 

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financial condition, and results of operations, including related industry trends affecting our operations; (b) our forecasted operating performance and projected future cash flows; (c) the illiquid nature of our ordinary shares; (d) liquidation preferences and other rights and privileges of our ordinary shares; (e) market multiples of our most comparable public peers; (f) recent sales of our securities; and (g) market conditions affecting our industry. Therefore, we considered three generally accepted approaches to value our ordinary shares: market approach, cost approach and income approach. We believe that the market approach and cost approach are inappropriate for the valuation. Firstly, the market approach requires market transactions of comparable assets as an indication of value, and we have not identified any current market transactions which are comparable. Secondly, the cost approach does not directly incorporate information about the economic benefits contributed by the underlying business. We decided to rely upon the income approach as the sole means of valuation since we believe we are a later-stage enterprise as opposed to an early-stage enterprise. We believe we have enough financial data on which to base a forecast of future results. In applying the income approach to determine the value of our ordinary shares, a discount was applied to reach the final valuation of our ordinary shares based on the fact that, inasmuch as we are a private company, there are impediments to liquidity, including lack of publicly available information and the lack of a trading market. The discounted cash flow method is a method within the income approach whereby the present value of future expected net cash flows is calculated using a discount rate.

The major assumptions used in calculating the fair values of our ordinary shares include:

 

    Weighted average cost of capital, or WACC: The WACCs were determined based on a consideration of the factors including risk-free rate, comparative industry risk, equity risk membership, company size and non-systematic risk factors;

 

    Comparable companies: In deriving the WACCs, which are used as the discount rates under the income approach, NetEase Inc., Giant Interactive Group Inc., Perfect World Co., Ltd., NetDragon Websoft Inc., Kingsoft Corp Ltd, Tencent Holdings Limited and NCSoft Corporation were selected for reference as our guideline companies.

 

    The income approach involves applying appropriate discount rates to estimated cash flows that are based on earnings forecasts. Our revenues and earnings growth rates, as well as major milestones that we have achieved, contributed significantly to the change in the fair value of our ordinary shares from January, 2011 to March 31, 2014. However, these fair values are inherently uncertain and highly subjective. The assumptions used in deriving the fair values are consistent with our business plan. These assumptions include: the projected business performances can be achieved with the effort of our managements; there will be no material change in the existing political, legal, technological, fiscal or economic conditions, which might adversely affect our business; the operational and contractual terms stipulated in the relevant contracts and agreements will be honored; and the facilities and systems proposed are sufficient for future expansion in order to realized the growth potential of the business and maintain a competitive edge;

 

    For the income approach, we forecasted our future debt-free net cash flows for five to six years subsequent to the valuation dates and applied H Model to calculate the terminal debt-free cash flow after five to six years. The net cash flow was then discounted to present value using a risk-adjusted discount rate, which was based on market inputs using a capital asset pricing model that reflected the risks associated with achieving our forecasts. The terminal or residual value at the end of the projection period was based on the H Model with the terminal growth rate assumed to be 3% for all the valuation dates. The resulting terminal value and interim debt-free cash flows were then discounted at a rate ranging from 27.6% to 32.4% for the respective valuation date which was based on the weighted average cost of capital of comparable companies, as adjusted for our specific risk profile.

 

   

Our total equity value was then allocated between the preferred shares and ordinary shares. The valuation model allocated the equity value between the ordinary shares and the preferred shares and calculated the fair value of ordinary shares based on the option-pricing method. Under this method, ordinary shares have value only if the funds available for distribution to shareholders exceed the value

 

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of the liquidation preference at the time of a liquidity event (for example, merger or sale) or the value of the redemption amount at the time of a redemption event. The ordinary shares are considered to be a call option with claim on the equity above the exercise price equal to the liquidation preferences or the redemption amount of the preferred shares.

 

    Discount for lack of marketability, or DLOM, a discount for lack of marketability 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 Pricing Model was used. Under the option pricing method, the fair value of the put option, which can hedge against a price decline before the privately held shares can be sold, was considered as a basis to determine the discount for lack of marketability.

 

    These assumptions are inherently uncertain. Different assumptions and judgments would affect our calculation of the fair value of the underlying ordinary shares for the options granted, and the valuation results and the amount of share-based compensation expenses would also vary accordingly.

Fair value of our convertible and redeemable preferred shares

In addition to our ordinary shares, we have determined the fair value of the Series A, Series A-1, Series B, Series B-1 and Series C convertible preferred shares. The result of which is used to determine the amount of redemption values of our convertible and redeemable preferred shares. Consistent with ordinary shares discussed above, the determination of the fair value of our Series A, Series A-1, Series B, Series B-1 and Series C convertible preferred shares requires complex and subjective judgments to be made regarding our projected financial and operating results, our unique business risk, the liquidity of these shares and our operating history and prospects at the time of valuation.

The major assumptions used in calculating the fair values of our Series A, Series A-1, Series B, Series B-1 and Series C convertible preferred shares include:

 

    Event scenario. Our best estimation of the occurrence and the timing of (1) a liquidation event; (2) a redemption event or (3) an initial public offering, or IPO, event. The probabilities of the occurrence of an IPO event are assumed to be ranging from 30% to 85% for the respective valuation dates and the probabilities of the occurrence of a liquidation event or a redemption event is each assumed to be ranging from 7.5% to 35% respectively for the respective valuation dates.

 

    Risk free rate. The risk free rates used in the liquidation and the redemption scenarios are assumed to be ranging from 0.9% to 1.7%, using the U.S. Treasury Bonds & Notes Yield corresponding to the assumed period to the occurrence of the event for the respective valuation dates. The risk-free rates used in the IPO event are assumed to be ranging from 0.1% to 0.4%, using the U.S. Treasury Bonds & Notes Yield corresponding to the assumed period to the occurrence of the event for the respective valuation dates.

 

    Volatility. The volatility estimate is based on the average volatility of the stock returns of selected comparable companies engaged in similar lines of business as ours and are publicly traded in international stock markets. The volatilities are assumed to be ranging from 40.8% to 57.1% for the respective valuation dates. NetEase Inc., Giant Interactive Group Inc., Perfect World Co., Ltd., NetDragon Websoft Inc., Kingsoft Corp Ltd, Tencent Holdings Limited and NCSoft Corporation were selected for reference as our guideline companies.

The option-pricing method was used to allocate enterprise value to preferred and ordinary shares, taking into account the guidance prescribed by the AICPA Audit and Accounting Practice Aid, “Valuation of Privately-Held Company Equity Securities Issued as Compensation.” The method treats common stock and preferred stock as call options on the enterprise’s value, with exercise prices based on the liquidation preference of the preferred shares.

 

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Consolidation

Our consolidated financial statements include the financial statements of iDreamSky, our subsidiaries and VIEs for which iDreamSky is the primary beneficiary. All transactions and balances between our subsidiaries, VIEs and us have been eliminated upon consolidation.

The assets and liabilities of the VIEs are consolidated in our financial statements based on historical cost. Our consolidated statements of operations and comprehensive loss and consolidated statements of cash flows include our results of operations and cash flows as if the current group structure had been in existence throughout the years ended December 31, 2012 and 2013, or since their respective dates of incorporation, whichever is the shorter. Our consolidated balance sheets have been prepared to present the financial position as of December 31, 2012 and 2013 as if the current group structure had been in existence as of these dates.

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

A VIE is an entity in which we, through contractual agreements, bear the risks of, and enjoys the rewards normally associated with the ownership of the entity, and therefore we are the primary beneficiary of the entity. In determining whether we are the primary beneficiary, we considered whether we have the power to direct activities that are significant to the VIEs economic performance, and also our obligation to absorb losses of the VIE that could potentially be significant to the VIEs or the right to receive benefits from the VIEs that could potentially be significant to the VIEs.

We hold all the variable interests of the VIEs and have been determined to be the primary beneficiary of the VIEs.

All significant transactions and balances among our subsidiaries, VIEs and us have been eliminated upon consolidation.

Income taxes and uncertain tax positions

Current income taxes are provided on the basis of net income for financial reporting purposes, adjusted for income and expense items which are not assessable or deductible for income tax purposes, in accordance with the regulations of the relevant tax jurisdictions. Deferred income taxes are accounted for using an asset and liability method. Under this method, deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. The effect on deferred taxes of a change in tax rates is recognized in the statements of operations and comprehensive loss in the period of change. A valuation allowance is provided to reduce the amount of deferred tax assets if it is considered more likely than not that some portion of, or all of the deferred tax assets will not be realized.

Significant judgment is required in evaluating our uncertain tax positions and determining its provision for income taxes. We recognize interests and penalties, if any, under accrued expenses and other current liabilities on the balance sheet and under other expenses in thes statements of operations and comprehensive loss. We did not recognize any significant interest and penalties associated with uncertain tax positions for the years ended December 31, 2012 and 2013 and the three months ended March 31, 2014. As of December 31, 2012 and 2013 and March 31, 2014, we did not have any significant unrecognized uncertain tax positions.

 

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Impairment of long-lived assets and intangible assets

For long-lived assets including amortizable intangible assets, we evaluate for impairment whenever events or changes (triggering events) indicate that the carrying amount of an asset may no longer be recoverable. We assesse the recoverability of the long-lived assets by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to receive from use of the assets and their eventual disposition. Such assets are considered to be impaired if the sum of the expected undiscounted cash flows is less than the carrying amount of the assets. The impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.

Foreign currency translation

We use the Renminbi as the reporting currency. The functional currency of our company and our subsidiaries incorporated in Hong Kong are the U.S. dollar and the Hong Kong dollar, respectively, while the functional currency of our other entities and VIEs and their subsidiary is the Renminbi, which is their respective local currency. In the consolidated financial statements, the financial information of our company, our subsidiaries and VIEs, which use either the U.S. dollar or Hong Kong dollar as their functional currency, have been translated into RMB. Assets and liabilities are translated at the exchange rates on the balance sheet date, equity amounts are translated at historical exchange rates, and revenues, expenses, gains, and losses are translated using the average exchange rate for the period. Translation adjustments arising from these are reported as other comprehensive income or loss in the statement of operations and comprehensive loss.

Foreign currency transactions denominated in currencies other than the functional currency are translated into the functional currency using the exchange rates prevailing at the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are remeasured at the applicable rates of exchange in effect at that date. Foreign exchange gains and losses resulting from the settlement of such transactions and from remeasurement at year-end are recognized in foreign currency exchange gains/losses, net in the consolidated statement of operations and comprehensive loss.

Internal Control over Financial Reporting

Prior to this offering, we have been a private company with limited accounting personnel and other resources to address our internal control over financial reporting. In connection with the preparation and external audit of our consolidated financial statements, we and our independent registered public accounting firm identified two material weaknesses and other control deficiencies in our internal control over financial reporting as of December 31, 2013. Neither we nor our independent registered public accounting firm undertook a comprehensive assessment of our internal control under the Sarbanes-Oxley Act for purposes of identifying and reporting any weakness or significant deficiency in our internal control over financial reporting, as we and they will be required to do once we become a public company. Had we performed a formal assessment of our internal control over financial reporting or had our independent registered public accounting firm performed an audit of our internal control over financial reporting, additional control deficiencies may have been identified.

One material weaknesses identified relates to our lack of sufficient accounting personnel with appropriate knowledge of U.S. GAAP and SEC reporting requirements to properly address complex U.S. GAAP technical accounting issues and prepare and review financial statements and related disclosures in accordance with U.S. GAAP and SEC reporting requirements. The other material weakness identified relates to our lack of effective control procedures, including the lack of a comprehensive accounting manual, to track, estimate and record the proceeds that we share with our game developer partners and to assess the completeness and accuracy of the related accruals on the proceeds sharing and withholding taxes. We do not believe that these material weaknesses had a significant impact on our financial reporting.

 

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To address the material weaknesses and control deficiencies identified and to improve our internal control over financial reporting and disclosure controls, we have taken initiatives to implement and plan to implement further measures, including:

 

    we have hired our chief financial officer, Jun Zou, who has over 20 years of finance experience, including serving as chief financial officer at two U.S.-listed companies whose financial statements were prepared under U.S. GAAP, and other major corporations in China and the United States. We are in the process of hiring additional accounting staff with U.S. GAAP and SEC reporting experience for our finance department. We are also building our internal audit function and have hired an internal auditor with prior experience working at a U.S. listed company overseeing Sarbanes-Oxley Act compliance matters and a “Big Four” accounting firm. We will implement policies to ensure the independence of our internal audit function;

 

    we have allocated greater internal resources to our finance department. We are in the process of improving our financial oversight function, introducing formal business performance review process for financial reporting, setting clear roles and responsibilities within the department, hiring more accounting and finance staff of different levels and providing them formal and regular trainings in U.S. GAAP and SEC reporting to ensure proper performance of relevant roles and responsibilities; and

 

    we are establishing, and will continue to update, a set of internal policies and accounting guidance to formalize our process to track, estimate and record the proceeds that we share with our game developer partners and to assess the completeness and accuracy of the related accruals on the proceeds sharing and withholding taxes. In order to enhance our ability to effectively perform this process, we will also provide trainings to our staff at relevant business departments.

We expect to complete the measures discussed above by the end of 2014 and will continue to implement measures to remedy our other control deficiencies. However, the implementation of these measures may not fully address the material weaknesses and other control deficiencies in our internal control over financial reporting. We are not able to estimate with reasonable certainty the costs that we will need to incur to implement these and other measures designed to improve our internal control over financial reporting. See “Risk Factors—Risks Related to Our Business—If we fail to establish an effective system of internal control, we may be unable to accurately and timely report our financial results or prevent fraud.”

 

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Results of Operations

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

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2012     2013     2013     2014  
    RMB     %     RMB     US$     %     RMB     %     RMB     US$     %  
    (in thousands, except share and per share data)  

Consolidated Statement of Operations Data:

                   

Revenues:

                   

Game revenues

    18,059        93.2        244,806        40,439        99.3        21,891        99.2        173,968        27,985        99.9   

Other revenues

    1,319        6.8        1,762        292        0.7        184        0.8        134        22        0.1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    19,378        100.0        246,568        40,731        100.0        22,075        100.0        174,102        28,007        100.0   

Cost of revenues

    (14,593     (75.3     (155,898     (25,753     (63.2     (13,487     (61.1     (101,268     (16,290     (58.2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    4,785        24.7        90,670        14,978        36.8        8,588        38.9        72,834        11,717        41.8   

Operating expenses:

                   

Research and development expenses

    (7,501     (38.7     (14,214     (2,348     (5.8     (2,343     (10.6     (6,799     (1,094     (3.9

Sales and marketing expenses

    (2,797     (14.4     (27,940     (4,615     (11.3     (4,698     (21.2     (12,460     (2,004     (7.1

General and administrative expenses

    (4,713     (24.3     (14,780     (2,442     (6.0     (2,263     (10.3     (11,281     (1,816     (6.5
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    (15,011     (77.5     (56,934     (9,405     (23.1     (9,304     (42.1     (30,540     (4,914     (17.5

Other gains, net

    946        4.9        106        17        0.0        46        0.2        1,194        192        0.7   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (loss)/profit

    (9,280     (47.9     33,842        5,590        13.7        (670     (3.0     43,488        6,995        25.0   

Interest income

    20        0.1        81        13        0.0        7        0.0        39        6        0.0   

Foreign exchange (loss)/gain and others

    (63     (0.3     266        44        0.1        (19     (0.1     (598     (96     (0.3

Share of loss from an equity investment

                  (170     (28     (0.1                   (29     (4     0.0