424B4 1 d145427d424b4.htm 424(B)(4) 424(B)(4)
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Filed Pursuant to Rule 424(b)(4)
Registration No.333-256281

3,623,000 American Depositary Shares

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Zhangmen Education Inc.

Representing 32,607,000 Class A Ordinary Shares

 

 

We are selling 3,623,000 American depositary shares, or ADSs. Each ADS represents nine of our Class A ordinary shares, par value US$0.00001 per share.

This is an initial public offering of American depositary shares, or ADSs, of Zhangmen Education Inc. Prior to this offering, there has been no public market for the ADSs or our Class A ordinary shares.

Our ADSs have been approved for listing on the New York Stock Exchange under the symbol “ZME.”

Following the completion of this offering, our issued and outstanding share capital will consist of Class A ordinary shares and Class B ordinary shares, and we will be a “controlled company” as defined under the NYSE corporate governance listing standards. Mr. Yi Zhang, our founder, chairman of the board of directors and chief executive officer, will beneficially own all of our issued Class B ordinary shares and will be able to exercise 82.7% of the total voting power of our issued and outstanding share capital immediately following the completion of this offering. Holders of Class A ordinary shares and Class B ordinary shares have the same rights except for voting and conversion rights. Each Class A ordinary share is entitled to one vote, and each Class B ordinary share is entitled to 30 votes and is convertible into one Class A ordinary share. Class A ordinary shares are not convertible into Class B ordinary shares under any circumstances.

Our existing principal shareholder, SVF II ZEAL SUBCO (DE) PTE. LTD., has subscribed for, and has been allocated by the underwriters an aggregate of 434,783 ADSs in this offering at the initial public offering price, representing approximately 12.0% of the ADSs being offered in this offering, assuming the underwriters do not exercise their overallotment option. The underwriters will receive the same underwriting discounts and commissions on any ADSs purchased by these parties as they will on any other ADSs sold to the public in this offering. See “Underwriting.”

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

 

Investing in the ADSs involves risks. See “Risk Factors” beginning on page 16 for factors you should consider before buying the ADSs.

 

 

PRICE US$11.50 PER ADS

 

 

Neither the United States Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

 

      

Per ADS

      

Total

 

Initial public offering price

       US$11.50          US$41,664,500  

Underwriting discounts and commissions(1)

       US$0.81          US$2,916,515  

Proceeds, before expenses, to us

       US$10.70          US$38,747,985  

 

(1)

See “Underwriting” for additional information regarding compensation payable by us to the underwriters.

We have granted the underwriters a 30-day option to purchase up to an additional 543,450 ADSs at the initial public offering less the underwriting discounts and commissions.

The underwriters expect to deliver the ADSs to purchasers on or about June 10, 2021.

 

 

 

Morgan Stanley   Credit Suisse

 

Citigroup   CICC   Macquarie Capital

 

FUTU   Tiger Brokers   Snowball

The date of this prospectus is June 7, 2021.


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Table of Contents

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Table of Contents

TABLE OF CONTENTS

 

     Page  

PROSPECTUS SUMMARY

     1  

RISK FACTORS

     16  

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     71  

USE OF PROCEEDS

     73  

DIVIDEND POLICY

     74  

CAPITALIZATION

     75  

DILUTION

     78  

ENFORCEABILITY OF CIVIL LIABILITIES

     80  

CORPORATE HISTORY AND STRUCTURE

     82  

SELECTED CONSOLIDATED FINANCIAL DATA

     88  

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

     91  

INDUSTRY

     114  

BUSINESS

     122  

REGULATION

     148  

MANAGEMENT

     169  

PRINCIPAL SHAREHOLDERS

     176  

RELATED PARTY TRANSACTIONS

     180  

DESCRIPTION OF SHARE CAPITAL

     181  

DESCRIPTION OF AMERICAN DEPOSITARY SHARES

     195  

SHARES ELIGIBLE FOR FUTURE SALE

     207  

TAXATION

     209  

UNDERWRITING

     216  

EXPENSES RELATED TO THIS OFFERING

     229  

LEGAL MATTERS

     230  

EXPERTS

     231  

WHERE YOU CAN FIND ADDITIONAL INFORMATION

     232  

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

     F-1  

Until July 2, 2021 (the 25th day after the date of this prospectus), all dealers that effect transactions is these ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealer’ obligation to deliver a prospectus when acting as an underwriter and with respect to their unsold allotments or subscriptions.

You should rely only on the information contained in this prospectus or in any free writing prospectus that we authorize to be distributed to you. We and the underwriters have not authorized anyone to provide you with any information other than that contained in this prospectus or in any free writing prospectus prepared by or on behalf of us or to which we have referred you, and neither we, nor the underwriters take responsibility for any other information others may give you. We are offering to sell, and seeking offers to buy the ADSs, only in jurisdictions where such offers and sales are permitted. The information in this prospectus or any free writing prospectus is accurate only as of its date, regardless of its time of delivery or the time of any sale of the ADSs. Our business, financial condition, results of operations and prospectus may have changed since that date.

Neither we nor any of the underwriters has taken any action to permit a public offering of the ADSs outside the United States or to permit the possession or distribution of this prospectus or any filed free writing prospectus outside the United States. Persons outside the United States who come into possession of this prospectus or any filed free writing prospectus must inform themselves about and observe any restrictions relating to the offering of the ADSs and the distribution of the prospectus or any filed free writing prospectus outside the United States.

 

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PROSPECTUS SUMMARY

The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information and financial statements appearing elsewhere in this prospectus. In addition to this summary, we urge you to read the entire prospectus carefully, especially the risks of investing in the ADSs discussed under “Risk Factors,” before deciding whether to invest in the ADSs. This prospectus contains information from an industry report commissioned by us dated in March 2021 and prepared by Frost & Sullivan, an independent research firm, to provide information regarding our industry and our market position in China. We refer to this report as the “Frost & Sullivan Report.”

Our Mission

We aspire to make learning an effective, personalized and enjoyable experience by leveraging the power of technology.

Who We Are

We are a leading online education company in China focused on providing personalized online courses to K-12 students according to the Frost & Sullivan Report. Our core course offerings encompass one-on-one and small-class after-school tutoring services covering all core K-12 academic subjects. According to the Frost & Sullivan Report, we have been the largest online K-12 one-on-one after-school tutoring service provider in China in terms of gross billings since 2017, with 31.9% market share in 2020, exceeding that of the rest of the top 10 players combined in 2020. We continually enrich our service and product offerings to address students’ evolving and diversified educational needs. We began to offer small-class K-12 after-school tutoring services in the third quarter of 2020 to drive and cater to diversified educational goals. To attract more students with higher lifetime value, we also provide early childhood education services covering a diverse array of subjects, including art, language skills, logical thinking, and learning methodology.

We have established a portfolio of well-recognized online education brands known for delivering exceptional learning outcomes to our students. We believe that personalized education service is the key to an effective learning experience, and as such, we strategically started our business by focusing on after-school tutoring services in one-on-one format. Leveraging our high-quality teaching talents with localized insights, data-driven localized educational content and powerful technology infrastructure, we provide a personalized and results-driven learning experience to students across different regions. The degree of localization in educational content is critical to improve students’ academic performance because curriculum and exam questions vary significantly across different regions. We are equipped with a proprietary content library featuring localized course materials and a localization research center that focuses on refining our education resources to align with local curriculum. We hire teachers and student service staff with local curriculum insights to address the varying learning needs of students from different regions. Over the years, we have successfully garnered wide recognition in the industry and established “Zhangmen” as a trusted online education brand. The effectiveness of our tutoring services is demonstrated by the strong track record of significant academic improvement and the outstanding performance of our students. We regularly review student survey data to measure academic improvement and student performance. Based on our student surveys conducted in 2019 and 2020, 74.9% and 74.7% of our students improved their test scores in school after taking our courses, respectively. The quality of our tutoring services is also evident from our high annual student retention rate and strong student acquisition through organic word-of-mouth referrals. In 2020, our annual student retention rate for our flagship online K-12 one-on-one after-school tutoring services, Zhangmen One-on-One, was over 80% and over 50% of our gross billings from the first-time paid student enrollments for our Zhangmen One-on-One program were generated by referrals from our existing students and their parents.

Our brand recognition, content development and proprietary technology infrastructure, as well as our unique teacher management system for our K-12 one-on-one tutoring service have contributed to the rapid growth of our



 

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small-class after-school tutoring services. We launched Zhangmen Small Class in the third quarter of 2020 to offer small-class K-12 after-school tutoring services. We typically have up to 25 students per class for our small-class courses. We execute our localization strategy by assigning students from the same city to teachers well versed in the curriculum and exam requirements of that particular region. According to the Frost & Sullivan Report, we are the third largest online K-12 small class after-school tutoring service provider in China as measured by gross billings in 2020, with the fastest quarter-on-quarter growth among the top 5 players in the industry in terms of gross billings in the fourth quarter of 2020.

We believe that above our deep industry expertise sits a differentiating theme of our company – a constant drive to deliver better educational content and operational efficiency through data analytics and other advanced technology. We have developed a massive, proprietary educational content library and accumulated a wealth of data through years of frequent interactions with our students. Our data insights and advanced AI technologies are applied in multiple areas of our business operations, including improving our modularized curriculum and content development, automatically generating and refining course materials tailored for each student according to their learning progress, as well as delivering an effective and enjoyable learning experience for students.

Since our inception, we have been pursuing operational efficiency and scalability through building and optimizing our proprietary technology infrastructure and business intelligence system. To streamline our operations, we have digitalized each critical step of our operations and centralized our key operating functions, including student acquisition and conversion, curriculum development, and teacher management. Powered by our centralized business intelligence system, we have optimized sales and marketing efficiency, achieved high student satisfaction and retention, improved our teachers’ utilization and productivity, and scaled up our new service offerings cost-effectively with consistent quality. We aim to maximize lifetime value of each student with a variety of programs tailored to different age groups. In 2020 and the three months ended March 31, 2021, 66.7% and 69.0% of our students enrolled in our Zhangmen Kids program continued to enroll in our Zhangmen One-on-One program, respectively.

We believe teachers are the pillars of the education industry. We selectively hire teaching talents and empower them with proprietary AI-driven teaching tools to propel the efficiency and productivity of teachers.

 

   

Teacher recruitment. Our rigorous teacher selection and training process dovetails with our proprietary smart content recommendation tools. As of March 31, 2021, we had over 45,000 well-trained teachers, all of whom graduated from universities or professional teaching colleges in China. We have adopted an effective and cost-efficient teacher recruiting and management mechanism focused on recruitment, training, and retention of high quality teachers. From the pool of prospective teachers in 2020, we accepted only 3.8% of the candidates as our teachers.

 

   

AI-driven teaching tools. Our proprietary smart teaching tools and content recommendation system have significantly improved the efficiency and productivity of our teachers, allowing us to expand rapidly while maintaining consistent teaching quality. Our smart teaching tools are integrated into teachers’ daily teaching activities including class preparation, course delivery, course review and academic assessment and quizzes. We have developed an intelligent content recommendation system that automatically generates bespoke course materials and complimentary optional practice exercises by leveraging our comprehensive content library and big data capabilities.

 

   

Teacher scheduling. We have developed a smart, data-driven course scheduling system, enabling us to properly forecast course demand to optimize our teachers’ utilization and provide guidance to our recruitment plans for teachers.

The success of our business model is evidenced by our rapid growth. Paid student enrollments of our online one-on-one after-school tutoring increased by 43.2% from 380,517 in 2019 to 544,813 in 2020, and by 52.2%



 

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from 87,783 for the three months ended March 31, 2020 to 133,601 for the same period in 2021. Paid student enrollments of our online small-class after-school tutoring reached 294,397 in the first quarter of 2021, representing a 222.6% growth from 91,260 in the third quarter of 2020. Our net revenues increased by 50.6% from RMB2,668.7 million in 2019 to RMB4,018.4 million (US$613.3 million) in 2020, and by 19.9% from RMB1,122.7 million for the three months ended March 31, 2020 to RMB1,345.7 million (US$205.4 million) for the same period in 2021. Our gross billings increased by 36.3% from RMB3,855.3 million in 2019 to RMB5,254.4 million (US$802.0 million) in 2020, and by 73.1% from RMB762.0 million for the three months ended March 31, 2020 to RMB1,319.3 million (US$201.4 million) for the same period in 2021. For discussions of gross billings and reconciliation of gross billings to net revenues, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-GAAP Financial Measure.” We have significantly improved our operating efficiency. Our sales and marketing expenses as a percentage of our net revenues decreased from 81.4% in 2019 to 64.1% in 2020. We had net loss of RMB1,504.0 million in 2019, RMB1,012.3 million (US$154.5 million) in 2020 and RMB497.3 million (US$75.9 million) for the three months ended March 31, 2021.

Our Strengths

We believe the following competitive strengths are essential for our success and differentiate us from our competitors:

 

   

clear market leader with well-established brand recognition;

 

   

high-quality teachers and expertise in teacher management;

 

   

personalized learning experience driven by data analytics and other advanced technology;

 

   

operational excellence powered by robust technology infrastructure and business intelligence system;

 

   

scalable and synergistic business model with comprehensive service offerings; and

 

   

visionary and entrepreneurial management with strong passion for education and innovation.

Our Strategies

We intend to enhance student engagement and increase our paid student enrollment by pursuing the following strategies:

 

   

further solidify our leadership position in the online K-12 one-on-one after-school tutoring market;

 

   

expand our online K-12 small class after-school tutoring services;

 

   

continue to focus on the quality of our teaching content and methods, as well as teaching staff recruitment;

 

   

further realize operating efficiencies; and

 

   

diversify our education service offerings to address unmet demands.

Industry Overview

China has the largest online education market in the world. According to the Frost & Sullivan Report, China’s online education market in terms of gross billings increased from RMB74.4 billion in 2016 to RMB260.6 billion in 2020, representing a CAGR of 36.8%, and is expected to further increase to RMB906.6 billion in 2025, representing a CAGR of 28.3% from 2020. China’s online education market, which delivers courses to students via websites, mobile apps and other online platforms, has emerged as an increasingly popular approach to address the expanding market demand for education.



 

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Online K-12 after-school tutoring market includes tutoring for all academic subjects taught in K-12 schools. Online K-12 after-school tutoring is an efficient method to solve the regional imbalance of K-12 education resources in China. China’s online K-12 after-school tutoring market in terms of gross billings grew from RMB5.8 billion in 2016 to RMB85.5 billion in 2020, representing a CAGR of 95.9%, and is expected to further increase to RMB414.0 billion in 2025, representing a CAGR of 37.1% from 2020. Online K-12 after-school tutoring courses are generally divided into one-on-one, mini-class, small-class, and large-class formats.

With one teacher attending to only one student in each class, online one-on-one tutoring delivers a more customized and personalized learning experience to students, catering to each student’s education needs. China’s online K-12 one-on-one after-school tutoring market in terms of gross billings reached RMB14.7 billion in 2020, and is expected further increase to RMB51.5 billion in 2025, representing a CAGR of 28.5%. The online K-12 one-on-one after-school tutoring market in China is currently at an early development stage. Despite its relatively short history, online K-12 after-school tutoring market is already more consolidated than the offline education market. The top five players, as a whole, are expected to grow faster than the overall online K-12 one-on-one after-school tutoring industry.

Online K-12 small-class after-school tutoring has become increasingly popular as it provides a flexible, cost-effective and interactive education solution to students and parents. The gross billings of China’s online K-12 small-class after-school tutoring market reached RMB2.5 billion in 2020, and is projected to reach RMB81.0 billion in 2025, representing a CAGR of 100.5%.

Recent Development

The State Council promulgated the amended Regulations on the Implementation of the Law for Promoting Private Education of the PRC on April 7, 2021, or the Amended Implementation Regulations of Private Education Law, which will become effective on September 1, 2021. The Amended Implementation Regulations of Private Education Law requires a private school engaging in online education activities using internet technology to obtain a private school operating permit. As advised by our PRC counsel, Tian Yuan Law Firm, we may need to obtain the private school operating permit as an online tutoring service provider, according to the Amended Implementation Regulations of Private Education Law. We intend to apply for this permit when the regulatory authorities issue detailed rules setting forth the level of government authorities in charge of permit review and issuance and when the government authorities start to accept applications around September 1, 2021. We have already made filings with the regulatory authorities as an online after-school training institution according to Implementation Opinions on Regulating Online After-School Training issued by the Ministry of Education, together with certain other PRC government authorities, in 2019. Based on our consultation with relevant government authorities, as we have made the foregoing filings, we do not perceive material obstacles to us obtaining the private school operating permit. For potential risks on our business due to the Amended Implementation Regulations of Private Education Law, see “Risk Factors—Risk Factors Related to Our Business and Industry—Certain aspects of our business operations may be deemed not to be in full compliance with PRC regulatory requirements regarding online private education. In addition, uncertainties exist in relation to new legislation or proposed changes in the PRC regulatory requirements regarding online private education, which may materially and adversely affect our business, financial condition and results of operations,” “Business—Impact of Amended Implementation Regulations of Private Education Law,” and “Regulation—Regulation Relating to Private Education.”

Summary of Risk Factors

Investing in the ADSs involves significant risks. You should carefully consider all of the information in this prospectus before making an investment in the ADSs. Below please find a summary of the principal risks we face, organized under relevant headings. These risks are discussed more fully in the section titled “Risk factors.”



 

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Risks relating to our business and industry

Risks and uncertainties relating to our business and industry include, but are not limited to, the following:

 

   

If we are not able to continue to attract students to purchase our courses and to increase the spending of our students, our business and prospects will be materially and adversely affected.

 

   

If we are unable to maintain consistent quality or timely develop our educational content in a cost-effective manner to make them appealing to existing and prospective students, our business and reputation may be materially and adversely affected.

 

   

Our business depends on the continued success of our brand, and if we fail to maintain and enhance the recognition of our brand, we may face difficulty attracting students to our online after-school tutoring service, and our reputation and operating results may be harmed.

 

   

We face significant competition, which could increase our customer acquisition cost, cause us to lose to our competitors, lead to pricing pressure and loss of market shares, and significantly reduce our net revenues.

 

   

If we are not able to continue to recruit, train and retain a sufficient number of qualified teachers, our business, financial conditions and operating results may be materially and adversely affected.

 

   

Some students may decide not to continue taking our courses for a number of reasons, including a perceived lack of improvement in their academic performance or general dissatisfaction with our courses, which may adversely affect our business, financial condition, results of operation and reputation.

 

   

Significant uncertainties exist in relation to new legislation or proposed changes in the PRC regulatory requirements in the private education industry, which may materially and adversely affect our business, financial condition and results of operations. In addition, certain aspects of our business operations may be deemed not to be in full compliance with PRC regulatory requirements regarding online private education and after-school training.

 

   

We face uncertainties with respect to the development of regulatory requirements on operating licenses and permits for our business operations in China. Failure to renew and maintain requested licenses or permits in a timely manner or obtain newly required ones due to adverse changes in regulations or policies could have a material adverse impact on our business, financial condition and results of operations.

Risks relating to our corporate structure

Risks and uncertainties relating to our corporate structure include, but are not limited to, the following:

 

   

If the PRC government finds that the agreements that establish the structure for operating certain of our operations in China do not comply with PRC regulations relating to the relevant industries, or if these regulations or the interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations.

 

   

We rely on contractual arrangements with our VIEs and their shareholders for our business operations, which may not be as effective as direct ownership in providing operational control.

 

   

Any failure by our VIEs or their shareholders to perform their obligations under our contractual arrangements with them would have a material and adverse effect on our business.



 

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Risks relating to doing business in China

We are also subject to risks and uncertainties relating to doing business in China in general, including, but are not limited to, the following:

 

   

Uncertainties in the interpretation and enforcement of PRC laws and regulations could limit the legal protections available to you and us.

 

   

You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing actions in China against us or our management named in the prospectus based on foreign laws.

 

   

Our ADSs may be delisted under the Holding Foreign Companies Accountable Act if the PCAOB is unable to inspect auditors who are located in China. The delisting of our ADSs, or the threat of their being delisted, may materially and adversely affect the value of your investment. Additionally, the inability of the PCAOB to conduct inspections would deprive our investors of the benefits of such inspections.

Risks relating to the ADS and this offering

In addition to the risks described above, we are subject to risks relating to the ADS and this offering, including, but not limited to, the following:

 

   

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

 

   

The trading price of the ADSs is likely to be volatile, which could result in substantial losses to investors.

 

   

If securities or industry analysts cease to publish research or reports about our business, or if they adversely change their recommendations regarding the ADSs, the market price for the ADSs and trading volume could decline.

 

   

Our proposed dual-class voting structure 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.

 

   

The dual-class structure of our ordinary shares may adversely affect the trading market for our ADSs.

See “Risk Factors” and other information included in this prospectus for a discussion of these and other risks and uncertainties that we face.

Corporate History and Structure

We commenced our operations in China from June 2014 through Shenzhen Zhangmenren Education Consultation Co., Ltd., or Shenzhen Zhangmenren.

Our holding company, Global Online Education Inc., was incorporated in November 2017 under the laws of Cayman Islands, and later changed its name to Zhangmen Education Inc. in April 2021. Shortly after its incorporation, Global Online Education Inc. established as a wholly owned subsidiary in Hong Kong, Global Online Education HK Limited. Global Online Education HK Limited established two wholly-owned subsidiaries in China, Shanghai Zhangxue Education Technology Co., Ltd., or Shanghai Zhangxue, and Shanghai Zhangneng Information Technology Co., Ltd., in April 2018 and March 2019, respectively.

In November 2016 and February 2019, Shanghai Zhangda Education Technology Co., Ltd., or Shanghai Zhangda, and Shanghai Zhangshi Education and Training Co., Ltd., or Shanghai Zhangshi, were established, respectively.



 

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Due to restrictions and prohibitions imposed by PRC laws and regulations on foreign ownership of companies that engage in the provision of value-added telecommunication services and other restricted businesses, Shanghai Zhangxue entered into a series of contractual arrangements with Shenzhen Zhangmenren, Shanghai Zhangda, and Shanghai Zhangshi, which three entities we collectively refer to as our VIEs in this prospectus, and their respectively shareholders. For more details, please see “Contractual Arrangements with Our VIEs and Their Respective Shareholders.” As a result of our direct ownership in our wholly-foreign owned enterprise, or WFOE, Shanghai Zhangxue, and the variable interest entity contractual arrangements, we are regarded as the primary beneficiary of our VIEs. We treat them and their subsidiaries as our consolidated affiliated entities under U.S. GAAP., and have consolidated the financial results of these entities in our consolidated financial statements in accordance with U.S. GAAP.

In April 2018, we gained control over Shenzhen Zhangmenren through Shanghai Zhangxue by entering into a series of contractual arrangements with Shenzhen Zhangmenren and its shareholders. In September 2020, Shanghai Zhangxue entered into a new series of contractual arrangements with Shenzhen Zhangmenren and its shareholders to replace the previous contractual arrangements. In April 2018, we gained control over Shanghai Zhangda through Shanghai Zhangxue by entering into a series of contractual arrangements with Shanghai Zhangda and its shareholders. We gained control over Shanghai Zhangshi in February 2019 through Shanghai Zhangxue by entering into a series of contractual arrangements with Shanghai Zhangshi and its shareholders.



 

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Corporate Structure

The following diagram illustrates our corporate structure, including our significant subsidiaries, our VIEs and subsidiary of our VIE, as of the date of this prospectus:

 

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Notes:

(1)

Shareholders of Shenzhen Zhangmenren and their respective shareholdings in Shenzhen Zhangmenren and relationship with our company are (i) Mr. Yi Zhang (62.5764%), our founder, chairman and chief executive officer; (ii) Shanghai Zhangda Education Technology Co., Ltd. (20.7022%); (ii) Mr. Teng Yu (16.7212%), our co-founder, director and senior vice president; (iii) Ms. Hongxia Shao (0.0001%), our shareholder; and (iv) Ms. Xiaohong Chen (0.0001%), our shareholder.

(2)

Mr. Yi Zhang, our founder, chairman and chief executive officer is the sole shareholder of Shanghai Zhangda.

(3)

Mr. Jiajun Wu, our employee, is the sole shareholder of Shanghai Zhangshi.

Implication of Being an Emerging Growth Company

As a company with less than US$1.07 billion in revenue for our last fiscal year, we qualify as an “emerging growth company” pursuant to the Jumpstart Our Business Startups Act of 2012, as amended, or the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other requirements compared to those 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 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



 

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accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards. Pursuant to the JOBS Act, we have elected to take advantage of the benefits of this extended transition period for complying with new or revised accounting standards. As a result, our operating results and financial statements may not be comparable to the operating results and financial statements of other companies who have adopted the new or revised accounting standards.

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

Implication of Being a Controlled Company

Upon the completion of this offering, our outstanding share capital will consist of Class A ordinary shares and Class B ordinary shares, and Mr. Yi Zhang, our founder, chairman of the board of directors and chief executive officer, will beneficially own all of our total issued and outstanding Class B ordinary shares, representing 82.7% of our total voting power, assuming that the underwriters do not exercise their option to purchase additional ADSs, or 82.6% of our total voting power, assuming that the option to purchase additional ADSs is exercised by the underwriters in full. As a result, we will be a “controlled company” as defined under the NYSE corporate governance listing standards because Mr. Yi Zhang will hold more than 50% of the voting power for the election of directors. As a “controlled company,” we are permitted to elect not to comply with certain corporate governance requirements. If we rely on these exemptions, you will not have the same protection afforded to shareholders of companies that are subject to these corporate governance requirements.

Corporate Information

Our principal executive offices are located at No.82 Tongjia Road, Hongkou District, Shanghai, People’s Republic of China. Our telephone number at this address is +86 (21) 6142 1535. Our registered office in the Cayman Islands is located at Maples Corporate Services Limited, PO Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands.

Investors should submit any inquiries to the address and telephone number of our principal executive offices. Our main website is https://www.zhangmen.com/. The information contained on our website is not a part of this prospectus. Our agent for service of process in the United States is Cogency Global Inc., located at 122 East 42nd Street, 18th Floor, New York, NY 10168.

Conventions that Apply to this Prospectus

Unless otherwise indicated or the context otherwise requires, references in this prospectus to:

 

   

“ADRs” are to the American depositary receipts that may evidence the ADSs;

 

   

“ADSs” are to the American depositary shares, each of which represents nine Class A ordinary shares;

 

   

“annual student retention rate” are to the percentage of paying students who continue to take our classes in a certain fiscal year after taking at least one class in the last fiscal year to the total paying students in the last fiscal year. Paying student for a specific period refers to a student that purchased at least one paid course package in such period.



 

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

 

   

“Class A ordinary shares” are to our Class A ordinary shares, par value US$0.00001 per share;

 

   

“Class B ordinary shares” are to our Class B ordinary shares, par value US$0.00001 per share;

 

   

“gross billings” for a specific period refer to the total amount of cash received for the sale of courses and course packages in such period, net of the total amount of refunds in such period;

 

   

“paid courses” refer to our courses for which we charge not less than RMB99.00 per course;

 

   

“paid course packages” refer to our course packages for which we charge not less than RMB99.00 per course package;

 

   

“paid student enrollments” for a specific period refer to the cumulative number of paid course packages, for our one-on-one courses, and paid courses, for our small-class courses, enrolled by our students in such period. Under this methodology, a student that purchased multiple paid course packages or paid courses in a specific period is treated as multiple paid student enrollments in such period;

 

   

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

 

   

“shares” or “ordinary shares” are to our Class A ordinary shares and Class B ordinary shares, par value US$0.00001 per share;

 

   

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

 

   

“VIEs” are to variable interest entities, and “our VIEs” are to Shanghai Zhangda Education Technology Co., Ltd., Shenzhen Zhangmenren Education Consulting Co., Ltd. and Shanghai Zhangshi Education and Training Co., Ltd. (each of which, “our VIE”); and

 

   

“we,” “us,” “our company” and “our” are to Zhangmen Education Inc., our Cayman Islands holding company and its subsidiaries, its consolidated variable interest entities and the subsidiaries of the consolidated variable interest entities.

Unless the context indicates otherwise, all information in this prospectus assumes no exercise by the underwriters of their option to purchase up to 543,450 additional ADSs representing 4,891,050 Class A ordinary shares.

Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this prospectus are made at a rate of RMB6.5518 to US$1.00, the exchange rate in effect as of March 31, 2021 as set forth in the H.10 statistical release of The Board of Governors of the Federal Reserve System. 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, or at all.



 

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The Offering

 

Offering price

US$11.50 per ADS.

 

ADSs offered by us

3,623,000 ADSs (or 4,166,450 ADSs if the underwriters exercise their option to purchase additional ADSs in full).

 

ADSs outstanding immediately after this offering

3,623,000 ADSs (or 4,166,450 ADSs if the underwriters exercise their option to purchase additional ADSs in full).

 

Ordinary shares issued and outstanding immediately after this offering

1,224,155,349 Class A ordinary shares (or 1,229,046,399 Class A ordinary shares if the underwriters exercise their option to purchase additional ADSs in full) and 194,878,011 Class B ordinary shares.

 

The ADSs

Each ADS represents nine Class A ordinary shares, par value US$0.00001 per share.

 

  The depositary will hold Class A ordinary shares underlying your ADSs. You will have rights as provided in the deposit agreement among us, the depositary and holders and beneficial owners of ADSs from time to time.

 

  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 ordinary shares after deducting its fees and expenses in accordance with the terms set forth in the deposit agreement.

 

  Subject to the terms of the deposit agreement, you may surrender your ADSs to the depositary for cancellation in exchange for Class A ordinary shares. The depositary will charge you fees for any cancellation.

 

  We may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs after an amendment to the deposit agreement, you agree to be bound by the deposit agreement as amended.

 

  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 aggregate of 543,450 additional ADSs to cover over-allotment.

 

Use of proceeds

We expect that we will receive net proceeds of approximately US$35.8 million from this offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us.


 

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  We intend to use the net proceeds from this offering for expanding and enhancing our products and services, improving our technology infrastructure, marketing and brand promotions, and the balance to fund working capital and for other general corporate purposes, which may include funding working capital needs and potential strategic investments and acquisitions, although we have not identified any specific investments or acquisition opportunities at this time. See “Use of Proceeds” for more information.

 

Lock-up

We and each of our officers, directors (other than our independent director appointees who do not own any of our shares as of the date of this prospectus) and 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 “Shares Eligible for Future Sale” and “Underwriting” for more information.

 

Listing

Our ADSs have been approved for listing on the New York Stock Exchange under the symbol “ZME.” The ADSs and our Class A ordinary shares will not be listed on any other stock exchange or traded on any automated quotation system.

 

Payment and settlement

The underwriters expect to deliver the ADSs against payment therefor through the facilities of the Depository Trust Company on June 10, 2021.

 

Depositary

Citibank, N.A.

The number of ordinary shares that will be outstanding immediately after this offering:

 

   

is based on 1,386,426,360 issued and outstanding ordinary shares as of the date of this prospectus, assuming (i) the automatic re-designation of 194,878,011 ordinary shares held by Mr. Yi Zhang into Class B ordinary shares on a one-for-one basis immediately prior to the completion of this offering, (ii) the automatic re-designation of all of our remaining 185,138,231 ordinary shares into 185,138,231 Class A ordinary shares on a one-for-one basis immediately prior to the completion of this offering, and (iii) the automatic re-designation of all of our issued and outstanding preferred shares into Class A ordinary shares on a one-for-one basis immediately prior to the completion of this offering;

 

   

includes 32,607,000 Class A ordinary shares in the form of ADSs that we will issue and sell in this offering, assuming the underwriters do not exercise their option to purchase additional ADSs; and

 

   

excludes Class A ordinary shares issuable upon exercise of outstanding options as of the date of this prospectus, and Class A ordinary shares reserved for future issuances pursuant to equity awards granted or to be granted under our share incentive plan as of the date of this prospectus.



 

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SUMMARY CONSOLIDATED FINANCIAL DATA

The following summary consolidated statements of operations for the years ended December 31, 2019 and 2020, summary consolidated balance sheet data as of December 31, 2019 and 2020, and summary consolidated cash flow data for the years ended December 31, 2019 and 2020 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The following summary consolidated statements of operations for the three months ended March 31, 2020 and 2021, summary consolidated balance sheet data as of March 31, 2021 and summary consolidated cash flow data for the three months ended March 31, 2020 and 2021 have been derived from our unaudited interim condensed consolidated financial statements included elsewhere in this prospectus. Our consolidated financial statements are prepared and presented in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP. Our historical results do not necessarily indicate results expected for any future periods. You should read this Summary Consolidated Financial and Operating Data section together with our consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

    For the Year Ended
December 31,
    For the Three Months Ended
March 31,
 
    2019     2020     2020     2021  
    RMB     RMB     US$     RMB     RMB     US$  
    (in thousands, except for share amount and per share data)  

Summary Consolidated Statements of Operations:

           

Net revenues

    2,668,735       4,018,429       613,332       1,122,670       1,345,664       205,388  

Cost of revenues

    (1,651,204     (2,203,966     (336,391     (604,402     (748,139     (114,188
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    1,017,531       1,814,463       276,941       518,268       597,525       91,200  

Operating expenses:

           

Sales and marketing expenses

    (2,171,875     (2,577,259     (393,367     (466,562     (908,696     (138,694

Research and development expenses

    (237,290     (317,873     (48,516     (70,022     (113,284     (17,291

General and administrative expenses

    (193,732     (207,617     (31,689     (41,818     (101,159     (15,440
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    (2,602,897     (3,102,749     (473,572     (578,402     (1,123,139     (171,425
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

    (1,585,366     (1,288,286     (196,631     (60,134     (525,614     (80,225
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income, net

    70,330       85,262       13,014       15,614       23,804       3,633  

Other income, net

    12,697       163,432       24,945       42,490       46,278       7,063  

Fair value change of investments and derivatives

    —         30,213       4,611       —         (41,801     (6,380

Loss before provision for income tax

    (1,502,339     (1,009,379     (154,061     (2,030     (497,333     (75,909

Income tax expenses

    (1,700     (2,967     (453     (6     —         —    

Net loss

    (1,504,039     (1,012,346     (154,514     (2,036     (497,333     (75,909

Net loss per ordinary share

           

Basic and diluted

    (8.86     (6.39     (0.98     (0.35     (4.40     (0.67

Weighted average shares used in calculating net loss per ordinary share

           

Basic and diluted

    227,222,692       305,651,877       305,651,877       306,191,338       315,775,597       315,775,597  


 

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The following table presents our summary consolidated balance sheets data as of December 31, 2019 and 2020 and as of March 31, 2021:

 

    As of December 31,     As of March 31,  
    2019     2020     2021  
    RMB     RMB     US$     RMB     US$  
    (in thousands)  

Summary Consolidated Balance Sheet Data:

     

Cash and cash equivalents

    1,673,091       721,462       110,117       2,991,025       456,520  

Total current assets

    3,051,387       4,811,331       734,353       4,310,227       657,869  

Total assets

    3,336,202       5,430,335       828,831       4,987,931       761,306  

Accrued payroll and other human resource expenses

    777,433       991,304       151,303       1,127,678       172,117  

Deferred revenue, current

    1,803,488       2,498,891       381,405       2,424,198       370,005  

Total current liabilities

    3,273,314       4,456,054       680,127       4,391,390       670,256  

Deferred revenue, non-current

    753,393       1,091,117       166,537       1,088,288       166,105  

Total liabilities

    4,137,133       5,650,658       862,459       5,663,193       864,371  

Total mezzanine equity

    3,543,812       6,220,779       949,476       7,250,482       1,106,640  

Total shareholders’ deficit

    (4,344,743     (6,441,102     (983,104     (7,925,744     (1,209,705

The following table presents our summary consolidated cash flow data for the years ended December 31, 2019 and 2020 and for the three months ended March 31, 2020 and 2021:

 

    For the Year Ended
December 31,
    For the Three Months Ended
March 31,
 
    2019     2020     2020     2021  
    RMB     RMB     US$     RMB     RMB     US$  
    (in thousands)  

Summary Consolidated Cash Flow Data:

       

Net cash generated from (used in) operating activities

    75,064       344,285       52,548       (345,319     (490,393     (74,850

Net cash generated from (used in) investing activities

    (1,028,586     (2,794,229     (426,482     447,352       2,851,801       435,270  

Net cash generated from (used in) financing activities

    788,181       1,714,285       261,651       (506     (2,438     (372

Net increase (decrease) in cash and cash equivalents

    (139,851     (840,842     (128,338     125,707       2,400,835       366,439  

Cash, cash equivalents and restricted cash at beginning of the year/period

    1,812,942       1,673,091       255,364       1,673,091       832,249       127,026  

Cash, cash equivalents and restricted cash at end of the year/period

    1,673,091       832,249       127,026       1,798,798       3,233,084       493,465  


 

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The table below sets forth a reconciliation of our net revenues to gross billings for the periods indicated. For discussions of gross billings and reconciliations of net revenues to gross billings, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-GAAP Financial Measure.”

 

     For the Year Ended December 31,      For the Three Months Ended
March 31,
 
     2019      2020      2020      2021  
     RMB      RMB      US$      RMB      RMB      US$  
     (in thousands)  

Net revenues

     2,668,735        4,018,429        613,332        1,122,670        1,345,664        205,388  

Add: VAT and surcharges

     159,626        241,293        36,829        67,413        82,200        12,546  

Add: ending deferred revenue

     2,556,881        3,590,008        547,942        2,148,251        3,512,486        536,110  

Add: ending refund liability

     395,124        356,721        54,446        375,652        325,647        49,703  

Less: beginning deferred revenue

     1,513,164        2,556,881        390,256        2,556,881        3,590,008        547,942  

Less: beginning refund liability

     411,913        395,124        60,308        395,124        356,721        54,446  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross billings (non-GAAP)

     3,855,289        5,254,446        801,985        761,981        1,319,268        201,359  

 



 

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RISK FACTORS

An investment in the 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 the 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. In particular, as we are a China-based company incorporated in the Cayman Islands, you should pay special attention to the subsection headed “Risks Relating to Doing Business in China” below.

Risks Relating to Our Business and Industry

If we are not able to continue to attract students to purchase our courses and to increase the spending of our students, our business and prospects will be materially and adversely affected.

We generate revenues primarily from students paying for our online after-school tutoring courses. Our ability to continue to attract students to purchase our online after-school tutoring courses and to increase their spending are critical to the continued success and growth of our business. This in turn will depend on several factors, including our ability to recruit, train and retain high-quality teaching staff, continue to develop, adapt or enhance the quality of our course offerings to meet the evolving demands of our existing or prospective students, adapt our promotional activities to changes in market demand, regulatory regime and practices, enhance our brand equity and awareness to a broader base of potential customers, and effectively utilize the data insights from our online course offerings to refine our educational content offered and provide a more localized, personalized and effective learning experience to our students.

Our ability to retain existing students by improving students’ academic performance and delivering a satisfactory learning experience is also critical to the success of our business. Our ability to improve the academic performance of our students related to the learning ability, attitude, efforts and time and resource commitments of each student, which are beyond our control. Students may feel dissatisfied with the quality of our educational content offerings and the teachers and student service staff they encounter during our courses or fail to perform up to expectation after attending our courses. In addition, our courses may not be able to satisfy all of our students’ requirements. Satisfaction with our courses may be affected by a number of factors, many of which may not relate to the quality or effectiveness of our course offerings. If students feel that we are not providing them the learning experience they have subscribed for, they may choose to withdraw from existing courses and seek refunds. In addition, the students who fail to improve their performance after attending our programs or have unsatisfactory learning experiences with us may also choose not to refer other students to us, which in turn may adversely affect the number of paid student enrollments.

All of these factors may contribute to reduced student engagement and increased challenges in attracting and enrolling prospective students. We must also manage our growth while maintaining consistent and high teaching quality, and respond effectively to competitive pressures. If we are unable to continue to attract and retain students to purchase our courses and to increase the spending of our students, our gross billings and net revenues may decline, which may have a material adverse effect on our business, financial condition and results of operations.

If we are unable to maintain consistent quality or timely develop our educational content in a cost-effective manner to make them appealing to existing and prospective students, our business and reputation may be materially and adversely affected.

We have developed an intelligent educational content recommendation system that automatically generates bespoke course materials and complimentary optional practice exercises, which is empowered by our comprehensive content library and big data capabilities. Our educational content development team work closely

 

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with our teachers on developing, updating and improving our course materials to stay abreast of the latest educational trends in their respective subject areas. The adjustments, updates and expansions of our existing education content offerings, development of new course materials and bespoke course materials generated by our content recommendation system, may not be accepted by existing or prospective students. Even if we are able to develop acceptable new course materials, we may not be able to introduce them as quickly as students require or as quickly as our competitors introduce competing offerings. Furthermore, offering new courses materials or upgrading existing ones may require us to spend significant resources and make significant investments in educational content development. If we are unsuccessful in pursuing content development and upgrading opportunities due to the financial constraints, unable to attract product and content development personnel, or encounter other related challenges, our ability to attract and retain students and our business and reputation may be materially and adversely affected.

Our business depends on the continued success of our brand, and if we fail to maintain and enhance the recognition of our brand, we may face difficulty attracting students to our online after-school tutoring service, and our reputation and operating results may be harmed.

We believe that market awareness of our brand has contributed significantly to the success of our business. Maintaining and enhancing our brand is critical to our efforts to attract students to our online after-school tutoring service, which are in turn critical to our business. Our ability to maintain and enhance brand recognition and reputation depends primarily on the perceived effectiveness and quality of our services, as well as the success of our branding and marketing efforts. Failure to maintain and enhance our brand recognition could have a material and adverse effect on our business, operating results and financial condition. In recent years, we have devoted significant resources to our brand promotion efforts, but we cannot assure you that these efforts will be successful. If we are unable to further enhance our brand recognition, or if our brand image is negatively impacted by any negative publicity relating to our company, courses or teachers, regardless of its veracity, we may not be able to attract students to our online after-school tutoring service successfully or efficiently, and our business and results of operations may be materially and adversely affected.

We face significant competition, which could increase our customer acquisition cost, cause us to lose students to our competitors, lead to pricing pressure and loss of market shares, and significantly reduce our net revenues.

The online education industry in China is competitive, and we expect competition in this sector to persist. We face competition in each part of our service offerings from other online and offline educational service providers. Some of our current or future competitors may have longer operating histories, greater brand recognition, or greater financial, technical or marketing resources than we do. We compete with these education service providers across a range of factors, including, among others, high-quality content synchronized with local curriculum, textbook versions and academic assessment objectives, insights based on learning data and empowered by data analytics capabilities, application of a wide range of advanced technology in different educational scenarios, functions covering diversified educational scenarios and friendly user experience, effectiveness of customer services and sales and marketing efforts, and track record, trust and brand recognition. Our competitors may adopt similar curricula and marketing approaches, with different pricing and service packages that may have greater appeal than our offerings. In addition, some of our competitors may have more resources than we do and may be able to devote greater resources than we can to the development and promotion of their products and services and respond more quickly than we can to the changes in student preferences, testing materials, admission standards, market needs or new technologies. As a result, our course enrollment may decrease due to intense competition. If we reduce course fees or increase spending in response to competition in order to retain or attract students and high quality teaching staff, or pursue new market opportunities, our net revenues may decrease and our costs and expenses may increase as a result of such actions which may adversely affect our operating margins. If we are unable to successfully compete for students, maintain or increase our level of course fees, attract and retain competent teaching staff or other key personnel, maintain our competitiveness in

 

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terms of the quality of our education services in a cost-effective manner, we may lose our market share and our financial condition may be materially and adversely affected.

If we are not able to continue to recruit, train and retain a sufficient number of qualified teachers, our business, financial conditions and operating results may be materially and adversely affected.

Our teachers are critical to maintaining the quality of our course offerings, the learning experience of our students and our brand and reputation. We seek to recruit high-quality teachers with strong education background and teaching skills who have a strong command of the subject areas to be taught and meet our qualifications. As we mainly offer courses in online one-one-one or small-class format, we require a sufficient number of teachers to deliver our courses. The supply of teachers in China with the necessary experience and qualifications to teach our courses is limited, and we must provide competitive pay and offer attractive career development opportunities to attract and retain them. As of March 31, 2021, we had over 45,000 teachers, including approximately 25,000 full-time teachers and approximately 20,000 part-time teachers, which also include those supplied by third-party service providers. In 2020 and the three months ended March 31, 2021, a substantial majority of our class hours were delivered by full-time teachers. We cannot assure that we will be able to continue recruit and retain a sufficient number of quality teachers in the future, and if we fail to do so, our teaching quality may be adversely affected. Departure of quality teachers may also reduce the attractiveness of our course offerings and negatively impact our paid student enrollments. We need to also provide on-going training to our teachers, particularly our part-time teachers, to ensure that they stay abreast of changes in course materials, student demands and other changes and trends necessary to teach effectively. Furthermore, as we continue to develop new educational content, we may need to engage additional high-quality teachers with appropriate skill sets or backgrounds to deliver instructions effectively. We cannot guarantee that we will be able to effectively engage and train such teachers quickly, or at all. In addition, given other potentially more attractive opportunities for our high-quality teachers, over time some of them may choose to leave us. In the event such teachers join our competitors, students may decide to follow such quality teachers and enroll in their courses offered through other online education companies, which may weaken our competitive position in the industry.

In addition, we engage third-party service providers through service agreements to help us recruit, train and manage teachers. As of March 31, 2021, we had 11,995 full-time teachers supplied by third-party service providers. If we are unable to enter into new agreements or extend existing agreements with such third-party service providers on terms and conditions acceptable to us and in compliance with PRC regulatory requirements, we may not be able to find alternative third-party service companies to provide similar services in a timely and reliable manner, or at all. Although we have not experienced major difficulties in engaging, training or retaining high-quality teachers in the past, we may not always be able to engage, train and retain a sufficient number of high-quality teachers to keep pace with our growth and our expansion into more comprehensive grade, subject matter and course material coverage, while maintaining consistent education quality. We may also face significant competition in engaging high-quality teachers from our competitors or from other opportunities that are perceived as more desirable. A shortage of high-quality teachers, a decrease in the quality of our teachers’ performance, whether actual or perceived, or a significant increase in the cost to engage or retain high-quality teachers would have a material adverse effect on our business, financial condition and results of operations.

Some students may decide not to continue taking our courses for a number of reasons, including a perceived lack of improvement in their academic performance or general dissatisfaction with our courses, which may adversely affect our business, financial condition, results of operation and reputation.

The success of our business depends in large part on our ability to retain our students by delivering a satisfactory learning experience and improving their academic performance. If students feel that we are not providing the experience they are seeking, they may choose to withdraw from existing courses and seek refunds. For example, our courses and teachers may fail to significantly improve a student’s academic performance. Student satisfaction with our programs may decline for a number of reasons, many of which may not reflect the effectiveness of our courses and teaching methods. A student’s learning experience may also suffer if his or her

 

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relationship with our teachers does not meet expectations. If a significant number of students fail to significantly improve their academic performance after taking our courses or if their learning experiences with us are unsatisfactory, they may not purchase additional courses from us or refer other students to us and our business, financial condition, results of operations and reputation would be adversely affected.

Significant uncertainties exist in relation to new legislation or proposed changes in the PRC regulatory requirements in the private education industry, which may materially and adversely affect our business, financial condition and results of operations. In addition, certain aspects of our business operations may be deemed not to be in full compliance with PRC regulatory requirements regarding online private education and after-school training.

The private education industry in the PRC is subject to heightened and evolving regulations in various aspects. Relevant rules and regulations are relatively new and evolving and could be changed by governmental authorities to affect the development of the education, in particular, the online private education markets from time to time.

Pursuant to the amended Law for Promoting Private Education, or the amended Private Education Law, a private school must obtain a private school operating permit. The State Council promulgated the amended Regulations on the Implementation of the Law for Promoting Private Education of the PRC on April 7, 2021, or the Amended Implementation Regulations of Private Education Law, which will become effective on September 1, 2021. The Amended Implementation Regulations of Private Education Law requires that a private school engaging in online education activities using internet technology obtain a private school operating permit. However, this new law does not specify the requirements that an online tutoring service provider like us need to satisfy in order to obtain a private school operating permit, nor does it specify which level of government authority has the authority to accept and examine our application for the private school operating permit. The Amended Implementation Regulations of Private Education Law further stipulates that private schools using internet technology to provide online educational courses establish and implement internet security management systems and technical measures for security protection. See “Regulations—Regulation Relating to Private Education.” We intend to apply for the private school operating permit when the regulatory authorities issue detailed rules setting forth the level of government authorities in charge of permit review and issuance and when the government authorities start to accept applications around September 1, 2021. According to our consultation with relevant government authorities, we do not perceive material obstacles for us to obtain a private school operating permit since we have made relevant required filings under the Online After-School Training Opinions as discussed below. However, since the Amended Implementation Regulations of Private Education Law is newly published and has not come into effect, the interpretation and implementation of such new law remain uncertain, we cannot assure you that we will be able to obtain a private school operating permit and comply with other regulatory requirements under such new law and any additional related rules and regulations, if any, in a timely manner, or at all. If we are not able to comply with the licensing requirement in a timely manner or at all, we may be subject to fines, confiscation of the gains derived from our non-compliant operations, mandatory modifications to our business practices, suspension of our non-compliant operations or claims for compensation of any economic loss suffered by our students or other relevant parties.

In addition, certain official media reported recently that the Comprehensive Deepening Reform Committee of the PRC government, recently approved the Opinions on Alleviating the Burden of Homework and After-School Training for Primary and Secondary School Students, or the Opinions, the full context of which is yet to be published.

According to the media report, it was mentioned at the most recent meeting held by the Comprehensive Deepening Reform Committee that measures should be taken to reduce the after-school academic burden on primary and secondary school students. Such proposed measures include: (i) strictly enforcing regulations against after-school tutoring institutions that fail to meet the relevant qualifications, have chaotic management, utilize

 

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unscrupulous tactics to collect money, utilize false advertising or collude with schools for inappropriate profit; (ii) setting appropriate fees standards to be charged by after-school tutoring institutions and strengthening the supervision of pre-payments by students; (iv) prohibiting inappropriate capital activities and profiteering in the after-school tutoring industry; and (iv) improving legislation to regulate the after-school tutoring institutions.

On June 2, 2021, the PRC government issued another article, which provides that the MOE’s Double Burden Reduction Special Work Office will work with relevant government authorities to implement the Opinions, including: (i) improving the teaching quality of schools and controlling the total amount of written homework; (ii) increasing the quantity and quality of after-school services and enriching the content of such after-school services provided by schools to meet the market demand; and (iii) strengthening the governance of after-school tutoring institutions by examining and approving the establishment of after-school tutoring institutions, strengthening the supervision of training content, innovating methods of tuition fee management, standardizing training behavior, investigating and penalizing illegal training behaviors, and safeguarding the rights and interests of parents and students.

As the full context of the Opinions has not yet been published, there is material uncertainty with respect to its interpretation and implementation and potential impacts on online tutoring service providers like us. We cannot preclude the risk that we may be subject to fines, penalties or regulatory orders, including orders to suspend our operations or to adjust or substantially limit our operations in various aspects (including advertising, fee standards or course schedule), we may also incur additional costs in complying with such laws, regulations or administrative measures, which may materially and adversely affect our business, financial conditions and results of operations.

Furthermore, the Ministry of Education, or the MOE, jointly with certain other PRC government authorities, promulgated the Implementation Opinions on Regulating Online After-School Training, or the Online After-School Training Opinions, effective on July 12, 2019. The Online After-School Training Opinions are intended to regulate online after-school academic training provided to students in primary and secondary schools. Among other things, the Online After-School Training Opinions require that online after-school training institutions file with the competent provincial education regulatory authorities and that such education regulatory authorities and other provincial government authorities jointly review these filings and the qualifications of the institutions making these filings. The Online After-School Training Opinions also impose a number of regulations requiring, among other things, that (i) each class not last longer than 40 minutes and be taken at intervals of not less than 10 minutes; (ii) live streaming courses provided to students receiving compulsory education not end later than 9:00 p.m.; (iii) the periods for which tuition is charged be consistent with its respective curriculum, and fees not be collected in a lump sum for more than 60 classes when charged based on the number of classes, or for a course length of more than three months when charged based on the length of the course, though the Online After-School Training Opinions do not specify which circumstances constitute charged based on number of classes or charged based on length of courses; (iv) the online after-school training institutions not engage in excessive marketing, make false or misleading promotion, or overstate the effect of the product; and (v) teachers providing after-school tutoring services related to academic curriculum are required to obtain the necessary teacher qualification licenses. The Online After-School Training Opinions and relevant regulations further provide that governmental authorities of market regulation, cyberspace administration, industry and information technology and others shall cooperate with the educational authorities based on their respective scope of duties to regulate after-school training institutions. See “Regulation—Regulation Relating to After-school Tutoring and Educational Apps.” Additionally, on March 23, 2021, the State Council’s Office of Education Steering Committee released an article alerting parents of K-12 students about after-school tutoring service providers’ collection of tuition fees in ways that are in violation of the Online After-School Training Opinions.

Moreover, the MOE, jointly with certain other PRC government authorities, issued the Opinions on Guiding and Regulating the Orderly and Healthy Development of Educational Mobile Apps on August 10, 2019, or the Opinions on Educational Apps, which requires, among others, mobile apps that offer services for school teaching and management, student learning and student life, or home-school interactions, with school faculty, students or parents as the main users, and with education or learning as the main application scenarios, be filed with the

 

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competent provincial regulatory authorities for education. In addition, the General Office of the MOE enacted the Notice of Strengthening the Management of Homework for Compulsory Education on April 8, 2021, which prohibits after-school training institutions from assigning homework to primary and secondary school students. Furthermore, the Minors Protection Law, as amended in October 2020, which took effect on June 1, 2021, provides that after-school training institutions may not provide primary school curriculum education to minors that are not yet school age. See “Regulation—Regulation Relating to After-school Tutoring and Educational Apps.”

We have completed the required filings in accordance with the Online After-School Training Opinions with respect to most of our online after-school tutoring programs, training contents and teachers, and we are currently in the process of completing filings or updating the filing information for the rest of our tutoring programs, training contents and teachers. In addition, we have completed the filing requirements for all of our after-school online tutoring apps that are in formal operations as required under the Opinions on Educational Apps. As the Online After-School Training Opinions and the other laws and regulations discussed above are relatively new and evolving, we cannot assure you that we are in full compliance with all relevant rules. The relevant governmental authorities have significant discretion in interpreting and implementing, and may, from time to time, conduct inspections on our compliance with such laws and regulations and their relevant local implementation rules. Failure to comply with these applicable regulatory requirements or promptly complete filings may subject us to fines, regulatory orders to suspend our operations or other regulatory and disciplinary sanctions. For example, as of March 31, 2021, 69.6% of our full-time K-12 teachers who are required by law to obtain teacher qualification licenses have done so, and 2.3% additional full-time K-12 teachers have passed the teacher qualification exam, which is the prerequisite for obtaining a teacher qualification license. Most of our part-time teachers have not yet obtained the necessary teacher qualification licenses. In addition, we cannot assure you whether our educational content, including our optional after-class exercises, would be deemed homework assignments by the relevant regulators under these new laws, in which case we may be subject to penalties or be required to remove such content. We are making efforts to comply with such laws and regulations by, for example, requiring our K-12 teachers to timely obtain the necessary teacher qualification licenses. As of the date of this prospectus, we have not received any written notice of warning from, or been subject to penalties imposed by, the relevant government authorities for any of the above alleged failure by us to comply with such laws and regulations.

As the Amended Implementation Regulations of Private Education Law is newly published and has not come into effect, we currently have limited visibility into its interpretation and implementation, such as requirements to obtain the permit and level of governmental authority in charge of review and issuance of the permit. There also exist uncertainties with respect to interpretation and application of other existing laws and regulations, as well as whether and how PRC government authorities would further promulgate new laws and regulations applicable to online training institutions in various aspects including, among others, the means and timing of fee collection, pricing, advertisements and promotion, prepaid tuitions under supervision, teachers’ qualification licenses, tuition refunds, course time and content, homework arrangement, student enrollment, and those promulgated to apply more stringent social and ethical standards in the education sector in general. There is no assurance that we can comply with any newly promulgated laws and regulations in a timely manner or at all, and any failure to comply may materially and adversely affect our business, financial condition and results of operations.

We face uncertainties with respect to the development of regulatory requirements on operating licenses and permits for our business operations in China. Failure to renew and maintain requested licenses or permits in a timely manner or obtain newly required ones could have a material adverse impact on our business, financial condition and results of operations.

As an internet-based education service provider, we are required to obtain and maintain all necessary approvals, licenses or permits and make all necessary registration and filings applicable to our business operations in China, and we may be required to apply for and obtain additional licenses or permits for our

 

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operations as the interpretation and implementation of current PRC laws and regulations are still evolving, and new laws and regulations may also be promulgated.

We may be deemed to provide certain services or conduct certain activities and thus be subject to certain licenses, approvals, permits, registrations and filings, or be required to expand the scope of the licenses so obtained by us, due to the lack of official interpretations of certain terms under internet related PRC regulations and laws.

For example, we print and provide physical education materials to our students. If the government authorities deem our printing and provision of physical education materials to students as “publication of books” under Administrative Regulations on Publishing, we may be required to engage qualified publishers to publish such physical education materials, failure of which may subject us to penalties, including orders to cease illegal activities, discontinuation of operations, correction order, condemnation, fines, civil and criminal liability. See “Regulation—Regulation Relating to Publishing.”

We offer our courses online where the live audio/video data are transmitted through the platforms between the specific recipients instantly. In addition, we also offer pre-recorded courses and certain other audio-video contents on our online platforms to our students. According to relevant PRC laws and regulations, no entities or individuals may provide internet audio-visual program services without a License for Online Transmission of Audio-Visual Programs (the “AVSP”) issued by the State Administration of Press, Publication, Radio, Film and Television, or the SAPPRFT (currently known as National Radio and Television Administration), or its local bureaus or completing the relevant registration procedures with SAPPRFT or its local bureaus. Currently only state-owned or state-controlled entities are eligible to apply for an AVSP. As of the date of this prospectus, online education institutions are not explicitly required to obtain the AVSP, or to complete filings as an internet live-streaming platform. As such, we currently do not hold an AVSP. However, there is possibility that the PRC government will change its view and find that our activities mentioned above or any other content offered by us fall within the definition of “internet audio-visual programs” and thus require us to obtain the AVSP. We are, however, not eligible to apply for such license since we are not a state-owned or state-controlled entity. If this were to occur, we may be subject to penalties, fines, legal sanctions or an order to suspend the provision of our relevant services.

Furthermore, each of Shanghai Zhangda, our VIE, and Shanghai Zhangxiaomen, a subsidiary of our VIE, Shenzhen Zhangmenren, currently holds a Value-added Telecommunications Business Operating License for certain internet information service, or ICP License. However, we cannot assure you that our ICP Licenses can be updated in a timely manner or at all with respect to business activities, websites and applications associated with our business operations because relevant laws and regulations are constantly evolving and can be subject to differing interpretations by PRC government authorities. Failures to obtain or update such licenses may subject us to fines, confiscation of relevant gains, suspend the operations of our online platforms and other liabilities. Last but not least, due to the ambiguity of the definition of “online publishing service,” and “internet live-streaming services”, the online distribution of content, including our course materials, and our internet education services may be regarded as an “online publishing service” or “internet live-streaming services” and therefore we may be required to obtain an Online Publishing License, or to complete filings as an internet live-streaming platform.

As of the date of this prospectus, no fines or other penalties have been imposed on us for failure to obtain such additional licenses or permits, or to expand the scope of our existing licenses and permits. However, there can be no assurance that once required, we will be able to obtain or maintain all the required approvals, licenses, permits and complete or maintain all necessary filings, records, renewals, expansion of scope, and registrations on a timely basis for our online after-school tutoring service, given the significant amount of discretion the PRC authorities may have in interpreting, implementing and enforcing relevant rules and regulations, as well as other factors beyond our control and anticipation. In addition, there can also be no assurance that we will be able to maintain our existing licenses, approvals, registrations or permits. If we fail to obtain and maintain required

 

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permits, to expand scope of such permits obtained by us in a timely manner or obtain or renew any permits and certificates, or fail to complete the necessary filings, records, renewals or registrations on a timely basis, we may be subject to fines, confiscation of the gains derived from our non-compliant operations, suspension of our non-compliant operations or claims for compensation of any economic loss suffered by our students or other relevant parties, and our business, financial conditions and operational results may be materially and adversely affected.

We have grown rapidly and expect to continue to invest in our growth for the foreseeable future. If we fail to manage this growth effectively, the success of our business model will be compromised.

We have experienced rapid growth in recent years, primarily driven by fast-growing paid student enrollments of our online one-on-one after-school tutoring courses. Our net revenues increased by 50.6% from RMB2,668.7 million in 2019 to RMB4,018.4 million (US$613.3 million) in 2020, and by 19.9% from RMB1,122.7 million for the three months ended March 31, 2020 to RMB1,345.7 million (US$205.4 million) for the same period in 2021. Our rapid growth has placed, and will continue to place, a significant strain on our demand for more teachers, student service staff, IT support staff, administrative and operating infrastructure, product development, educational content development, sales and marketing capacities, facilities and other resources. To further expand our business operations, we need to attract more students, scale up our educational content offerings, diversify our course delivery formats, increase our educational content development professionals and employees of other functions, as well as strengthen our technology and infrastructure. We will also be required to maintain the effectiveness of our operational, financial and management controls and reporting systems and procedures. If we fail to efficiently manage this expansion of our business, our costs and expenses may increase more than we plan and we may not successfully attract a sufficient number of qualified teachers in a cost-effective manner, respond to competitive challenges, or otherwise execute our business strategies. In addition, we may, as part of carrying out our growth strategies, adopt new initiatives to offer additional courses and educational content and to implement new pricing models and strategies. We cannot assure you that these initiatives may achieve the anticipated results. These proposed changes may not be well received by our existing and prospective students, in which case their experience with our online after-school tutoring service may suffer, which could damage our reputation and business prospects.

Our ability to effectively implement our strategies and manage any significant growth of our business will depend on a number of factors, including our ability to: (i) continually develop and improve our online tutoring offerings to make it more appealing to existing and prospective students; (ii) maintain and increase our paid student enrollments in our course offerings; (iii) effectively recruit, train, retain and motivate a large number of new employees, particularly our teachers, student service staff, IT support staff and educational product and content development professionals to meet our growing business demands; (iv) continue to improve our operational, financial and management controls and efficiencies; (v) successfully implement enhancements and improvements to our IT and operational systems and infrastructure; (vi) protect and further develop our intellectual property rights; and (vii) make sound business decisions in light of the scrutiny associated with operating as a public company. These activities require significant capital expenditures and investment of valuable management and financial resources, and our growth will continue to place significant demands on our management. There are no guarantees that we will be able to effectively manage any future growth in an efficient, cost-effective and timely manner, or at all. If we do not effectively manage the growth of our business and operations, our reputation, results of operations and overall business and prospects could be negatively impacted.

We have a history of net losses and we may not achieve profitability in the future.

We had net losses of RMB1,504.0 million, RMB1,012.3 million (US$154.5 million) and RMB497.3 million (US$75.9 million), respectively, in 2019, 2020 and the three months ended March 31, 2021. We cannot assure you that we will be able to generate net profits or positive cash flow from operating activities in the future. Our ability to achieve profitability will depend in large part on our ability to increase our operating margin, either by

 

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growing our revenues at a rate faster than our costs and operating expenses increase, or by reducing our costs and operating expenses as a percentage of our net revenues. Accordingly, we intend to continue to invest to attract new students, hire high-quality teachers and other personnel, and strengthen our educational content development and technologies and data analytics capabilities to enhance student experience, in cost-effective manners. These efforts may be more costly than we expect, and our net revenues may not increase sufficiently to offset the expenses. We may continue to take actions and make investments that do not generate optimal financial results and may even result in significantly increased operating and net losses in the short term with no assurance that we will eventually achieve our intended long-term benefits or profitability. These factors, among others set out in this “Risk Factors” section, may negatively affect our ability to achieve profitability in the near term, if at all.

We may not be successful in our expansion of online after-school tutoring service or in our exploration of additional educational services.

We offer comprehensive tutoring courses covering all core K-12 academic subjects and certain early childhood education courses. We mainly offer after-school tutoring services in online one-one-one format through our flagship program, Zhangmen One-on-One. We recently launched after-school tutoring services in small-class format and AI courses and plan to expand such course offerings to capture new market opportunities and expand our geographic reach. We aim to continue to expand the coverage of such tutoring courses to cover additional subjects and more versions of different education curricula and textbooks within each subject matter and each grade. Expansions and upgrades to our existing products and courses may not be well received by our students and teachers, and newly introduced course offerings and educational content may not achieve success as expected. Our lack of experience with these new products and services may adversely affect our prospects and our ability to compete with the existing market players in any of these product and service categories. The development of new products, services and content could disrupt our ongoing business, disrupt our management’s attention, be costly and time-consuming and require us to make significant investments in research and product development, develop new technologies, and increase sales and marketing efforts, all of which may not be successful. We cannot assure you that any of such new products or services will achieve market acceptance or generate sufficient revenues to offset the costs and expenses incurred in relation to our development and promotion efforts. If we are unsuccessful in our expansion of after-school tutoring products or in our exploration of additional educational services due to financial constraints, failure to attract qualified personnel or other reasons, our business, financial condition and results of operations could be adversely affected.

We may not be able to maintain or increase our course fee levels.

Our results of operations are affected by the pricing of our online K-12 after-school course offerings. We determine our course fees primarily based on the demand for our course offerings, the cost of our operations, the course fees charged by our competitors, our pricing strategy to gain market share and general economic conditions in the PRC. We cannot guarantee that we will be able to maintain or increase our tuition levels in the future without adversely affecting the demand for our online course offerings.

If we are unable to conduct sales and marketing activities cost-effectively, our results of operations and financial condition may be materially and adversely affected.

We have incurred significant sales and marketing expenses, which primarily consist of (i) salaries and welfare for sales and marketing personnel and teachers’ compensation for trial courses, (ii) channel and branding expenses, including expenses relating to our online traffic acquisition channels and marketing and branding activities, and (iii) other expenses associated with our sales and marketing activities, including rental expenses. We had 17,351 sales and marketing staff (including those supplied by third-party service providers) as of March 31, 2021. We incurred RMB2,182.6 million, RMB2,627.3 million (US$401.0 million) and RMB908.7 million (US$138.7 million) in sales and marketing expenses in 2019, 2020 and the three months ended March 31, 2021, respectively.

 

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Our sales activities may not be well received by students and may not result in the levels of sales that we anticipate and our trial lessons may not be attractive to our prospective students. Furthermore, we may not be able to achieve the operational efficiency necessary to increase the revenues per sales and marketing staff. We also may not be able to retain or recruit experienced sales and marketing staff, or to efficiently train junior staff. Further, marketing and branding approaches and tools in the online education market in China are evolving, especially for mobile platforms. This further requires us to enhance our marketing and branding approaches and experiment with new methods to keep pace with industry developments and student preferences. Failure to refine our existing marketing and branding approaches or to introduce new marketing and branding approaches in a cost-effective manner may reduce our market share, cause our revenues to decline and negatively impact our profitability.

Our advertising and promotional content may subject us to penalties and other administrative actions.

Under PRC advertising, pricing and anti-unfair competition laws and regulations, we are obligated to monitor our advertising and promotional content to ensure that such content is true, accurate not misleading and in full compliance with applicable laws and regulations. For example, the PRC Pricing Law provides that an operator is prohibited from using false or misleading pricing methods to induce consumers or other operators to enter into transactions with it. The PRC Anti-Unfair Competition Law prohibits business operators from making false or misleading commercial promotions regarding its performance, functions, quality, sales, user feedback or accolades, to defraud or mislead customers. In addition, education or training advertisements are further prohibited from containing content such as guarantees that a candidate will pass the examination or regarding the effect of education or training, recommendation and/or endorsement by scientific research institutes, academic institutions, educational organizations, industry associations, professionals or beneficiaries using their name or image. Violation of these laws and regulations may subject us to penalties, including fines, confiscation of relevant income, orders to cease dissemination of the inappropriate advertisements and promotions, and orders to publish an announcement correcting the misleading information. We have implemented internal review and employee training procedures to ensure the appropriateness of our advertising and promotional content. However, there is no guarantee that such measures would always be effective in preventing potential violations, particularly in light of the evolving laws and regulations and the increased regulatory scrutiny in recent periods. For example, historically we had been subject to fines imposed by relevant governmental authority for making misleading advertisements and promotions (including recently with respect to certain inappropriate advertisements concerning the enrollment, faculty, content, effectiveness and pricing of our courses) and had been ordered to remove such advertisements and promotions. In circumstances involving serious violations by us, PRC government authorities may force us to terminate our advertising and promotional operations or revoke our licenses. See “Regulation—Regulation Relating to Advertising, Pricing and Promotion.”

Relevant PRC regulatory authorities have significant discretion in interpreting and implementing the PRC Advertising Law, PRC Pricing Law, the PRC Anti-Unfair Competition Law and the related rules and regulations. While we have made more efforts to ensure that our advertisements are in full compliance with applicable PRC laws and regulations, we cannot assure you that all the content contained in our advertisements and promotions is true and accurate as required by, and complies in all aspects with, such laws and regulations. We also cannot assure you that we can rectify content that is deemed in violation of such laws and regulations, in a timely manner, or at all, especially given the uncertainty in the interpretation of these PRC laws and regulations. If we are found to be in violation of such laws and regulations, we may be subject to penalties and our reputation may be harmed, which may result in a material adverse impact on our business, financial condition, results of operations and prospects.

Tuition refunds or potential refund disputes may negatively affect our cash flows, financial condition, and reputation.

We generally offer refunds for the remaining classes in a course to students who withdraw from such course, subject to certain conditions in the service contract between us and each of our students. When

 

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calculating gross billings for a specific period, we deduct the total amount of refunds from the total amount of cash received for the sale of courses or course packages for such period. We offer full refunds in certain circumstances. For example, for Zhangmen One-on-One and Zhangmen Kids, if students withdraw from a course before the start of the fourth classes and within 31 days upon enrollment, they are offered a full, unconditional refund after deducting certain management fees. For Zhangmen Small Class, if students withdraw from a course before the start of the third classes upon enrollment, they are also offered a full, unconditional refund. In 2020, the refund rate (calculated by dividing the total amount of refund payments processed by the total amount of gross billings generated that year deducting the refund amounts) of Zhangmen One-on-One was approximately 11%.

The number of refund requests and the amount of refunds could be affected by a number of factors, many of which are beyond our control. These factors include, without limitation to, student dissatisfaction with our teaching quality and our educational content offerings, a perceived decline in our teaching quality due to the departure of popular teachers, privacy concerns relating to our services, negative publicity regarding us or online education in general, and any change or development in PRC laws and regulations with respect to fees and tuitions charged by online after-school tutoring service providers like us. Any refund payments that we may be required to make to our students, as well as the expenses we could incur for processing refunds and resolving refund disputes, could be substantial and could adversely affect our business operations and financial condition. A high volume of refunds and refund disputes may also generate negative publicity that could harm our reputation.

If our AI programs or proprietary data analytics algorithms, especially those related to localized and real-time educational content generation, are flawed or ineffective, our business and reputation could be harmed.

We rely on our proprietary data analytics algorithms to analyze student practice exercises and academic assessment results data and based thereon to generate personalized and localized recommended study questions for students and teachers to aid in their learning and teaching, respectively, and to continually develop and improve the educational content offered in our online after-school tutoring courses. Although we have invested substantially in the development and continued improvement of our algorithms, we cannot assure you that our algorithms do not and will not carry any flaw or defect that could compromise our data analysis results. Particularly, some of these flaws or defects may not become evident until the algorithm is put to actual usage or after its continued failure to accurately generate on-point personalized or localized study question recommendations. Even if the algorithm is properly designed, its performance may be affected by the quality and volume of student learning performance data we aggregated. We also expect to experience significant growth in the amount of data we need to process as we continue to develop our business and grow our student base. As the amount of data and variables we process increases, the calculations that our algorithms must process become increasingly complex and the likelihood of any defect or error increases. In addition, a significant component of our online courses is powered by our AI programs, which address complex challenges such as autoscoring, practice exercise review and monitor of in-class interactions. We may incur significant expenses to remediate any defects in our AI programs or data analytics algorithms, or may not be able to correct them at all. Although we have not experienced any material defects to date, we cannot assure you that our AI programs and algorithms are flawless. If any incidents of material defects took place, our student and teacher experiences with our products and courses would be significantly harmed, and they may lose confidence and trust in our products and courses. As a result, we may incur significant reputational damage and market share loss.

Inability to adequately and promptly respond to changes in examination systems, admission standards, test materials, teaching methods and regulation changes in the PRC could render our courses and services less attractive to students.

In China, school admissions rely heavily on examination results, and students’ performance in these exams is critical to their education and future employment prospects. It is therefore common for students to take after-school tutoring classes to improve their test performance, and the success of our business to a large extent

 

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depends on the continued use of entrance exams or tests by schools in their admissions. However, such heavy emphasis on examination scores may decline or fall out of favor with educational institutions or government authorities in China.

Admission and assessment processes undergo constant changes, in terms of subject and skill focus, question type, examination format and the manner in which the processes are administered. We are therefore required to continually update and enhance our curricula, course materials and teaching methods. Any failure to respond to the changes in a timely and cost-effective manner will adversely impact the marketability of our courses and products, which would have a material adverse effect on our business, financial condition and results of operations.

Regulations and policies that decrease the weight of scholastic competition achievements in the admissions process mandated by government authorities or adopted by schools may have an impact on our enrollments. For example, the MOE has issued certain implementation guidelines to clarify that local educational administrative departments at all levels, public schools and private schools are not allowed to use examinations to select their students for admission to middle schools from primary schools. As a result, public schools may not use various competitions or examination certificates as the criteria or basis for enrollment. Failure to track and respond to these changes in a timely and cost-effective manner would render our courses, services and products less attractive to students, which may materially and adversely affect our reputation and ability to continue to attract students.

Our failure to protect our intellectual property rights may undermine our competitive position, and litigation to protect our intellectual property rights or defend against third-party allegations of infringement may be costly and ineffective.

We believe that our patents, copyrights, trademarks and other intellectual property are essential to our success. We have devoted considerable time and energy to the development and improvement of our websites, mobile apps, our system infrastructure and our course materials.

We rely primarily on patents, copyrights, trademarks, trade secrets and other contractual restrictions for the protection of the intellectual property used in our business. Nevertheless, these provide only limited protection and the actions we take to protect our intellectual property rights may not be adequate. Furthermore, our pending intellectual property right applications may be rejected. Our trade secrets may become known or be independently discovered by our competitors. Third parties may pirate our educational content and course materials developed in-house and may infringe upon or misappropriate our other intellectual property. Infringement upon or the misappropriation of, our proprietary technologies or other intellectual property could have a material adverse effect on our business, financial condition or results of operations. Although we have taken measures to monitoring and policing the unauthorized use of our copyrighted course materials, policing the unauthorized use of intellectual property rights can be difficult and expensive. For example, even though the contracts we entered into with our teachers specify that we shall have sole ownership over intellectual properties relating to our course content, we and our teachers may be deemed to have joint ownership over intellectual properties relating to our course content. Our teachers may continue to use these content in our course materials if they resign with us and join our competitors, which may negatively impact the attractiveness of our courses to prospective students, and our intellectual property rights for such content could be costly and time consuming to defend. Although the agreements entered into with our teachers prohibit them from using our course content without our prior consent, we cannot ensure compliance of teachers with such agreement.

Furthermore, litigation may be necessary to enforce our intellectual property rights, protect our trade secrets or determine the validity and scope of the proprietary rights of others. Such litigation may be costly and divert management’s attention away from our business. An adverse determination in any such litigation would impair our intellectual property rights and may harm our business, prospects and reputation. The legal regime relating to the recognition and enforcement of intellectual property rights in China is particularly limited, and does not

 

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protect intellectual property rights to the same extent as federal and state laws in the United States. Legal proceedings to enforce our intellectual property in China may progress slowly, during which time infringement may continue largely unimpeded. Enforcement of judgments in China is uncertain, and even if we are successful in litigation, it may not provide us with an effective remedy. In addition, we have no insurance coverage against litigation costs and would have to bear all costs arising from such litigation to the extent we are unable to recover them from other parties. The occurrence of any of the foregoing could have a material adverse effect on our business, financial condition and results of operations.

We may be involved in legal and other disputes from time to time arising out of our operations, in particular for allegations relating to our infringement of intellectual property rights of third parties, which may be expensive to defend and may disrupt our business and operations.

We have and may continue to be involved in legal and other disputes in the ordinary course of our business, including allegations against us for potential infringement of third-party copyrights or other intellectual property rights. We may also encounter disputes from time to time over rights and obligations concerning intellectual property rights and other legal rights, in particular third-party copyrights that may be infringed by us or the teachers and student service staff in our business operation, and we may not prevail in those disputes. Our educational content is typically subject to internal review before being approved to launch and our content monitoring personnel are responsible for monitoring content delivered in our courses. We have also adopted policies and procedures to prohibit teachers, student service staff and other personnel from infringing upon third-party copyrights or, other intellectual property rights. However, we cannot assure you that our efforts will be effective in preventing potential infringement of third-party intellectual property rights or that teachers, student service staff or other personnel will not, against our policies, use third-party copyrighted materials or intellectual property without proper authorization in our classes or on our applications or websites. The students and teachers using our applications or websites may post unauthorized third-party content on our applications or websites, which we may not be able to detect in time, or at all. We may incur liability for unauthorized duplication or distribution of materials posted on our applications or websites or used in our classes. We have been, and may be in the future, subject to allegations on the grounds of intellectual property rights infringement and other legal theories based on the content of the materials that we or teachers and student service staff of our courses distribute or use in our business operation.

Any claims against us, with or without merit, could be time-consuming and costly to defend or litigate, divert our management’s attention and resources or result in the loss of goodwill associated with our brand. The application and interpretation of China’s intellectual property right laws and the procedures and standards for granting trademarks, patents, copyrights, know-how or other intellectual property rights in China, and the laws governing personal rights are still evolving and remain uncertain, and we cannot assure you that PRC courts or regulatory authorities would agree with our analysis. If a lawsuit against us is successful, we may be required to pay substantial damages and/or enter into royalty or license agreements with commercially unreasonable terms, or we may be unable to enter into such agreements at all. We may also lose, or be limited in, the rights to offer some of our course offerings, parts of our products or be required to make changes to our course materials, applications or other software. As a result, the scope of our course materials could be reduced, which could adversely affect the effectiveness of our curriculum, limit our ability to attract new students, harm our reputation and have a material adverse effect on our results of operations and financial condition.

If our security measures are breached or failed and result in unauthorized disclosure or unintended leakage of data, including confidential information of our teachers and students, we could lose existing teachers and students, fail to attract new teachers and students and be exposed to protracted and costly litigation.

Maintaining platform security is of critical importance to us because we store and transmit proprietary and confidential information, which includes proprietary and confidential student and teaching staff information, such as names, addresses, ID card number, bank account number and other personal information, which is primarily stored in our digital database. To ensure the confidentiality and integrity of our data, we maintain a

 

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comprehensive and rigorous data security program. For example, we anonymize and encrypt confidential personal information and take other technological measures to ensure the secure processing, transmission and usage of data. See “Business—Data Privacy and Security.” These measures, however, may not be as effective as we anticipate. As an online education company, we face an increasing number of threats to our platform and computer systems, including unauthorized activity and access, system viruses, worms, malicious code, denial of service attacks, phishing attacks, and organized cyberattacks, any of which could breach our security and disrupt our platform and technology infrastructure. The techniques used by computer hackers and cyber criminals to obtain unauthorized access to data or to sabotage computer systems change frequently and generally are not detected until after an incident has occurred. We have implemented certain safeguards and processes to thwart hackers and protect the data in our platform and computer systems. However, our efforts to maintain the security and integrity of our platform, and the cybersecurity measures taken by our third-party service providers may be unable to anticipate, detect or prevent all attempts to compromise our systems. If our security measures are breached or fail as a result of third-party action, employee error, malfeasance or otherwise, it could result in the loss or misuse of or authorized third-party access to proprietary and confidential student, teacher, employee and company information, which could subject us to liability, interrupt our business or adversely affect our reputation, potentially over an extended period of time.

Increased regulation of data utilization practices, including self-regulation, under existing laws that limit our ability to collect, transfer and use data, could have an adverse effect on our business. If we were to disclose data about our students, teachers, and student service staff in a manner that was objectionable to them, our business reputation could be adversely affected, and we could face potential legal claims that could impact our operating results. Failure to comply with these obligations could subject us to liability, and to the extent that we need to alter our business model or practices to adapt to these obligations, we could incur additional expenses.

Any of these issues could harm our reputation, adversely affect our ability to attract and enroll prospective students, adversely affect our ability to maintain our filings, cause prospective students not to enroll or stay enrolled, or subject us to third-party lawsuits, regulatory fines or other action or liability. Further, any reputational damage resulting from breach of our security measures could create distrust of our company by prospective students or investors. We may be required to expend significant additional resources to protect us against the threat of security measures breaches or to alleviate problems caused by such disruptions or breaches.

Because we collect, store, process and use data, some of which contains sensitive personal information, we face concerns over the collection, improper use, storage or disclosure of personal information, which could discourage current and potential users from using our services, damage our reputation, face regulatory scrutiny, and in turn materially and adversely affect our business, financial condition and results of operations.

Concerns or claims about our practices with regard to the collection, storage, processing or use of personal information or other privacy-related matters, even if unfounded, could damage our reputation and results of operations. Under the Cyber Security Law of China, the owners and administrators of networks and network service providers have various personal information security protection obligations, including restrictions on the collection, storage and use of personal information of users, and they are required to take steps to prevent personal data from being divulged, stolen, or tampered with. See “Regulation—Regulation Relating to Internet Information Security and Privacy Protection.”

Regulatory requirements regarding the protection and privacy of data are constantly evolving and can be subject to differing interpretations or significant change, making the extent of our responsibilities in that regard uncertain. For example, the Cybersecurity Law of the PRC became effective in June 2017, but there are great uncertainties as to the interpretation and application of the law. It is possible that those regulatory requirements may be interpreted and applied in a manner that is inconsistent with our practices. Another example of such evolving regulatory requirements is the Draft Law of Personal Information Protection, which was published for public comments on October 21, 2020. When it is passed in the future, this law will function jointly with the

 

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Cyber Security Law to regulate China’s online spheres in relation to personal information protection. Complying with new laws and regulations could cause us to incur substantial costs or require us to change our business practices in a manner materially adverse to our business. In addition, the Office of the Central Cyberspace Affairs Commission, the Ministry of Industry and Information Technology, the Ministry of Public Security, and the State Administration for Market Regulation jointly issued an announcement on January 23, 2019 regarding carrying out special campaigns against mobile internet application programs collecting and using personal information in violation of applicable laws and regulations, which prohibits business operators from collecting personal information irrelevant to their services, or forcing users to give authorization in disguised manner. Furthermore, the Cyberspace Administration of China issued the Provisions on the Cyber Protection of Children’s Personal Information on August 22, 2019, which took effect on October 1, 2019. The Provisions on the Cyber Protection of Children’s Personal Information requires, among others, that network operators who collect, store, use, transfer and disclose personal information of children under the age of 14 shall establish special rules and user agreements for the protection of children’s personal information, inform the children’s guardians in a noticeable and clear manner, and shall obtain the consent of the children’s guardians. We have been taking and will continue to take reasonable measures to comply with such announcement and provisions, however, as the announcement and provisions are relatively new, we cannot assure you we can adapt our operations to it in a timely manner. Evolving interpretations of such announcements and provisions or any future regulatory changes might impose additional restrictions on us generating and processing personal and behavioral data. We may be subject to additional regulations, laws and policies adopted by the PRC government to apply more stringent social and ethical standards in data privacy resulting from the increased global focus on this area. To the extent that we need to alter our business model or practices to adapt to these announcement and provisions and future regulations, laws and policies, we could incur additional expenses.

Any failure, or perceived failure, by us, or by our third-party partners, to maintain the security of our user data or to comply with applicable privacy, data security and personal information protection laws, regulations, policies, contractual provisions, industry standards, and other requirements, may result in civil or regulatory liability, including governmental or data protection authority enforcement actions and investigations, fines, penalties, enforcement orders requiring us to cease operating in a certain way, litigation, or adverse publicity, and may require us to expend significant resources in responding to and defending allegations and claims. Moreover, claims or allegations that we have failed to adequately protect our users’ data, or otherwise violated applicable privacy, data security and personal information protection laws, regulations, policies, contractual provisions, industry standards, or other requirements, may result in damage to our reputation and a loss of confidence in us by our students, teachers, or our partners, potentially causing us to lose course enrollments, content providers, other business partners and revenues, which could have a material adverse effect on our business, financial condition and results of operations.

The success and future growth of our business will be affected by students’ acceptance of and market trends in integration of technology and education.

We operate at the intersection of the education and technology industries, and our business model features integrating technology closely with education to provide a more efficient and engaging learning experience. However, the integration of technology and education remains a relatively new concept in China, and there are limited proven methods to project user demand or preference or available industry standards on which we can rely. For example, despite the growing enrollment of our online tutoring courses, there is no guarantee that it will also be well received by the broader students. In addition, even with the proliferation of internet and mobile devices in China, we believe that some of our target students may still be inclined to choose traditional, face-to-face courses over online courses as they find the former more intimate and reliable. We cannot assure you that our products and services will continue to be attractive to our users in the future. If our online after-school tutoring courses, which utilize data insights and technology, become less appealing to our users, our business, financial condition and results of operations could be materially and adversely affected.

 

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Any significant disruption to or failures of our information technology systems, including events beyond our control, could reduce student satisfaction and could harm our reputation and cause our online after-school tutoring service to be less attractive to our students.

The performance and reliability of our information technology system is critical to our operations and reputation. Our network infrastructure is currently deployed and our data is currently mainly maintained through several third-party internet data centers and cloud computing service providers in China. Our operations depend on each of the data centers’ and service providers’ ability to protect its and our system in its facilities against events such as damage or interruption from natural disasters, power or telecommunications failures, air quality issues, environmental conditions, computer viruses or attempts to harm our systems, criminal acts and similar events, which events are beyond our control. If our arrangements with such data centers and service providers are terminated or if there is a lapse of service or damage to any of their facilities, we could experience interruptions in our service. Although we continually back up our databases on both real-time and delayed bases, we may still lose important operating data or suffer disruption to our operations if there is a failure of the database system or the backup system. We may be required to invest significant resources in protecting against the foregoing technological disruptions, or to remediate problems and damages caused by such incidents, which could increase the cost of our business and in turn adversely affect our financial conditions and results of operations. We cannot assure you that we will be able to expand our information technology infrastructure in a timely and cost-effective manner to meet the increasing demands of our business growth. Any interruptions in the accessibility of or deterioration of the quality of access to our system could reduce teachers’ and students’ satisfaction and reduce the attractiveness of our online K-12 tutoring course offerings, which would result in reduction in the number of students enrolling in our after-school tutoring courses. Although we have not experienced any significant disruptions to or failures of our information technology systems, we cannot assure you that such disruptions or failures will not happen in the future.

In addition, we rely on third-party mobile application distribution channels, such as Apple’s App Store and Android application stores, to distribute our mobile applications to students and teachers. As such, the promotion, distribution and operation of our mobile applications are subject to such distribution channels’ standard terms and policies for application developers, which are subject to the interpretation of, and frequent changes by, these distribution channels. If third-party app stores or any other major distribution channel interprets or changes its standard terms and conditions in a manner that is detrimental to us in the future, or terminate its existing relationship with us, or if any third-party infringement claims are brought against our mobile applications, our mobile applications could be temporarily or permanently removed from such third-party mobile application distribution channels and our business, financial condition and results of operations may be materially and adversely affected.

If we fail to adopt new technologies that are important to our business, in particular the technology upgrades related to live broadcasting and AI, our competitive position and ability to generate revenues may be materially and adversely affected.

The technology used in internet and value-added telecommunications services in general, and in online education services in particular, may evolve and change over time. We believe our technologies are core to our success and are critical to the implementation of our business model. In particular, implementation of technologies to improve teaching efficiency is an important part of our online K-12 tutoring course offerings and is critical to attracting new students to enroll in our online courses. As an online education company, we must anticipate and adapt to such technological changes and adopt new technologies in a timely fashion. We also rely on our data and technology capabilities to build and maintain our platform and infrastructure. We cannot assure you that we can keep up with the fast pace of the technology industry, and continue to develop, innovate and utilize our proprietary capabilities. In particular, the application of technology in education is still at an early stage and under exploration. Our technologies may become obsolete or insufficient, and we may have difficulties in following and adapting to technological changes in the online education industry in a timely and cost-effective manner. New solutions and technologies developed and introduced by competitors could render our technology

 

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obsolete. Developing and integrating new technologies into our existing programs and algorithms could be expensive and time-consuming. We may not succeed in developing and incorporating new technologies at all. If we fail to continue to develop, innovate and utilize our technologies effectively and on a timely basis, our business, financial performance and prospects could be materially and adversely affected.

We may need additional capital in the future to pursue our business objectives. If we cannot obtain additional capital on acceptable terms, or at all, our business, financial condition and results of operations may be materially and adversely affected.

We may need to raise additional capital to respond to business challenges or opportunities, accelerate our growth, develop new offerings or enhance our technological capacities. Due to the unpredictable nature of the capital markets and our industry, there can be no assurance that we will be able to raise additional capital on terms favorable to us, or at all, if and when required, especially if we experience disappointing results of operations. If adequate capital is not available to us as required, our ability to fund our operations, take advantage of unanticipated opportunities, develop or enhance our infrastructure or respond to competitive pressures could be significantly limited. If we do raise additional funds through the issuance of equity or convertible debt securities, the ownership interests of our shareholders could be significantly diluted. These newly issued securities may have rights, preferences or privileges senior to those of existing shareholders.

We cannot assure you that we will not be subject to liability claims for any inappropriate or illegal content offered as part of our online courses, which could cause us to incur legal costs and damages our reputation.

Although we implement various content monitoring procedures, we cannot assure you that there will be no inappropriate or illegal content included in our educational content or applications and websites. In addition, our quiz questions designed internally based on our understanding of the relevant examination requirements may be investigated by the regulatory authorities. We may face civil, administrative or criminal liability or legal or regulatory sanctions, such as requiring us to restrict or discontinue our content, products or services, if an individual or corporate, governmental or other entity believes that any of our educational content or content displayed on our applications and websites violates any laws, regulations or governmental policies or infringes upon its legal rights. Even if such a claim were not successful, defending such a claim may cause us to incur substantial costs. Moreover, any accusation of inappropriate or illegal content in our educational content offerings or our applications and websites could lead to significant negative publicity, which could harm our reputation, business, financial condition and results of operations.

The recognition of our brand may be adversely affected by any negative publicity concerning us and our business, shareholders, affiliates, directors, officers, our employees, teachers and student service staff, as well as the industry in which we operate, regardless of its accuracy, which could harm our reputation and business.

We believe that the market recognition of our brand has significantly contributed to the success of our business and that maintaining and enhancing our brand recognition is critical to sustaining our competitive advantages. Negative publicity about us and our business, shareholders, affiliates, directors, officers, teachers, student service staff, other employees, and other part-time workers, as well as the industry in which we operate, can harm the recognition of our brand. Negative publicity, regardless of merits, could be related to a wide variety of matters, including but not limited to:

 

   

alleged misconduct or other improper activities committed by our students or our shareholders, affiliates, directors, officers, teachers, student service staff, other employees, and other part-time workers, including misrepresentation made by our employees during sales and marketing activities, and other fraudulent activities to artificially inflate the popularity of our products, services or course offerings;

 

   

false or malicious allegations or rumors about us or our shareholders, affiliates, directors, officers, teachers, student service staff, other employees, teaching staff and other part-time workers;

 

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complaints by our students and their parents about our course offerings;

 

   

refund disputes of course fees or disputes relating to tuition fee installment payments between us and our students and their parents;

 

   

lack of required teaching qualifications;

 

   

security breaches or misuse of private user or transaction data or other information;

 

   

employment-related claims relating to alleged employment discrimination, wage and hour violations, as well as outsourced or flexible staffing arrangements; and

 

   

governmental and regulatory investigations or penalties resulting from our failure to comply with applicable laws, regulations and policies, including those adopted by the government to apply more stringent social, ethical and environmental standards in connection with increased global focus on these areas.

In addition to traditional media, there has been an increasing use of social media platforms and similar technologies in China, including instant messaging applications, social media websites and other forms of internet-based communications that provide individuals with access to a broad audience of consumers and other interested persons. The availability of information on instant messaging applications and social media platforms is virtually immediate as is its impact without affording us an opportunity for redress or correction. The opportunity for dissemination of information, including inaccurate information, is seemingly limitless and readily available. Information concerning our company, shareholders, affiliates, directors, officers, teachers, student service staff, other employees, and other part-time workers, may be posted on such platforms at any time. The risks associated with any such negative publicity or incorrect or misleading information cannot be completely eliminated or mitigated and may materially harm the recognition of our brand, reputation, business, financial condition and results of operations.

Failure to make adequate contributions to various employee benefits plans as required by PRC regulations may subject us to penalties.

Companies operating in China are required to participate in various government-sponsored employee benefit plans, including certain social insurance, housing funds and other welfare-oriented payment obligations, and contribute to the plans in amounts equal to certain percentages of salaries, including bonuses and allowances, of employees up to a maximum amount specified by the local government from time to time at locations where our employees are based. The requirement of employee benefit plans has not been implemented consistently by the local governments in China given the different levels of economic development in different locations. To efficiently administrate the contribution of employment benefit plans of our employees in some cities, we engage third-party agents to make the contribution for our employees. Our failure in making contributions to various employee benefit plans and in complying with applicable PRC labor-related laws may subject us to late payment penalties, and we could be required to make up the contributions for these plans as well as to pay late fees and fines. If we are subject to late fees or fines in relation to the underpaid employee benefits, our financial condition and results of operations may be adversely affected. In addition, to the extent that we can make a reasonable estimate of the liability arising from our failure in making full contributions to various employee benefit plans, we record a related contingent liability. However, the amount of our estimates may be inaccurate, in which case our financial condition and cash flow may be adversely affected if we were to pay late fees or fines in relation to the underpaid employee benefits.

If our senior management and other key personnel are unable to work together effectively or efficiently or if we lose their services, our business may be severely affected.

The continued services of our senior management and other key personnel are important to our continued success. In particular, we rely on the expertise and experience of Mr. Yi Zhang, our founder, chairman and CEO.

 

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We also rely on the experience and services from other senior management. If we lose any of such senior management, we might not be able to replace them easily or at all, and our business, financial condition and results of operations may be materially and adversely affected. Competition for experienced management personnel in the online education industry is intense, the pool of qualified candidates is limited, and we may not be able to retain the services of our senior executives or key personnel, or to attract and retain high-quality senior executives or key personnel in the future. If any of our senior management joins a competitor or forms a competing business, we may lose students, teaching staff, and other key professionals and staff members. Our senior management has entered into employment agreements with us which contain confidentiality and non-compete clauses. However, if any dispute arises between our senior management and us, we may have to incur substantial costs and expenses in order to enforce such agreements in China or we may be unable to enforce them at all. As we have been a private company since our inception, our senior management also has limited experience in managing internal control, financial reporting, and other regulatory and compliance matters of a public company.

Our success also depends on our having highly trained content and product development, financial, technical, human resource, sales and marketing staff, management personnel and qualified and dedicated teachers and student service staff. We will need to continue to hire additional personnel as our business grows. A shortage in the supply of personnel with requisite skills or our failure to recruit them could impede our ability to increase revenues from our existing courses, products and services, to launch new offerings and to expand our operations, and would have an adverse effect on our business and financial results.

We have granted, and expect to continue to grant, share-based awards under our share incentive plan, which may result in increased share-based compensation expenses.

We adopted share incentive plans in 2018 and 2021, or the 2018 Plan and the 2021 Plan, respectively, for the purpose of granting share-based compensation awards to employees, officers, directors and consultants to incentivize their performance and promote the success of our business. The maximum aggregate number of ordinary shares that may be issued under the 2018 Plan and the 2021 Plan is 93,082,225 ordinary shares and 38,000,000 ordinary shares, respectively. See “Management—Share Incentive Plans.” We recorded RMB7.4 million, RMB20.5 million (US$3.1 million) and RMB24.1 million (US$3.7 million) in 2019, 2020 and the three months ended March 31, 2021, respectively, in share-based compensation expenses. We expect to continue to grant awards under our share incentive plan, which we believe is of significant importance to our ability to attract and retain key personnel and employees. As a result, our expenses associated with share-based compensation may increase, which may have an adverse effect on our results of operations.

We are subject to risks related to third-party payment processing.

We accept payments through major third-party online payment channels in China. We may also be susceptible to fraud, user data leakage and other illegal activities in connection with the various payment methods we offer. In addition, our business depends on the billing, payment and escrow systems of the third-party payment service providers to maintain accurate records of payments by customers and collect such payments. If the quality, utility, convenience or attractiveness of these payment processing and escrow services declines, or if we have to change the pattern of using these payment services for any reason, the attractiveness of our company could be materially and adversely affected. We are also subject to various rules, regulations and requirements, regulatory or otherwise, governing electronic funds transfers which could change or be reinterpreted to make it difficult or impossible for us to comply. If we fail to comply with these rules or requirements, we may be subject to fines and higher transaction fees and become unable to accept the current online payments solutions from our customers, and our business, financial condition and results of operations could be materially and adversely affected. Business involving online payment services is subject to a number of risks that could materially and adversely affect third-party online payment service providers’ ability to provide payment processing and escrow services to us, including:

 

   

dissatisfaction with these online payment services or decreased use of their services;

 

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increasing competition, including from other established Chinese internet companies, payment service providers and companies engaged in other financial technology services;

 

   

changes to rules or practices applicable to payment systems that link to third-party online payment service providers;

 

   

breach of customers’ personal information and concerns over the use and security of information collected from buyers;

 

   

service outages, system failures or failures to effectively scale the system to handle large and growing transaction volumes;

 

   

increasing costs to third-party online payment service providers, including fees charged by banks to process transactions through online payment channels, which would also increase our costs of revenues; and

 

   

failure to manage funds accurately or loss of funds, whether due to employee fraud, security breaches, technical errors or otherwise.

We may face risks associated with the installment tuition payment plan we offer to our students.

We have introduced an installment payment option enabling eligible students to obtain loans from accredited third-party credit providers in China to finance all or part of their tuition fees. The third-party credit providers are responsible for performing credit assessment, approving loan applications, providing the funds, and collecting delinquent loan payments. Under the loan agreement, the parents of our students are obligated to repay the loan to the credit providers. We generally do not provide any guarantees for the repayment of student loans in favor of the credit providers. In 2019, 2020 and the three months ended March 31, 2021, approximately 10%, 8% and 7%, respectively, of our gross billings were received from third-party credit providers.

The availability of funding from our existing and potential credit providers depends on many factors, such as their liquidity and capital sufficiency, the legal and regulatory environment, the general economic conditions, default rates of our students on the loans, and, where applicable, the availability of lenders on the credit providers’ platforms. In addition, our credit providers may seek to acquire borrowers independently instead of through cooperation with us. We currently work with a limited number of credit providers and we cannot assure you that our credit providers will continue to cooperate with us on commercially favorable terms, or at all, or that existing or potential credit providers will be able to provide loans in a sufficient amount to meet our students’ borrowing needs. If any of these were to occur, our course packages may become less compelling to prospective students who wish to obtain student loans, and as a result our business and financial condition may be negatively affected.

Our brand image, business and results of operations may be adversely impacted by misconduct, improper activities and misuse of our product and service offerings by students, teaching staff and employees, many of which are beyond our control.

Our teachers and student service staff engage in real-time communications with our students. Our courses undergo multiple rounds of internal review and pilot testing before being broadly released. We regularly and actively monitor our live courses, chat messages and other content and communications on our platform to ensure that we are able to identify content that may be deemed inappropriate or in violation of laws, regulations and government policies. When any inappropriate or illegal content is identified, we promptly remove the content. However, since we have limited control over the real-time and offline activities of our students and teaching staff, to the extent any improper behavior is associated with our content, applications or websites, our ability to protect our brand image and reputation may be limited. In addition, if any of our students or teaching staff suffer or allege to have suffered physical, financial or emotional harm following contact initiated through our content, applications or websites, we may face civil lawsuits or other liabilities initiated by the affected

 

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individual or governmental or regulatory actions against us. In response to allegations of illegal or inappropriate activities conducted on our applications or websites or any negative media coverage about us, PRC governmental authorities may intervene and hold us liable for non-compliance with PRC laws and regulations concerning the dissemination of information on the internet and subject us to administrative penalties or other sanctions, such as requiring us to restrict or discontinue some of the content, features and services provided through our applications or websites. As a result, our business may suffer and our brand image, student and teacher base, results of operations and financial condition may be materially and adversely affected.

We are exposed to the risk of other types of employee fraud or other misconduct. Other types of employee misconduct include, but are not limited to, intentionally failing to comply with government regulations, engaging in unauthorized activities when interacting with our students and during the course of their work, such as mishandling student records and data, and making misrepresentation to our prospective students during marketing activities, all of which could harm our business and reputation. It is not always possible to deter employee misconduct, and the precautions we take to prevent and detect this activity may not be effective in controlling unknown or unmanaged risks or losses, which could harm our business, financial condition and results of operations.

Increases in labor costs and compliance with stricter labor laws in the PRC may adversely affect our business and results of operations.

The currently effective PRC Labor Contract Law took effect from January 1, 2008 and was later amended on December 28, 2012. The PRC Labor Contract Law has reinforced the protection of employees who, under the PRC Labor Contract Law, have the right, among others, to have written employment contracts, to enter into employment contracts with no fixed term under certain circumstances, to receive overtime wages and to terminate or alter terms in labor contracts. Furthermore, the PRC Labor Contract Law sets forth additional restrictions and increases the costs involved with dismissing employees. To the extent that we need to significantly reduce our workforce, the PRC Labor Contract Law could adversely affect our ability to do so in a timely and cost-effective manner, and our results of operations could be adversely affected. In addition, for employees whose employment contracts include noncompetition terms, the PRC Labor Contract Law requires us to pay monthly compensation after such employment is terminated, which will increase our operating expenses. Because the PRC governmental authorities have introduced various new labor-related regulations since the PRC Labor Contract Law took effect, and the interpretation and implementation of these regulations are still evolving, our employment practices could violate the PRC Labor Contract Law and related regulations and could be subject to related penalties, fines or legal fees. If we are subject to severe penalties or incur significant legal fees in connection with labor law disputes or investigations, our business, financial condition and results of operations may be adversely affected.

As of March 31, 2021, we had 11,995 full-time teachers, 7,843 education program consultants and 7,006 student service staff supplied by third-party service providers. However, we cannot preclude the possibility that these workers supplied by third-party service providers may be classified as “dispatched workers” or our employees by courts, arbitration tribunals or government agencies. PRC labor laws and regulations impose stringent requirements on the use of employees of temp agencies, who are known in China as “dispatched workers.” For example, the number of dispatched workers may not exceed 10% of its total number of employees and the dispatched workers can only engage in temporary, auxiliary or substitutable work. However, since the application and interpretation of the PRC Labor Contract Law and other related laws and regulations are limited and uncertain, we cannot assure you our business operation will be deemed to be in full compliance with them. If we are found to be in violation of any requirements under the Labor Contract Law, the Interim Provisions on Labor Dispatch or their related rules and regulations, we may be ordered by the labor authority to rectify the non-compliance by entering into written employment contracts with the deemed “dispatched workers,” or be subject to regulatory penalty, other sanction or liability or be subject to labor disputes.

We expect that our labor costs, including wages and employee benefits, will continue to increase. Unless we are able to pass on these increased labor costs to our customers by attracting new customers or increasing the

 

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prices of our products and courses, our financial conditions and results of operations would be materially and adversely affected.

Our results of operations are subject to seasonal fluctuations.

Our industry generally experiences seasonality, reflecting a combination of traditional education industry patterns and new patterns associated with the online platform in particular. Seasonal fluctuations have affected, and are likely to continue to affect, our business. We generally generate higher gross billings in the second and fourth quarters in a given year because of the increased paid student enrollments for the spring and fall semesters. Overall, the historical seasonality of our business has been relatively mild due to our rapid growth, but seasonality may increase in the future. The seasonal trends that we have experienced in the past may not be indicative of our future operating results. Our financial condition and results of operations for future periods may continue to fluctuate. As a result, the trading price of our ADSs may fluctuate from time to time due to seasonality.

If we cannot maintain our corporate culture as we grow, we could lose the innovation, collaboration and focus that contribute to our business.

We believe that a critical component of our success is our corporate culture, which fosters innovation and has roots in a deep understanding of our students, teachers as well as the evolving education industry in China. As we continue to expand and grow our business, we may find it difficult to maintain these valuable aspects of our corporate culture. Any failure to preserve our culture could undermine our reputation in the marketplace and negatively impact our ability to attract and retain employees and students, which would in turn jeopardize our future success.

We may be the subject of detrimental conduct by third parties such as our competitors, including complaints to regulatory agencies and the public dissemination of malicious assessments of our business, which could have a negative impact on our reputation and cause us to lose market share, students and revenues, and adversely affect the price of our ADSs.

We have been, and in the future may be, the target of anti-competitive, harassing or other detrimental conduct by third parties including our competitors. Such conduct may include complaints, anonymous or otherwise, to regulatory agencies regarding our operations, accounting, business relationships, business prospects and business ethics. Additionally, allegations, directly or indirectly against us, may be posted online by anyone, whether or not related to us, on an anonymous basis. We may be subject to government or regulatory investigation as a result of such third-party conduct and may be required to expend significant time and incur substantial costs to address such third-party conduct, and there is no assurance that we will be able to conclusively refute each of the allegations within a reasonable period of time, or at all. Our reputation may also be materially negatively affected as a result of the public dissemination of anonymous allegations or malicious statements about our business, which in turn may cause us to lose students and revenues, and adversely affect the price of our ADSs.

We face risks related to natural and other disasters, health epidemics, and other extraordinary events, such as the COVID-19 pandemic, which could significantly disrupt our operations.

Our business could be materially and adversely affected by natural disasters, other health epidemics or other public safety concerns affecting the PRC, and particularly Shanghai. Natural disasters may give rise to server interruptions, breakdowns, system failures, technology platform failures, internet failures or other operation interruptions for us and our service providers, which could cause the loss or corruption of data or malfunction of software or hardware as well as adversely affect our ability and the ability of our service providers to conduct daily operations and to deliver our products and course offerings. Our business could also be adversely affected if employees of ours or our service providers are affected by health epidemics. In addition, our results of operations could be adversely affected to the extent that any health epidemic harms the Chinese economy in general.

 

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The COVID-19 pandemic has created unique global and industry-wide challenges, including challenges to our business. In early 2020, the COVID-19 pandemic resulted in the temporary closure of many corporate offices and schools across China. Given the strict quarantine measures put in place during this period, normal economic activity throughout China was sharply curtailed and normal in-school education was temporarily suspended. Substantially all of our revenues and our workforce are concentrated in China. Consequently, to the extent that COVID-19 exerts long-term negative impact on the Chinese economy, our results of operations and financial performance may be adversely affected. Since we lease offices in certain Chinese cities to support our online after-school tutoring service operation, research and development and daily operations, the COVID-19 outbreak caused temporary office closures and rotation arrangements from late January to late March 2020, resulting in lower work efficiency and productivity. We also incurred insignificant costs in relation to the measures we took to reduce the impact of this epidemic outbreak in 2020, including purchasing personal protective equipment, upgrading our technology system to support the growth in online courses, monitoring our employees’ health, and rotation arrangements to avoid infection transmission. During this period impacted by the COVID-19 pandemic, as a result of the temporary closure of schools in China, students were prompted to engage in more online education as they study at home, which has positively affected the online after-school tutoring industry, including us. In addition, the number of students enrolled in our online courses also grew more rapidly during this period of temporary school closure and students became more open to accepting the integration of technology and teaching.

Many of the quarantine measures within China have since been relaxed as of the date of this prospectus. However, relaxation of restrictions on economic and social activities may lead to new cases. There has been occasional outbreaks of COVID-19 in various cities in China, and the Chinese government may again take measures to keep COVID-19 in check. Our results of operations may still be adversely affected to the extent that COVID-19 continues to affect the Chinese economy in general. In addition, the longer-term trajectory of COVID-19, both in terms of scope and intensity of the pandemic, in China as well as globally, together with its impact on the industry and the broader economy are still difficult to assess or predict and face significant uncertainties that will be difficult to quantify. If there is not a material recovery in the COVID-19 situation, or the situation further deteriorates in China or globally, our business, results of operations and financial condition could be materially and adversely affected.

Our headquarters are located in Shanghai. Most of our system hardware and back-up systems are hosted in facilities located in China and most of our service providers are located in China. Consequently, if any natural disasters, health epidemics or other public safety concerns were to affect Shanghai, our operation may experience material disruptions, which may materially and adversely affect our business, financial condition and results of operations.

We currently have no business insurance coverage, which could expose us to significant costs and business disruption.

Insurance companies in China currently do not offer as extensive an array of insurance products as insurance companies in more developed economies. We do not maintain any liability insurance or property insurance policies covering students, equipment and facilities for injuries, death or losses due to fire, earthquake, flood or any other disaster. Consistent with customary industry practice in China, we do not maintain business interruption insurance, nor do we maintain key-man life insurance. We have determined that the costs of insuring for these risks and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. Any uninsured business disruptions may result in our incurring substantial costs and the diversion of resources, which could have an adverse effect on our results of operations and financial condition.

 

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

Prior to this offering, we were a private company with limited accounting personnel and other resources with which to address our internal control over financial reporting. In the course of auditing our consolidated financial statements as of and for the years ended December 31, 2019 and 2020, we and our independent registered public accounting firm identified one material weakness and other control deficiencies in our internal control over financial reporting. As defined in the standards established by the U.S. Public Company Accounting Oversight Board, a “material weakness” is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.

The material weakness that has been identified relates to lack of sufficient skilled staff with U.S. GAAP knowledge for the purpose of financial reporting and lack of formal accounting policies and procedures manual to ensure proper financial reporting to comply with U.S. GAAP and SEC requirements. The material weakness, if not timely remedied, may lead to significant misstatements in our consolidated financial statements in the future. Neither we nor our independent registered public accounting firm undertook a comprehensive assessment of our internal control for purposes of identifying and reporting material weakness and other control deficiencies in our internal control over financial reporting. 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 deficiencies may have been identified.

Following the identification of the material weakness, we have taken measures and plan to continue to take measures to remediate these control deficiencies. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Internal Control Over Financial Reporting.” However, the implementation of these measures may not fully address the material weakness in our internal control over financial reporting, and we cannot conclude that they have been fully remediated. Our failure to correct the material weakness or our failure to discover and address any other deficiencies could result in inaccuracies in our financial statements and impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis.

We have become a public company in the United States subject to the Sarbanes-Oxley Act of 2002. Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, requires that we include a report from management on our internal control over financial reporting in our annual report on Form 20-F beginning with our annual report for the fiscal year ending December 31, 2022. In addition, once we cease to be an “emerging growth company” as such term is defined in the JOBS Act, our independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting. Our management may conclude that our internal control over financial reporting is not effective. Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm, after conducting its own independent testing, may issue a report that is qualified if it is not satisfied with our internal control over financial reporting or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. In addition, as a result of becoming a public company, our reporting obligations may place a significant strain on our management, operational and financial resources and systems for the foreseeable future. We may be unable to timely complete our evaluation testing and any required remediation.

During the course of documenting and testing our internal control procedures, in order to satisfy the requirements of Section 404, we may identify other or more material weakness or deficiencies in our internal control over financial reporting. In addition, if we fail to maintain the adequacy of our internal control over financial reporting, as these standards are modified, supplemented or amended from time to time, we may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in

 

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accordance with Section 404. Generally speaking, if we fail to achieve and maintain an effective internal control environment, we could suffer material misstatements in our financial statements and fail to meet our reporting obligations, which would likely cause investors to lose confidence in our reported financial information. This could in turn limit our access to capital markets, harm our results of operations and lead to a decline in the trading price of our ADSs. Additionally, ineffective internal control over financial reporting could expose us to increased risk of fraud or misuse of corporate assets and subject us to potential delisting from the stock exchange on which we list, regulatory investigations and civil or criminal sanctions. We may also be required to restate our consolidated financial statements for prior periods.

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

Upon completion of this offering, we will become a public company and expect to incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC and the New York Stock Exchange, impose various requirements on the corporate governance practices of public companies. As a company with less than US$1.07 billion in revenues for our last fiscal year, we qualify as an “emerging growth company” pursuant to the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally to public companies. These provisions include exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, in the assessment of the emerging growth company’s internal control over financial reporting. The JOBS Act also permits an emerging growth company to delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have elected to take advantage of such transition period.

We expect these rules and regulations to increase our legal and financial compliance costs and to make some corporate activities more time-consuming and costly. After we are no longer an “emerging growth company,” we expect to incur significant expenses and devote substantial management effort toward ensuring compliance with the requirements of Section 404 and the other rules and regulations of the SEC. For example, as a result of becoming a public company, we will need to increase the number of independent directors and adopt policies regarding internal controls and disclosure controls and procedures. We also expect that operating as a public company will make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. In addition, we will incur additional costs associated with our public company reporting requirements. It may also be more difficult for us to find qualified persons to serve on our Board of Directors or as executive officers. We are currently evaluating and monitoring developments with respect to these rules and regulations, and we cannot predict or estimate with any degree of certainty the amount of additional costs we may incur or the timing of such costs.

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

The successful operation of our business depends on the performance of the internet infrastructure and telecommunications networks in China. Almost all access to the internet is maintained through state-owned telecommunications operators under the administrative control and regulatory supervision of the MIIT. Moreover, we have entered into contracts with various subsidiaries of a limited number of telecommunications service providers at provincial level and rely on them to provide us with data communications capacity through local telecommunications lines. We have limited access to alternative networks or services in the event of disruptions, failures or other problems with China’s internet infrastructure or the telecommunications networks provided by telecommunications service providers. We regularly serve a large number of students and teachers. With the expansion of our business, we may be required to upgrade our technology and infrastructure to keep up with the increasing traffic on our online applications and websites. However, we have no control over the costs of the services provided by telecommunications service providers. If the prices we pay for telecommunications and internet services rise significantly, our results of operations may be materially and adversely affected. If internet

 

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access fees or other charges to internet users increase, our user traffic may decline and our business may be harmed.

We may not be able to achieve the benefits we expect from future investments and acquisitions.

We may make equity investments in or acquisitions of additional businesses, assets and technologies that complement our existing business in the future. This may include opportunities to expand our offerings and strengthen our technology and data capabilities. If the businesses or assets we acquire or invest in do not subsequently generate the anticipated financial performance or if any goodwill impairment test triggering event occurs, we may need to revalue or write down the value of goodwill and other intangible assets in connection with such acquisitions or investments, which would harm our results of operations. In addition, investments and acquisitions could result in the use of substantial amounts of cash, potentially dilutive issuances of equity securities, significant amortization expenses related to intangible assets, significant diversion of management attention and exposure to potential unknown liabilities of the acquired business. In addition, if we make equity investments in the future, we cannot ensure that these companies will always comply with applicable laws and regulations in their business operations. Material non-compliance by our investees may cause substantial harms to our reputations and the value of our investment. In addition, we may be unable to identify appropriate acquisition or strategic investment targets when it is necessary or desirable to make such acquisition or investment to remain competitive or to expand our business. Even if we identify an appropriate acquisition or investment target, we may not be able to successfully negotiate the terms of the acquisition or investment, finance the proposed transaction or integrate the relevant businesses into our existing business and operations. In the event that our investments and acquisitions are not successful, our results of operations and financial condition may be materially and adversely affected.

Increasing focus with respect to environmental, social and governance matters may impose additional costs on us or expose us to additional risks. Failure to comply with the laws and regulations on environmental, social and governance matters may subject us to penalties and adversely affect our business, financial condition and results of operation.

The PRC government and public advocacy groups have been increasingly focused on environment, social and governance, or ESG, issues in recent years, making our business more sensitive to ESG issues and changes in governmental policies and laws and regulations associated with environment protection and other ESG-related matters. Investor advocacy groups, certain institutional investors, investment funds, and other influential investors are also increasingly focused on ESG practices and in recent years have placed increasing importance on the implications and social cost of their investments. Regardless of the industry, increased focus from investors and the PRC government on ESG and similar matters may hinder access to capital, as investors may decide to reallocate capital or to not commit capital as a result of their assessment of a company’s ESG practices. In the PRC, there are comprehensive environmental regulations and policies governing electronic product manufacturing in general, and the PRC may adopt more stringent standards in terms of ESG matters in the future. Any ESG concern or issue could increase our regulatory compliance costs. If we do not adapt to or comply with the evolving expectations and standards on ESG matters from investors and the PRC government or are perceived to have not responded appropriately to the growing concern for ESG issues, regardless of whether there is a legal requirement to do so, we may suffer from reputational damage and the business, financial condition, and the price of our ADSs could be materially and adversely effected.

A severe and prolonged global economic recession and the slowdown in the Chinese economy may adversely affect our business and results of operations.

COVID-19 had a severe and negative impact on the Chinese and the global economy in 2020. National Bureau of Statistics of China reported a 2.3% growth in gross domestic product (GDP) for the year of 2020, as compared a growth of 6.1% in 2019. Even before the outbreak of COVID-19, the global macroeconomic environment was facing numerous challenges. The growth rate of the Chinese economy had already been

 

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slowing since 2012 compared to the previous decade and the trend may continue. There is considerable uncertainty over the long-term effects of the expansionary monetary and fiscal policies which had been adopted by the central banks and financial authorities of some of the world’s leading economies, including the United States and China, even before 2020. Unrest, terrorist threats and the potential for war in the Middle East and elsewhere may increase market volatility across the globe. There have also been concerns about the relationship between China and other countries, including the surrounding Asian countries, which may potentially have economic effects. In particular, there is significant uncertainty about the future relationship between the United States and China with respect to trade policies, treaties, government regulations and tariffs. It is unclear whether these challenges and uncertainties will be contained or resolved and what effects they may have on the global political and economic conditions in the long term. Economic conditions in China are sensitive to global economic conditions, as well as changes in domestic economic and political policies and the expected or perceived overall economic growth rate in China. Any severe or prolonged slowdown in the global or Chinese economy may materially and adversely affect our business, results of operations and financial condition.

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

The conversion of Renminbi into foreign currencies, including the U.S. dollar, is based on rates set by the People’s Bank of China. The Renminbi has fluctuated against the U.S. dollar and other currencies, at times significantly and unpredictably. The value of Renminbi against the U.S. dollar and other currencies is affected by changes in China’s political and economic conditions and by China’s foreign exchange policies, among other things. We cannot assure you that Renminbi will not appreciate or depreciate significantly in value against the U.S. dollar and other currencies in the future. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between Renminbi and U.S. dollar in the future.

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

Very limited hedging options are available in China to reduce our exposure to exchange rate fluctuations. We have entered into certain hedging transactions, including foreign exchange forward contracts and foreign currency option contracts, in an effort to reduce our exposure to foreign currency exchange risk. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Quantitative and Qualitative Disclosures about Market Risk—Foreign exchange risk.” While we may continue 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 Renminbi into foreign currency.

We face certain risks relating to the real properties that we lease.

We lease real properties from third parties primarily for our office in China, and the lease agreements for most of these leased properties have not been registered with the PRC government authorities as required by PRC law. Although the failure to do so does not in itself invalidate the leases, we may be ordered by the PRC government authorities to rectify such noncompliance and, if such noncompliance were not rectified within a given period of time, we may be subject to fines imposed by PRC government authorities ranging from RMB1,000 and RMB10,000 for those of our lease agreements that have not been registered with the relevant PRC government authorities.

 

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As of the date of this prospectus, we are not aware of any regulatory or governmental actions, claims or investigations being contemplated or any challenges by third parties to our use of our leased properties the lease agreements of which have not been registered with the government authorities. However, we cannot assure you that the government authorities will not impose fines on us due to our failure to register any of our lease agreements, which may negatively impact our financial condition.

In addition, some of the ownership certificates or other similar proof of certain leased properties have not been provided to us by the relevant lessors. Therefore, we cannot assure you that such lessors are entitled to lease the relevant real properties to us. If the lessors are not entitled to lease the real properties to us and the owners of such real properties decline to ratify the lease agreements between us and the respective lessors, we may not be able to enforce our rights to lease such properties under the respective lease agreements against the owners. As of the date of this prospectus, we are not aware of any claim or challenge brought by any third parties concerning the use of our leased properties without obtaining proper ownership proof. If our lease agreements are claimed as null and void by third parties who are the real owners of such leased real properties, we could be required to vacate the properties, in the event of which we could only initiate the claim against the lessors under relevant lease agreements for indemnities for their breach of the relevant leasing agreements. We cannot assure you that suitable alternative locations are readily available on commercially reasonable terms, or at all, and if we are unable to relocate our operations in a timely manner, our operations may be interrupted.

Risks Relating to Our Corporate Structure

If the PRC government finds that the agreements that establish the structure for operating certain of our operations in China do not comply with PRC regulations relating to the relevant industries, or if these regulations or the interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations.

Foreign ownership in entities that provide value-added telecommunication services (except for e-commerce, domestic multi-party communications, store-and-forward and call center), such as provision of online course content, is subject to restrictions under current PRC laws and regulations. Specifically, foreign ownership of an internet information service provider may not exceed 50%, and the major foreign investor is required to have a record of good performance and operating experience in managing value-added telecommunications business. We are a company registered in the Cayman Islands. Shanghai Zhangxue, or our wholly foreign owned entity, or our WFOE, is our PRC subsidiaries and foreign-invested enterprise under PRC laws. To comply with PRC laws and regulations, we conduct such business activities in China through subsidiaries of Shenzhen Zhangmenren, Shanghai Zhangshi and Shanghai Zhangda, our VIEs. Our WFOE has entered into a series of contractual arrangements with our respective VIEs and their respective shareholders. For a description of these contractual arrangements, see “Corporate History and Structure.” As a result of these contractual arrangements, we exert control over our VIEs and consolidate financial results of our VIEs and their subsidiaries in our financial statements under U.S. GAAP. Our VIEs hold the licenses, approvals and key assets that are essential for our operations.

In the opinion of our PRC counsel, Tian Yuan Law Firm, (i) the ownership structure of our VIEs and our WFOE does not result in any violation of PRC laws and regulations currently in effect; and (ii) the contractual arrangements among our WFOE, our respective VIEs and their respective shareholders governed by PRC law will not result in any violation of PRC laws or regulations currently in effect. However, we have been further advised by our PRC counsel that there are substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations. Thus, the PRC government may ultimately take a view contrary to the opinion of our PRC counsel. If the PRC government otherwise find that we are in violation of any existing or future PRC laws or regulations or lack the necessary permits or licenses to operate our business, the relevant governmental authorities would have broad discretion in dealing with such violation, including, without limitation:

 

   

revoking the business licenses and/or operating licenses of such entities;

 

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imposing fines on us;

 

   

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

 

   

discontinuing or placing restrictions or onerous conditions on our operations;

 

   

placing restrictions on our right to collect revenues; and

 

   

shutting down our servers or blocking our application/software.

Any of these events could cause significant disruption to our business operations and severely damage our reputation, which would in turn materially and adversely affect our business, financial condition and results of operations. If occurrences of any of these events results in our inability to direct the activities of our VIEs in China that most significantly impact its economic performance, and/or our failure to receive the economic benefits from our consolidated variable interest entities, we may not be able to consolidate their financial results in our consolidated financial statements in accordance with U.S. GAAP.

We rely on contractual arrangements with our VIEs and their shareholders for our business operations, which may not be as effective as direct ownership in providing operational control.

We have relied and expect to continue to rely on contractual arrangements with our VIEs, and their shareholders to operate our business in China. These contractual arrangements may not be as effective as direct ownership in providing us with control over our VIEs. For example, our VIEs and their shareholders could breach their contractual arrangements with us by, among other things, failing to conduct the operations of our VIEs in an acceptable manner or taking other actions that are detrimental to our interests.

If we had direct ownership of our VIEs in China, we would be able to exercise our rights as a shareholder to effect changes in the board of directors of our VIEs, which in turn could implement changes, subject to any applicable fiduciary obligations, at the management and operational level. However, under the current contractual arrangements, we rely on the performance by our VIEs and their shareholders of their obligations under the contracts to exercise control over our VIEs. The shareholders of our VIEs may not act in the best interests of our company or may not perform their obligations under these contracts. Such risks exist throughout the period in which we intend to operate certain portion of our business through the contractual arrangements with our VIEs. If any dispute relating to these contracts remains unresolved, we will have to enforce our rights under these contracts through the operations of PRC law and arbitration, litigation and other legal proceedings and therefore will be subject to uncertainties in the PRC legal system. See “—Any failure by our VIEs or their shareholders to perform their obligations under our contractual arrangements with them would have a material and adverse effect on our business.” Therefore, our contractual arrangements with our VIEs may not be as effective in ensuring our control over the relevant portion of our business operations as direct ownership would be.

Any failure by our VIEs or their shareholders to perform their obligations under our contractual arrangements with them would have a material and adverse effect on our business.

If our VIEs or their shareholders fail to perform their respective obligations under the contractual arrangements, we may have to incur substantial costs and expend additional resources to enforce such arrangements. We may also have to rely on legal remedies under PRC law, including seeking specific performance or injunctive relief, and contractual remedies, which we cannot assure you will be sufficient or effective under PRC law. For example, if the shareholders of our VIEs were to refuse to transfer their equity interests in our VIEs to us or our designee if we exercise the purchase option pursuant to these contractual arrangements, or if they were otherwise to act in bad faith toward us, then we may have to take legal actions to compel them to perform their contractual obligations.

All the agreements under our contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in China. Accordingly, these contracts would be interpreted in

 

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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 some other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements. Meanwhile, there are very few precedents and little formal guidance as to how contractual arrangements in the context of a consolidated variable interest entity should be interpreted or enforced under PRC law. There remain significant uncertainties regarding the ultimate outcome of such arbitration should legal action become necessary. In addition, under PRC law, rulings by arbitrators are final, parties cannot appeal the arbitration results in courts, and if the losing parties fail to carry out the arbitration awards within a prescribed time limit, the prevailing parties may only enforce the arbitration awards in PRC courts through arbitration award recognition proceedings, which would require additional expenses and delay. In the event we are unable to enforce these contractual arrangements, or if we suffer significant delay or other obstacles in the process of enforcing these contractual arrangements, we may not be able to exert effective control over our VIEs, and our ability to conduct our business may be negatively affected. See “—Risks Relating to Doing Business in China—Uncertainties in the interpretation and enforcement of PRC laws and regulations could limit the legal protections available to you and us.”

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

The shareholders of our VIEs may have actual or potential conflicts of interest with us. These shareholders may breach, or cause our VIEs to breach, or refuse to renew, the existing contractual arrangements we have with them and our VIEs, which would have a material and adverse effect on our ability to effectively control our VIEs and receive economic benefits from them. For example, the shareholders may be able to cause our agreements with our VIEs to be performed in a manner adverse to us by, among other things, failing to remit payments due under the contractual arrangements to us on a timely basis. We cannot assure you that when conflicts of interest arise any or all of these shareholders will act in the best interests of our company or such conflicts will be resolved in our favor.

Currently, we do not have any arrangements to address potential conflicts of interest between these shareholders and our company, except that we could exercise our purchase option under the exclusive option agreements with these shareholders to request them to transfer all of their equity interests in the VIEs to a PRC entity or individual designated by us, to the extent permitted by PRC law. For individuals who are also our directors and officers, we rely on them to abide by the laws of the Cayman Islands, which provide that directors and officers owe a fiduciary duty to the company that requires them to act in good faith and in what they believe to be the best interests of the company and not to use their position for personal gains. The shareholders of our respective VIEs have executed powers of attorney to appoint our WFOE or a person designated by our WFOE to vote on their behalf and exercise voting rights as shareholders of our respective VIEs. If we cannot resolve any conflict of interest or dispute between us and the shareholders of our VIEs, we would have to rely on legal proceedings, which could result in disruption of our business and subject us to substantial uncertainty as to the outcome of any such legal proceedings.

Contractual arrangements in relation to our VIEs may be subject to scrutiny by the PRC tax authorities and they may determine that we or our PRC consolidated variable interest entities owe additional taxes, which could negatively affect our financial condition and the value of your investment.

Under applicable PRC laws and regulations, arrangements and transactions among related parties may be subject to audit or challenge by the PRC tax authorities. We could face material and adverse tax consequences if the PRC tax authorities determine that the contractual arrangements in relation to our VIEs were not entered into on an arm’s length basis in such a way as to result in an impermissible reduction in taxes under applicable PRC laws, rules and regulations, and adjust income of our VIEs in the form of a transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in a reduction of expense deductions recorded by our VIEs for PRC tax purposes, which could in turn increase their tax liabilities without reducing corresponding PRC

 

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subsidiaries’ tax expenses. In addition, the PRC tax authorities may impose late payment fees and other penalties on our VIEs for the adjusted but unpaid taxes according to the applicable regulations. Our financial position could be materially and adversely affected if our VIEs’ tax liabilities increase or if they are required to pay late payment fees and other penalties.

Our current corporate structure and business operations may be affected by the Foreign Investment Law and its Implementation Rules.

On March 15, 2019, the National People’s Congress promulgated the Foreign Investment Law, which took effect on January 1, 2020. Since it is relatively new, uncertainties exist in relation to its interpretation and implementation. The Foreign Investment Law does not explicitly classify whether variable interest entities that are controlled through contractual arrangements would be deemed as foreign invested enterprises if they are ultimately “controlled” by foreign investors. However, it has a catch-all provision under definition of “foreign investment” that includes investments made by foreign investors in China through other means as provided by laws, administrative regulations or the State Council. Therefore it still leaves leeway for future laws, administrative regulations or provisions of the State Council to provide for contractual arrangements as a form of foreign investment, and it remains uncertain whether our contractual arrangements will be deemed to be in violation of the market access requirements for foreign investment in the PRC and if yes, how our contractual arrangements should be dealt with.

The Foreign Investment Law grants national treatment to foreign-invested entities, except for those foreign-invested entities that operate in industries specified as either “restricted” or “prohibited” from foreign investment in the Special Administrative Measures (Negative List) for Foreign Investment Access jointly promulgated by Ministry of Commerce, or MOFCOM, and the National Development and Reform Commission as amended from time to time. The Foreign Investment Law provides that foreign-invested entities are barred from operating in “prohibited” industries and will require market entry clearance and other approvals from relevant PRC government authorities if operating in “prohibited” industries. On December 26, 2019, the Supreme People’s Court issued the Interpretations on Certain Issues Regarding the Application of Foreign Investment Law, or the FIL Interpretations, which came into effect on January 1, 2020. In accordance with the FIL Interpretations, any claim to invalidate an investment agreement will be supported by courts if such agreement is found to be entered into for purposes of making investments in the “prohibited industries” under the negative list or for purposes of investing in “restricted industries” while failing to satisfy the conditions set out in the Negative List. If our control over our VIEs through contractual arrangements are deemed as foreign investment in the future, and any business of our VIEs is “restricted” or “prohibited” from foreign investment under the “negative list” effective at the time, we may be deemed to be in violation of the Foreign Investment Law, the contractual arrangements that allow us to have control over our VIEs may be deemed as invalid and illegal, and we may be required to unwind such contractual arrangements and/or restructure our business operations, any of which may have a material adverse effect on our business operation.

Furthermore, if future laws, administrative regulations or provisions mandate further actions to be taken by companies with respect to existing contractual arrangements, we may face substantial uncertainties as to whether we can complete such actions in a timely manner, or at all. Failure to take timely and appropriate measures to cope with any of these or similar regulatory compliance challenges could materially and adversely affect our current corporate structure and business operations.

We may lose the ability to use and enjoy assets held by our VIEs that are material to the operation of certain portion of our business if the entities go bankrupt or become subject to a dissolution or liquidation proceeding.

As part of our contractual arrangements with our VIEs, our VIEs hold certain assets that are material to the operation of certain portion of our business, including licenses, permits, domain names and most of our IP rights. If our VIEs go bankrupt 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

 

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business, financial condition and results of operations. Under the contractual arrangements, our VIEs may not, in any manner, sell, transfer, mortgage or dispose of their assets or legal or beneficial interests in the business without our prior consent. If our VIEs undergoes a voluntary or involuntary liquidation proceeding, the independent third-party creditors may claim rights to some or all of these assets, thereby hindering our ability to operate our business, which could materially and adversely affect our business, financial condition and results of operations.

Recently introduced economic substance legislation of the Cayman Islands may adversely impact us or our operations.

The Cayman Islands, together with several other non-European Union jurisdictions, has recently introduced legislation aimed at addressing concerns raised by the Council of the European Union as to offshore structures engaged in certain activities which attract profits without real economic activity. With effect from January 1, 2019, the International Tax Co-operation (Economic Substance) Law, 2018, or the Substance Law, and issued Regulations and Guidance Notes came into force in the Cayman Islands introducing certain economic substance requirements for “relevant entities” which are engaged in certain “relevant activities,” which in the case of exempted companies incorporated before January 1, 2019, will apply in respect of financial years commencing July 1, 2019 and onwards. A “relevant entity” includes an exempted company incorporated in the Cayman Islands; however, it does not include an entity that is tax resident outside the Cayman Islands. Accordingly, for so long as we are a tax resident in China (being a jurisdiction outside the Cayman Islands), we are not required to satisfy the economic substance test. Although it is presently anticipated that the Substance Law will have little material impact on us and our operations, as the legislation is new and remains subject to further clarification and interpretation it is not currently possible to ascertain the precise impact of these legislative changes on us and our operations.

Changes in China’s or global economic, political or social conditions or government policies could have a material adverse effect on overall economic growth in China, which could materially and adversely affect our business.

Substantially all of our operations are conducted in China, and most of our assets are located in China. Accordingly, our business, financial condition, results of operations and prospects may be influenced to a significant degree by economic, political and social conditions in China generally. The PRC economy differs from the economies of most developed countries in many respects, including the level of development, growth rate, level of government involvement and control of foreign exchange and allocation of resources. The PRC government exercises significant control over China’s economic growth through allocating resources, controlling payment of foreign currency-denominated obligations, setting monetary policy, and providing preferential treatment to particular industries or companies. In addition, the PRC government continues to play a significant role in regulating industry development by imposing relevant industrial policies.

While the PRC economy has experienced significant growth over the past decades, growth has been uneven, both geographically and among various sectors of the economy. In addition, the rate of growth has been slowing since 2012, and the impact of COVID-19 on the Chinese and global economies in 2020 is likely to be severe. In particular, the National Bureau of Statistics of China reported a 2.3% growth in gross domestic product (GDP) for the year of 2020, as compared a growth of 6.1% in 2019. Any adverse changes in economic conditions in China, in the policies of the PRC government or in the laws and regulations in China could have a material adverse effect on the overall economic growth of China. Such developments could adversely affect our business and operating results, lead to reduction in demand for our solutions and services and adversely affect our competitive position. The PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures may benefit the overall PRC economy, but may have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations. In addition, in the past, the PRC government has implemented certain measures, including interest rate adjustment, to control the pace of

 

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economic growth. These measures may cause decreased economic activity in China, which may adversely affect our business and results of operations. In addition, the increased global focus on social, ethical and environmental issues may lead to China’s adoption of more stringent standards in these areas, which may adversely impact the operations of China-based companies including us.

In addition, political tensions between the United States and China have escalated due to, among other things, trade disputes, the COVID-19 outbreak, sanctions imposed by the U.S. Department of Treasury on certain officials of the Hong Kong Special Administrative Region and the central government of the PRC and the executive orders issued by the then U.S. President in August 2020 that prohibit certain transactions with certain Chinese companies and their applications. Rising political tensions could reduce levels of trades, investments, technological exchanges and other economic activities between the two major economies, which would have a material adverse effect on global economic conditions and the stability of global financial markets. Any of these factors could have a material adverse effect on our business, prospects, financial condition and results of operations. Furthermore, there have been recent media reports on deliberations within the U.S. government regarding potentially limiting or restricting China-based companies from accessing U.S. capital markets. If any such deliberations were to materialize, the resulting legislation may have material and adverse impact on the stock performance of China-based issuers listed in the United States.

Risks Relating to Doing Business in China

Uncertainties in the interpretation and enforcement of PRC laws and regulations could limit the legal protections available to you and us.

The PRC legal system is a civil law system based on written statutes. Unlike the common law system, prior court decisions may be cited for reference but have limited precedential value. The PRC legal system is evolving rapidly, and the interpretations of many laws, regulations and rules may contain inconsistencies and enforcement of these laws, regulations and rules involves uncertainties.

Our PRC subsidiaries are foreign-invested enterprises and are subject to laws and regulations applicable to foreign-invested enterprises as well as various Chinese laws and regulations generally applicable to companies incorporated in China. However, since these laws and regulations are relatively new and the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involves uncertainties.

From time to time, we may have to resort to administrative and court proceedings to enforce our legal rights. However, since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to evaluate the outcome of administrative and court proceedings and the level of protection we enjoy than in more developed legal systems. Furthermore, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all, and which may have a retroactive effect. As a result, we may not be aware of our violation of any of these policies and rules until sometime after the violation. In addition, any administrative and court proceedings in China may be protracted, resulting in substantial costs and diversion of resources and management attention. Such uncertainties, including uncertainty over the scope and effect of our contractual, property (including intellectual property) and procedural rights, and any failure to respond to changes in the regulatory environment in China could materially and adversely affect our business and impede our ability to continue our operations.

You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing actions in China against us or our management named in the prospectus based on foreign laws.

We are an exempted company incorporated under the laws of the Cayman Islands; however, we conduct substantially all of our operations in China and most of our assets are located outside of the United States. In

 

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addition, all of our directors and executive officers are nationals or residents of jurisdictions other than the United States and most of their assets are located outside the United States. As a result, it may be difficult for you to effect service of process upon us or our management named in the prospectus inside mainland China. It may also be difficult for you to enforce in U.S. courts of the judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors. In addition, there is uncertainty as to whether the courts of the Cayman Islands or the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the United States or any state.

The recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on principles of reciprocity between jurisdictions. China does not have any treaties or other forms of written arrangement with the United States that provide for the reciprocal recognition and enforcement of foreign judgments. In addition, according to the PRC Civil Procedures Law, the PRC courts 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 laws or national sovereignty, security or public interest. As a result, it is uncertain whether and on what basis a PRC court would enforce a judgment rendered by a court in the United States.

Our ADSs may be delisted under the Holding Foreign Companies Accountable Act if the PCAOB is unable to inspect auditors who are located in China. The delisting of our ADSs, or the threat of their being delisted, may materially and adversely affect the value of your investment. Additionally, the inability of the PCAOB to conduct inspections would deprive our investors of the benefits of such inspections.

The Holding Foreign Companies Accountable Act, or the HFCA Act, was enacted on December 18, 2020. The HFCA Act states if the SEC determines that we have filed audit reports issued by a registered public accounting firm that has not been subject to inspection by the PCAOB for three consecutive years beginning in 2021, the SEC shall prohibit our shares or ADSs from being traded on a national securities exchange or in the over the counter trading market in the U.S.

Our auditor, the independent registered public accounting firm that issues the audit report included elsewhere in this prospectus, as an auditor of companies that are traded publicly in the United States and a firm registered with the PCAOB, is subject to laws in the United States pursuant to which the PCAOB conducts regular inspections to assess its compliance with the applicable professional standards. Since our auditor is located in China, a jurisdiction where the PCAOB has been unable to conduct inspections without the approval of the Chinese authorities, our auditor is currently not inspected by the PCAOB.

On March 24, 2021, the SEC adopted interim final rules relating to the implementation of certain disclosure and documentation requirements of the HFCA Act. We will be required to comply with these rules if the SEC identifies us as having a “non-inspection” year under a process to be subsequently established by the SEC. The SEC is assessing how to implement other requirements of the HFCA Act, including the listing and trading prohibition requirements described above.

The SEC may propose additional rules or guidance that could impact us if our auditor is not subject to PCAOB inspection. For example, on August 6, 2020, the President’s Working Group on Financial Markets, or the PWG, issued the Report on Protecting United States Investors from Significant Risks from Chinese Companies to the then President of the United States. This report recommended the SEC implement five recommendations to address companies from jurisdictions that do not provide the PCAOB with sufficient access to fulfil its statutory mandate. Some of the concepts of these recommendations were implemented with the enactment of the HFCA Act. However, some of the recommendations were more stringent than the HFCA Act. For example, if a company was not subject to PCAOB inspection, the report recommended that the transition period before a company would be delisted would end on January 1, 2022.

 

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The SEC has announced that the SEC staff is preparing a consolidated proposal for the rules regarding the implementation of the HFCA Act and to address the recommendations in the PWG report. It is unclear when the SEC will complete its rulemaking and when such rules will become effective and what, if any, of the PWG recommendations will be adopted. The implications of this possible regulation in addition the requirements of the HFCA Act are uncertain. Such uncertainty could cause the market price of our ADSs to be materially and adversely affected, and our securities could be delisted or prohibited from being traded “over-the-counter” earlier than would be required by the HFCA Act. If our securities are unable to be listed on another securities exchange by then, such a delisting would substantially impair your ability to sell or purchase our ADSs when you wish to do so, and the risk and uncertainty associated with a potential delisting would have a negative impact on the price of our ADSs.

The PCAOB’s inability to conduct inspections in China prevents it from fully evaluating the audits and quality control procedures of our independent registered public accounting firm. As a result, we and investors in our ordinary shares are deprived of the benefits of such PCAOB inspections. The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our independent registered public accounting firm’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to the PCAOB inspections, which could cause investors and potential investors in our stock to lose confidence in our audit procedures and reported financial information and the quality of our financial statements.

In May 2013, the PCAOB announced that it had entered into a Memorandum of Understanding on Enforcement Cooperation with the CSRC and the PRC Ministry of Finance, which establishes a cooperative framework between the parties for the production and exchange of audit documents relevant to investigations undertaken by the PCAOB in the PRC or by the CSRC or the PRC Ministry of Finance in the United States. The PCAOB continues to be in discussions with the CSRC and the PRC Ministry of Finance to permit joint inspections in the PRC of audit firms that are registered with the PCAOB and audit Chinese companies that trade on U.S. exchanges.

The custodians or authorized users of our controlling non-tangible assets, including chops and seals, may fail to fulfill their responsibilities, or misappropriate or misuse these assets.

Under the PRC law, legal documents for corporate transactions, including agreements and contracts are executed using the chop or seal of the signing entity or with the signature of a legal representative whose designation is registered and filed with relevant PRC market regulation administrative authorities.

In order to secure the use of our chops and seals, we have established internal control procedures and rules for using these chops and seals. In any event that the chops and seals are intended to be used, the responsible personnel will submit the application through our office automation system and the application will be verified and approved by authorized employees in accordance with our internal control procedures and rules. In addition, in order to maintain the physical security of our chops, we generally have them stored in secured locations accessible only to authorized employees. Although we monitor such authorized employees, the procedures may not be sufficient to prevent all instances of abuse or negligence. There is a risk that our employees could abuse their authority, for example, by entering into a contract not approved by us or seeking to gain control of one of our subsidiaries or our VIEs or their subsidiaries. If any employee obtains, misuses or misappropriates our chops and seals or other controlling non-tangible assets for whatever reason, we could experience disruption to our normal business operations. We may have to take corporate or legal action, which could involve significant time and resources to resolve and divert management from our operations.

If we are classified as a PRC resident enterprise for PRC income tax purposes, such classification could result in unfavorable tax consequences to us and our non-PRC shareholders or ADS holders.

Under the PRC Enterprise Income Tax Law and its implementation rules, an enterprise established outside of the PRC with a “de facto management body” within China is considered a “resident enterprise” and will be

 

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subject to the enterprise income tax on its global income at the rate of 25%. The implementation rules define the term “de facto management body” as the body that exercises full and substantial control and overall management over the business, productions, personnel, accounts and properties of an enterprise. In 2009, the State Administration of Taxation, or the SAT, issued the Circular of the State Administration of Taxation on Issues Relating to Identification of PRC-Controlled Overseas Registered Enterprises as Resident Enterprises in Accordance with the De Facto Standards of Organizational Management, or SAT Circular 82, which provides certain specific criteria for determining whether the “de facto management body” of a PRC-controlled enterprise that is incorporated offshore is located in China. Although this circular only applies to offshore enterprises controlled by PRC enterprises or PRC enterprise groups, not those controlled by PRC individuals or foreigners, the criteria set forth in the circular may reflect SAT’s general position on how the “de facto management body” text should be applied in determining the tax resident status of all offshore enterprises. According to SAT Circular 82, an offshore incorporated enterprise controlled by a PRC enterprise or a PRC enterprise group will be regarded as a PRC tax resident by virtue of having its “de facto management body” in China and will be subject to PRC enterprise income tax on its global income only if all of the following conditions are met: (i) the primary location of the day-to-day operational management is in China; (ii) decisions relating to the enterprise’s financial and human resource matters are made or are subject to approval by organizations or personnel in China; (iii) the enterprise’s primary assets, accounting books and records, company seals, and board and shareholder resolutions, are located or maintained in China; and (iv) at least 50% of voting board members or senior executives habitually reside in China.

We believe none of our entities outside of China is a PRC resident enterprise for PRC tax purposes. However, the tax resident status of an enterprise is subject to determination by the PRC tax authorities and uncertainties remain with respect to the interpretation of the term “de facto management body.” If the PRC tax authorities determine that our company or any of our subsidiaries outside of China is a PRC resident enterprise for enterprise income tax purposes, we could be subject to PRC tax at a rate of 25% on our worldwide income, which could materially reduce our net income, and we may be required to withhold a 10% withholding tax from dividends we pay to our shareholders that are non-resident enterprises, including the holders of our ADSs. In addition, non-resident enterprise shareholders (including the ADS holders) may be subject to PRC tax at a rate of 10% on gains realized on the sale or other disposition of ADSs or Class A ordinary shares, if such income is treated as sourced from within China. Furthermore, if we are deemed a PRC resident enterprise, dividends payable to our non-PRC individual shareholders (including the ADS holders) and any gain realized on the transfer of ADSs or Class A ordinary shares by such shareholders may be subject to PRC tax at a rate of 10% in the case of non-PRC enterprises or a rate of 20% in the case of non-PRC individuals unless a reduced rate is available under an applicable tax treaty. It is unclear whether non-PRC shareholders of our company would be able to claim the benefits of any tax treaties between their country of tax residence and the PRC in the event that we are treated as a PRC resident enterprise. Any such tax may reduce the returns on your investment in the ADSs or Class A ordinary shares.

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

We face uncertainties regarding the reporting on and consequences of previous private equity financing transactions involving the transfer and exchange of shares in our company by non-resident investors. In February 2015, the State Administration of Taxation, or SAT, issued the Bulletin on Issues of Enterprise Income Tax on Indirect Transfers of Assets by Non-PRC Resident Enterprises, or SAT Bulletin 7. Pursuant to SAT Bulletin 7, an “indirect transfer” of PRC assets, including a transfer of equity interests in an unlisted non-PRC holding company of a PRC resident enterprise, by non-PRC resident enterprises may be re-characterized and treated as a direct transfer of the underlying PRC assets, if such arrangement does not have a reasonable commercial purpose and was established for the purpose of avoiding payment of PRC enterprise income tax. As a result, gains derived from such indirect transfer may be subject to PRC enterprise income tax, and the transferee or other person who is obligated to pay for the transfer is obligated to withhold the applicable taxes, currently at a rate of 10% for the transfer of equity interests in a PRC resident enterprise. On October 17, 2017, the SAT issued the Announcement

 

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of the State Administration of Taxation on Issues Concerning the Withholding of Non-resident Enterprise Income Tax at Source, or SAT Bulletin 37, which came into effect on December 1, 2017. The SAT Bulletin 37 further clarifies the practice and procedure of the withholding of nonresident enterprise income tax. We also face uncertainties on the reporting and consequences of future private equity financing transactions, share exchanges or other transactions involving the transfer of shares in our company by investors that are non-PRC resident enterprises.

The PRC tax authorities may pursue non-resident enterprises involved in our previous or future private equity financing transactions with respect to a filing or the transferees with respect to withholding obligation, and request our PRC subsidiaries to assist in the filing. As a result, we and non-resident enterprises in such transactions may become at risk of being subject to filing obligations or being taxed under SAT Bulletin 7 and SAT Bulletin 37, and may be required to expend valuable resources to comply with them or to establish that we and our non-resident enterprises should not be taxed under these regulations, which may have a material adverse effect on our financial condition and results of operations.

If our preferential tax treatments are revoked or become unavailable or if the calculation of our tax liability is successfully challenged by the PRC tax authorities, we may be required to pay tax, interest and penalties in excess of our tax provisions.

Under the PRC Enterprise Income Tax Law and its implementation rules, the statutory enterprise income tax rate is 25%, but certain “high and new technology enterprises strongly supported by the state,” or HNTEs, are qualified for a preferential enterprise income tax rate of 15% subject to certain qualification criteria. Currently, Shanghai Zhangxue, or our WFOE, enjoys a preferential enterprise income tax rate of 15% as it is recognized as a HNTE by relevant PRC governmental authorities. The qualification as an HNTE is subject to annual evaluation and a three-year review by the relevant PRC governmental authorities. If Shanghai Zhangxue fails to maintain its HNTE status, experiences any increase in the enterprise income tax rate, or faces any discontinuation, retroactive or future reduction or refund of any of the preferential tax treatments currently enjoyed, our business, financial condition and results of operations could be materially and adversely affected.

Further, in the ordinary course of our business, we are subject to complex income tax and other tax regulations, and significant judgment is required in the determination of a provision for income taxes. Although we believe our tax provisions are reasonable, if the PRC tax authorities successfully challenge our position and we are required to pay tax, interest and penalties in excess of our tax provisions, our financial condition and results of operations would be materially and adversely affected.

The M&A Rules and certain other PRC regulations establish complex procedures for some acquisitions of Chinese companies by foreign investors, which could make it more difficult for us to pursue growth through acquisitions in China.

The Regulations on Mergers and Acquisitions of Domestic Companies by Foreign Investors, or the M&A Rules, adopted by six PRC regulatory agencies in 2006 and amended in 2009, and some other regulations and rules concerning mergers and acquisitions established complex procedures and requirements for some acquisitions of Chinese companies by foreign investors, including requirements in some instances that the MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise. Moreover, the Anti-Monopoly Law promulgated by the Standing Committee of the National People’s Congress which became effective in 2008 requires that transactions which are deemed concentrations and involve parties with specified turnover thresholds must be cleared by relevant governmental authorities before they can be completed. In February 7, 2021, the Anti-monopoly Commission of the State Council, published the Anti-Monopoly Guidelines for the Internet Platform Economy Sector that aims at specifying some of the circumstances under which an activity of internet platforms may be identified as monopolistic act as well as classifying that concentrations involving variable interest entities shall also be subject to anti-monopoly review. In addition, the security review rules issued by the MOFCOM that became effective in

 

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September 2011 specify that mergers and acquisitions by foreign investors that raise “national defense and security” concerns and mergers and acquisitions through which foreign investors may acquire de facto control over domestic enterprises that raise “national security” concerns are subject to strict review by the MOFCOM, and the rules prohibit any activities attempting to bypass a security review, including by structuring a transaction through a proxy or contractual control arrangement.

In the future, we may pursue potential strategic acquisitions that are complementary to our business and operations. Complying with the requirements of the above-mentioned regulations and other relevant rules to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval or clearance from MOFCOM, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.

The approval of the China Securities Regulatory Commission may be required in connection with this offering, and, if required, we cannot predict whether we will be able to obtain such approval.

The M&A Rules requires overseas special purpose vehicles that are controlled by PRC companies or individuals formed for the purpose of seeking a public listing on an overseas stock exchange through acquisitions of PRC domestic companies using shares of such special purpose vehicles or held by their shareholders as considerations to obtain the approval of the China Securities Regulatory Commission, or the CSRC, prior to the listing and trading of such special purpose vehicle’s securities on an overseas stock exchange. However, the application of the M&A Rules remains unclear. If CSRC approval is required, it is uncertain whether it would be possible for us to obtain the approval. Any failure to obtain or delay in obtaining CSRC approval for this offering would subject us to sanctions imposed by the CSRC and other PRC regulatory agencies.

Our PRC legal counsel has advised us based on their understanding of the current PRC laws, regulations and rules that the CSRC’s approval may not be required for the listing and trading of our ADSs on the New York Stock Exchange in the context of this offering, given that: (i) the CSRC currently has not issued any definitive rule or interpretation concerning whether offerings like ours in this prospectus are subject to this regulation, (ii) our WFOE was incorporated as a wholly foreign-owned enterprise by means of direct investment rather than by merger or acquisition of equity interest or assets of a PRC domestic company owned by PRC companies or individuals as defined under the M&A Rules, and (iii) no explicit provision in the M&A Rules clearly classifies contractual arrangements as a type of acquisition transaction subject to such Rules.

However, our PRC legal counsel has further advised us that there remains some uncertainty as to how the M&A Rules will be interpreted or implemented in the context of an overseas offering and its opinions summarized above are subject to any new laws, regulations and rules or detailed implementations and interpretations in any form relating to the M&A Rules. We cannot assure you that relevant PRC government agencies, including the CSRC, would reach the same conclusion as our PRC legal counsel does. If it is determined that CSRC approval is required for this offering, we may face sanctions by the CSRC or other PRC regulatory agencies for failure to obtain or delay in obtaining CSRC approval for this offering. These sanctions may include fines and penalties on our operations in China, limitations on our operating privileges in China, delays in or restrictions on the repatriation of the proceeds from this offering into the PRC, restrictions on or prohibition of the payments or remittance of dividends by our subsidiaries in China, or other actions that could have a material and adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our ADSs. The CSRC or other PRC regulatory agencies may also take actions requiring us, or making it advisable for us, to halt this offering before the settlement and delivery of the ADSs that we are offering. Consequently, if you engage in market trading or other activities in anticipation of and prior to the settlement and delivery of the ADSs we are offering, you would be doing so at the risk that the settlement and delivery may not occur. In addition, if the CSRC or other regulatory agencies later promulgate new rules or explanations requiring that we obtain their approvals for this offering, we may be unable to obtain a waiver of such approval requirements.

 

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Failure to comply with PRC regulations regarding the registration requirements for employee stock ownership plans or share option plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.

In February 2012, the State Administration of Foreign Exchange, or SAFE, promulgated the Notices on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly Listed Company, replacing earlier rules promulgated in 2007. Pursuant to these rules, PRC citizens and non-PRC citizens who reside in China for a continuous period of not less than one year and participate in any stock incentive plan of an overseas publicly listed company are required to register with SAFE through a domestic qualified agent, which could be the PRC subsidiaries of such overseas-listed company, and complete certain other procedures, unless certain exceptions are available. In addition, an overseas-entrusted institution must be retained to handle matters in connection with the exercise or sale of stock options and the purchase or sale of shares and interests. We and our executive officers and other employees who are PRC citizens or non-PRC citizens living in China for a continuous period of not less than one year and have been granted options are subject to these regulations as our company has become an overseas-listed company. Failure to complete SAFE registrations may subject them to fines of up to RMB300,000 for entities and up to RMB50,000 for individuals and may also limit our ability to contribute additional capital into our PRC subsidiaries and our PRC subsidiaries’ ability to distribute dividends to us. We also face regulatory uncertainties that could restrict our ability to adopt additional incentive plans for our directors, executive officers and employees under PRC law. See “Regulation—Regulation Relating to Foreign Exchange—Regulation on Stock Incentive Plans.”

In addition, the SAT has issued certain circulars concerning employee share options and restricted shares. Under these circulars, our employees working in China who exercise share options or are granted restricted shares will be subject to PRC individual income tax. Our PRC subsidiaries have obligations to file documents related to employee share options or restricted shares with relevant tax authorities and to withhold individual income taxes for those employees who exercise their share options. If our employees fail to pay or we fail to withhold their income taxes according to relevant laws and regulations, we may face sanctions imposed by the tax authorities or other PRC government authorities. See “Regulation—Regulation Relating to Foreign Exchange—Regulation on Stock Incentive Plans.”

PRC regulations relating to offshore investment activities by PRC residents may limit our PRC subsidiaries’ ability to change their registered capital or distribute profits to us or otherwise expose us or our PRC resident beneficial owners to liability and penalties under PRC laws.

In July 2014, SAFE promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Offshore Investment and Financing and Roundtrip Investment Through Special Purpose Vehicles, or SAFE Circular 37. SAFE Circular 37 requires PRC residents (including PRC individuals and PRC corporate entities as well as foreign individuals that are deemed as PRC residents for foreign exchange administration purposes) to register with SAFE or its local branches in connection with their direct or indirect offshore investment activities. SAFE Circular 37 further requires amendment to the SAFE registrations in the event of any changes with respect to the basic information of the offshore special purpose vehicle, such as change of a PRC individual shareholder, name and operation term, or any significant changes with respect to the offshore special purpose vehicle, such as increase or decrease of capital contribution, share transfer or exchange, or mergers or divisions. SAFE Circular 37 is applicable to our shareholders who are PRC residents and may be applicable to any offshore acquisitions that we make in the future. According to the Notice on Further Simplifying and Improving Policies for the Foreign Exchange Administration of Direct Investment released on February 13, 2015 by the SAFE, local banks will examine and handle foreign exchange registration for overseas direct investment, including the initial foreign exchange registration and amendment registration, under SAFE Circular 37 from June 1, 2015. The PRC residents shall, by themselves or entrusting accounting firms or banks, file with the online information system designated by SAFE with respect to its existing rights under offshore direct investment each year prior to the requisite time.

 

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If our shareholders who are PRC residents or entities do not complete their registration with the local SAFE branches or qualified local banks or complete annual filing of its existing rights under offshore direct investment, our PRC subsidiaries may be prohibited from distributing to us its profits and proceeds from any reduction in capital, share transfer or liquidation, and we may be restricted in our ability to contribute additional capital to our PRC subsidiaries. Moreover, failure to comply with the SAFE registration described above could result in liability under PRC laws for evasion of applicable foreign exchange restrictions.

We have used our best efforts to notify PRC residents or entities who directly or indirectly hold shares in our Cayman Islands holding company and who are known to us as being PRC residents or entities to complete the foreign exchange registrations and annual filings of its existing rights under offshore direct investment. However, we may not be informed of the identities of all the PRC residents or entities holding direct or indirect interest in our company, nor can we compel our beneficial owners to comply with SAFE registration requirements. We cannot assure you that all shareholders or beneficial owners of ours who are PRC residents or entities have complied with, and will in the future make, obtain or update any applicable registrations or approvals required by, SAFE regulations.

The failure or inability of such shareholders or beneficial owners to comply with SAFE regulations, or failure by us to amend the foreign exchange registrations of our PRC subsidiaries, could subject us to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our PRC subsidiaries’ ability to make distributions or pay dividends to us or affect our ownership structure. As a result, our business operations and our ability to distribute profits to you could be materially and adversely affected.

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

We are a Cayman Islands holding company and we rely principally on dividends and other distributions on equity from our PRC subsidiaries for our cash requirements, including the funds necessary to pay dividends and other cash distributions to our shareholders for services or any debt we may incur. If our PRC subsidiaries incur debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us. Under PRC laws and regulations, our PRC subsidiaries, which is a foreign-owned enterprise, may pay dividends only out of its respective accumulated profits as determined in accordance with PRC accounting standards and regulations. In addition, a foreign-owned enterprise is required to set aside at least 10% of its accumulated after-tax profits each year, if any, to fund a certain statutory reserve fund, until the aggregate amount of such fund reaches 50% of its registered capital. Such reserve funds cannot be distributed to us as dividends. At its discretion, a foreign-owned enterprise may allocate a portion of its after-tax profits based on PRC accounting standards to an enterprise expansion fund.

Our PRC subsidiaries generate essentially all of their revenue in Renminbi, which is not freely convertible into other currencies. As a result, any restriction on currency exchange may limit the ability of our PRC subsidiaries to use their Renminbi revenues to pay dividends to us.

The PRC government may continue to strengthen its capital controls, and more restrictions and substantial vetting processes may be put forward by SAFE for cross-border transactions falling under both the current account and the capital account. Any limitation on the ability of our PRC subsidiaries to pay dividends or make other kinds of payments to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends, or otherwise fund and conduct our business.

In addition, the Enterprise Income Tax Law and its implementation rules provide that a withholding tax rate of up to 10% will be applicable to dividends payable by Chinese companies to non-PRC-resident enterprises unless exempted or reduced according to treaties or arrangements between the PRC central government and governments of other countries or regions where the non-PRC-resident enterprises are incorporated.

 

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PRC regulation of loans to and direct investment in PRC entities by offshore holding companies and governmental control of currency conversion may delay or prevent us from using the proceeds of this offering to make loans or additional capital contributions to our PRC subsidiaries and our VIEs in China, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

We are an offshore holding company conducting our operations in China through our PRC subsidiaries and VIEs and their subsidiaries. We may make loans to our PRC subsidiaries and VIEs and their subsidiaries subject to the approval from or registration with governmental authorities and limitation on amount, or we may make additional capital contributions to our wholly foreign-owned subsidiaries in China. Any loans to our wholly foreign-owned subsidiaries in China, which are treated as foreign-invested enterprises, or FIEs, under PRC law, are subject to applicable foreign exchange loan registrations. In addition, an FIE shall use its capital pursuant to the principle of authenticity and self-use within its business scope. The capital of an FIE shall not be used for the following purposes: (i) directly or indirectly used for payment beyond the business scope of such FIE or the payment prohibited by relevant laws and regulations; (ii) directly or indirectly used for investment in securities or investments in financial management other than banks’ principal-secured products unless otherwise provided by relevant laws and regulations; (iii) the granting of loans to non-affiliated enterprises, except where it is expressly permitted in the business license; and (iv) paying the expenses related to the purchase of real estate that is not for self-use (except for the foreign-invested real estate enterprises).

SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming the Administration of Foreign Exchange Settlement of Capital of Foreign-invested Enterprises, or SAFE Circular 19, effective June 2015, in replacement of a former regulation. According to SAFE Circular 19, the flow and use of the RMB capital converted from foreign currency-denominated registered capital of a foreign-invested company is regulated such that RMB capital may not be used for the issuance of RMB entrusted loans, the repayment of inter-enterprise loans or the repayment of bank loans that have been transferred to a third party. Although SAFE Circular 19 allows RMB capital converted from foreign currency-denominated registered capital of a foreign-invested enterprise to be used for equity investments within China, it also reiterates the principle that RMB converted from the foreign currency-denominated capital of a foreign-invested company may not be directly or indirectly used for purposes beyond its business scope. Thus, it is unclear whether SAFE will permit such capital to be used for equity investments in China in actual practice. SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming and Standardizing the Foreign Exchange Settlement Management Policy of Capital Account, or SAFE Circular 16, effective on June 9, 2016, which reiterates some of the rules set forth in SAFE Circular 19, but changes the prohibition against using RMB capital converted from foreign currency-denominated registered capital of a foreign-invested company to issue RMB entrusted loans to a prohibition against using such capital to issue loans to non-associated enterprises. Violations of SAFE Circular 19 and SAFE Circular 16 could result in administrative penalties. SAFE Circular 19 and SAFE Circular 16 may significantly limit our ability to transfer any foreign currency we hold, including the net proceeds from this offering, to our PRC subsidiaries, which may adversely affect our liquidity and our ability to fund and expand our business in China. On October 23, 2019, the SAFE promulgated the Notice of the State Administration of Foreign Exchange on Further Promoting the Convenience of Cross-border Trade and Investment, or the SAFE Circular 28, which, among other things, allows all foreign-invested companies to use Renminbi converted from foreign currency-denominated capital for equity investments in China, as long as the equity investment is genuine, does not violate applicable laws, and complies with the negative list on foreign investment. However, since the SAFE Circular 28 is newly promulgated, it is unclear how SAFE and competent banks will carry this out in practice.

In light of the various requirements imposed by PRC regulations on loans to and direct investment in PRC entities by offshore holding companies, we cannot assure you that we will be able to complete the necessary government registrations or obtain the necessary government approvals on a timely basis, or at all, with respect to future loans by us to our PRC subsidiaries or VIEs or their subsidiaries or with respect to future capital contributions by us to our PRC subsidiaries. If we fail to complete such registrations or obtain such approvals, our ability to use the proceeds from our initial public offering and to capitalize or otherwise fund our PRC

 

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operations may be negatively affected, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

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 all of our revenues in Renminbi. Under our current corporate structure, our Cayman Islands holding company may rely on dividend payments from our PRC subsidiaries to fund any cash and financing requirements we may have. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior approval of the State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. Specifically, under the existing exchange restrictions, without prior approval of SAFE, cash generated from the operations of our PRC subsidiaries in China may be used to pay dividends to our company. However, approval from or registration with appropriate government authorities is required where 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. As a result, we need to obtain SAFE approval to use cash generated from the operations of our PRC subsidiaries and consolidated variable interest entities to pay off their respective debt in a currency other than Renminbi owed to entities outside China, or to make other capital expenditure payments outside China in a currency other than Renminbi.

In light of the flood of capital outflows of China in 2016 due to the weakening Renminbi, the PRC government has imposed more restrictive foreign exchange policies and stepped up scrutiny of major outbound capital movement including overseas direct investment. More restrictions and substantial vetting processes are put in place by SAFE to regulate cross-border transactions falling under the capital account. If any of our shareholders regulated by such policies fails to satisfy the applicable overseas direct investment filing or approval requirement timely or at all, it may be subject to penalties from the relevant PRC authorities. The PRC government may at its discretion further restrict access in the future to foreign currencies for current account transactions. 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.

It may be difficult for overseas regulators to conduct investigations or collect evidence within China.

Shareholder claims or regulatory investigations that are common in jurisdictions outside China are difficult to pursue as a matter of law or practicality in China. For example, in China, there are significant legal and other obstacles to providing information needed for regulatory investigations or litigation initiated outside China. Although the authorities in China may establish a regulatory cooperation mechanism with the securities regulatory authorities of another country or region to implement cross-border supervision and administration, such cooperation with the securities regulatory authorities in the United States or other jurisdictions may not be efficient in the absence of a mutual and practical cooperation mechanism. Furthermore, according to Article 177 of the PRC Securities Law, or Article 177, which became effective in March 2020, no overseas securities regulator is allowed to directly conduct investigation or evidence collection activities within the territory of the PRC, and without the consent by the Chinese securities regulatory authorities and the other competent governmental agencies, no entity or individual may provide documents or materials related to securities business to any foreign party. While detailed interpretation of or implementation rules under Article 177 have yet to be promulgated, the inability of an overseas securities regulator to directly conduct investigation or evidence collection activities within China and the potential obstacles for information provision may further increase difficulties you face in protecting your interests. See also “—Risks relating to the ADS and this offering—You may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are incorporated under Cayman Islands law” for risks associated with investing in us as a Cayman Islands company.

 

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Additional remedial measures could be imposed on certain PRC-based accounting firms, including our independent registered public accounting firm, in administrative proceedings instituted by the SEC, as a result of which our financial statements may be determined to not be in compliance with the requirements of the Exchange Act, if at all.

In December 2012, the SEC brought administrative proceedings against the PRC-based “big four” accounting firms, including our independent registered public accounting firm, alleging that they had violated U.S. securities laws by failing to provide audit work papers and other documents related to certain other PRC-based companies under investigation by the SEC. On January 22, 2014, an initial administrative law decision was issued, censuring and suspending these accounting firms from practicing before the SEC for a period of six months. The decision was neither final nor legally effective until reviewed and approved by the SEC, and on February 12, 2014, the PRC-based accounting firms appealed to the SEC against this decision. In February 2015, each of the four PRC-based accounting firms agreed to a censure and to pay a fine to the SEC to settle the dispute and avoid suspension of their ability to practice before the SEC. The settlement required the firms to follow detailed procedures to seek to provide the SEC with access to such firms’ audit documents via the CSRC. If the firms did not follow these procedures or if there is a failure in the process between the SEC and the CSRC, the SEC could impose penalties such as suspensions, or it could restart the administrative proceedings. Under the terms of the settlement, the underlying proceeding against the four PRC-based accounting firms was deemed dismissed with prejudice four years after entry of the settlement. The four-year mark occurred on February 6, 2019. While we cannot predict if the SEC will further challenge the four PRC-based accounting firms’ compliance with U.S. law in connection with U.S. regulatory requests for audit work papers or if the results of such challenge would result in the SEC imposing penalties such as suspensions.

In the event that the PRC-based “big four” accounting firms become subject to additional legal challenges by the SEC or PCAOB, depending upon the final outcome, listed companies in the U.S. with major PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the PRC, which could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act, including possible delisting. Moreover, any negative news about any such future proceedings against these audit firms may cause investor uncertainty regarding China-based, U.S.-listed companies and the market price of the ADSs may be adversely affected.

If our independent registered public accounting firm were denied, even temporarily, the ability to practice before the SEC and we were unable to timely find another registered public accounting firm to audit and issue an opinion on our consolidated financial statements, our consolidated financial statements could be determined not to be in compliance with the requirements of the Exchange Act. Such a determination could ultimately lead to the delay or abandonment of this offering, delisting of the ADSs from the NYSE or deregistration from the SEC, or both, which would substantially reduce or effectively terminate the trading of the ADSs in the U.S.

Litigation and negative publicity surrounding China-based companies listed in the U.S. may result in increased regulatory scrutiny of us and negatively impact the trading price of our ADSs.

We believe that litigation and negative publicity surrounding companies with operations in China that are listed in the U.S. have negatively impacted stock prices for such companies. Various equity-based research organizations have published reports on China-based companies after examining, among other things, their corporate governance practices, related party transactions, sales practices and financial statements that have led to special investigations and stock suspensions on national exchanges. Any similar scrutiny of us, regardless of its lack of merit, could result in a diversion of management resources and energy, potential costs to defend ourselves against rumors, decreases and volatility in the ADS trading price, and increased directors and officers insurance premiums, and could have a material adverse effect upon our business, results of operations and financial condition.

 

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The ability of U.S. authorities to bring actions for violations of U.S. securities law and regulations against us, our directors, executive officers or the expert named in this prospectus may be limited. Therefore, you may not be afforded the same protection as provided to investors in U.S. domestic companies.

The SEC, the U.S. Department of Justice, or the DOJ, and other U.S. authorities often have substantial difficulties in bringing and enforcing actions against non-U.S. companies such as us, and non-U.S. persons, such as our directors and executive officers in China. Due to jurisdictional limitations, matters of comity and various other factors, the SEC, the DOJ and other U.S. authorities may be limited in their ability to pursue bad actors, including in instances of fraud, in emerging markets such as China. We conduct our operations mainly in China and our assets are mainly located in China and outside of the United States. In addition, a majority of our directors and executive officers reside within China. There are significant legal and other obstacles for U.S. authorities to obtain information needed for investigations or litigation against us or our directors, executive officers or other gatekeepers in case we or any of these individuals engage in fraud or other wrongdoing. In addition, local authorities in China may be constrained in their ability to assist U.S. authorities and overseas investors in connection with legal proceedings. As a result, if we, our directors, executive officers or other gatekeepers commit any securities law violation, fraud or other financial misconduct, the U.S. authorities may not be able to conduct effective investigations or bring and enforce actions against us, our directors, executive officers or other gatekeepers. Therefore, you may not be able to enjoy the same protection provided by various U.S. authorities as it is provided to investors in U.S. domestic companies.

Risks relating to the ADS and this offering

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

Prior to this initial public offering, there has been no public market for our shares or ADSs. The ADSs have been approved for listing on the New York Stock Exchange. Our shares will not be listed on any exchange or quoted for trading on any over-the-counter trading system. If an active trading market for our ADSs does not develop after this offering, the market price and liquidity of our ADSs will be materially and adversely affected.

Negotiations with the underwriters determined the initial public offering price for our ADSs which may bear no relationship to their market price after the initial public offering. We cannot assure you that an active trading market for our ADSs will develop or that the market price of our ADSs will not decline below the initial public offering price.

The trading price of the ADSs is likely to be volatile, which could result in substantial losses to investors.

The trading price of the ADSs is likely to be volatile and could fluctuate widely due to factors beyond our control. This may happen because of broad market and industry factors, including the performance and fluctuation of the market prices of other companies with business operations located mainly in China that have listed their securities in the United States. In addition to market and industry factors, the price and trading volume for the ADSs may be highly volatile for factors specific to our own operations, including the following:

 

   

actual or anticipated variations in our revenues, earnings, cash flow and changes or revisions of our expected results;

 

   

fluctuations in operating metrics;

 

   

announcements of new investments, acquisitions, strategic partnerships or joint ventures by us or our competitors;

 

   

announcements of new products, services and courses and expansions by us or our competitors;

 

   

changes in financial estimates by securities analysts;

 

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announcements of studies and reports relating to the quality of our product, service and course offerings or those of our competitors;

 

   

changes in the performance or market valuations of other online education companies;

 

   

conditions in the online education market;

 

   

detrimental negative publicity about us, our competitors or our industry;

 

   

additions or departures of key personnel;

 

   

release of lockup or other transfer restrictions on our outstanding equity securities or sales of additional equity securities;

 

   

regulatory developments affecting us or our industry;

 

   

general economic or political conditions affecting China or elsewhere in the world;

 

   

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

 

   

potential litigation or regulatory investigations.

Any of these factors may result in large and sudden changes in the volume and price at which the ADSs will trade. Furthermore, the stock market in general experiences price and volume fluctuations that are often unrelated or disproportionate to the operating performance of companies like us. These broad market and industry fluctuations may adversely affect the market price of our ADSs. Volatility or a lack of positive performance in the ADS price may also adversely affect our ability to retain key employees, most of whom have been granted equity incentives.

In the past, shareholders of public companies have often brought securities class action suits against companies following periods of instability in the market price of their securities. If we were involved in a class action suit, it could divert a significant amount of our management’s attention and other resources from our business and operations and require us to incur significant expenses to defend the suit, which could harm our results of operations. Any such class action suit, whether or not successful, could harm our reputation and restrict our ability to raise capital in the future. In addition, if a claim is successfully made against us, we may be required to pay significant damages, which could have a material adverse effect on our financial condition and results of operations.

If securities or industry analysts cease to publish research or reports about our business, or if they adversely change their recommendations regarding the ADSs, the market price for the ADSs and trading volume could decline.

The trading market for the ADSs will be influenced by research or reports that industry or securities analysts publish about our business. If one or more analysts who cover us downgrade the ADSs, the market price for the ADSs would likely decline. If one or more of these analysts cease to cover us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which, in turn, could cause the market price or trading volume for the ADSs to decline.

Our proposed dual-class voting structure 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.

Our authorized share capital will be divided into Class A ordinary shares and Class B ordinary shares effective immediately prior to the completion of this offering (with certain shares remaining undesignated, with power for our directors to designate and issue such classes of shares as they think fit). 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

 

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thirty votes per share. We will issue Class A ordinary shares represented by our ADSs in this offering. Each Class B ordinary share is convertible into one Class A ordinary share at any time by the holder thereof, while Class A ordinary shares are not convertible into Class B ordinary shares under any circumstances. After this offering, the holder of Class B ordinary shares will have the ability to control matters requiring shareholders’ approval, including any amendment of our memorandum and articles of association. Any future issuances of Class B ordinary shares may be dilutive to the voting power of holders of Class A ordinary shares. Any conversions of Class B ordinary shares into Class A ordinary shares may dilute the percentage ownership of the existing holders of Class A ordinary shares within their class of ordinary shares. Such conversions may increase the aggregate voting power of the existing holders of Class A ordinary shares. In the event that we have multiple holders of Class B ordinary shares in the future and certain of them convert their Class B ordinary shares into Class A ordinary shares, the remaining holders who retain their Class B ordinary shares may experience increases in their relative voting power.

Upon the completion of this offering, Mr. Yi Zhang, our founder, chairman of the board of directors and chief executive officer, will beneficially own all of our issued Class B ordinary shares. These Class B ordinary shares will constitute 13.7% of our total issued and outstanding share capital immediately after the completion of this offering and 82.7% of the aggregate voting power of our total issued and outstanding share capital due to the disparate voting powers associated with our dual-class share structure, assuming the underwriters do not exercise their option to purchase additional ADSs. As a result of the dual-class share structure and the concentration of ownership, holders of Class B ordinary shares will have considerable influence over matters such as decisions regarding mergers and consolidations, election of directors and other significant corporate actions. Such holders may take actions that are not in the best interest of us or our other shareholders. This concentration of ownership may discourage, delay or prevent a change in control of our company, which could have the effect of depriving our other shareholders of the opportunity to receive a premium for their shares as part of a sale of our company and may reduce the price of our ADSs. This concentrated control will limit your ability to influence corporate matters and could discourage others from pursuing any potential merger, takeover or other change of control transactions that holders of Class A ordinary shares and ADSs may view as beneficial.

The dual-class structure of our ordinary shares may adversely affect the trading market for our ADSs.

Certain shareholder advisory firms have announced changes to their eligibility criteria for inclusion of shares of public companies on certain indices, including the S&P 500, to exclude companies with multiple classes of shares and companies whose public shareholders hold no more than 5% of total voting power from being added to such indices. In addition, several shareholder advisory firms have announced their opposition to the use of multiple class structures. As a result, the dual class structure of our ordinary shares may prevent the inclusion of our ADSs representing Class A ordinary shares in such indices and may cause shareholder advisory firms to publish negative commentary about our corporate governance practices or otherwise seek to cause us to change our capital structure. Any such exclusion from indices could result in a less active trading market for our ADSs. Any actions or publications by shareholder advisory firms critical of our corporate governance practices or capital structure could also adversely affect the value of our ADSs.

We currently do not expect to pay dividends in the foreseeable future after this offering and you must rely on price appreciation of our ADSs for return on your investment.

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

Our board of directors has complete discretion as to whether to distribute dividends, subject to certain requirements of Cayman Islands law. 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

 

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Cayman Islands company may pay a dividend out of either profit or share premium account, provided that in no circumstances may a dividend be paid if this would result in the company being unable to pay its debts as they fall due in the ordinary course of business. Even if our board of directors decides to declare and pay dividends, the timing, amount and form of future dividends, if any, will depend on our future results of operations and cash flow, our capital requirements and surplus, the amount of distributions, if any, received by us from our subsidiaries, our financial condition, contractual restrictions and other factors deemed relevant by our board of directors. Accordingly, the return on your investment in our ADSs will likely depend entirely upon any future price appreciation of our ADSs. There is no guarantee that our ADSs will appreciate in value after this offering or even maintain the price at which you purchased the ADSs. You may not realize a return on your investment in our ADSs and you may even lose your entire investment in our ADSs.

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

If you purchase ADSs in this offering, you will pay more for your ADSs than the amount paid by our existing shareholders for their ordinary shares on a per ADS basis. As a result, you will experience immediate and substantial dilution, representing the difference between the initial public offering price of US$11.50 per ADS, and our adjusted net tangible book value of US$(0.14) per ADS as of March 31, 2021, after giving effect to our sale of the ADSs offered in this offering. In addition, you may experience further dilution to the extent that our Class A ordinary shares are issued upon the exercise of share options. See “Dilution” for a more complete description of how the value of your investment in the ADSs will be diluted upon completion of this offering.

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

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

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

Sales of the ADSs 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. All ADSs sold in this offering will be freely transferable without restriction or additional registration under the Securities Act. The remaining ordinary shares issued and outstanding after this offering will be available for sale, upon the expiration of the 180-day lock-up period beginning from the date of the final prospectus, subject to volume and other restrictions as applicable provided in Rules 144 and 701 under the Securities Act. Any or all of these shares may be released prior to the expiration of the lock-up period at the discretion of the representatives of the underwriters of this offering. To the extent shares are released before the expiration of the lock-up period and sold into the market, the market price of our ADSs could decline.

After completion of this offering, certain holders of our Class A ordinary shares may cause us to register under the Securities Act the sale of their shares, subject to the 180-day lock-up period in connection with this offering. Registration of these shares under the Securities Act would result in ADSs representing these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of such registration. Sales of these registered shares in the form of ADSs in the public market could cause the price of our ADSs to decline.

 

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Techniques employed by short sellers may drive down the market price of our ADSs.

Short selling is the practice of selling securities that the seller does not own but rather has borrowed from a third party with the intention of buying identical securities back at a later date to return to the lender. The short seller hopes to profit from a decline in the value of the securities between the sale of the borrowed securities and the purchase of the replacement shares, as the short seller expects to pay less in that purchase than it received in the sale. As it is in the short seller’s interest for the price of the security to decline, many short sellers publish, or arrange for the publication of, negative opinions regarding the relevant issuer and its business prospects in order to create negative market momentum and generate profits for themselves after selling a security short. These short attacks have, in the past, led to selling of shares in the market.

Public companies that have substantially all of their operations in China have been the subject of short selling. Much of the scrutiny and negative publicity has centered on allegations of a lack of effective internal control over financial reporting resulting in financial and accounting irregularities and mistakes, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result, many of these companies are now conducting internal and external investigations into the allegations and, in the interim, are subject to shareholder lawsuits and/or SEC enforcement actions.

It is not clear what effect such negative publicity could have on us. If we were to become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we could have to expend a significant amount of resources to investigate such allegations and/or defend ourselves. While we would strongly defend against any such short seller attacks, we may be constrained in the manner in which we can proceed against the relevant short seller by principles of freedom of speech, applicable state law or issues of commercial confidentiality. Such a situation could be costly and time-consuming, and could distract our management from growing our business. Even if such allegations are ultimately proven to be groundless, allegations against us could severely impact our business operations, and any investment in the ADSs could be greatly reduced or even rendered worthless.

Our post-offering memorandum and articles of association contain anti-takeover provisions that could have a material adverse effect on the rights of holders of our ordinary shares and the ADSs.

We have conditionally adopted a tenth amended and restated memorandum and articles of association that will become effective immediately prior to the completion of this offering. Our post-offering memorandum and articles of association contain provisions to 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 similar transaction. Our board of directors has the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix their designations, powers, preferences, privileges and relative participating, optional or special rights and the qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our ordinary shares, including Class A ordinary shares represented by ADSs. Preferred shares could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preferred shares, the price of the ADSs may fall and the voting and other rights of the holders of our ordinary shares and the ADSs may be materially and adversely affected.

 

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Our post-offering memorandum and articles of association and the deposit agreement provide that the United States District Court for the Southern District of New York (or, if the United States District Court for the Southern District of New York lacks subject matter jurisdiction over a particular dispute, the state courts in New York County, New York) is the exclusive judicial forum within the U.S. for the resolution of any complaint asserting a cause of action arising out of or relating in any way to the federal securities laws of the United States, and any suit, action or proceeding arising out of or relating in any way to the ADSs or the deposit agreement, which could limit the ability of holders of our ordinary shares, the ADSs or other securities to obtain a favorable judicial forum for disputes with us, our directors and officers, the depositary, and potentially others.

Our post-offering memorandum and articles of association provide that the United States District Court for the Southern District of New York (or, if the United States District Court for the Southern District of New York lacks subject matter jurisdiction over a particular dispute, the state courts in New York County, New York) is the exclusive forum within the United States for the resolution of any complaint asserting a cause of action arising out of or relating in any way to the federal securities laws of the United States, regardless of whether such legal suit, action, or proceeding also involves parties other than our company. The deposit agreement provides that the United States District Court for the Southern District of New York (or, if the United States District Court for the Southern District of New York lacks subject matter jurisdiction over a particular dispute, the state courts in New York County, New York) shall have exclusive jurisdiction over any suit, action or proceeding against or involving us or the depositary, arising out of or relating in any way to the deposit agreement, including without limitation claims under the Securities Act of 1933 arising out of or relating in any way to the deposit agreement. The enforceability of similar federal court choice of forum provisions in other companies’ organizational documents has been challenged in legal proceedings in the United States, and it is possible that a court could find this type of provision to be inapplicable or unenforceable. If a court were to find the federal choice of forum provision contained in our post-offering memorandum and articles of association or the deposit agreement to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions. If upheld, the forum selection clause in our post-offering memorandum and articles of association, as well as the forum selection provision in the deposit agreement, may limit a security-holder’s ability to bring a claim against us, our directors and officers, the depositary, and potentially others in his or her preferred judicial forum, and this limitation may discourage such lawsuits. Holders of our shares or the ADSs will not be deemed to have waived our compliance with the federal securities laws and the regulations promulgated thereunder pursuant to the exclusive forum provision in the post-offering memorandum and articles of association and deposit agreement.

The voting rights of holders of ADSs are limited by the terms of the deposit agreement, and you may not be able to exercise your right to direct the voting of the underlying Class A ordinary shares represented by your ADSs.

Holders of ADSs do not have the same rights as our registered shareholders. As a holder of ADSs, you will not have any direct right to attend general meetings of our shareholders or to cast any votes at such meetings. You will only be able to exercise the voting rights attached to the underlying Class A ordinary shares represented by your ADSs indirectly by giving voting instructions to the depositary in accordance with the provisions of the deposit agreement. Where any matter is to be put to a vote at a general meeting where we asked the depositary to solicit your instruction, then upon receipt of your voting instructions, the depositary will try, as far as is practicable, to vote the underlying Class A ordinary shares represented by your ADSs in accordance with your instructions, in the case of voting by poll, and in accordance with the voting instructions received from a majority of ADS holders who provide voting instructions, in the case of voting by show of hands. You will not be able to directly exercise your right to vote with respect to the underlying Class A ordinary shares unless you cancel and withdraw the shares and become the registered holder of such shares prior to the record date for the general meeting.

When a general meeting is convened, you may not receive sufficient advance notice of the meeting to withdraw the underlying Class A ordinary shares represented by your ADSs and become the registered holder of

 

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such shares to allow you to attend the general meeting and to vote directly with respect to any specific matter or resolution to be considered and voted upon at the general meeting. In addition, under our post-offering memorandum and articles of association that will become effective immediately prior to completion of this offering, for the purposes of determining those shareholders who are entitled to attend and vote at any general meeting, our directors may close our register of members and/or fix in advance a record date for such meeting, and such closure of our register of members or the setting of such a record date may prevent you from withdrawing the underlying Class A ordinary shares represented by your ADSs and from becoming the registered holder of such shares prior to the record date, so that you would not be able to attend the general meeting or to vote directly. Where any matter is to be put to a vote at a general meeting, upon our instruction the depositary will notify you of the upcoming vote and will arrange to deliver our voting materials to you. We cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote the underlying Class A ordinary shares represented by your ADSs.

In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for their manner of carrying out your voting instructions. This means that you may not be able to exercise your right to direct how the underlying Class A ordinary shares represented by your ADSs are voted and you may have no legal remedy if the underlying Class A ordinary shares represented by your ADSs are not voted as you requested. In addition, in your capacity as an ADS holder, you will not be able to call a shareholders’ meeting.

Further, under the deposit agreement for the ADSs, if you do not vote, the depositary will give us a discretionary proxy to vote the Class A ordinary shares underlying your ADSs at shareholders’ meetings if:

 

   

we have instructed the depositary that we wish a discretionary proxy to be given;

 

   

we have confirmed to the depositary that there is no substantial opposition as to a matter to be voted on at the meeting; and

 

   

we have confirmed to the depositary that a matter to be voted on at the meeting would not have a material adverse impact on shareholders.

The effect of this discretionary proxy is that you cannot prevent our Class A ordinary shares underlying your ADSs from being voted under the circumstances described above. This may adversely affect your interests and make it more difficult for ADS holders to influence the management of our company. Holders of our Class A ordinary shares are not subject to this discretionary proxy.

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

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

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

Your ADSs are transferable on the books of the depositary. However, the depositary may close its books at any time or from time to time when it deems expedient in connection with the performance of its duties. The

 

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depositary may close its books from time to time for a number of reasons, including in connection with corporate events such as a rights offering, during which time the depositary needs to maintain an exact number of ADS holders on its books for a specified period. The depositary may also close its books in emergencies, and on weekends and public holidays. The depositary may refuse to deliver, transfer or register transfers of the ADSs generally when our share register or the books of the depositary are closed, or at any time if we or the depositary thinks it is advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

You may experience dilution of your holdings due to inability to participate in rights offerings.

We may, from time to time, distribute rights to our shareholders, including rights to acquire securities. Under the deposit agreement, the depositary will not distribute rights to holders of ADSs unless the distribution and sale of rights and the securities to which these rights relate are either exempt from registration under the Securities Act with respect to all holders of ADSs, or are registered under the provisions of the Securities Act. The depositary may, but is not required to, attempt to sell these undistributed rights to third parties, and may allow the rights to lapse. We may be unable to establish an exemption from registration under the Securities Act, and we are under no obligation to file a registration statement with respect to these rights or underlying securities or to endeavor to have a registration statement declared effective. Accordingly, holders of ADSs may be unable to participate in our rights offerings and may experience dilution of their holdings as a result.

You may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are incorporated under Cayman Islands law.

We are an exempted company incorporated under the laws of the Cayman Islands. Our corporate affairs are governed by our post-offering memorandum and articles of association, the Companies Act (As Revised) of the Cayman Islands and the common law of the Cayman Islands. The rights of shareholders to take action against our directors, actions by our minority shareholders and the fiduciary duties of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from the common law of England, the decisions of whose courts are of persuasive authority, but are not binding, on a court in the Cayman Islands. The rights of our shareholders and the fiduciary duties of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities laws than the United States. Some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands. In addition, Cayman Islands companies may not have the standing to initiate a shareholder derivative action in a federal court of the United States.

Shareholders of Cayman Islands exempted companies like us have no general rights under Cayman Islands law to inspect corporate records or to obtain copies of lists of shareholders of these companies. Our directors have discretion under our tenth amended and restated articles of association that will become effective immediately prior to completion of this offering to determine whether or not, and under what conditions, our corporate records may be inspected by our shareholders, but are not obliged to make them available to our shareholders. This may make it more difficult for you to obtain the information needed to establish any facts necessary for a shareholder motion or to solicit proxies from other shareholders in connection with a proxy contest.

As a result of all of the above, our public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of our board of directors or controlling shareholders than they would as public shareholders of a company incorporated in the United States. For a discussion of significant differences between the provisions of the Companies Act of the Cayman Islands and the laws applicable to companies incorporated in the United States and their shareholders, see “Description of Share Capital—Differences in Corporate Law.”

 

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

We are a Cayman Islands exempted company and most of our assets are located in China. All of our current operations are conducted in China. In addition, most of our current directors and senior executive officers are nationals and residents of jurisdictions other than the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the 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 of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities.”

ADS holders may not be entitled to a jury trial with respect to claims arising under the deposit agreement, which could result in less favorable outcomes to the plaintiff(s) in any such action.

The deposit agreement governing the ADSs representing our Class A ordinary shares provides that the United States District Court for the Southern District of New York (or, if the United States District Court for the Southern District of New York lacks subject matter jurisdiction over a particular dispute, in the state courts in New York County, New York) shall have exclusive jurisdiction to hear and determine claims arising out of or relating in any way to the deposit agreement (including claims arising under the Exchange Act or the Securities Act) and in that regard, to the fullest extent permitted by law, ADS holders waive the right to a jury trial of any claim they may have against us or the depositary arising out of or relating to our shares, the ADSs or the deposit agreement, including any claim under the U.S. federal securities laws.

If we or the depositary opposed a jury trial demand based on the waiver, the court would determine whether the waiver was enforceable based on the facts and circumstances of that case in accordance with the applicable state and federal law. To our knowledge, the enforceability of a contractual pre-dispute jury trial waiver in connection with claims arising under the federal securities laws has not been finally adjudicated by the United States Supreme Court. However, we believe that a contractual pre-dispute jury trial waiver provision is generally enforceable, including under the laws of the State of New York, which govern the deposit agreement. In determining whether to enforce a contractual pre-dispute jury trial waiver provision, courts will generally consider whether a party knowingly, intelligently and voluntarily waives the right to a jury trial. We believe that this is the case with respect to the deposit agreement and the ADSs. It is advisable that you consult legal counsel regarding the jury waiver provision before investing in the ADSs.

If you or any other holders or beneficial owners of ADSs bring a claim against us or the depositary in connection with matters arising under the deposit agreement or the ADSs, including claims under federal securities laws, you or such other holder or beneficial owner may not be entitled to a jury trial with respect to such claims, which may have the effect of limiting and discouraging lawsuits against us or the depositary, lead to increased costs to bring a claim, limited access to information and other imbalances of resources between such holder and us, or limit such holder’s ability to bring a claim in a judicial forum that such holder finds favorable. If a lawsuit is brought against us or the depositary under the deposit agreement, it may be heard only by a judge or justice of the applicable trial court, which would be conducted according to different civil procedures and may result in different outcomes than a trial by jury would have had, including results that could be less favorable to the plaintiff(s) in any such action.

Nevertheless, if this jury trial waiver provision is not enforced, to the extend a court action proceeds, it would proceed under the terms of the deposit agreement with a jury trial. No condition, stipulation or provision of the deposit agreement or ADSs shall relieve us or the depositary from our respective obligations to comply with the Securities Act and the Exchange Act nor serve as a waiver by any holder or beneficial owner of ADSs of compliance with the U.S. federal securities laws and the rules and regulations promulgated thereunder.

 

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An ADS holder’s right to pursue claims against the depositary is limited by the terms of the deposit agreement.

Under the deposit agreement, any legal suit, action or proceeding against or involving us or the depositary, arising out of or relating in any way to the deposit agreement or the transactions contemplated thereby or by virtue of owning the ADSs may only be instituted in the United States District Court for the Southern District of New York (or, if the United States District Court for the Southern District of New York lacks subject matter jurisdiction over a particular dispute, in the state courts in New York County, New York), and a holder of our ADSs, will have irrevocably waived any objection which such holder may have to the laying of venue of any such proceeding, and irrevocably submitted to the exclusive jurisdiction of such courts in any such action or proceeding. However, the enforceability of similar federal court choice of forum provisions in other companies’ organizational documents has been challenged in legal proceedings in the United States, and it is possible that a court could find this type of provision to be inapplicable or unenforceable. Accepting or consenting to this forum selection provision does not represent you are waiving compliance with the U.S. federal securities laws and the rules and regulations promulgated thereunder. Furthermore, investors cannot waive compliance with the U.S. federal securities laws and rules and regulations promulgated thereunder. See “Description of American Depositary Shares” for more information.

We are an emerging growth company within the meaning of the Securities Act and may take advantage of certain reduced reporting requirements.

As a company with less than US$1.07 billion in revenues for our last fiscal year, we qualify as an “emerging growth company” pursuant to the JOBS Act. Therefore, we may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally to public companies. These provisions include exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, in the assessment of the emerging growth company’s internal control over financial reporting and permission to delay adopting new or revised accounting standards until such time as those standards apply to private companies. As a result, if we elect not to comply with such reporting and other requirements, in particular the auditor attestation requirements, our investors may not have access to certain information they may deem important.

The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards.

As a company incorporated in the Cayman Islands, we are permitted to adopt certain home country practices in relation to corporate governance matters that differ significantly from the NYSE listing standards.

As a Cayman Islands exempted company listed on the New York Stock Exchange, we are subject to the NYSE listing standards, which requires listed companies to have, among other things, a majority of their board members to be independent and independent director oversight of executive compensation and nomination of directors. However, NYSE rules permit a foreign private issuer like us to follow the corporate governance practices of its home country. Certain corporate governance practices in the Cayman Islands, which is our home country, may differ significantly from the NYSE listing standards. For example, Cayman Islands does not require us to comply with the following corporate governance listing standards of the New York Stock Exchange: (i) having the majority of our board of directors composed of independent directors, (ii) having a minimum of three members in our audit committee, (iii) holding annual shareholders’ meetings, (iv) having a compensation committee composed entirely of independent directors, and (v) having a nominating and corporate governance committee composed entirely of independent directors.

We are permitted to elect to rely on home country practice to be exempted from the corporate governance requirements. If we choose to follow home country practice in the future, our shareholders may be afforded less protection than they would otherwise enjoy if we complied fully with the NYSE listing standards.

 

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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 the filing with 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 stock ownership and trading activities and liability for insiders who profit from trades made in a short period of time;

 

   

the selective disclosure rules by issuers of material nonpublic information under Regulation FD; and

 

   

certain audit committee independence requirements in Rule 10A-3 of the Exchange Act.

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 NYSE. Press releases relating to financial results and material events will also be furnished to the SEC on Form 6-K. However, the information we are required to file with or furnish to the SEC will be less extensive and less timely compared to that required to be filed with the SEC by U.S. domestic issuers. As a result, you may not be afforded the same protections or information that would be made available to you were you investing in a U.S. domestic issuer.

We will be a “controlled company” within the meaning of the New York Stock Exchange listing rules and, as a result, may rely on exemptions from certain corporate governance requirements that provide protection to shareholders of other companies.

We will be a “controlled company” as defined under the New York Stock Exchange listing rules because Mr. Yi Zhang, our founder, chairman of the board of directors and chief executive officer, will beneficially own more than 50% of our total voting power immediately after the completion of this offering. For so long as we remain a controlled company under that definition, we are permitted to elect to rely on, and may rely on, certain exemptions from corporate governance rules, including an exemption from the rule that a majority of our board of directors must be independent directors. As a result, you will not have the same protection afforded to shareholders of companies that are subject to these corporate governance requirements.

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

For U.S. federal income tax purposes, a non-U.S. corporation, such as our company, will be treated as a passive foreign investment company, or PFIC, for any taxable year, if either (1) 75% or more of its gross income for such year consists of certain types of “passive” income (the “income test”); or (2) 50% or more of the value of its assets (generally determined on the basis of a quarterly average) during such year is attributable to assets that produce or are held for the production of passive income (the “asset test”). Although the law in this regard is not entirely clear, we treat our VIEs and their subsidiaries as being owned by us for U.S. federal income tax purposes because we control their management decisions and are entitled to substantially all of the economic benefits associated with them. As a result, we consolidate their results of operations in our consolidated U.S. GAAP financial statements. If it were determined, however, that we are not the owner of our VIEs and their subsidiaries for U.S. federal income tax purposes, we may be treated as a PFIC for the current taxable year and

 

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any future taxable year. Assuming that we are the owner of our VIEs and their subsidiaries for U.S. federal income tax purposes, and, based upon our current and projected income and assets, including the expected cash proceeds from this offering, and projections as to the value of our assets, taking into account the projected market value of our ADSs following this offering, we do not presently expect to be a PFIC for the current taxable year or the foreseeable future.

However, while we do not expect to be or become a PFIC, no assurance can be given in this regard because the determination of whether we will be or become a PFIC for any taxable year is a fact-intensive determination made annually that depends, in part, upon the composition and classification of our income and assets. Fluctuations in the market price of our ADSs may cause us to be or become a PFIC for the current or subsequent taxable years because the value of our assets for purposes of the asset test, including the value of our goodwill and other unbooked intangibles, may be determined by reference to the market price of our ADSs from time to time (which may be volatile). The composition of our income and assets may also be affected by how, and how quickly, we use our liquid assets and the cash raised in this offering. If we were to be or become a PFIC for any taxable year during which a U.S. Holder (as defined in “Taxation—United States Federal Income Tax Considerations”) holds our ADSs or ordinary shares, certain adverse U.S. federal income tax consequences could apply to such U.S. Holder. See “Taxation—United States Federal Income Tax Considerations—Passive Foreign Investment Company Rules.”

We will incur increased costs as a result of being a public company, particularly after we cease to qualify as an “emerging growth company.”

Upon completion of this offering, we will become a public company and expect to incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC and NYSE, impose various requirements on the corporate governance practices of public companies. We expect these rules and regulations to increase our legal and financial compliance costs and to make some corporate activities more time-consuming and costly.

As a result of becoming a public company, we will need to increase the number of independent directors and adopt policies regarding internal controls and disclosure controls and procedures. We also expect that operating as a public company will make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. In addition, we will incur additional costs associated with our public company reporting requirements. It may also be more difficult for us to find qualified persons to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these rules and regulations, and we cannot predict or estimate with any degree of certainty the amount of additional costs we may incur or the timing of such costs.

In addition, after we are no longer an “emerging growth company,” we expect to incur significant expenses and devote substantial management effort toward ensuring compliance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 and the other rules and regulations of the SEC.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that reflect our current expectations and views of future events. The forward looking statements are contained principally in the sections entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” Known and unknown risks, uncertainties and other factors, including those listed under “Risk Factors,” 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 some of these forward-looking statements by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “is/are likely to,” “potential,” “continue” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include statements relating to:

 

   

our mission, goals and strategies;

 

   

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

 

   

the expected growth of the online education industry in China;

 

   

our expectations regarding the prospects of our business model and the demand for and market acceptance of our services;

 

   

our ability to retain and increase our enrollment;

 

   

our ability to engage, train and retain new teachers;

 

   

competition in our industry;

 

   

our proposed use of proceeds from this offering;

 

   

relevant government policies and regulations relating to our industry;

 

   

general economic and business conditions globally and in China; and

 

   

assumptions underlying or related to any of the foregoing.

These forward-looking statements involve various risks and uncertainties. Although we believe that our expectations expressed in these forward-looking statements are reasonable, our expectations may later be found to be incorrect. Our actual results could be materially different from our expectations. Important risks and factors that could cause our actual results to be materially different from our expectations are generally set forth in “Prospectus Summary—Our Challenges,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business,” “Regulation” and other sections in this prospectus. You should read thoroughly this prospectus and the documents that we refer to with the understanding that our actual future results may be materially different from and worse than what we expect. We qualify all of our forward-looking statements by these cautionary statements.

This prospectus contains certain data and information that we obtained from various government and private publications. Statistical data in these publications also includes projections based on a number of assumptions. Our industry may not grow at the rate projected by market data, or at all. Failure of this market to grow at the projected rate may have a material and adverse effect on our business and the market price of the ADSs. In addition, the rapidly evolving nature of this industry results in significant uncertainties for any projections or estimates relating to the growth prospects or future condition of our market. Furthermore, if any one or more of the assumptions underlying the market data are later found to be incorrect, actual results may differ from the projections based on these assumptions. 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 the statements are made in this prospectus. Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, after the date on which the statements are made or to reflect the occurrence of unanticipated events. You should read this prospectus and the documents that we refer to in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect.

 

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USE OF PROCEEDS

We estimate that we will receive net proceeds from this offering of approximately US$35.8 million, or approximately US$41.6 million if the underwriters exercise their option to purchase additional ADSs in full, after deducting underwriting discounts and commissions and the estimated offering expenses payable by us.

The primary purposes of this offering are to create a public market for our shares for the benefit of all shareholders, retain talented employees by providing them with equity incentives, and obtain additional capital. We plan to use the net proceeds of this offering as follows:

 

   

approximately 50% for expanding and enhancing our products and services;

 

   

approximately 20% for improving our technology infrastructure;

 

   

approximately 10% for marketing and brand promotions; and

 

   

the balance to fund working capital and for other general corporate purposes, which may include funding working capital needs and potential strategic investments and acquisitions, although we have not identified any specific investments or acquisition opportunities at this time.

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. See “Risk Factors—Risks Relating to Our ADSs and This Offering—We have not determined a specific use for a portion of the net proceeds from this offering and we may use these proceeds in ways with which you may not agree.”

Pending any use described above, we plan to invest the net proceeds in short-term, interest-bearing, debt instruments or demand deposits.

In using the proceeds of this offering, we are permitted under PRC laws and regulations as an offshore holding company to provide funding to our PRC subsidiaries only through loans or capital contributions and to our consolidated VIEs only through loans, subject to satisfaction of applicable government registration and approval requirements. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, or at all. See “Risk Factors—Risks Relating to Doing Business in China—PRC regulation of loans to and direct investment in PRC entities by offshore holding companies and governmental control of currency conversion may delay or prevent us from using the proceeds of this offering to make loans or additional capital contributions to our PRC subsidiaries and our VIEs in China, which could materially and adversely affect our liquidity and our ability to fund and expand our business.”

 

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DIVIDEND POLICY

Our board of directors has discretion on whether to distribute dividends, subject to certain requirements of Cayman Islands law. In addition, our shareholders may by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended by our board of directors. In either case, all dividends are subject to certain restrictions under Cayman Islands law, namely that our company may only pay dividends out of profits or share premium, and provided always that in no circumstances may a dividend be paid if this would result in our company being unable to pay its debts as they fall due in the ordinary course of business. Even if we decide 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.

We do not have any present plan to pay any cash dividends on our ordinary shares in the foreseeable future after this offering. We currently intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.

We are a holding company incorporated in the Cayman Islands. We may rely on dividends from our subsidiaries in China for our cash requirements, including any payment of dividends to our shareholders. PRC regulations may restrict the ability of our PRC subsidiaries to pay dividends to us. See “Regulation—Regulation Relating to Foreign Exchange.”

If we pay any dividends on our ordinary shares, we will pay those dividends which are payable in respect of the underlying Class A ordinary shares represented by the ADSs to the depositary, as the registered holder of such Class A ordinary shares, and the depositary then will pay such amounts to the ADS holders in proportion to the underlying Class A ordinary shares represented by the ADSs held by such ADS holders, 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.

 

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CAPITALIZATION

The following table sets forth our capitalization as of March 31, 2021:

 

   

on an actual basis;

 

   

on a pro forma basis to reflect (i) the re-designation of 194,878,011 ordinary shares beneficially owned by Mr. Yi Zhang into Class B ordinary shares on a one-for-one basis immediately prior to the completion of this offering, (ii) the re-designation of all of the remaining ordinary shares beneficially into Class A ordinary shares on a one-for-one basis immediately prior to the completion of this offering, (iii) the automatic conversion of all of our issued and outstanding preferred shares into Class A ordinary shares on a one-for-one basis immediately prior to the completion of this offering; and (iv) the issuance of series G preferred shares and automatic conversion of such preferred shares on a one-for-one basis into Class A ordinary shares immediately prior to the completion of this offering; and

 

   

on a pro forma as adjusted basis to reflect (i) the re-designation of 194,878,011 ordinary shares beneficially owned by Mr. Yi Zhang into Class B ordinary shares on a one-for-one basis immediately prior to the completion of this offering, (ii) the re-designation of all of the remaining ordinary shares into Class A ordinary shares on a one-for-one basis immediately prior to the completion of this offering, (iii) the automatic conversion of all of our issued and outstanding preferred shares, into Class A ordinary shares on a one-for-one basis immediately prior to the completion of this offering, (iv) the issuance of series G preferred shares and automatic conversion of such preferred shares on a one-for-one basis into Class A ordinary shares immediately prior to the completion of this offering, and (v) the issuance and sale of 32,607,000 Class A ordinary shares in the form of ADSs by us in this offering at an initial public offering price of US$11.50 per ADS, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us, assuming the underwriters do not exercise their option to purchase additional ADSs.

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

 

    As of March 31, 2021  
    Actual     Pro Forma     Pro Forma As Adjusted(1)  
    (in thousands)  
    RMB     US$     RMB     US$     RMB     US$  

Mezzanine equity

           

Series Seed convertible redeemable preferred shares (US$0.00001 par value; 40,449,195 shares authorized, issued and outstanding as of March 31, 2021)

    4,348       664       —         —         —         —    

Series A-1 convertible redeemable preferred shares(US$0.00001 par value; 13,748,842 shares authorized, issued and outstanding as of March 31, 2021)

    72,281       11,032       —         —         —         —    

Series A-2 convertible redeemable preferred shares(US$0.00001 par value; 79,703,434 shares authorized, issued and outstanding as of March 31, 2021)

    418,049       63,807       —         —         —         —    

Series B convertible redeemable preferred shares(US$0.00001 par value; 53,630,172 shares authorized, issued and outstanding as of March 31, 2021)

    282,394       43,102       —         —         —         —    

 

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    As of March 31, 2021  
    Actual     Pro Forma     Pro Forma As Adjusted(1)  
    (in thousands)  
    RMB     US$     RMB     US$     RMB     US$  

Series C-1 convertible redeemable preferred shares(US$0.00001 par value; 98,438,068 shares authorized, issued and outstanding as of March 31, 2021)

    520,728       79,479       —         —         —         —    

Series C-2 convertible redeemable preferred shares(US$0.00001 par value; 15,570,878 shares authorized, issued and outstanding as of March 31, 2021)

    83,044       12,675       —         —         —         —    

Series C-3 convertible redeemable preferred shares(US$0.00001 par value; 5,819,616 shares authorized, issued and outstanding as of March 31, 2021)

    30,729       4,690       —         —         —         —    

Series D convertible redeemable preferred shares(US$0.00001 par value; 207,611,712 shares authorized, issued and outstanding as of March 31, 2021)

    1,159,696       177,004       —         —         —         —    

Series E convertible redeemable preferred shares(US$0.00001 par value; 243,380,841 shares authorized, issued and outstanding as of March 31, 2021)

    2,211,922       337,605       —         —         —         —    

Series F-1 convertible redeemable preferred shares(US$0.00001 par value; 22,969,863 shares authorized, issued and outstanding as of March 31, 2021)

    190,203       29,031       —         —         —         —    

Series F-2 convertible redeemable preferred shares(US$0.00001 par value; 199,277,610 shares authorized, issued and outstanding as of March 31, 2021)

    2,137,277       326,212       —         —         —         —    

Series G convertible redeemable preferred shares (US$0.00001 par value; nil shares authorized, issued and outstanding as of March 31, 2021)

    —         —         —         —         —         —    

Redeemable ordinary shares (US$0.00001 par value; 23,448,013 shares authorized, issued and outstanding as of March 31, 2021)

    139,811       21,339       —         —         —         —    

Total mezzanine equity

    7,250,482       1,106,640       —         —         —         —    

Shareholders’ Deficit:

           

Ordinary shares (par value of US$0.00001 per share; 4,019,399,769 shares authorized as of March 31, 2021; 330,104,617 shares issued and outstanding as of March 31, 2021, respectively)

    21       3       —         —         —         —    

Class A ordinary shares (US$0.00001 par value; none issued or outstanding on an actual basis, 1,165,084,737 issued and outstanding on a pro forma basis, and 1,197,691,737 issued and outstanding on a pro forma as adjusted basis)

    —         —         76       12       78       12  

Class B ordinary shares (US$0.00001 par value; none issued or outstanding on an actual basis, 194,878,011 issued and outstanding on a pro forma basis, and 194,878,011 issued and outstanding on a pro forma as adjusted basis)

    —         —         13       2       13       2  

Additional paid-in capital

    —         —         7,545,245       1,151,629       7,780,033       1,187,465  

 

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    As of March 31, 2021  
    Actual     Pro Forma     Pro Forma As Adjusted(1)  
    (in thousands)  
    RMB     US$     RMB     US$     RMB     US$  

Accumulated other comprehensive loss

    (67,864     (10,358     (67,864     (10,358     (67,864     (10,358

Accumulated deficit

    (7,857,901     (1,199,350     (7,857,901     (1,199,350     (7,857,901     (1,199,350

Total shareholders’ deficit

    (7,925,744     (1,209,705     (380,431     (58,065     (145,641     (22,229

Total mezzanine equity and shareholders’ deficit

    (675,262     (103,065     (380,431     (58,065     (145,641     (22,229

 

Note:

(1)

The pro forma as adjusted information discussed above is illustrative only.

 

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DILUTION

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

Our net tangible book value as of March 31, 2021 was approximately US$(103.1) million, or US$(0.08) per ordinary share after giving effect to the conversion of our convertible redeemable preferred shares and redeemable ordinary shares issued and outstanding as of that date and US$(0.70) 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 net tangible book value per ordinary share, after giving effect to the automatic conversion of preferred shares and additional proceeds we will receive from this offering, from the initial public offering price of US$1.28 per Class A ordinary share, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. Because the Class A ordinary shares and Class B ordinary shares have the same dividend and other rights, except for voting and conversion rights, the dilution is presented based on all issued and outstanding ordinary shares, including Class A ordinary shares and Class B ordinary shares.

Without taking into account any other changes in pro forma net tangible book value after March 31, 2021, other than to give effect to our sale of the ADSs offered in this offering at the initial public offering price of US$11.50 per ADS, after deduction of the underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of March 31, 2021 would have been US$(22.2) million, or US$(0.02) per ordinary share and US$(0.14) per ADS. This represents an immediate increase in net tangible book value of US$0.02 per ordinary share and US$0.24 per ADS to the existing shareholders and an immediate dilution in net tangible book value of US$1.30 per ordinary share and US$11.64 per ADS to investors purchasing ADSs in this offering. The following table illustrates such dilution:

 

     Per Ordinary
Share
    Per ADS  

Initial public offering price

   US$ 1.28     US$ 11.50  

Net tangible book value after giving effect to the conversion of our convertible redeemable preferred shares and redeemable ordinary shares issued and outstanding as of March 31, 2021

   US$ (0.08   US$ (0.70)  

Pro forma net tangible book value after giving effect to (i) the conversion of our convertible redeemable preferred shares and redeemable ordinary shares issued and outstanding as of March 31, 2021, and (ii) the issuance and conversion of Series G convertible redeemable preferred shares

   US$ (0.04   US$ (0.38)  

Pro forma as adjusted net tangible book value after giving effect to (i) the conversion of our convertible redeemable preferred shares and redeemable ordinary shares issued and outstanding as of March 31, 2021, (ii) the issuance and conversion of Series G convertible redeemable preferred shares, and (iii) this offering

   US$ (0.02   US$ (0.14)  

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

   US$ 1.30     US$ 11.64  

 

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The following table summarizes, on a pro forma as adjusted basis as of March 31, 2021, 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 per ADS paid before deducting the underwriting discounts and commissions and estimated offering expenses payable by us. The total number of ordinary shares does not include ordinary shares underlying the ADSs issuable upon the exercise of the option to purchase additional ADSs granted to the underwriters.

 

     Ordinary Shares
Purchased
    Total
Consideration
     Average
Price
Per
Ordinary
Share
 
     Number      Percent     Amount  

Existing shareholders

     1,359,962,748        97.66   US$ 681,156      US$ 0.50  

New investors

     32,607,000        2.34   US$ 41,665      US$ 1.28  
  

 

 

    

 

 

   

 

 

    

Total

     1,392,569,748        100.00   US$ 722,821     
  

 

 

    

 

 

   

 

 

    

The pro forma as adjusted information discussed above is illustrative only.

The discussion and tables above assume no exercise of options outstanding or vest of restricted shares outstanding as of the date of this prospectus. As of the date of this prospectus, there are 8,618,019 outstanding options with average exercise price of RMB0.0005 to RMB0.025 per share and 26,463,613 outstanding unvested restricted shares. To the extent that any of these options are exercised or restricted shares are vested, there will be further dilution to new investors.

 

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ENFORCEABILITY OF CIVIL LIABILITIES

We are incorporated under the laws of the Cayman Islands as an exempted company with limited liability. We are incorporated in the Cayman Islands 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 the United States and these securities laws provide significantly less protection to investors as compared to the United States; and

 

   

Cayman Islands companies may not have standing to sue before the federal courts of the United States.

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

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

We have appointed Cogency Global Inc., located at 122 East 42nd Street, 18th Floor, New York, NY 10168, as our agent upon whom process may be served in any action brought against us under the securities laws of the United States.

We have been informed by Maples and Calder (Hong Kong) LLP, our counsel as to Cayman Islands law, that there is uncertainty as to whether the courts of the Cayman Islands would (i) recognize or enforce judgments of U.S. courts obtained against us or our directors or officers that are predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States, or (ii) entertain original actions brought in the Cayman Islands against us or our directors or officers that are predicated upon the securities laws of the United States or any state in the United States. We have also been advised by Maples and Calder (Hong Kong) LLP that although there is no statutory enforcement in the Cayman Islands of judgments obtained in a U.S. court (and the Cayman Islands are not a party to any treaties for the reciprocal enforcement or recognition of such judgments), the courts of the Cayman Islands will, at common law, recognize and enforce a foreign money judgment of a foreign court of competent jurisdiction without any re-examination of the merits of the underlying dispute based on the principle that a judgment of a competent foreign court imposes upon the judgment debtor an obligation to pay the liquidated sum for which such judgment has been given, provided such judgment, provided such judgment (i) is given by a foreign court of competent jurisdiction, (ii) imposes on the judgment debtor a liability to pay a liquidated sum for which the judgment has been given, (iii) is final and conclusive, (iv) is not in respect of taxes, a fine or a penalty, and (v) 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.

 

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However, the Cayman Islands courts are unlikely to enforce a judgment obtained from the United States courts under the civil liability provisions of the securities laws if such judgement is determined by the courts of the Cayman Islands to give rise to obligations to make payments that are penal or punitive in nature. Because the courts of the Cayman Islands have yet to rule on whether such judgments are penal or punitive in nature, it is uncertain whether such civil liability judgments from U.S. courts would be enforceable in the Cayman Islands.

Tian Yuan Law Firm, our counsel as to PRC law, has advised us that there is uncertainty as to whether the courts of China 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 each respective jurisdiction against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States.

Tian Yuan Law Firm has further advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law and other applicable laws and regulations based either on treaties between China and the country where the judgment is made or on principles of reciprocity between jurisdictions. China does not have any treaties or other form of reciprocity with the United States or the Cayman Islands that provide for the reciprocal recognition and enforcement of foreign 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 uncertain whether and on what basis a PRC court would enforce a judgment rendered by a court in the United States or in the Cayman Islands. Under the PRC Civil Procedures Law, foreign shareholders may originate actions based on PRC law against a company in China for disputes if they can establish sufficient nexus to the PRC for a PRC court to have jurisdiction, and meet other procedural requirements, including, among others, the plaintiff must have a direct interest in the case, and there must be a concrete claim, a factual basis and a cause for the suit. It will be, however, difficult for U.S. shareholders to originate actions against us in the PRC in accordance with PRC laws because we are incorporated under the laws of the Cayman Islands and it will be difficult for U.S. shareholders, by virtue only of holding the ADSs or ordinary shares, to establish a connection to the PRC for a PRC court to have jurisdiction as required under the PRC Civil Procedures Law.

 

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CORPORATE HISTORY AND STRUCTURE

Corporate History

We commenced our operations in China from June 2014 through Shenzhen Zhangmenren Education Consultation Co., Ltd., or Shenzhen Zhangmenren.

Our holding company, Global Online Education Inc., was incorporated in November 2017 under the laws of Cayman Islands, and later changed its name to Zhangmen Education Inc. in April 2021. Shortly after its incorporation, Global Online Education Inc. established as a wholly owned subsidiary in Hong Kong, Global Online Education HK Limited. Global Online Education HK Limited established two wholly-owned subsidiaries in China, Shanghai Zhangxue Education Technology Co., Ltd., or Shanghai Zhangxue, and Shanghai Zhangneng Information Technology Co., Ltd., in April 2018 and March 2019, respectively.

In November 2016 and February 2019, Shanghai Zhangda Education Technology Co., Ltd., or Shanghai Zhangda, and Shanghai Zhangshi Education and Training Co., Ltd., or Shanghai Zhangshi, were established, respectively.

Due to restrictions and prohibitions imposed by PRC laws and regulations on foreign ownership of companies that engage in the provision of value-added telecommunication services and other restricted businesses, Shanghai Zhangxue entered into a series of contractual arrangements with Shenzhen Zhangmenren, Shanghai Zhangda, and Shanghai Zhangshi, which three entities we collectively refer to as our VIEs in this prospectus, and their respectively shareholders. For more details, please see “—Contractual Arrangements with Our VIEs and Their Respective Shareholders.” As a result of our direct ownership in our WFOE, Shanghai Zhangxue, and the variable interest entity contractual arrangements, we are regarded as the primary beneficiary of our VIEs. We treat them and their subsidiaries as our consolidated affiliated entities under U.S. GAAP., and have consolidated the financial results of these entities in our consolidated financial statements in accordance with U.S. GAAP.

In April 2018, we gained control over Shenzhen Zhangmenren through Shanghai Zhangxue by entering into a series of contractual arrangements with Shenzhen Zhangmenren and its shareholders. In September 2020, Shanghai Zhangxue entered into a new series of contractual arrangements with Shenzhen Zhangmenren and its shareholders to replace the previous contractual arrangements. In April 2018, we gained control over Shanghai Zhangda through Shanghai Zhangxue by entering into a series of contractual arrangements with Shanghai Zhangda and its shareholders. We gained control over Shanghai Zhangshi in February 2019 through Shanghai Zhangxue by entering into a series of contractual arrangements with Shanghai Zhangshi and its shareholders.

 

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Corporate Structure

The following diagram illustrates our corporate structure, including our significant subsidiaries, our VIEs and subsidiary of our VIE, as of the date of this prospectus:

 

LOGO

Notes:

(1)

Shareholders of Shenzhen Zhangmenren and their respective shareholdings in Shenzhen Zhangmenren and relationship with our company are (i) Mr. Yi Zhang (62.5764%), our founder, chairman and chief executive officer; (ii) Shanghai Zhangda Education Technology Co., Ltd. (20.7022%); (ii) Mr. Teng Yu (16.7212%), our co-founder director and senior vice president; (iii) Ms. Hongxia Shao (0.0001%), our shareholder; and (iv) Ms. Xiaohong Chen (0.0001%), our shareholder.

(2)

Mr. Yi Zhang, our founder, chairman and chief executive officer is the sole shareholder of Shanghai Zhangda.

(3)

Mr. Jiajun Wu, our employee, is the sole shareholder of Shanghai Zhangshi.

Contractual Arrangements with Our VIEs and Their Respective Shareholders

Current PRC laws and regulations impose certain restrictions or prohibitions on foreign ownership of companies that engage in value-added telecommunication services and certain other businesses. We are an exempted company incorporated in the Cayman Islands. Shanghai Zhangxue Education Technology Co., Ltd. is our PRC subsidiary, which we refer to as Shanghai Zhangxue in this prospectus, and it is foreign-invested enterprise under PRC Laws. To comply with PRC laws and regulations, we conduct certain of our business in China through Shenzhen Zhangmenren, Shanghai Zhangshi and Shanghai Zhangda, our consolidated variable interest entities in China which we refer to as our VIEs in this prospectus, based on a series of contractual arrangements by and among Shanghai Zhangxue, our VIEs and their respective shareholders.

 

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Our contractual arrangements with our VIEs and their respective shareholders allow us to (i) exercise effective control over our VIEs, (ii) receive substantially all of the economic benefits of our VIEs, and (iii) have an exclusive call option to purchase all or part of the equity interests in our VIEs when and to the extent permitted by PRC law.

As a result of our direct ownership in Shanghai Zhangxue and the contractual arrangements with our VIEs, we are regarded as the primary beneficiary of our VIEs, and we treat our VIEs and their subsidiaries as our consolidated affiliated entities under U.S. GAAP. We have consolidated the financial results of our VIEs and their subsidiaries in our consolidated financial statements in accordance with U.S. GAAP.

The following is a summary of the currently effective contractual arrangements by and among Shanghai Zhangxue, our VIEs and their respective shareholders.

Agreements that provide us with effective control over our VIEs

Powers of Attorney. In September 2020, each of the shareholders of Shenzhen Zhangmenren granted an irrevocable power of attorney to replace the irrevocable powers of attorney previously executed in April 2018. Pursuant to the power of attorney, each of the shareholders of Shenzhen Zhangmenren irrevocably authorized Shanghai Zhangxue or its designee(s) to act on its behalf as proxy attorney, to the extent permitted by law, to exercise all rights of shareholder concerning all the equity interest held by each of the shareholders in Shenzhen Zhangmenren, including but not limited to proposing to convene or attend shareholders meetings, receiving any notice about the convening of the shareholders meeting and related procedures, signing written resolutions, voting at such meetings, nominating and appointing directors and selling, transferring, pledging or disposing of all the equity held in part or in whole, and exercising all other rights as shareholder. The power of attorney issued by each of the shareholders of Shenzhen Zhangmenren will remain in force for so long as the shareholder remains a shareholder of Shenzhen Zhangmenren.

In April 2018, the sole shareholder of Shanghai Zhangda granted an irrevocable power of attorney, which includes terms substantially similar to the powers of attorney relating to Shenzhen Zhangmenren as described above.

In May 2020, the sole shareholder of Shanghai Zhangshi granted an irrevocable power of attorney, which includes terms substantially similar to the powers of attorney relating to Shenzhen Zhangmenren as described above.

Equity Pledge Agreement. In September 2020, Shanghai Zhangxue, Shenzhen Zhangmenren and each of the shareholders of Shenzhen Zhangmenren entered into an equity pledge agreement to replace the equity pledge agreement previously executed in April 2018. Pursuant to the equity pledge agreements, each of the shareholders of Shenzhen Zhangmenren pledged all of its equity interests of Shenzhen Zhangmenren to Shanghai Zhangxue as security for performance of the obligations of Shenzhen Zhangmenren and the shareholders of Shenzhen Zhangmenren, under the exclusive management services and business cooperation agreement, the exclusive option agreement and power of attorney. During the term of the equity pledge agreement, Shanghai Zhangxue has the right to receive all of Shenzhen Zhangmenren’s dividends and profits distributed on the pledged equity. If any of the specified events of default occurs, Shanghai Zhangxue, as pledgee, will have the right to purchase, auction or sell all or part of the pledged equity interests in Shenzhen Zhangmenren and will have priority in receiving the proceeds from such disposal. Shanghai Zhangxue may transfer all or any of its rights and obligations under the equity pledge agreement to its designee(s) at any time. Shenzhen Zhangmenren and its shareholders undertake that, without the prior written consent of Shanghai Zhangxue, they will not transfer, or create or allow any encumbrance on the pledged equity interests. The agreement will remain in effect until the fulfillment of all the obligations under the exclusive management services and business cooperation agreement, the exclusive option agreement and power of attorney.

 

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In April 2018, Shanghai Zhangxue, Shanghai Zhangda and the sole shareholder of Shanghai Zhangda entered into an equity pledge agreement, which includes terms substantially similar to the equity pledge agreement relating to Shenzhen Zhangmenren as described above.

In May 2020, Shanghai Zhangxue, Shanghai Zhangshi and the sole shareholder of Shanghai Zhangshi, entered into an equity pledge agreement, which includes terms substantially similar to the equity pledge agreement relating to Shenzhen Zhangmenren as described above.

We have completed the registration of the equity interest pledge under the equity pledge agreement in relation to Shenzhen Zhangmenren, Shanghai Zhangda and Shanghai Zhangshi with the relevant office of the State Administration for Market Regulation in accordance with the PRC Civil Code.

Agreements that allow us to receive economic benefits from our VIEs

Exclusive Management Services and Business Cooperation Agreement. In September 2020, Shanghai Zhangxue and Shenzhen Zhangmenren entered into an exclusive management services and business cooperation agreement to replace the exclusive management services and business cooperation agreement previously executed in April 2018. Pursuant to the exclusive management services and business cooperation agreement, Shanghai Zhangxue has the exclusive right to provide or designate any third-party to provide, among other things, license of technology and software, development, maintenance and update of relevant software, design, installation and daily management, maintenance and update of computer network systems, hardware equipment and databases, development and test of new offerings, employee professional support and training services, market survey and research services, enterprise management consulting, lease of facilities and property and other business and technological support as needed to Shenzhen Zhangmenren. In exchange, Shenzhen Zhangmenren agrees to pay service fees to Shanghai Zhangxue in an amount equal to the income of Shenzhen Zhangmenren, deducting necessary costs and expenses acknowledged by Shanghai Zhangxue. Without the prior written consent of Shanghai Zhangxue, Shenzhen Zhangmenren cannot accept services provided by, or establish similar cooperation relationship with, any third-party. Shanghai Zhangxue has the exclusive ownership of all intellectual property rights created as a result of the performance of this agreement. The exclusive management services and business cooperation agreement has an indefinite term, unless otherwise terminated by Shanghai Zhangxue in its sole discretion with 30 days’ prior written notice or pursuant to the mandatory requirement under PRC laws or regulations. Under no circumstances can Shenzhen Zhangmenren terminate the exclusive management services and business cooperation agreement without the written consent of Shanghai Zhangxue.

In April 2018, Shanghai Zhangxue and Shanghai Zhangda entered into an exclusive management services and business cooperation agreement, which includes terms substantially similar to the exclusive management services and business cooperation agreement relating to Shenzhen Zhangmenren as described above.

In May 2020, Shanghai Zhangxue and Shanghai Zhangshi entered into an exclusive management services and business cooperation agreement, which includes terms substantially similar to the exclusive management services and business cooperation agreement relating to Shenzhen Zhangmenren as described above.

Agreements that provide us with the option to purchase the equity interests in our VIEs

Exclusive Option Agreement. In September 2020, Shanghai Zhangxue, Shenzhen Zhangmenren and each of the shareholders of Shenzhen Zhangmenren entered into an exclusive option agreement to replace the exclusive option agreement previously executed in April 2018. Under the exclusive option agreement, each of the shareholders of Shenzhen Zhangmenren has irrevocably granted Shanghai Zhangxue an exclusive call option to purchase, or designate a third-party to purchase, all or any part of his equity interests in Shenzhen Zhangmenren at a purchase price equal to the higher of (i) actual capital contribution, and (ii) the lowest price permissible by the then-applicable PRC laws and regulations. Shenzhen Zhangmenren has irrevocably granted Shanghai Zhangxue an exclusive call option to purchase, or designate a third-party to purchase, all or any part of its assets,

 

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at a purchase price equal to the lowest price permissible by the then-applicable PRC laws and regulations. Shenzhen Zhangmenren and each of the shareholders of Shenzhen Zhangmenren covenant that, without Shanghai Zhangxue’s prior written consent, they will not, among other things, (i) create any pledge or encumbrance on their equity interests in Shenzhen Zhangmenren; (ii) transfer or otherwise dispose of their equity interests in Shenzhen Zhangmenren; (iii) amend Shenzhen Zhangmenren’s articles of association or change Shenzhen Zhangmenren’s registered capital or change its equity interests structure; (iv) cause Shenzhen Zhangmenren to enter into any material contract to which Shenzhen Zhangmenren is a party, except in the ordinary course of business; (v) allow Shenzhen Zhangmenren to incur, inherit, guarantee or permit any debts, except for those payables incurred in the ordinary or usual course of business or those disclosed to and agreed by Shanghai Zhangxue; (vi) merge or consolidate Shenzhen Zhangmenren with any other entity or acquire or invest in any other entity; (vii) distribute any dividend; (viii) sell, transfer, mortgage or otherwise dispose of any of Shenzhen Zhangmenren’s assets or allow any encumbrance of any assets without the prior consent of Shanghai Zhangxue; or (ix) terminate, liquidate or dissolve Shenzhen Zhangmenren unless otherwise provided by PRC laws and regulations. The exclusive option agreement remains effective until all of the equity interests in or all of the assets of Shenzhen Zhangmenren are transferred to Shanghai Zhangxue in the manner provided in the exclusive option agreements. Under no circumstances can Shenzhen Zhangmenren or any of its shareholders unilaterally terminate the exclusive option agreement unless otherwise provided by mandatory PRC laws and regulations.

In April 2018, Shanghai Zhangxue, Shanghai Zhangda and the sole shareholder of Shanghai Zhangda entered into an exclusive option agreement, which includes terms substantially similar to the exclusive option agreement relating to Shenzhen Zhangmenren as described above.

In May 2020, Shanghai Zhangxue, Shanghai Zhangshi and the sole shareholder of Shanghai Zhangshi, entered into an exclusive option agreement, which includes terms substantially similar to the exclusive option agreement relating to Shenzhen Zhangmenren as described above.

Spousal Consent Letters. In September 2020, each spouse of the individual shareholders of Shenzhen Zhangmenren signed a spousal consent letter to replace the spousal consent letter signed in April 2018. Pursuant to the consent letters, each spouse of the individual shareholders of Shenzhen Zhangmenren unconditionally and irrevocably agreed that the equity interest in Shenzhen Zhangmenren held by and registered in the name of such shareholder be disposed of in accordance with the power of attorney, the equity pledge agreement, and the exclusive option agreement described above, and that such shareholder may perform, amend or terminate such agreements without any additional consent of his or her spouse. Additionally, the signing spouse agreed not to assert any rights over the equity interest in Shenzhen Zhangmenren held by the shareholder. In addition, in the event that the signing spouse obtain any equity interest in Shenzhen Zhangmenren held by the shareholders for any reason, they agree to be bound by and sign any legal documents substantially similar to the contractual arrangements described above, as may be amended from time to time.

In April 2018, the spouse of the sole shareholder of Shanghai Zhangda signed a spousal consent letter, which includes terms substantially similar to the consent letter relating to Shenzhen Zhangmenren as described above.

In December 2020, the spouse of the sole shareholder of Shanghai Zhangshi signed a spousal consent letter, which includes terms substantially similar to the consent letter relating to Shenzhen Zhangmenren as described above.

In the opinion of Tian Yuan Law Firm, our PRC legal counsel:

 

   

the ownership structures of our VIEs and Shanghai Zhangxue in China, both currently and immediately after giving effect to this offering, are not in violation of applicable PRC laws and regulations currently in effect; and

 

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the contractual arrangements between Shanghai Zhangxue, our VIEs and their respective shareholders governed by PRC law are valid, binding and enforceable, and will not result in any violation of applicable PRC laws and regulations currently in effect.

However, our PRC legal counsel has also advised us 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 take a view that is contrary to the opinion of our PRC legal counsel. It is uncertain whether any new PRC laws or regulations relating to variable interest entity structures will be adopted or if adopted, what they would provide. If we or our VIEs are found to be in violation of any existing or future PRC laws or regulations, or fail to obtain or maintain any of the required permits or approvals, the relevant PRC regulatory authorities would have broad discretion to take action in dealing with such violations or failures. See “Risk Factors—Risks Relating to Our Corporate Structure—If the PRC government finds that the agreements that establish the structure for operating certain of our operations in China do not comply with PRC regulations relating to the relevant industries, or if these regulations or the interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations,” “Risk Factors—Risks Relating to Our Corporate Structure—Our current corporate structure and business operations may be affected by the Foreign Investment Law and its Implementation Rules” and “Risk Factors—Risks Relating to Doing Business in China—Uncertainties in the interpretation and enforcement of PRC laws and regulations could limit the legal protections available to you and us.”

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated statements of operations for the years ended December 31, 2019 and 2020, selected consolidated balance sheet data as of December 31, 2019 and 2020, and selected consolidated cash flow data for the years ended December 31, 2019 and 2020 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The following selected consolidated statements of operations for the three months ended March 31, 2020 and 2021, selected consolidated balance sheet data as of March 31, 2021 and selected consolidated cash flow data for the three months ended March 31, 2020 and 2021 have been derived from our unaudited interim condensed consolidated financial statements included elsewhere in this prospectus. Our consolidated financial statements are prepared and presented in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP. Our historical results do not necessarily indicate results expected for any future periods. You should read this Selected Consolidated Financial and Operating Data section together with our consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2019     2020     2020     2021  
    RMB     RMB     US$     RMB     RMB     US$  
    (in thousands, except for share amount and per share data)  

Selected Consolidated Statements of Operations:

           

Net revenues

    2,668,735       4,018,429       613,332       1,122,670       1,345,664       205,388  

Cost of revenues

    (1,651,204     (2,203,966     (336,391     (604,402     (748,139     (114,188
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    1,017,531       1,814,463       276,941       518,268       597,525       91,200  

Operating expenses:

           

Sales and marketing expenses

    (2,171,875     (2,577,259     (393,367     (466,562     (908,696     (138,694

Research and development expenses

    (237,290     (317,873     (48,516     (70,022     (113,284     (17,291

General and administrative expenses

    (193,732     (207,617     (31,689     (41,818     (101,159     (15,440
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    (2,602,897     (3,102,749     (473,572     (578,402     (1,123,139     (171,425
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

    (1,585,366     (1,288,286     (196,631     (60,134     (525,614     (80,225
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income, net

    70,330       85,262       13,014       15,614       23,804       3,633  

Other income, net

    12,697       163,432       24,945       42,490       46,278       7,063  

Fair value change of investments and derivatives

    —         30,213       4,611       —         (41,801     (6,380
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before provision for income tax

    (1,502,339     (1,009,379     (154,061     (2,030     (497,333     (75,909

Income tax expenses

    (1,700     (2,967     (453     (6     —         —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

    (1,504,039     (1,012,346     (154,514     (2,036     (497,333     (75,909
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per ordinary share

           

Basic and diluted

    (8.86     (6.39     (0.98     (0.35     (4.40     (0.67
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares used in calculating net loss per ordinary share

           

Basic and diluted

    227,222,692       305,651,877       305,651,877       306,191,338       315,775,597       315,775,597  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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The following table presents our selected consolidated balance sheets data as of December 31, 2019 and 2020 and as of March 31, 2021:

 

    As of December 31,     As of March 31,  
    2019     2020     2021  
    RMB     RMB     US$     RMB     US$  
    (in thousands)  

Selected Consolidated Balance Sheet Data:

     

Cash and cash equivalents

    1,673,091       721,462       110,117       2,991,025       456,520  

Total current assets

    3,051,387       4,811,331       734,353       4,310,227       657,869  

Total assets

    3,336,202       5,430,335       828,831       4,987,931       761,306  

Accrued payroll and other human resource expenses

    777,433       991,304       151,303       1,127,678       172,117  

Deferred revenue, current

    1,803,488       2,498,891       381,405       2,424,198       370,005  

Total current liabilities

    3,273,314       4,456,054       680,127       4,391,390       670,256  

Deferred revenue, non-current

    753,393       1,091,117       166,537       1,088,288       166,105  

Total liabilities

    4,137,133       5,650,658       862,459       5,663,193       864,371  

The following table presents our selected consolidated cash flow data for the years ended December 31, 2019 and 2020 and for the three months ended March 31, 2020 and 2021:

 

    For the Year Ended December 31,     For the Three Months Ended
March 31,
 
    2019     2020     2020     2021  
    RMB     RMB     US$     RMB     RMB     US$  
    (in thousands)  

Selected Consolidated Cash Flow Data:

       

Net cash generated from (used in) operating activities

    75,064       344,285       52,548       (345,319     (490,393     (74,850

Net cash generated from (used in) investing activities

    (1,028,586     (2,794,229     (426,482     447,352       2,851,801       435,270  

Net cash generated from (used in) financing activities

    788,181       1,714,285       261,651       (506     (2,438     (372

Net increase (decrease) in cash and cash equivalents

    (139,851     (840,842     (128,338     125,707       2,400,835       366,439  

Cash, cash equivalents and restricted cash at beginning of the year/period

    1,812,942       1,673,091       255,364       1,673,091       832,249       127,026  

Cash, cash equivalents and restricted cash at end of the year/period

    1,673,091       832,249       127,026       1,798,798       3,233,084       493,465  

 

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The table below sets forth a reconciliation of our net revenues to gross billings for the periods indicated. For discussions of gross billings and reconciliations of net revenues to gross billings, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-GAAP Financial Measure.”

 

     For the Year Ended December 31,      For the Three Months Ended
March 31,
 
     2019      2020      2020      2021  
     RMB      RMB      US$      RMB      RMB      US$  
     (in thousands)  

Net revenues

     2,668,735        4,018,429        613,332        1,122,670        1,345,664        205,388  

Add: VAT and surcharges

     159,626        241,293        36,829        67,413        82,200        12,546  

Add: ending deferred revenue

     2,556,881        3,590,008        547,942        2,148,251        3,512,486        536,110  

Add: ending refund liability

     395,124        356,721        54,446        375,652        325,647        49,703  

Less: beginning deferred revenue

     1,513,164        2,556,881        390,256        2,556,881        3,590,008        547,942  

Less: beginning refund liability

     411,913        395,124        60,308        395,124        356,721        54,446  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross billings (non-GAAP)

     3,855,289        5,254,446        801,985        761,981        1,319,268        201,359  

 

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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 the section entitled “Selected Consolidated Financial Data” and our consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties about our business and operations. Our actual results and the timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those we describe under “Risk Factors” and elsewhere in this prospectus. See “Special Note Regarding Forward-Looking Statements.”

Overview

We are a leading online education company in China focused on providing personalized online courses to K-12 students, according to the Frost & Sullivan Report. Our core course offerings encompass one-on-one and small-class after-school tutoring services covering all core K-12 academic subjects. We continually enrich our service and product offerings to address students’ evolving and diversified educational needs. We began to offer small-class K-12 after-school tutoring services in the third quarter of 2020 to drive and cater to diversified educational goals. Replicating our success in one-on-one tutoring services, our online K-12 small-class after-school tutoring services rapidly became the third largest in China in terms of gross billings in 2020, with the fastest quarter-on-quarter growth among the top 5 players in the industry in terms of gross billings in the fourth quarter of 2020, according to the Frost & Sullivan Report.

We have established a portfolio of well-recognized online education brands known for delivering exceptional learning outcomes to our students. We believe that personalized education service is the key to an effective learning experience, and as such, we strategically started our business by focusing on after-school tutoring services in one-on-one format. Leveraging our high-quality teaching talents with localized insights, data-driven localized educational content and powerful technology infrastructure, we provide a personalized and results-driven learning experience to students across different regions. We have established a portfolio of well-recognized online education brands known for quality of service and effective education results.

We generate the substantial majority of our net revenues from our one-on-one tutoring services. In 2019, 2020 and the three months ended March 31, 2021, we derived 94.0%, 93.1% and 87.3%, respectively, of our net revenues from one-on-one courses. Driven by our brand equity and quality services, we have launched premium courses for our one-on-one tutoring services in January 2020, where we charge double the price of our standard courses, and our paid student enrollments for such courses have experienced rapid growth.

Our net revenues increased by 50.6% from RMB2,668.7 million in 2019 to RMB4,018.4 million (US$613.3 million) in 2020, and by 19.9% from RMB1,122.7 million for the three months ended March 31, 2020 to RMB1,345.7 million (US$205.4 million) for the same period in 2021. Our gross billings increased by 36.3% from RMB3,855.3 million in 2019 to RMB5,254.4 million (US$802.0 million) in 2020, and by 73.1% from RMB762.0 million for the three months ended March 31, 2020 to RMB1,319.3 million (US$201.4 million) for the same period in 2021. For discussions of gross billings and reconciliation of gross billings to net revenues, see “—Non-GAAP Financial Measure—Gross Billings.” We incurred a net loss of RMB1,012.3 million (US$154.5 million) in 2020, compared with a net loss of RMB1,504.0 million in 2019.

General Factors Affecting Our Results of Operations

Our results of operations and financial condition are affected by the general factors driving China’s online education industry. We have benefited from China’s overall economic growth, significant urbanization rate, and higher per capita disposable income of households, and increased penetration of internet and mobile applications in China. At the same time, our results are subject to changes in the regulatory regime governing China’s

 

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education industry, particularly uncertainties relating to online education services. The PRC government regulates various aspects of our business and operations, including the qualification, licensing or filing requirements for entities that provide online education services and limitations on foreign investments in the online education industry. See ‘‘Risk Factors—Risks Related to Our Business and Industry—We face uncertainties with respect to the development of regulatory requirements on operating licenses and permits for our business operations in China. Failure to renew and maintain requested licenses or permits in a timely manner or obtain newly required ones due to adverse changes in regulations or policies could have a material adverse impact on our business, financial condition and results of operations.” and “—Certain aspects of our business operations may be deemed not to be in full compliance with PRC regulatory requirements regarding online private education. In addition, uncertainties exist in relation to new legislation or proposed changes in the PRC regulatory requirements regarding online private education, which may materially and adversely affect our business, financial condition and results of operations.” In addition, the COVID-19 pandemic has also broadly affected China’s education industry. For discussion of the impact of COVID-19, see “—Impact of COVID-19.”

Specific Factors Affecting Our Results of Operations

Besides the general factors affecting the education industry in China, our results of operations are affected by the following specific factors relating to our business:

Our ability to increase paid student enrollments

Our net revenues primarily consist of course fees received from our students. Our growth in net revenues was historically, and is expected in the near future to be, primarily driven by growth in our paid student enrollments for one-on-one courses. Our paid student enrollments for one-on-one courses increased by 43.2% from 380,517 in 2019 to 544,813 in 2020, and by 52.0% from 87,873 for the three months ended March 31, 2020 to 133,601 for the same period in 2021. We believe the growth in our paid student enrollments is directly affected by the quality and effectiveness of our course offerings. We are committed to providing personalized education services to our students and will continue to enhance students’ learning experience by implementing our localization strategy, developing better learning materials, and strengthening our personalization and recommendation technologies.

Our ability to increase our tuition fee levels

Our net revenues are also affected by the levels of tuition fees we charge. Our tuition fees are charged based on the number of class hours per course package for one-on-one courses. Each class hour is 40 minutes. Growth in the levels of tuition fees we charge is dependent on our increased ability to command premium pricing for our courses. We generally raise our standard tuition fees every six months for one-on-one courses. Our average course fee per class hour of our standard one-on-one courses increased by 3.6% from 2019 to 2020, and by 1.3% from the first quarter of 2020 to the first quarter of 2021. In 2019 and 2020, we had one of the highest tuition fee levels for our standard one-on-one courses among one-on-one after-school tutoring service providers in China, according to the Frost & Sullivan Report. Since January 2020, we have offered premium courses for our one-on-one tutoring services, charged at double the price of our standard courses, as a result of the quality and effectiveness of our services, our brand equity and leading market position. Our net revenues generated from our premium courses for one-on-one tutoring services as a percentage of our net revenues from one-on-one courses grew from 0.5% in the first quarter of 2020 to 4.7% in the first quarter of 2021. Our ability to charge premium pricing is affected by the quality and effectiveness of our course offerings, the overall demand for our courses, and prices and availability of competing courses. We will continue to monitor these factors in our operations. At the same time, we expect to be able to, and intend to, further increase the tuition fee levels for our one-on-one courses in the same manner and at a similar rate as our past practice. Our premium courses will continue to be charged at double the price of our standard courses.

 

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Our ability to expand our online tutoring offerings

Leveraging our success from one-on-one tutoring services, we have achieved rapid growth in our online K-12 small-class tutoring services. Our paid student enrollments for small-class tutoring services reached 294,397 in the first quarter of 2021, representing a 222.6% growth from 91,260 in the third quarter of 2020. We intend to continue to expand our small class tutoring services through continued improvements in teaching quality, localization development, and expanding our program portfolio. We plan to launch more offline experience stores for small class after-school tutoring services in selected cities to continue to attract new student enrollments for our small-class after-school tutoring services.

Our ability to manage our costs and expenses effectively

Our gross and net margins depend on our ability to control our costs and expenses as we expand. A substantial majority of our cost of revenues consists of compensation to our teachers. We offer competitive compensation to our teachers in order to attract and retain the best teaching talents. Our ability to continually improve teachers’ utilization and productivity affects our operating efficiency. Our teacher compensation costs as a percentage of our net revenues decreased from 57.9% in 2019 to 51.8% in 2020.

Sales and marketing expenses have been the largest component of our operating expenses. Our sales and marketing expenses are primarily composed of compensation to our sales and marketing personnel and expenses relating to online traffic acquisition channels. We have substantially improved our sales and marketing efficiency as our services scaled up rapidly, resulting in a significant decrease of sales and marketing expenses as a percentage of our net revenues from 81.4% in 2019 to 64.1% in 2020. To further drive our sales and marketing effectiveness, we will continue to leverage on our brand value and recognition of the quality and effectiveness of our course offerings to achieve word-of-mouth referrals.

We offer the majority of our courses online in a live format. We plan to devote more resources in the development of our technology capabilities, including technology infrastructure and big data and AI technologies, and further develop our course modules. We will continue to optimize our course content and enhance our technologies to attract new students and improve our operating efficiency.

Impact of COVID-19

The COVID-19 pandemic has broadly affected China’s education industry. In early 2020, the COVID-19 pandemic resulted in the temporary closure of many corporate offices and schools across China. Given the strict quarantine measures put in place during this period, normal economic activity throughout China was sharply curtailed and normal in-school education was temporarily suspended. Substantially all of our revenues and our workforce are concentrated in China. Consequently, to the extent that COVID-19 exerts long-term negative impact on the Chinese economy, our results of operations and financial performance may be adversely affected. Since we lease offices in certain Chinese cities to support our online after-school tutoring service operation, research and development and daily operations, the COVID-19 outbreak caused temporary office closures and rotation arrangements from late January to late March 2020, resulting in lower work efficiency and productivity. We also incurred insignificant costs in relation to the measures we took to reduce the impact of this epidemic outbreak in 2020, including purchasing personal protective equipment, upgrading our technology system to support the growth in online courses, monitoring our employees’ health, and rotation arrangements to avoid infection transmission. These costs were immaterial to our business and results of operations. Due to the public health concerns and the need for higher efficiency from relevant governmental authorities, schools and other stakeholders in the education industry, there has been an accelerating demand for online after school tutoring services in China since the outbreak of COVID-19. During the COVID-19 lock-down period, many students were prompted to engage in online education as they study at home, and an increasing number of parents and students therefore realized the efficiency and the effectiveness of online education, which accelerated the shift to online education. According to the Frost and Sullivan report, the growth in online after-school tutoring services is

 

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expected to continue after the COVID-19 pandemic subsides, with the penetration rate of the online K-12 one-on-one after-school tutoring market expected to continue to increase from 15.5% in 2020 to 25.3% in 2025. However, COVID-19 has had, and may continue to have, a negative impact on the Chinese and world’s economy in general and our operations in particular. For more information, see “Risk Factors—Risks Relating to Our Business and Industry—We face risks related to natural and other disasters, health epidemics, and other extraordinary events, such as the COVID-19 pandemic, which could significantly disrupt our operations.” and “—A severe and prolonged global economic recession and the slowdown in the Chinese economy may adversely affect our business and results of operations.”

Since January 2020, in accordance with the Announcement on Tax Policies to Support Prevention and Control of COVID-19 issued by Ministry of Finance and SAT, and the Announcement on the Period of Implementation of Tax Policies to Support Epidemic Prevention and Control and to Ensure Supply (collectively, the “Tax Policies”), due to the COVID-19, the VAT from providing daily life services would be exempted starting on January 1, 2020 and ending on March 31, 2021. As a result, in 2020 and the three months ended March 31, 2021, we recognized RMB144.5 million (US$22.1 million) and RMB42.1 million (US$6.4 million) in other income arising from the VAT exemption according to the Tax Polices, respectively. We expect this to be a one-off VAT exemption to control the COVID-19 impact and do not expect to receive such exemption in the future. In addition, due to COVID-19, we enjoyed a temporary exemption from making social insurance contribution of RMB360.2 million (US$55.0 million) in 2020. Starting from January 1, 2021, such exemption was no longer available.

Key Components of Results of Operations

Net Revenues

In 2019, 2020 and the three months ended March 31, 2021, we derived substantially all of our net revenues from the course fees that we charge to our students for our one-on-one courses. In 2020, we also started to generate a small portion of our net revenues from delivering small-class courses to our students. Our other net revenues consist of course fees from our other tutoring programs, including our early childhood education, large-class courses and AI courses. The following table sets forth a breakdown of our total net revenues by amounts and percentages for the periods presented:

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2019     2020     2020     2021  
    RMB     %     RMB     US$     %     RMB     %     RMB     US$     %  
   

(in thousands, except for percentages)

 

Net revenues:

                   

One-on-one courses

    2,507,556       94.0       3,739,564       570,769       93.1       1,071,585       95.4       1,174,757       179,303       87.3  

Small-class courses

    —         —         62,714       9,572       1.6       —         —         105,328       16,076       7.8  

Others

    161,179       6.0       216,151       32,991       5.3       51,085       4.6       65,579       10,009       4.9  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    2,668,735       100.0       4,018,429       613,332       100.0       1,122,670       100.0       1,345,664       205,388       100.0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

We generally collect tuition fees in advance, which we initially record as deferred revenues. We recognize revenues generated from our courses proportionally as the classes are delivered.

Cost of revenues

Our cost of revenues primarily consists of teacher compensation costs and others. We expect our cost of revenues to increase in absolute amounts in the foreseeable future as we serve more students and offer more courses.

 

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The following table sets forth the components of our cost of revenues by amounts and percentages of our net revenues for the periods presented:

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2019     2020     2020     2021  
    RMB     %     RMB     US$     %     RMB     %     RMB     US$     %  
   

(in thousands, except for percentages)

 

Cost of revenues:

                   

Teacher compensation costs

    1,544,840       57.9       2,081,220       317,656       51.8       578,315       51.5       704,324       107,501       52.3  

Others

    106,364       4.0       122,746       18,735       3.0       26,087       2.3       43,815       6,687       3.3  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    1,651,204       61.9       2,203,966       336,391       54.8    

 

 

 

604,402

 

 

 

 

 

 

53.8

 

 

 

 

 

 

748,139

 

 

 

 

 

 

114,188

 

 

 

 

 

 

55.6

 

 

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Teacher compensation costs. Our teacher compensation costs primarily include base salaries and additional compensation calculated based on hourly rates and the total number of class hours in connection with the courses delivered by our teachers.

Others. Our other cost of revenues primarily include costs of teaching materials, course content development costs, and bandwidth costs.

Operating expenses

Our operating expenses consist of sales and marketing expenses, research and development expenses, and general and administrative expenses. The following table sets forth the components of our operating expenses by amounts and percentages of our net revenues for the periods presented:

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2019     2020     2020     2021  
    RMB     %     RMB     US$     %     RMB     %     RMB     US$     %  
   

(in thousands, except for percentages)

 

Operating expenses:

                   

Sales and marketing expenses

    (2,171,875     (81.4     (2,577,259     (393,367     (64.1     (466,562)       (41.6)       (908,696)       (138,694)       (67.5)  

Research and development expenses

    (237,290     (8.9     (317,873     (48,516     (7.9     (70,022)       (6.2)       (113,284)       (17,291)       (8.5)  

General and administrative expenses

    (193,732     (7.3     (207,617     (31,689     (5.2     (41,818)       (3.7)       (101,159)       (15,440)       (7.5)  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    (2,602,897     (97.6     (3,102,749     (473,572     (77.2     (578,402)       (51.5)       (1,123,139)       (171,425)       (83.5)  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Sales and marketing expenses. Our sales and marketing expenses primarily consist of (1) salaries and welfare for sales and marketing personnel and teachers’ compensation for trial courses, (2) channel and branding expenses, including expenses relating to our online traffic acquisition channels and marketing and branding activities, and (3) other expenses associated with our sales and marketing activities, including rental expenses. We expect our sales and marketing expenses to increase in absolute amounts in the foreseeable future as we seek to further promote our service offerings, such as our small-class course offerings.

 

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The following table sets forth the components of our sales and marketing expenses by amounts and percentages of our net revenues for the periods presented:

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2019     2020     2020     2021  
    RMB     %     RMB     US$     %     RMB     %     RMB     US$     %  
   

(in thousands, except for percentages)

 

Sales and marketing expenses:

                   

Salaries and welfare

    1,060,521       39.7       1,205,116       183,937       30.0       224,625       20.0       491,678       75,045       36.5  

Channel and branding expenses

    882,300       33.1       1,067,263       162,896       26.6       164,729       14.7       316,068       48,241       23.5  

Other expenses

    229,054       8.6       304,880       46,534       7.5       77,208       6.9       100,950       15,408       7.5  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    2,171,875       81.4       2,577,259       393,367       64.1       466,562       41.6       908,696       138,694       67.5  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Research and development expenses. Our research and development expenses consist primarily of (1) salaries and welfare for technology and educational product development personnel, and (2) general expenses and depreciation expenses associated with our research and development activities. We expect our research and development expenses to increase in absolute amounts in the foreseeable future as we continue to invest in product development and technology development.

General and administrative expenses. Our general and administrative expenses consist primarily of (1) salaries and welfare for our administrative personnel, (2) professional service fees, and (3) other general and administrative expenses, including rental, amortization and depreciation expenses. We expect our general and administrative expenses to increase in absolute amounts in the future as our business grows and as we incur increased costs related to complying with our reporting obligations as a public company under U.S. securities laws.

Taxation

Cayman Islands

We are incorporated in Cayman Islands. Under the current laws of Cayman Islands, we are not subject to income, corporate or capital gains tax, and Cayman Islands currently have no form of estate duty, inheritance tax or gift tax. In addition, payments of dividends and capital in respect of their shares are not subject to taxation and no withholding will be required in the Cayman Islands on the payment of any dividend or capital to any holder of their shares, nor will gains derived from the disposal of their shares be subject to Cayman Islands income or corporation tax. No provision for income taxes in Cayman Islands has been made as we had no taxable income for the years ended December 31, 2019 and 2020 and for the three months ended March 31, 2021.

Hong Kong

Under the current Hong Kong Inland Revenue Ordinance, our subsidiary, Global Online Education HK Limited., which domiciled in Hong Kong, has introduced a two-tiered profits tax rate regime which is applicable to any year of assessment commencing on or after April 1, 2018. The profits tax rate for the first HK dollar 2,000 of profits of corporations will be lowered to 8.25%, while profits above that amount will continue to be subject to the tax rate of 16.5%. Additionally, payments of dividends by the subsidiary incorporated in Hong Kong to us are not subject to any Hong Kong withholding tax.

PRC

Generally, our PRC subsidiaries, VIEs and VIEs’ subsidiaries are subject to enterprise income tax on their taxable income in China at a statutory rate of 25%. The enterprise income tax is calculated based on the entity’s

 

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global income as determined under PRC tax laws and accounting standards. Shanghai Zhangxue, our WFOE, qualified as a High and New Technology Enterprise, or HNTE, in 2020, which reduced its enterprise income tax rate to 15%. Its current HNTE status is set to expire in 2023.

Our subsidiary, the VIEs and the VIEs’ subsidiaries, which were entities incorporated in the PRC (the “PRC entities”), are subject to PRC Enterprise Income Tax (“EIT”) on their taxable income in accordance with the relevant PRC income tax laws, which have adopted a unified income tax rate of 25%. Zhangxue obtained High and New Technology Enterprise status from 2020 and accordingly was entitled to the 15% preferential tax rate if certain conditions were met. Certain of our entities are qualified as small low-profit enterprises. In accordance with Cai Shui [2019] No.13, the portion of annual taxable income amount of a small low-profit enterprises which does not exceed RMB1 million shall be computed at a reduced rate of 25% as taxable income amount, and be subject to enterprise income tax at 20% tax rate; the portion of annual taxable income amount which exceeds RMB1 million but does not exceed RMB3 million shall be computed at a reduced rate of 50% as taxable income amount, and be subject to enterprise income tax at 20% tax rate.

Dividends paid by our wholly foreign-owned subsidiaries in China to our intermediary holding company in Hong Kong will be subject to a withholding tax rate of 10%, unless the relevant Hong Kong entity satisfies all the requirements under the Arrangement between China and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion with respect to Taxes on Income and Capital and receives approval from the relevant tax authority. If our Hong Kong subsidiary satisfies all the requirements under the tax arrangement and receives approval from the relevant tax authority, then the dividends paid to the Hong Kong subsidiary would be subject to withholding tax at the standard rate of 5%. Effective from November 1, 2015, the above mentioned approval requirement has been abolished, but a Hong Kong entity is still required to file application package with the relevant tax authority, and settle the overdue taxes if the preferential 5% tax rate is denied based on the subsequent review of the application package by the relevant tax authority. See “Risk Factors—Risks Related to Our Corporate Structure—We may rely on dividends and other distributions on equity paid by our PRC subsidiaries to fund any cash and financing requirements we may have, and any limitation on the ability of our PRC subsidiaries to make payments to us could have a material and adverse effect on our ability to conduct our business.”

If our holding company in the Cayman Islands or any of our subsidiaries outside of China were deemed to be a “resident enterprise” under the PRC Enterprise Income Tax Law, it would be subject to enterprise income tax on its worldwide income at a rate of 25%. See “Risk Factors—Risks Related to Doing Business in China— If we are classified as a PRC resident enterprise for PRC income tax purposes, such classification could result in unfavorable tax consequences to us and our non-PRC shareholders or ADS holders.”

 

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Results of Operations

The following table sets forth a summary of our consolidated results of operations for the periods presented, both in absolute amount and as a percentage of our net revenues for the periods presented. 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 particular period are not necessarily indicative of our future trends.

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2019     2020     2020     2021  
    RMB     %     RMB     US$     %     RMB     %     RMB     US$     %  
   

(in thousands, except for percentages)

 

Net revenues

    2,668,735       100.0       4,018,429       613,332       100.0       1,122,670       100.0       1,345,664       205,388       100.0  

Cost of revenues

    (1,651,204     (61.9     (2,203,966     (336,391     (54.8     (604,402     (53.8     (748,139     (114,188     (55.6
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    1,017,531       38.1       1,814,463       276,941       45.2       518,268       46.2       597,525       91,200       44.4  

Operating expenses:

                   

Sales and marketing expenses

    (2,171,875     (81.4     (2,577,259     (393,367     (64.1     (466,562     (41.6     (908,696     (138,694     (67.5

Research and development expenses

    (237,290     (8.9     (317,873     (48,516     (7.9     (70,022     (6.2     (113,284     (17,291     (8.5

General and administrative expenses

    (193,732     (7.3     (207,617     (31,689     (5.2     (41,818     (3.7     (101,159     (15,440     (7.5
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    (2,602,897     (97.6     (3,102,749     (473,572     (77.2     (578,402 )      (51.5 )      (1,123,139 )      (171,425 )      (83.5 ) 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

    (1,585,366     (59.5     (1,288,286     (196,631     (32.0     (60,134 )      (5.3 )      (525,614 )      (80,225 )      (39.1 ) 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income, net

    70,330       2.6       85,262       13,014       2.1       15,614       1.4       23,804       3,633       1.8  

Other income, net

    12,697       0.5       163,432       24,945       4.1       42,490       3.8       46,278       7,063       3.4  

Fair value change of investments and derivatives

    —         0.0       30,213       4,611       0.8       —         —         (41,801     (6,380     (3.1

Loss before provision for income tax

    (1,502,339     (56.4     (1,009,379     (154,061     (25.0     (2,030 )      (0.1 )      (497,333 )      (75,909 )      (37.0 ) 

Income tax expenses

    (1,700     (0.1     (2,967     (453     (0.1     (6     (0.0     —         —         —    

Three months ended March 31, 2021 compared to three months ended March 31, 2020

Net revenues

Our net revenues increased from RMB1,122.7 million for the three months ended March 31, 2020 to RMB1,345.7 million (US$205.4 million) for the three months ended March 31, 2021. The increase was across all revenue streams, consisting of revenues from one-on-one courses, small class and others.

 

   

One-on-one courses. Net revenues from our one-on-one courses increased from RMB1,071.6 million for the three months ended March 31, 2020 to RMB1,174.8 million (US$179.3 million) for the three months ended March 31, 2021. This increase was primarily driven by the increase in paid student enrollments and higher level of tuition fees. Our paid student enrollments for one-on-one courses increased by 52.0% from 87,873 for the three months ended March 31, 2020 to 133,601 for the three months ended March 31, 2021. From the first quarter of 2020 to the first quarter of 2021, our average course fee per class hour of our standard one-on-one courses increased by approximately 1.3%. We launched our premium courses for one-on-one tutoring services, charged at double the price of our standard courses, in January 2020. Our net revenues generated from our premium courses for one-on-one tutoring services as a percentage of our net revenues from one-on-one courses grew from 0.5% in the first quarter of 2020 to 4.7% in the first quarter of 2021.

 

   

Small-class courses. We launched our small-class tutoring services in the third quarter of 2020 and generated RMB105.3 million (US$16.1 million) in net revenues from small class courses for the three months ended March 31, 2021. We have achieved rapid growth in our small-class tutoring services

 

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since its launch. Our paid student enrollments for small-class tutoring services reached 294,397 in the first quarter of 2021, representing an increase of 222.6% from 91,260 in the third quarter of 2020. We plan to further expand our small-class tutoring services in the near future.

 

   

Others. Net revenues from others increased from RMB51.1 million for the three months ended March 31, 2020 to RMB65.6 million (US$10.0 million) for the three months ended March 31, 2021.

Cost of revenues

Our cost of revenues increased from RMB604.4 million for the three months ended March 31, 2020 to RMB748.1 million (US$114.2 million) for the three months ended March 31, 2021. This increase was primarily due to (1) the increase in teacher compensation costs from RMB578.3 million for the three months ended March 31, 2020 to RMB704.3 million (US$107.5 million) for the three months ended March 31, 2021, which was primarily due to the increase in base salaries from RMB194.3 million for the three months ended March 31, 2020 to RMB244.2 million (US$37.3 million) for the three months ended March 31, 2021, and the increase in social insurance contribution from RMB49.6 million for the three months ended March 31, 2020 to RMB116.1 million (US$17.7 million) for the three months ended March 31, 2021, which was primarily due to the termination of the temporary exemption from making social insurance contribution due to the COVID-19 pandemic, and (2) the increase of other costs, including the increase in our technology service fees from RMB13.2 million for the three months ended March 31, 2020 to RMB17.6 million (US$2.7 million) for the three months ended March 31, 2021, and the increase in teaching materials from RMB2.6 million for the three months ended March 31, 2020 to RMB9.6 million (US$1.5 million) for the three months ended March 31, 2021.

Gross profit

As a result of the foregoing, our gross profit increased from RMB518.3 million for the three months ended March 31, 2020 to RMB597.5 million (US$91.2 million) for the three months ended March 31, 2021.

Operating expenses

Our total operating expenses increased from RMB578.4 million for the three months ended March 31, 2020 to RMB1,123.1 million (US$171.4 million) for the three months ended March 31, 2021.

Sales and marketing expenses. Our sales and marketing expenses increased from RMB466.6 million for the three months ended March 31, 2020 to RMB908.7 million (US$138.7 million) for the three months ended March 31, 2021. This increase was mainly driven by (1) the increase in salaries and welfare for our sales and marketing personnel, student service staff and teachers’ compensation for trial courses from RMB224.6 million for the three months ended March 31, 2020 to RMB491.7 million (US$75.0 million) for the three months ended March 31, 2021, which was mainly due to the increase in the number of sales and marketing staff (including those supplied by third-party service providers) from 8,335 for the three months ended March 31, 2020 to 17,351 for the three months ended March 31, 2021, and the increase in social insurance contribution from RMB26.9 million for the three months ended March 31, 2020 to RMB69.3 million (US$10.6 million) for the three months ended March 31, 2021, which was primarily due to the termination of the temporary exemption from making social insurance contribution due to the COVID-19 pandemic, (2) the increase in channel and branding expenses from RMB164.7 million for the three months ended March 31, 2020 to RMB316.1 million (US$48.2 million) for the three months ended March 31, 2021, and (3) the increase in other sales and marketing expenses, including rental expenses for our office and offline experience stores from RMB25.5 million for the three months ended March 31, 2020 to RMB36.7 million (US$5.6 million) for the three months ended March 31, 2021.

Research and development expenses. Our research and development expenses increased from RMB70.0 million for the three months ended March 31, 2020 to RMB113.3 million (US$17.3 million) for the three months ended March 31, 2021, which was primarily due to the increase in salaries and welfare expenses of

 

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our research and development personnel from RMB65.7 million for the three months ended March 31, 2020 to RMB109.2 million (US$16.7 million) for the three months ended March 31, 2021, as our technology and product development personnel increased from 788 for the three months ended March 31, 2020 to 973 for the three months ended March 31, 2021 to develop new course offerings, such as Xiaoli (formerly known as Zhangmen AI), and to upgrade our existing technology infrastructure.

General and administrative expenses. Our general and administrative expenses increased from RMB41.8 million for the three months ended March 31, 2020 to RMB101.2 million (US$15.4 million) for the three months ended March 31, 2021, which was primarily attributable to (1) the increase in salaries and welfare to our general and administrative personnel from RMB20.5 million for the three months ended March 31, 2020 to RMB49.8 million (US$7.6 million) for the three months ended March 31, 2021 which was primarily due to increase of general and administrative personnel from 939 for the three months ended March 31, 2020 to 2,278 for the three months ended March 31, 2021 as well as the termination of the temporary exemption from making social insurance contribution due to the COVID-19 pandemic, and (2) the increase in share-based compensation expenses from RMB1.0 million for the three months ended March 31, 2020 to RMB21.7 million (US$3.3 million) for the three months ended March 31, 2021. The increases were partially offset by the decrease in rental expenses for office space from RMB5.2 million for the three months ended March 31, 2020 to RMB4.2 million (US$0.6 million) for the three months ended March 31, 2021.

Loss from operations

Our loss from operations increased from RMB60.1 million for the three months ended March 31, 2020 to RMB525.6 million (US$80.2 million) for the three months ended March 31, 2021, due to the factors above.

Other income, net

Our other income increased from RMB42.5 million for the three months ended March 31, 2020 to RMB46.3 million (US$7.1 million) for the three months ended March 31, 2021.

Fair value change of investments and derivatives

Our fair value change of investments and derivatives was RMB41.8 million (US$6.4 million) for the three months ended March 31, 2021, compared to nil for the three months ended March 31, 2020, due to the structured products and derivative instruments we purchased from financial institutions starting from the second quarter in 2020.

Net loss

As a result of the foregoing, we incurred net loss of RMB497.3 million (US$75.9 million) for the three months ended March 31, 2021, compared with RMB2.0 million for the three months ended March 31, 2020.

Year ended December 31, 2020 compared to year ended December 31, 2019

Net revenues

Our net revenues increased from RMB2,668.7 million in 2019 to RMB4,018.4 million (US$613.3 million) in 2020. The increase was across all revenue streams, consisting of revenues from one-on-one courses, small class and others.

 

   

One-on-one courses. Net revenues from our one-on-one courses increased from RMB2,507.6 million in 2019 to RMB3,739.6 million (US$570.8 million) in 2020. This increase was primarily driven by the increase in paid student enrollments and higher level of tuition fees. Our paid student enrollments for

 

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one-on-one courses increased by 43.2% from 380,517 in 2019 to 544,813 in 2020. Between 2019 and 2020, our average course fee per class hour of our standard one-on-one courses increased by approximately 3.9%. Furthermore, driven by our brand equity and quality services, in January 2020, we launched our premium courses for one-on-one tutoring services, charged at double the price of our standard courses. Our net revenues generated from our premium courses for one-on-one tutoring services as a percentage of our net revenues from one-on-one courses grew from 0.5% in the first quarter of 2020 to 3.5% in the fourth quarter of 2020.

 

   

Small-class courses. We launched our small-class tutoring services in the third quarter of 2020 and generated RMB62.7 million (US$9.6 million) in net revenues from small class courses in 2020. We have achieved rapid growth in our small-class tutoring services since its launch. Our paid student enrollments for small-class tutoring services reached 292,802 in the fourth quarter of 2020, representing an increase of 220.8% from 91,260 in the third quarter of 2020.

 

   

Others. Net revenues from others increased from RMB161.2 million in 2019 to RMB216.2 million (US$33.0 million) in 2020.

Cost of revenues

Our cost of revenues increased from RMB1,651.2 million in 2019 to RMB2,204.0 million (US$336.4 million) in 2020. This increase was primarily due to (1) the increase in teacher compensation costs from RMB1,544.8 million in 2019 to RMB2,081.2 million (US$317.7 million) in 2020, which was mainly due to the increase in base salaries from RMB570.5 million in 2019 to RMB773.5 million (US$118.1 million) in 2020, and the increase in the compensation calculated based on hourly rates and the total number of class hours delivered by our teachers from RMB600.7 million in 2019 to RMB964.2 million (US$147.2 million) in 2020, primarily as a result of the increase in the number of class hours delivered by our teachers, (2) the increase of other costs, including the increase in our technology service fees from RMB46.2 million in 2019 to RMB52.6 million (US$8.0 million) in 2020, partially offset by the temporary social insurance contribution exemption of RMB211.2 million (US$32.2 million) we enjoyed in 2020 due to the COVID-19 pandemic. The decrease in our teacher compensation cost as a percentage of our net revenues from 57.9% in 2019 to 51.8% in 2020 was mainly due to our ability to increase our teachers’ productivity and utilization efficiency.

Gross profit

As a result of the foregoing, our gross profit increased from RMB1,017.5 million in 2019 to RMB1,814.5 million (US$276.9 million) in 2020.

Operating expenses

Our total operating expenses increased from RMB2,602.9 million in 2019 to RMB3,102.7 million (US$473.6 million) in 2020.

Sales and marketing expenses. Our sales and marketing expenses increased from RMB2,171.9 million in 2019 to RMB2,577.3 million (US$393.4 million) in 2020. This increase was mainly driven by (1) the increase in channel and branding expenses from RMB882.3 million in 2019 to RMB1,067.2 million (US$162.9 million) in 2020 as we increased our marketing related spending to acquire new students, (2) the increase in salaries and welfare for our sales and marketing personnel, student service staff and teachers’ compensation for trial courses from RMB1,060.5 million in 2019 to RMB1,205.1 million (US$183.9 million) in 2020 due to the increase in the number of sales and marketing staff (including those supplied by third-party service providers) from 7,479 in 2019 to 18,438 in 2020, and (3) increase in other sales and marketing expenses, including rental expenses for our office and offline experience stores from RMB101.2 million in 2019 to RMB117.6 million (US$17.9 million) in 2020, partially offset by the temporary social insurance contribution exemption of RMB113.3 million (US$17.3 million) we enjoyed in 2020 due to the COVID-19 pandemic.

 

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Research and development expenses. Our research and development expenses increased from RMB237.3 million in 2019 to RMB317.9 million (US$48.5 million) in 2020, which was primarily due to the increase in salaries and welfare expenses of our research and development personnel from RMB224.6 million in 2019 to RMB302.2 million (US$46.1 million) in 2020, as our technology and product development personnel increased from 789 in 2019 to 1,029 in 2020 to develop new course offerings, such as Xiaoli (formerly known as Zhangmen AI), and to upgrade our existing course offerings and technology infrastructure.

General and administrative expenses. Our general and administrative expenses increase from RMB193.7 million in 2019 to RMB207.6 million (US$31.7 million) in 2020, which was primarily attributable to (1) the increase in salaries and welfare to our general and administrative personnel from RMB79.6 million in 2019 to RMB90.9 million (US$13.9 million) in 2020. (2) the increase in rental expenses for office space from RMB14.9 million in 2019 to RMB19.1 million (US$2.9 million) in 2020 as we expanded our office space in existing cities and entered into new cities. The increases were partially offset by the decrease in professional service fees from RMB44.2 million in 2019 to RMB38.6 million (US$5.9 million) in 2020.

Loss from operations

Our loss from operations decreased from RMB1,585.4 million in 2019 to RMB1,288.3 million (US$196.6 million) in 2020, due to the factors above.

Other income, net

Our other income increased from RMB12.7 million in 2019 to RMB163.4 million (US$24.9 million) in 2020, primarily due to RMB144.5 million (US$22.1 million) we recognized arising from VAT exemption according to the Tax Policies. We expect this to be a one-off VAT exemption in 2020 to control the COVID-19 impact and do not expect to receive such exemption in the future.

Net loss

As a result of the foregoing, we incurred net loss of RMB1,012.3 million (US$154.5 million) in 2020, compared with RMB1,504.0 million in 2019.

 

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Selected Quarterly Results of Operations

The following table sets forth our unaudited consolidated quarterly results of operations for each of the nine quarters from January 1, 2019 to March 31, 2021. You should read the following table in conjunction with our audited consolidated financial statements and unaudited condensed consolidated financial statements and the related notes included elsewhere in this prospectus. We have prepared this unaudited condensed consolidated quarterly financial data on the same basis as we have prepared our audited consolidated financial statements. The unaudited condensed consolidated financial data include all adjustments, consisting only of normal and recurring adjustments, that our management considered necessary for a fair statement of our financial position and results of operation for the quarters presented.

 

    Three Months Ended  
    Mar 31,
2019
    Jun 30,
2019
    Sep 30,
2019
    Dec 31,
2019
    Mar 31,
2020
    Jun 30,
2020
    Sep 30,
2020
    Dec 31,
2020
    Mar 31,
2021
 
    RMB     RMB     RMB     RMB     RMB     RMB     RMB     RMB     RMB  

Net revenues

    514,420       599,789       787,244       767,282       1,122,670       931,527       1,018,261       945,971       1,345,664  

Cost of revenues

    (328,670     (372,423     (493,502     (456,609     (604,402     (506,083     (563,798     (529,683     (748,139
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    185,750       227,366       293,742       310,673       518,268       425,444       454,463       416,288       597,525  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

                 

Sales and marketing expenses

    (392,449     (583,104     (650,048     (546,274     (466,562     (546,546     (621,634     (942,517     (908,696

Research and development expenses

    (44,776     (57,212     (66,295     (69,007     (70,022     (75,446     (83,051     (89,354     (113,284

General and administrative expenses

    (39,270     (39,281     (50,706     (64,475     (41,818     (41,876     (49,532     (74,391     (101,159
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    (476,495 )      (679,597 )      (767,049 )      (679,756 )      (578,402 )      (663,868 )      (754,217 )      (1,106,262 )      (1,123,139 ) 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

    (290,745 )      (452,231 )      (473,307 )      (369,083 )      (60,134 )      (238,424 )      (299,754 )      (689,974 )      (525,614 ) 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income, net

    14,600       17,992       17,638       20,100       15,614       18,757       21,767       29,124       23,804  

Other income, net

    107       1,926       3,188       7,476       42,490       46,083       40,020       34,839       46,278  

Fair value change of investments and derivatives

    —         —         —         —         —         286       2,024       27,903       (41,801
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before provision for income tax

    (276,038 )      (432,313 )      (452,481 )      (341,507 )      (2,030 )      (173,298 )      (235,943 )      (598,108 )      (497,333 ) 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income tax expenses

    (304     (476     (504     (416     (6     (504     (686     (1,771     —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

    (276,342 )      (432,789 )      (452,985 )      (341,923 )      (2,036 )      (173,802 )      (236,629 )      (599,879 )      (497,333 ) 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Deemed dividend

    —         —         —         —         —         —         (101,795     —         —    

Accretion of convertible redeemable preferred shares and redeemable ordinary shares

    (129,024     (149,115     (122,423     (107,568     (105,519     (117,259     (394,032     (221,046     (890,700
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss available to ordinary shareholders of Zhangmen Education Inc.

    (405,366 )      (581,904 )      (575,408 )      (449,491 )      (107,555 )      (291,061 )      (732,456 )      (820,925 )      (1,369,865 ) 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Our net revenues generally continued to increase during the nine quarters from January 1, 2019 to March 31, 2021, primarily driven by the increased revenues from our one-on-one courses, which in turn was due to the increase in paid-students enrollments, our ability to charge higher tuition fees and our enhanced brand name. We generated higher net revenues from our one-on-one courses in the third quarter in 2019 and 2020, mainly due to the seasonality in paid-student enrollments in our courses. Historically, we tend to have larger paid-student enrollments in the third quarter when the students could spend more time in after-school tutoring over the summer break. In addition, the net revenues also increased significantly in the first quarter in 2020, because many students switched to online tutoring due to the temporary closure of schools across China as a result of COVID-19 pandemic. As a result, our net loss in the first quarter of 2020 was much lower compared with the other quarters. In addition, we enjoyed a temporary exemption from making social insurance contribution of RMB360.2 million (US$55.0 million) in 2020. Starting from January 1, 2021, such exemption was no longer available.

During the quarters presented, we also experienced generally continued increases in cost of revenues and operating expenses, which were generally in line with our net revenue growth during the same periods. Our sales

 

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and marketing expenses increased significantly in the fourth quarter in 2020 and the first quarter in 2021, primarily because we began to strategically increase our spending on online traffic acquisition channels in order to promote our small-class courses. As a result, we experienced a significant increase in net loss in the fourth quarter of 2020. We expect such increase in sales and marketing expenses to drive our student enrollments for the remaining quarters of 2021.

Non-GAAP Financial Measure

Gross billings

Gross billings is a non-GAAP financial measure. We define gross billings for a specific period as the total amount of cash received for the sale of courses and course packages in such period, net of the total amount of refunds in such period. We generally bill our students at the time of sale of our courses and course packages and recognize revenue proportionally. We consider gross billings to be a valuable measure for monitoring the sales of our courses and course packages and the business performance of our business.

This non-GAAP financial measure should not be considered in isolation from, or as a substitute for, its most directly comparable financial measure prepared in accordance with GAAP. A reconciliation of the historical non-GAAP financial measure to its most directly comparable GAAP measure has been provided in the financial statement tables included below. Investors are encouraged to review the reconciliation of the historical non-GAAP financial measure to its most directly comparable GAAP financial measure. As gross billings has material limitations as an analytical metrics and may not be calculated in the same manner by all companies, it may not be comparable to other similarly titled measures used by other companies. In light of the foregoing limitations, you should not consider gross billings as a substitute for, or superior to, net revenues prepared in accordance with GAAP. We encourage investors and others to review our financial information in its entirety and not rely on a single financial measure.

We compensate for these limitations by relying primarily on our GAAP results and using gross billings only as a supplemental measure. The table below sets forth a reconciliation of our net revenues to gross billings for the periods indicated:

 

     For the Year Ended December 31,      For the Three Months Ended March 31,  
     2019      2020      2020      2021  
     RMB      RMB      US$      RMB      RMB      US$  
    

(in thousands)

 

Net revenues

     2,668,735        4,018,429        613,332        1,122,670        1,345,664        205,388  

Add: VAT and surcharges

     159,626        241,293        36,829        67,413        82,200        12,546  

Add: ending deferred revenue

     2,556,881        3,590,008        547,942        2,148,251        3,512,486        536,110  

Add: ending refund liability

     395,124        356,721        54,446        375,652        325,647        49,703  

Less: beginning deferred revenue

     1,513,164        2,556,881        390,256        2,556,881        3,590,008        547,942