F-1 1 d494072df1.htm FORM F-1 Form F-1
Table of Contents

As filed with the Securities and Exchange Commission on February 23, 2018.

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM F-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Sunlands Online Education Group

(Exact name of Registrant as specified in Its charter)

 

 

Not Applicable

(Translation of Registrant’s name into English)

 

 

 

 

Cayman Islands   8200   Not Applicable
(State or other jurisdiction of
incorporation or organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification Number)

Building 4-6, Chaolai Science Park, No. 36

Chuangyuan Road, Chaoyang District,

Beijing, 100012, the People’s Republic of China

+86-10-52413738

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 

 

Cogency Global Inc.

10 E. 40th Street, 10th Floor, New York, NY

10016

(800) 221-0102

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

 

 

Copies to:

Li He, Esq.
Davis Polk & Wardwell LLP
2201 China World Office 2

No.1 Jian Guo Men Wai Avenue

Chaoyang District, Beijing, 100004

People’s Republic of China

+86 10-8567-5000

 

James C. Lin, Esq.

Davis Polk & Wardwell LLP

c/o 18th Floor The Hong Kong Club Building

3A Chater Road

Central, Hong Kong

+852 2533-3300

 

David T. Zhang, Esq.

Benjamin W. James, Esq.

Steve Lin, Esq.

Kirkland & Ellis International LLP

c/o 26th Floor, Gloucester Tower

The Landmark

15 Queen’s Road Central

Hong Kong

+852 3761-3300

 

 

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

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

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

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

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

Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933.

Emerging growth company  ☒

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 7(a)(2)(B) of the Securities Act.  ☒

† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of each class of

securities to be registered

 

Proposed

maximum

aggregate

offering price(1)

  Amount of
registration fee

Class A Ordinary shares, par value US$0.00005 per share(2)(3)

  US$300,000,000   US$37,350

 

 

(1) Estimated solely for the purpose of determining the amount of registration fee in accordance with Rule 457(o) under the Securities Act of 1933.
(2) Includes Class A ordinary shares initially offered and sold outside the United States that may be resold from time to time in the United States either as part of their distribution or within 40 days after the later of the effective date of this registration statement and the date the shares are first bona fide offered to the public, and also includes Class A ordinary shares that may be purchased by the underwriters pursuant to an over-allotment option. These Class A ordinary shares are not being registered for the purpose of sales outside the United States.
(3) American depositary shares issuable upon deposit of the Class A ordinary shares registered hereby will be registered under a separate registration statement on Form F-6 (Registration No.333-            ). Each American depositary share represents              Class A ordinary shares.

 

 

 

The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the registration statement shall become effective on such date as the Commission, acting pursuant to such Section 8(a), may determine.

 

 

 


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

 

Subject to completion

Preliminary Prospectus dated                 , 2018

             American Depositary Shares

 

LOGO

Sunlands Online Education Group

Representing              Class A Ordinary Shares

 

 

This is an initial public offering of American depositary shares, or ADSs, representing Class A ordinary shares of Sunlands Online Education Group.

We are offering              ADSs. Each ADS represents              of our Class A ordinary shares, par value US$0.00005 per share.

Prior to this offering, there has been no public market for the ADSs. It is currently estimated that the initial public offering price per share will be between US$             and US$            .

We have applied for listing the ADSs on the New York Stock Exchange under the symbol “STG.”

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

 

 

See “Risk Factors” beginning on page 15 for factors you should consider before buying the ADSs.

 

 

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

 

     Per ADS      Total  

Public offering price

   US$                   US$               

Underwriting discounts and commissions(1)

   US$                   US$               

Proceeds, before expenses, to us

   US$                   US$               

 

(1) See “Underwriting” for additional disclosure regarding compensation payable by us to the underwriters.

The underwriters have a 30-day option to purchase up to an additional                  ADSs from us at the initial public offering price less the underwriting discount.

Immediately upon the completion of this offering, our outstanding share capital will consist of Class A ordinary shares, Class B ordinary shares and Class C ordinary shares. Holders of Class A ordinary shares, Class B ordinary shares and Class C ordinary shares have the same rights except for voting and conversion rights. Each Class A ordinary share is entitled to one vote; each Class B ordinary share is entitled to seven votes and is convertible into one Class A ordinary share at any time by the holder thereof; and each Class C ordinary share is entitled to ten votes and is convertible into one Class A ordinary share at any time by the holder thereof. Class A ordinary shares are not convertible into Class B ordinary shares or Class C ordinary shares, Class B ordinary shares are not convertible into Class C ordinary shares, and Class C ordinary shares are not convertible into Class B ordinary shares under any circumstances. Immediately upon the completion of this offering, Mr. Peng Ou, our founder and chairman of our Board of Directors, Mr. Tongbo Liu, our chief executive officer and director, and certain of our senior management and employees will collectively beneficially own all of our issued and outstanding Class C ordinary shares. These Class C ordinary shares will constitute approximately     % of our total issued and outstanding share capital and     % of the aggregate voting power of our total issued and outstanding share capital immediately upon the completion of this offering, assuming the underwriters do not exercise their over-allotment option. In addition, upon the completion of this offering, up to 120,394 ordinary shares (constituting approximately     % of our total issued and outstanding share capital and     % of the aggregate voting power of our total issued and outstanding share capital immediately upon the completion of this offering) reserved and issuable upon the exercise of options granted pursuant to our equity incentive plan adopted in October 2017 shall be, upon issuance of such ordinary shares, designated as Class C ordinary shares, the voting power of which will be held by certain of our senior employees. Immediately upon the completion of this offering, PV PLUTO LIMITED, an entity wholly owned and controlled by Primavera Capital Fund, will beneficially own all of our issued and outstanding Class B ordinary shares, which will constitute approximately     % of our total issued and outstanding share capital and     % of the aggregate voting power of our total issued and outstanding share capital immediately after the completion of this offering, assuming the underwriters do not exercise their over-allotment option.

The underwriters expect to deliver the ADSs against payment in U.S. dollars in New York, New York on                 , 2018.

 

 

 

Goldman Sachs (Asia) L.L.C.   J.P. Morgan   Credit Suisse

 

 

  CLSA  

 

 

The date of this prospectus is                  , 2018.


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TABLE OF CONTENTS

 

     Page  

PROSPECTUS SUMMARY

     1  

IMPLICATIONS OF BEING AN EMERGING GROWTH COMPANY

     6  

OUR CORPORATE INFORMATION

     6  

CONVENTIONS WHICH APPLY TO THIS PROSPECTUS

     7  

THE OFFERING

     8  

OUR SUMMARY CONSOLIDATED FINANCIAL DATA AND OPERATING DATA

     10  

RISK FACTORS

     15  

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     54  

LETTER FROM OUR FOUNDER AND CHAIRMAN

     55  

USE OF PROCEEDS

     56  

DIVIDEND POLICY

     57  

CAPITALIZATION

     58  

DILUTION

     60  

EXCHANGE RATE INFORMATION

     62  

ENFORCEABILITY OF CIVIL LIABILITIES

     63  

CORPORATE HISTORY AND STRUCTURE

     65  

SELECTED CONSOLIDATED FINANCIAL DATA

     69  

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

     73  

INDUSTRY OVERVIEW

     97  

BUSINESS

     104  

REGULATION

     128  

MANAGEMENT

     146  

PRINCIPAL SHAREHOLDERS

     154  

RELATED PARTY TRANSACTIONS

     157  

DESCRIPTION OF SHARE CAPITAL

     159  

DESCRIPTION OF AMERICAN DEPOSITARY SHARES

     171  

SHARES ELIGIBLE FOR FUTURE SALE

     179  

TAXATION

     181  

UNDERWRITING

     187  

EXPENSES RELATING TO THIS OFFERING

     196  

LEGAL MATTERS

     197  

EXPERTS

     198  

WHERE YOU CAN FIND ADDITIONAL INFORMATION

     199  

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

     F-1  

We are responsible for the information contained in this prospectus. We have not authorized anyone to provide you with different information, and we take no responsibility for any other information others may give you. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should not assume that the information contained in this prospectus is accurate as of any date other than its date.

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

 

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We have not 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 outside the United States. Persons outside the United States who come into possession of this prospectus must inform themselves about and observe any restrictions relating to the offering of the ADSs and the distribution of the prospectus outside the United States.

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

 

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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 and the related notes 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 our ADSs discussed under “Risk Factors” and information contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” before deciding whether to buy our ADSs. This prospectus contains information derived from various public sources and certain information from an industry report commissioned by us and prepared by iResearch, a third-party industry research firm, to provide information regarding our industry and market position in China. We refer to this report as the iResearch Report. Such information involves a number of assumptions and limitations, and you are cautioned not to give undue weight to these estimates. We have not independently verified the accuracy or completeness of the data contained in these industry publications and reports. The industry in which we operate is subject to a high degree of uncertainty and risk due to variety of factors, including those described in the “Risk Factors” section. These and other factors could cause results to differ materially from those expressed in these publications and reports.

Our Mission

We believe education should nurture and spread new ideas to enrich lives. High-quality education should be available to everyone. We all share a common aspiration to improve ourselves through education. Our mission is to transform education through technology and innovation, making learning experience enjoyable and rewarding.

Our Business

We are the leader in China’s online post-secondary and professional education in terms of gross billings in 2017, according to iResearch. We have a deep understanding of the educational needs of our prospective students and offer solutions that help them achieve their goals. We offer various degree- and diploma-oriented post-secondary courses through our online platforms. In addition, we offer online professional courses and educational content to help students prepare for professional certification exams and attain professional skills.

Founded in 2003 as a traditional education company, we transitioned to an online education model in 2014. Our online education model enables our students to access our course and educational content offerings anywhere and anytime.

We have been successful in addressing the unmet demand of a large, growing market and served approximately 550,000 students across China since we transitioned to an online education model in 2014. The number of our students was 205,806, 382,805, 286,899 and 407,960, respectively, in 2015 and 2016 and for the six months ended June 30, 2016 and 2017. For the same periods, our new student enrollments were 179,172, 188,733, 89,066 and 148,573, respectively.

We offer post-secondary and professional education through extensive courses and educational content offerings. As of June 30, 2017, we offered Self-taught Higher Education Examination, or STE, programs covering 18 majors, MBA-related programs, and professional certification and skills programs. We adopt a counseling-oriented sales and marketing approach that seeks to offer our education solutions to meet their needs based on their education background and goals. We provide professional assistance and counseling to help students make informed decisions that best suit their learning needs. In addition, our enrollment consultants also help them formulate effective study plans throughout their enrollments in our courses.



 

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Our students can access our services either through PC or mobile application. Our online platform cultivates a personalized, interactive learning environment by featuring virtual learning community and a vast library of educational content offerings that are adapted to the learning habits of our students.

Our success has been driven by our ability to cultivate an engaging community among students, teachers and mentors, strong educational content development capability, and high-quality faculty, which combined allow us to continually improve student learning experience. We encourage students to become more committed and engaged by creating an interactive learning environment that fosters their desire to learn. We also provide our students with strong learning support through our dedicated mentors.

We offer a unique approach to education research and development that organizes subject content into Learning Outcome Trees, our proprietary knowledge management system. Our Learning Outcome Trees enable us to customize teaching notes for our teachers, and develop comprehensive course outlines and quiz banks to enhance the learning experience. Based on student feedback and latest updates on exam policies, we further update our educational content in our Learning Outcome Trees to continually improve teaching quality. As of December 31, 2017, we had developed over 1,750 Learning Outcome Trees covering over 123,000 knowledge points and a quiz bank designed for students pursuing STE exams covering over 973,000 quizzes.

We believe our strong branding, competitive compensation structure and robust teaching and research support enable us to attract and incentivize a large team of talented faculty members. We seek to hire experienced and passionate teachers who can make learning fun and interactive. We equip our faculty members not only with a comprehensive set of teaching methods but also advanced technologies and data insights to enable them to develop their professional skills and enhance our overall teaching quality.

Our focus on teaching quality and operating efficiency is demonstrated in recognition and awards we have received and student results. We have received numerous awards and recognition, including “Influential Online Education Brand” awarded by Tencent from 2015 to 2017. According to iResearch, Jiangsu, a populous province in China, is the only region in China that allows private education institutions to access the student STE exam results, and the average pass rate of our students taking STE exams in Jiangsu Province was 71.9% in 2016. According to the same source, the national average pass rate of the STE exam takers who had participated in STE tutoring courses was 46.5% in the same year. In student reviews collected following classes delivered in 2017, 98.6% of reviewers indicated their satisfaction with a four- or five-star rating out of five.

Our gross billings for the six months ended June 30, 2017 reached RMB912.5 million (US$134.6 million), representing an increase of 187.8% from RMB317.1 million in the same period in 2016. Our gross billings in 2016 reached RMB741.0 million (US$109.3 million), representing an increase of 66.1% from RMB446.1 million in 2015. Our net revenues for the six months ended June 30, 2017 reached RMB361.5 million (US$53.3 million), representing an increase of 107.3% from RMB174.3 million in the same period in 2016. Our net revenues in 2016 reached RMB418.9 million (US$61.8 million), representing an increase of 163.4% from RMB159.0 million in 2015. Our net loss in 2015 and 2016 and the six months ended June 30, 2016 and 2017 was RMB318.3 million, RMB253.6 million (US$37.4 million), RMB118.5 million and RMB231.8 million (US$34.2 million), respectively. Our deferred revenue was RMB414.1 million, RMB727.6 million (US$107.3 million) and RMB1,269.1 million (US$187.2 million), respectively, as of December 31, 2015 and 2016 and June 30, 2017. Our net cash provided by operating activities was RMB41.2 million and RMB 267.5 million (US$39.5 million), respectively, for the six months ended June 30, 2016 and 2017 and RMB0.4 million and RMB89.3 million (US$13.2 million), respectively, for the years ended December 31, 2015 and 2016.

Market Opportunities

China’s education market consists of formal and informal education. Post-secondary and professional education, which targets people at the age of 18 or above, belongs to the informal education segment. Post-



 

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secondary and professional education in China can be further divided into diploma- and degree-oriented education and professional education. The post-secondary and professional education market in China has grown rapidly in the past several years and is expected to continue to grow by virtue of students’ desire for better employment, career advancement, salary increases, local residence permits, and higher social status. According to iResearch, the size of China’s post-secondary and professional education market increased from approximately RMB163.9 billion in 2015 to RMB197.8 billion in 2017 and is expected to continue to grow to approximately RMB355.2 billion in 2022, representing a CAGR of 12.4% between 2017 and 2022.

The online education model has transformed the post-secondary and professional education market in China. It has made a tremendous number of students aware of the more flexible, cost-effective education solutions provided by online education. We expect that this trend will continue to drive further demand for such services and result in online education providers taking market share away from traditional offline players. Driven by the increasing number of internet and mobile users, China’s online education has enjoyed an annual growth of approximately 20% since 2013, according to iResearch. In particular, according to the same source, China’s online post-secondary and professional education market is expected to grow from approximately RMB33.6 billion in 2017 to RMB130.1 billion in 2022, representing a CAGR of 31.1%.

STE tutoring represents the largest vertical in China’s post-secondary education market and is expected to grow from a market size of approximately RMB46.6 billion in 2017 to RMB79.1 billion in 2022, representing a CAGR of 11.2%. Given the difficulty of STE exams, it generally takes students one to five years to prepare for and pass the STE exams, which makes class-time flexibility especially important. Online education models offer greater flexibility and have been a major factor driving demand in this market. China’s online STE tutoring market size is expected to grow from approximately RMB4.5 billion in 2017 to RMB44.7 billion in 2022, representing a CAGR of 58.3%, accounting for more than 50% of the overall STE market in 2022, according to iResearch.

There is a large demand for education services from people without a bachelor’s degree at the age of 18 or above. According to iResearch, as of December 31, 2017, there were approximately 606 million people at the age of 18 or above without a bachelor’s degree in China. Most of them desire to acquire new knowledge, seek better jobs, earn higher salaries and improve their social status. They are typically busy urban blue- and white-collar workers who need greater flexibility in study time and location, are generally heavy mobile users, and desire an engaging, interactive learning atmosphere that encourages participation and interaction. In addition, such students generally require specific guidance in identifying and selecting education products that best address their needs, especially given the complexity of China’s post-secondary education system and the relatively high cost of education.

Our Strengths

We have become the market leader by capitalizing on our early-mover advantage and substantial investment in people, technology and education research and development. In particular, we have developed a comprehensive suite of Learning Outcome Trees and accumulated massive operating data, which allow us to continually improve our teaching quality and strengthen our market leadership. As a result, we believe our business model not only enjoys strong organic momentum that drives our future growth, but also presents a high barrier to entry. In particular, we believe our success is primarily attributable to the following strengths:

 

    the leader in China’s online post-secondary and professional education with substantial growth potential;

 

    strong flywheel effect generated by our unique business model;

 

    strong brand rooted in teaching quality;


 

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    robust proprietary technology infrastructure; and

 

    innovative and visionary management team with proven track record.

Our Strategies

We intend to achieve our mission by pursuing the following strategies:

 

    expand into new markets with unmet demand;

 

    strengthen our existing leadership position;

 

    enhance student experience;

 

    further enhance our brand;

 

    continue to invest in technology; and

 

    pursue selective strategic alliances and acquisitions.

Our Challenges

Our growth is subject to risks and uncertainties, including the following:

 

    our ability to maintain our student enrollments and growth;

 

    our ability to conduct sales and marketing activities cost-effectively;

 

    our ability to timely improve and expand our course and educational content offerings in a cost-effective manner;

 

    our ability to recruit, train and retain a sufficient number of qualified faculty members;

 

    our ability to maintain and enhance the recognition of our brand;

 

    our ability to comply with the relevant laws and regulations in the PRC; and

 

    our ability to exercise effective control over our variable interest entity structure.

We also face other challenges, risks and uncertainties that may materially and adversely affect our business, financial condition, results of operations and prospectus. You should consider the risk discussed in “Risk Factors” and elsewhere in this prospectus before investing in the ADSs.

Corporate History and Structure

We commenced our education service business in August 2003. We remained an offline, classroom-based education service provider until we transitioned to an exclusively online education model in 2014.

In September 2015, Studyvip Online Education International Limited, our current ultimate holding company, was incorporated under the laws of the Cayman Islands. In October 2017, Studyvip Online Education International Limited was renamed as Sunlands Online Education Group.



 

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The following diagram illustrates our corporate structure immediately following the completion of this offering, assuming no exercise of the over-allotment option granted to the underwriters:

 

LOGO

 

LOGO

   Equity interest

LOGO

   Contractual arrangements, including the exclusive technical consultation and service agreement, the business operation agreement, the equity interest pledge agreement, the option agreement, the powers of attorney and the spousal consent letters. See “Corporate History and Structure—Contractual Arrangements with Beijing Sunlands.”

 

(1) The Founder Holding Platform refers to Pingxiang Miniewa Asset Management Consultancy Center (Limited Partnership), whose general partner is Mr. Jianhong Yin, also known as Peng Ou, our founder and chairman of our Board of Directors.
(2) The Senior Management Holding Platforms consist of Pingxiang Wuerken Asset Management Consultancy Center (Limited Partnership), Pingxiang Saiersi Asset Management Consultancy Center (Limited Partnership), Pingxiang Xisailuo Asset Management Consultancy Center (Limited Partnership) and Pingxiang Bosaidong Asset Management Consultancy Center (Limited Partnership). The general partner of each of these entities is Mr. Tongbo Liu, our chief executive officer and director.


 

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IMPLICATIONS OF BEING AN EMERGING GROWTH COMPANY

As a company with less than US$1.07 billion in revenue for the last fiscal year, we qualify as an “emerging growth company” pursuant to the Jumpstart Our Business Startups Act of 2012 (as amended by the Fixing America’s Surface Transportation Act of 2015), or the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally to public companies. These provisions include exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, in the assessment of the emerging growth company’s internal control over financial reporting. The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards. However, we have elected to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted for public companies. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.

We will remain an emerging growth company until the earliest of (i) the last day of our fiscal year during which we have total annual gross revenues of at least US$1.07 billion; (ii) the last day of our fiscal year following the fifth anniversary of the completion of this offering; (iii) the date on which we have, during the previous three-year period, issued more than US$1.0 billion in non-convertible debt; or (iv) 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 our 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.

OUR CORPORATE INFORMATION

The principal executive offices of our main operations are located Building 4-6, Chaolai Science Park, No. 36 Chuangyuan Road, Chaoyang District, Beijing, the People’s Republic of China. Our telephone number at this address is +86-10-52413738. Our registered office in the Cayman Islands is located at the offices of Maples Corporate Services Limited at PO Box 309, Ugland House, Grand Cayman KY1-1104, Cayman Islands. Our agent for service of process in the United States is Cogency Global Inc. located at 10 East 40th Street, 10th Floor, New York, N.Y. 10016. Our corporate website is www.sunlands.com. The information contained in our website is not a part of this prospectus.



 

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CONVENTIONS WHICH APPLY TO THIS PROSPECTUS

Unless we indicate otherwise, all information in this prospectus reflects the following:

 

    no exercise by the underwriters of their over-allotment option to purchase up to              additional ADSs representing             Class A ordinary shares from us; and

Except where the context otherwise requires and for purposes of this prospectus only:

 

    “ADSs” refers to the American depositary shares, each representing              of our Class A ordinary shares;

 

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

 

    “Class A ordinary shares” refers to Class A ordinary shares, par value US$0.00005 per share;

 

    “Class B ordinary shares” refers to Class B ordinary shares, par value US$0.00005 per share;

 

    “Class C ordinary shares” refers to Class C ordinary shares, par value US$0.00005 per share;

 

    “gross billings” for a given period refers to the total amount of cash received for the sale of course packages net of the total amount of refunds in such period;

 

    “mobile student acquisition rate” for a given period refers to the total number of orders placed by students acquired by us from mobile marketing channels divided by total new student enrollments;

 

    “number of students” for a given period refers to the total number of orders placed by students which remain in their respective service periods;

 

    “new student enrollments” for a given period refers to the total number of orders placed by students that newly enroll in at least one course during that period (including those students that enroll and then terminate their enrollment with us);

 

    “ordinary shares” prior to the completion of this offering refers to our ordinary shares, par value US$0.00005 per share and, immediately upon and after the completion of this offering, collectively, our Class A ordinary shares, Class B ordinary shares and Class C ordinary shares, par value of US$0.00005 per share;

 

    “preferred shares” refers to series A, series B and series B+ preferred shares of Sunlands Online Education Group, par value US$0.00005 per share;

 

    “RMB” or “Renminbi” refers to the legal currency of the People’s Republic of China;

 

    “service period” for a given student refers to the period covered by the contract between us and such student pursuant to which such student can attend our courses;

 

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

 

    “we,” “us,” “our company,” and “our,” refer to Sunlands Online Education Group, a Cayman Islands company and its subsidiaries and, in the context of describing our operations and consolidated financial information, its consolidated variable interest entity, or VIE.

This prospectus contains information and statistics relating to China’s economy and its education industry derived from various publications issued by market research companies and PRC governmental entities, which have not been independently verified by us, the underwriters or any of their respective affiliates or advisers. The information in such sources may not be consistent with other information compiled in or outside China.

Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this prospectus are made at RMB6.7793 to US$1.00, the exchange rate set forth in the H.10 statistical release of the Federal Reserve Board on June 30, 2017. We make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any particular rate, the rates stated below, or at all. On February 16, 2018, the noon buying rate for Renminbi was RMB6.3438 to US$1.00.



 

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Table of Contents

THE OFFERING

 

Offering price

US$         per ADS.

 

ADSs offered by us

             ADSs (or             ADSs if the underwriters exercise their over-allotment option in full).

 

The ADSs

Each ADS represents             Class A ordinary shares, par value US$0.00005 per share. The depositary will hold the Class A ordinary shares underlying your ADSs. You will have rights as provided in the deposit agreement.

 

  We do not expect to pay dividends in the foreseeable future. If, however, we declare dividends on our Class A ordinary shares, the depositary will pay you the cash dividends and other distributions it receives on our Class A ordinary shares, after deducting its fees and expenses in accordance with the terms set forth in the deposit agreement.

 

  You may turn in your ADSs to the depositary in exchange for Class A ordinary shares. The depositary will charge you fees for any exchange.

 

  We may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs 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.

 

Ordinary shares

We will issue             Class A ordinary shares represented by ADSs in this offering.

 

  We have adopted a triple-class ordinary share structure that will become effective immediately upon the completion of this offering. Our authorized share capital upon the completion of this offering will be US$50,000 divided into 1,000,000,000 shares with a par value of US$0.00005 each, comprising (i) 796,062,195 Class A ordinary shares with a par value of US$0.00005 each, (ii) 826,389 Class B ordinary shares with a par value of US$0.00005 each, and (iii) 203,111,416 Class C ordinary shares with a par value of US$0.00005 each.

 

  All options, regardless of grant dates, will entitle holders to the equivalent number of ordinary shares once the vesting and exercising conditions on such share-based compensation awards are met.


 

8


Table of Contents
  For a description of our ordinary shares, see “Description of Share Capital.”

 

Ordinary shares outstanding immediately after this offering

            Class A ordinary shares (or             Class A ordinary shares if the underwriters exercise their over-allotment option in full), 826,389 Class B ordinary shares, and 4,265,286 Class C ordinary shares, each with a par value US$0.00005 per share.

 

Over-allotment option

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

 

Use of proceeds

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

 

  We plan to use the net proceeds of this offering primarily for the following purposes: (i) approximately US$             million for our course and educational content development, (ii) approximately US$             million for our research and development relating to our IT systems, (iii) approximately US$             million for our marketing and branding activities, (iv) approximately US$             million for potential selective investment and acquisition opportunities, and (v) approximately US$             million for general corporate purpose. See “Use of Proceeds.”

 

Lockup

We[, our directors, executive officers and existing shareholders] have agreed with the underwriters, subject to certain exceptions, not to sell, transfer or dispose of, directly or indirectly, any of ADSs or ordinary shares or securities convertible into or exercisable or exchangeable for ADSs or ordinary shares for a period of 180 days after the date of this prospectus. See “Shares Eligible for Future Sale” and “Underwriting” for more information.

 

NYSE trading symbol

STG

 

Payment and settlement

The underwriters expect to deliver the ADSs against payment therefor through the facilities of The Depository Trust Company on             , 2018.

 

Depositary

The Bank of New York Mellon

 

Directed share program

At our request, the underwriters have reserved for sale, at the initial public offering price, up to an aggregate of              ADSs offered in this offering to our directors, officers, employees, business associates and related persons.

 

Risk factors

See “Risk Factors” and other information included in this prospectus for discussions of the risks relating to investing in the ADSs. You should carefully consider these risks before deciding to invest in the ADSs.


 

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Table of Contents

OUR SUMMARY CONSOLIDATED FINANCIAL DATA AND OPERATING DATA

The following summary consolidated statements of operations data for the years ended December 31, 2015 and 2016, summary consolidated balance sheet data as of December 31, 2015 and 2016 and summary consolidated cash flow data for the years ended December 31, 2015 and 2016 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The following summary consolidated statements of operations for the six months ended June 30, 2016 and 2017, summary consolidated balance sheet data as of June 30, 2017 and summary consolidated cash flows data for the six months ended June 30, 2016 and 2017 have been derived from our unaudited condensed consolidated financial statements included elsewhere in this prospectus and have been prepared on the same basis as our audited consolidated financial statements and include all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the periods presented. Our historical results are not necessarily indicative of results expected for future periods. You should read this Summary Consolidated Financial Data 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 Six Months Ended June 30,  
     2015     2016     2016     2017  
     RMB     RMB     US$     RMB     RMB     US$  
     (in thousands, except for share, per share and per ADS data)  

Net revenues

     159,010       418,910       61,793       174,329       361,463       53,319  

Cost of revenues(1)

     (61,713     (70,986     (10,471     (27,778     (46,179     (6,812
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     97,297       347,924       51,322       146,551       315,284       46,507  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

            

Sales and marketing expenses(1)

     (333,253     (503,643     (74,291     (215,057     (492,795     (72,691

Product development expenses(1)

     (5,189     (13,932     (2,055     (6,401     (11,039     (1,628

General and administrative expenses(1)

     (76,022     (89,390     (13,186     (46,483     (46,879     (6,915

Total operating expenses

     (414,464     (606,965     (89,532     (267,941     (550,713     (81,234
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (317,167     (259,041     (38,210     (121,390     (235,429     (34,727
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income

     814       3,051       450       1,532       4,053       598  

Other income, net

     770       2,423       357       1,404       —         —    

Loss before income tax expenses

     (315,583     (253,567     (37,403     (118,454     (231,376     (34,129

Income tax expenses

     —         —         —         —         —         —    

Net loss from continuing operations

     (315,583     (253,567     (37,403     (118,454     (231,376     (34,129

Net loss from discontinued operations, net of income tax expenses of nil

     (2,719     —         —         —         —         —    

Loss from equity method investment

     —         —         —         —         (398     (59
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (318,302     (253,567     (37,403     (118,454     (231,774     (34,188
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Less: Net loss attributable to noncontrolling interests

     —         —         —         —         (42     (6

Net loss from continuing operations attributable to Sunlands

     (315,583     (253,567     (37,403     (118,454     (231,732     (34,182

Net loss from discontinued operations attributable to Sunlands

     (2,719     —         —         —         —         —    

Net loss per share attributable to ordinary shareholders—basic and diluted

     (83.36     (66.40     (9.79     (31.02     (60.68     (8.95

Income per ADS(2)

            


 

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     For the Year Ended December 31,      For the Six Months Ended June 30,  
     2015      2016      2016      2017  
     RMB      RMB      US$      RMB      RMB      US$  
     (in thousands, except for share, per share and per ADS data)  

Basic

                 

Diluted

                 

 

Notes:

(1)  Share-based compensation expenses included in:

 

     For the Year Ended December 31,      For the Six Months Ended June 30,  
     2015      2016      2016      2017  
     RMB      RMB      US$      RMB      RMB      US$  
     (in thousands)  

Cost of revenues

     —          —          —          —          —          —    

Sales and marketing expenses

     2,014        —          —          —          —          —    

Product development expenses

     —          —          —          —          —          —    

General and administrative expenses

     21,643        —          —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     23,657        —          —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(2)  Each ADS represents              Class A ordinary shares.

The following table presents our selected consolidated balance sheet data as of December 31, 2015 and 2016 and June 30, 2017.

 

     As of December 31,     As of June 30, 2017  
     2015     2016     RMB     US$     US$ Pro
forma(1)
 
     RMB     RMB     US$        
     (in thousands)  

Summary Consolidated Balance Sheet Data:

            

Cash and cash equivalents

     4,446       23,103       3,408       101,048       14,905    

Total assets

     100,098       244,991       36,139       558,215       82,341    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Deferred revenue

     414,077       727,569       107,322       1,269,073       187,198    

Accrued expenses and other current liabilities

     33,765       71,377       10,530       74,671       11,015    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

     471,842       798,946       117,852       1,343,744       198,213    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total mezzanine equity

     —         335,000       49,415       335,000       49,415    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total shareholders’ deficit

     (371,744     (888,955     (131,128     (1,120,529     (165,287  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Notes:

(1) All of the preferred shares will automatically convert into ordinary shares on a one-on-one basis immediately upon the completion of this offering. The unaudited pro forma balance sheet information assumes the automatic conversion of all of the outstanding preferred shares into ordinary shares on a one-to-one basis, as if conversion would have occurred on December 31, 2017.


 

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The following table presents our selected consolidated cash flow data for the years ended December 31, 2015 and 2016 and for the six months ended June 30, 2016 and 2017.

 

     For the Year Ended December 31,     For the Six Months Ended June 30,  
     2015     2016     2016      2017  
     RMB     RMB     US$     RMB      RMB     US$  
     (in thousands)  

Net cash provided by operating activities

     445       89,272       13,169       41,193        267,516       39,461  

Net cash provided by/(used in) investing activities

     (26,508     (117,695     (17,361     8,055        (127,733     (18,842

Net cash provided by/(used in) financing activities

     21,771       47,080       6,944       141,977        (61,838     (9,122

Net (decrease)/increase in cash and cash equivalents

     (4,292     18,657       2,752       191,225        77,945       11,497  

Cash and cash equivalents at beginning of the year/period

     8,738       4,446       656       4,446        23,103       3,408  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Cash and cash equivalents at end of the year/period

     4,446       23,103       3,408       195,671        101,048       14,905  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Selected Quarterly Results of Operations

The following table sets forth our unaudited consolidated quarterly results of operations for the periods indicated. You should read the following table in conjunction with our consolidated financial statements and related notes included elsewhere in this prospectus. We have prepared the unaudited consolidated quarterly financial information on the same basis as our consolidated financial statements. The unaudited consolidated quarterly financial information includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair representation of our operating results for the quarters presented.

 

     For the Three Months Ended  
     March 31,
2016
    June 30,
2016
    September 30,
2016
    December 31,
2016
    March 31,
2017
    June 30,
2017
 
     (RMB in thousands)  

Net revenues

     79,425       94,904       113,392       131,189       155,637       205,826  

Cost of revenues

     (11,697     (16,081     (22,507     (20,701     (19,426     (26,753
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     67,728       78,823       90,885       110,488       136,211       179,073  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

            

Sales and marketing expenses

     (99,140     (115,917     (131,289     (157,297     (210,184     (282,611

Product development expenses

     (3,028     (3,373     (3,569     (3,962     (4,725     (6,314

General and administrative expenses

     (21,855     (24,628     (19,871     (23,036     (21,172     (25,707

Total operating expenses

     (124,023     (143,918     (154,729     (184,295     (236,081     (314,632
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (56,295     (65,095     (63,844     (73,807     (99,870     (135,559
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income

     606       926       846       673       856       3,197  

Other income, net

     1,395       9       198       821       —         —    

Loss before income tax expenses

     (54,294     (64,160     (62,800     (72,313     (99,014     (132,362

Income tax expenses

     —         —         —         —         —         —    

Loss from equity method investment

     —         —         —         —         (348     (50
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (54,294     (64,160     (62,800     (72,313     (99,362     (132,412
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to noncontrolling interests

     —         —         —         —         (12     (30

Net loss attributable to Sunlands

     (54,294     (64,160     (62,800     (72,313     (99,350     (132,382


 

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Non-GAAP Financial Measure

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 course packages, net of the total amount of refunds paid in such period. For more details about our refunds, see “Business—Our Tuition and Fees.” Our management uses gross billings as a performance measurement because we generally bill our students for the entire course tuition at the time of sale of our course packages and recognize revenue proportionally over a period generally ranging from 18 to 36 months (with a weighted average of 21 months) for our degree- or diploma-oriented post-secondary courses and a period generally ranging from six to 24 months (with a weighted average of 17 months) for our professional certification preparation and professional skills courses. We believe that gross billings provide valuable insight into the sales of our course packages and the 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 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 metric 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 gross billings to net revenues for the periods indicated:

 

     For the Year Ended December 31,     For the Six Months Ended June 30,  
     2015     2016     2016     2017  
     RMB     RMB     US$     RMB     RMB     US$  
     (in thousands)  

Net revenues

     159,010       418,910       61,793       174,329       361,463       53,319  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Less: other revenues(1)

     (454     (5,741     (847     (2,340     (2,620     (386

Add: tax and surcharges

     5,517       14,302       2,110       5,699       12,124       1,788  

Add: ending deferred revenue

     414,077       727,569       107,322       553,472       1,269,073       187,198  

Less: beginning deferred revenue

     (132,024     (414,077     (61,080     (414,077     (727,569     (107,322
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross billings (non-GAAP)

     446,126       740,963       109,298       317,083       912,471       134,597  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Note: (1) Including commissions received for providing referral services to third-party education institutions.

 

     For the Three Months Ended  
     March 31,
2016
    June 30,
2016
    September 30,
2016
    December 31,
2016
    March 31,
2017
    June 30,
2017
 
     (RMB in thousands)  

Net revenues

     79,425       94,904       113,392       131,189       155,637       205,826  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Less: other revenues(1)

     (354     (1,986     (1,513     (1,888     (888     (1,732

Add: tax and surcharges

     1,798       3,901       4,064       4,539       5,230       6,894  

Add: ending deferred revenue

     482,718       553,472       628,062       727,569       979,703       1,269,073  

Less: beginning deferred revenue

     (414,077     (482,718     (553,472     (628,062     (727,569     (979,703
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross billings (non-GAAP)

     149,510       167,573       190,533       233,347       412,113       500,358  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Note: (1) Including commissions received for providing referral services to third-party education institutions.



 

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Adjusted net loss represents net loss before share-based compensation expenses. The table below sets forth a reconciliation of our net loss and adjusted net loss for the periods indicated:

 

     For the Year Ended December 31,     For the Six Months Ended June 30,  
     2015     2016     2016     2017  
     RMB     RMB     US$     RMB     RMB     US$  
     (in thousands)  

Net loss

     (318,302     (253,567     (37,403     (118,454     (231,774     (34,188

Add: Share-based compensation expenses

     23,657       —         —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net loss

     (294,645     (253,567     (37,403     (118,454     (231,774     (34,188
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Key Operating Data

The following table presents our key operating data for the periods indicated:

 

     For the Year Ended
December 31,
    For the Six Months Ended
June 30,
 
     2015     2016     2016     2017  

New student enrollments

     179,172       188,733       89,066       148,573  

Gross billings per new student enrollment (RMB)

     2,489.9       3,926.0       3,560.1       6,141.6  

Marketing effectiveness ratio(1)

     28.3     24.8     24.8     22.1

Number of students

     205,806       382,805       286,899       407,960  

 

Note: (1) Calculated by dividing our marketing spending by our gross billings.

 

     For the Three Months Ended  
     March 31,
2016
    June 30,
2016
    September 30,
2016
    December 31,
2016
    March 31,
2017
    June 30,
2017
 

New student enrollments

     43,090       45,976       49,952       49,715       66,555       82,018  

Gross billings per new student enrollment (RMB)

     3,469.7       3,644.8       3,814.3       4,693.7       6,192.1       6,100.6  

Marketing effectiveness ratio(1)

     24.8     24.8     24.7     25.0     22.1     22.1

Number of students

     246,051       260,591       283,125       299,765       328,351       365,764  

 

Note: (1) Calculated by dividing our marketing spending by our gross billings.



 

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RISK FACTORS

You should consider carefully all of the information in this prospectus, including the risks and uncertainties described below and our consolidated financial statements and related notes, before making an investment in our ADSs. Any of the following risks and uncertainties could have a material adverse effect on our business, financial condition, results of operations and prospects. The market price of our ADSs could decline significantly as a result of any of these risks and uncertainties, and you may lose all or part of your investment.

Risks Related to Our Business

If we fail to increase student enrollments, our net revenues may decline, and we may not be able to maintain growth.

 

We generate revenue primarily from the tuition we collect from our students. It is critical for us to enroll prospective students in a cost-effective manner. Some of the factors, many of which are largely beyond our control, could prevent us from successfully increasing enrollment of new students in a cost-effective manner, or at all. These factors include, among other things, (i) reduced interest in the degrees, diplomas, professions or certifications for which our course offerings are designed; (ii) negative publicity or perceptions regarding us, or online education services in general; (iii) the emergence of alternative course delivery models; (iv) the inability of students to pay the tuition; (v) increasing market competition, particularly price reductions by competitors that we are unable or unwilling to match; and (vi) adverse changes in relevant government policies or general economic conditions. If one or more of these factors reduce market demand for our services, our student enrollments could be negatively affected or our costs associated with student acquisition and retention could increase, or both, any of which could materially affect our ability to grow our gross billings and net revenues. These developments could also harm our brand and reputation, which would negatively impact our ability to expand our business.

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 gross billings and net revenues in recent years, primarily driven by our fast-growing student enrollments since our transition to an online course delivery model in 2014 which allows students to access our courses from anywhere connected to the internet. Our net revenues grew by 163.4% from approximately RMB159.0 million in 2015 to RMB418.9 million (US$61.8 million) in 2016 and by 107.3% from RMB174.3 million in the six months ended June 30, 2016 to RMB361.5 million (US$53.3 million) in the six months ended June 30, 2017. Over the same periods, our gross billings grew by 66.1% from approximately RMB446.1 million to RMB741.0 million (US$109.3 million) and by 187.8% from RMB317.1 million to RMB912.5 million (US$134.6 million).

Our rapid growth has placed, and will continue to place, a significant strain on our sales and marketing capacities, administrative and operating infrastructure, facilities and other resources. To maintain our growth, we need to continue to acquire more students, scale up our course offerings, increase our academic and administrative faculty, as well as strengthen our platforms and systems. We will also be required to refine 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 students and qualified academic and administrative faculty in a cost-effective manner, respond to competitive challenges, or otherwise execute our business plans. In addition, we may, as part of carrying out our growth strategies, adopt new initiatives to offer additional course packages 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 education service may suffer, which could damage our reputation and business prospect.

 

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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) identify and effectively market our products and services in new markets with sufficient growth potential; (ii) develop and improve course offerings and educational contents to make them appealing to existing and prospective students, particularly working adult students; (iii) maintain and increase our student enrollments; (iv) effectively recruit, train and motivate a large number of new employees, including our faculty members and sales and marketing personnel; (v) successfully implement enhancements and improvements to the systems and platforms; (vi) continue to improve our operational, financial and management controls and efficiencies; (vii) protect and further develop our intellectual property rights; and (viii) 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. Our growth in a relatively short period of time is not necessarily indicative of results that we may achieve in the future. 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 RMB318.3 million, RMB253.6 million (US$37.4 million) and RMB231.8 million (US$34.2 million) in 2015 and 2016 and for the six months ended June 30, 2017, respectively. We cannot assure you that we will be able to generate net profits in the future.

We expect that our sales and marketing expenses will continue to increase as we invest in branding and sales and marketing efforts, including hiring additional sales and marketing personnel, investing in data analytics in the student counseling and sales process, and broadening our online marketing channels. In addition, we intend to continue to invest heavily for the foreseeable future in increasing our market share, improving the capacity of our technology infrastructure to better support an even larger student base and to offer additional courses and educational content.

These efforts may be more costly than we expect and our net revenues may not increase sufficiently to offset these expenses. We may continue to take actions and make investments that do not generate optimal short-term financial results and may even result in increased operating 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.

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 rely heavily on our sales and marketing efforts to increase student enrollments. Our sales and marketing expenses primarily include employee salaries and student acquisition expenses. We incurred approximately RMB333.3 million, RMB503.6 million (US$74.3 million) and RMB492.8 million (US$72.7 million), respectively, in sales and marketing expenses in 2015 and 2016 and for the six months ended June 30, 2017. We expect our sales and marketing expenses to continue to increase in the future as we further expand our operations.

Our sales and marketing activities may not be well received by the market and may not result in the levels of sales that we anticipate. We also may not be able to retain or recruit a sufficient number of experienced sales and marketing personnel, or to train newly hired sales and marketing personnel, which we believe is critical to implementing our sales and marketing strategies cost-effectively. Further, sales and marketing approaches and tools in China’s online education market are evolving rapidly. This requires us to continually enhance our sales and marketing approaches and experiment with new methods to keep pace with industry developments and student preferences. Moreover, our sales and marketing activities may be deemed to violate PRC laws and regulations, and we may be exposed to administrative penalties, such as paying fines or publishing explanatory notes to limit the adverse effects of our marketing efforts. If we are deemed guilty of significant infringements, we may be ordered to cease sales and marketing activities temporarily and our business license may be revoked.

 

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Failure to engage in sales and marketing activities in a compliant and cost-effective manner may reduce our market share, cause our revenues and gross billings to decline, negatively impact our profitability, and materially harm our business, financial condition and results of operation.

We may be adversely affected by any negative publicity concerning us and our business, shareholders, affiliates, directors, officers and employees and the industry in which we operate, regardless of its accuracy, that could harm our reputation and business.

Negative publicity about us and our business, shareholders, affiliates, directors, officers, and teachers and other employees, as well as the industry in which we operate, can harm our operations. We have been exposed to negative publicity concerning refund dispute and administrative penalty and alledged improper or misleading statement made in our sales and marketing activities in the past. Negative publicity concerning these parties could be related to a wide variety of matters, including, but are not limited to:

 

    alleged misconduct or other improper activities committed by our students or our directors, officers, and teachers and other employees, including misrepresentation made by our employees to potential students during sales and marketing activities;

 

    false or malicious allegations or rumors about us or our directors, shareholders, affiliates, officers, and teachers and other employees;

 

    complaints by our students about our education services and sales and marketing activities;

 

    tuition refund disputes between us and our students or administrative penalties;

 

    security breaches of confidential student or employee information;

 

    employment-related claims relating to alleged employment discrimination, wage and hour violations; and

 

    governmental and regulatory investigations or penalties resulting from our failure to comply with applicable laws and regulations.

In addition to traditional media, there has been an increasing use of social media platforms and similar devices in China, including instant messaging applications, such as Weixin/WeChat, 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, directors, officers and employees may be posted on such platforms at any time. The risks associated with any such negative publicity or incorrect information cannot be completely eliminated or mitigated and may materially harm our reputation, business, financial condition and results of operations.

We face risks associated with our lack of a private school operating permit for our online education services as well as uncertainties surrounding PRC laws and regulations governing the education industry in general, including the Law for Promoting Private Education and its Implementation Rules.

Beijing Sunlands, through which we operate our online education business, currently does not hold a private school operating permit for our online education services, and we may be subject to risks of administrative sanctions due to our lack of such permit.

Pursuant to the Administrative Regulations on Educational Websites and Online and Distance Education Schools promulgated by the Ministry of Education of the PRC, or the MOE, on July 5, 2000, “educational websites and online education schools” that provide educational services in relation to higher education, elementary education, pre-school education, teaching education, occupational education, adult and other education and public educational information services, are subject to approval from competent education authorities, depending on the type of education service provided. In February 2016, the State Council issued a government decision which explicitly withdrew the above-mentioned approval requirement. See “Regulation—

 

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Regulations on Online and Distance Education.” On November 7, 2016, China’s National People’s Congress passed an amendment to the Promotion of Private Education Law, or the Amendment, which became effective on September 1, 2017. The Amendment applies different regulatory requirements to non-profit and for-profit private schools. See “Regulation—Regulation Relating to Private Education—The Law for Promoting Private Education and its Implementing Rules.”

In December 2016, several PRC government agencies, including the MOE, the State Administration for Industry and Commerce, or the SAIC, and the Ministry of Human Resources and Social Welfare, jointly promulgated the Implementation Rules on the Supervision and Administration of For-profit Private Schools, or the Implementation Rules. Under the Implementation Rules, the establishment, division, merger or any other material change in a for-profit private school shall be approved by the competent education authorities or the authorities in charge of labor and social welfare and be registered with the competent local branch of SAIC, and a duly approved private school will be granted a private school operating permit. The Implementation Rules also provide that the provisions contained therein should be applicable to “for-profit private training institutions” in an analogous manner. See “Regulations—Regulation Relating to Private Education—The Law for Promoting Private Education and its Implementing Rules. ”

As of the date of this prospectus, we have not received any notice of warning or been subject to any penalties or disciplinary action from government authorities due to our lack of a private school operating permit for our online education services. In addition, we have made inquiries to the relevant education authorities and were informed that online education service providers were not required to obtain a private school operating permit for the provision of online education services, and that if such educational authorities were to require us to obtain a private school operating permit in the future, such authorities would not subject us to penalties for the provision of our services without obtaining a private school operating permit. Nonetheless, as advised by Tian Yuan Law Firm, our PRC legal counsel, the current PRC laws and regulations, including the Amendment and the Implementation Rules, remain unclear as to whether the requirement for a private school operating permit is applicable to an online education service provider. We cannot assure you that the PRC government will not in the future require us to obtain a private school operating permit, given the lack of clear and consistent statutory interpretation regarding the implementation of the Amendment and the Implementation Rules and other relevant laws and regulations. If the PRC government requires us to obtain a private school operating permit or introduces additional amendments and guidelines to expand the coverage of the Amendment to explicitly cover online education service providers, and if we fail to do so, we may be subject to fines up to five times the illegitimate gains generated from the provision of training services without a proper license, other administrative sanctions, such as being ordered to refund tuition payments to the students, or criminal liabilities, for our lack of a private school operating permit. We may also be subject to regulatory requirements that are more stringent than the ones currently applicable to us, including those relating to sales and marketing, courses and educational content offerings, teachers’ qualification, as well as tuition fee rates and tuition refund policies, or laws and regulations that require us to obtain and maintain additional licenses and permits, and we may incur substantial expenses or alter or change our business to comply with these requirements.

Under the Amendment and the Implementation Rules, a material change in a for-profit private school shall be approved by the competent education authorities or the authorities in charge of labor and social welfare before it can be registered with the competent local branch of SAIC. If we were required to expand the authorized scope of our business license to cover our business of online education services, which shall be registered with the SAIC, to comply with applicable licensing requirements, we may not able to do so before we have obtained a private school operating permit. If any of the foregoing were to happen, our business operations may be disrupted, and our financial condition, results of operations and reputation may be materially and adversely affected.

We face regulatory risks and uncertainties associated with our teachers lack of teaching licenses.

Pursuant to the Implementation Rules, the teachers employed by a for-profit private school shall obtain the teaching licenses or relevant professional skill qualifications required by PRC laws and regulations, although the

 

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definition or the scope of the “relevant professional skill qualifications” is not explicitly stated in the Implementation Rules. A substantial majority of our teachers currently do not hold teaching licenses.

As of the date of this prospectus, we have not received any notice of warning or been subject to any penalties or disciplinary action from government authorities due to the lack of teaching licenses. As advised by Tian Yuan Law Firm, our PRC legal counsel, the current PRC laws and regulations, including the Amendment and the Implementation Rules, remain unclear as to whether the Implementation Rules is applicable to an online education service provider like us, and accordingly, whether our teachers are required to obtain and hold teaching licenses. We cannot assure you that the PRC government authorities will not take a contrary view. In the event that in the future our teachers are required by laws to obtain teaching licenses, we cannot assure you that they can meet the requirements for applying for teaching licenses. If our teachers are not able to apply for and obtain the teaching licenses on a timely basis, or at all, we may be ordered to rectify such noncompliance or subject to penalties under the then-effective PRC laws and regulations, in which case our business may be disrupted, and our financial condition, reputation and prospects would be materially and adversely affected.

We face regulatory risks and uncertainties with respect to the licensing requirement for the online transmission of internet audio-visual programs.

On December 20, 2007, the State Administration of Press Publication Radio Film and Television, or SAPPRFT, and the Ministry of Industry and Information Technology, or the MIIT, jointly promulgated the Administrative Provisions on Internet Audio Visual Program Services, or the Audio Visual Program Provisions, which became effective on January 31, 2008 and were amended on August 28, 2015. Among other things, the Audio Visual Program Provisions stipulate that no entities or individuals may provide Internet audio-visual program services without a License for Online Transmission of Audio-Visual Programs issued by SAPPRFT or completing the relevant filing with SAPPRFT or its local bureaus, and only state-owned or state-controlled entities are eligible to apply for a License for Online Transmission of Audio Visual Programs. On April 1, 2010, SAPPRFT promulgated the Provisional Implementations of Tentative Categories of Internet Audio Visual Program Services, or the Categories, which clarified the scope of Internet audio-visual programs services, which was amended on March 10, 2017. According to the Categories, there are four categories of Internet audio-visual program services which are further divided into seventeen sub-categories. Sub-category No. 3 to the second category covers the making and editing of certain specialized audio-visual programs concerning, among other things, educational content, and broadcasting such content to the general public online. Sub-category No. 5 of the first category and sub-category No. 7 of the second category cover the live broadcasting of important political, martial, economic, social, cultural, sports activities or events or general social or community cultural activities, sports games and other organized activities. However, there are still significant uncertainties relating to the interpretation and implementation of the Audio Visual Program Provisions, in particular, the scope of “internet audio-visual programs.” See “Regulations—Regulations Relating to Online Transmission of Audio-Visual Programs.”

We deliver our courses in live streaming format. Our teachers and students communicate and interact live with each other via our virtual learning community. The audio and video data are transmitted through the platforms between specific recipients instantly without any further redaction. We believe the nature of the raw data we transmit distinguishes us from general providers of internet audio-visual program services, such as the operator of online video websites, and the provision of the Audio-Visual Program Provisions are not applicable with regard to our offering of the courses. However, we cannot assure you that the competent PRC government authorities will not ultimately take a view contrary to our opinion. In addition, we also offer video recordings of live streaming courses and certain other audio-video contents on our online platforms to our students as supplementary course materials on our platforms. If the government authorities determine that our offering of the courses fall within the relevant category of Internet audio-visual program services under the Categories, we may be required to obtain the License for Online Transmission of Audio Visual Programs.

The Categories describe “Internet audio-visual program services” in a very broad, vague manner and are unclear as to whether online courses, whether delivered in a live streaming format or through video recordings,

 

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fall into the definition of audio-visual programs. We have made inquiries to the relevant bureaus of SAPPRFT and were informed that online educational content provided through live streaming or recorded courses does not fall within the scope of internet audio-visual programs, the transmission of which does not require a License for Online Transmission of Audio-Visual Programs. We cannot assure you that the PRC government will not ultimately take a view that live streaming or recorded courses or any other content offered on our platforms are subject to the Audio Visual Program Provisions. We currently do not hold a License for Online Transmission of Audio Visual Programs, and since we are not a state-owned or state-controlled entity, we are not eligible to apply for such license. If the PRC government determines that our content should be considered as “internet audio-visual programs” for the purpose of the Audio-Visual Program Provisions, we may be required to obtain a License for Online Transmission of Audio Visual Programs. We are, however, not eligible 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 live streaming courses. As of the date of this prospectus, we have not received any notice of warning or been subject to penalties or other disciplinary action from the relevant governmental authorities regarding the lack of a License for Online Transmission of Audio Visual Programs in conducting of our business.

Our failure to obtain and maintain other approvals, licenses or permits applicable to our business could have a material adverse impact on our business, financial conditions and results of operations.

A number of PRC regulatory authorities, such as the SAIC, the Cyberspace Administration of China, the MITT, the SAPPRFT, and the State Council Information Office, the Ministry of Civil Affairs, and the Ministry of Human Resources and Social Welfare, oversee different aspects of our business operations, and we are required to obtain a wide range of government approvals, licenses and permits in connection with our operations.

We currently do not hold several approvals, licenses and permits that are required for certain aspects of our business operations. Under the current PRC laws and regulations, the provision of our educational content through our online platform may be considered “online publishing” and may require us to obtain an Internet Publishing License, which we currently do not have. See “Regulations—Regulations Relating to Online Publishing.” As of the date of this prospectus, we have submitted an application to the competent government authorities for the approval of an Internet Publishing License. However, we may not be able to receive the approval for such licenses in a timely manner, or at all. In addition, we do not have the Job Agency Service License required for the job referral services we provide to some of our students as an ancillary part of their course packages.

Furthermore, Beijing Sunlands, our consolidated VIE, and certain of its operating subsidiaries currently do not include “occupational training” and “educational facilitation services” in their authorized scope of business. Before the Amendment was issued, we attempted to apply to the competent authorities in Beijing to add “occupational training” and “educational facilitation services” to the authorized scope of business of Beijing Sunlands, but our application was rejected by such authorities without being provided any formal explanations for such rejection. After the issuance of the Amendment, based on our consultation with the competent government authorities, such government authorities currently may not accept applications for inclusion of “occupational training,” “educational facilitation services” or similar items in the scope of business of companies that do not hold a private school operating permit. For additional information about the private school operating permit, see “—We face risks associated with our lack of a private school operating permit for our online education services as well as uncertainties surrounding PRC laws and regulations governing the education industry in general, including the Law for Promoting Private Education and its Implementation Rules.” Even if our application were to be accepted, there is no assurance that it will be approved by the government authorities in a timely fashion, or at all. If it comes to the attention of the government authorities that Beijing Sunlands is operating beyond its authorized scope of business, we may be subject to fines, confiscation of the gains derived from the noncompliant operations, or may be required to cease Beijing Sunlands’ noncompliant operations.

As of the date of this prospectus, we have not been subject to any fines or other form of regulatory or administrative penalties or sanctions due to the lack of any the above-mentioned approvals, licenses or permits.

 

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However, we cannot guarantee that the government authorities will not impose any penalties or sanctions on us in the future, which may include warnings, fines, mandates to remedy any violations, confiscation of the gains derived from the services for which approvals, licenses or permits are required, and/or an order to cease to provide such services. In addition, we cannot guarantee that the government will not promulgate new laws and regulations that require additional licenses, permits and/or approvals for the operation of any of our existing or future business. If we are unable to obtain such licenses, permits, or approvals in a timely fashion, we could be subject to penalties and operational disruption and our financial condition and results of operations could be adversely affected.

We have a limited history of operating as an online education service provider.

We have been a part of China’s education industry since we commenced operations in August 2003. Although we started exploring online course delivery model in 2011, we remained an offline, classroom-based education service provider until we transitioned to an online education model in 2014. Our limited history of operating as an online education service provider may not serve as an adequate basis for evaluating our future prospect and operating results, including gross billings, net revenue, cash flows and profitability. We have encountered, and may continue to encounter in the future, risks, challenges and uncertainties associated with operating an internet-based business, such as building and managing reliable and secure IT systems and infrastructure, addressing regulatory compliance and uncertainty, and hiring and training IT support staff, all of which we have limited experience with. In addition, we may be faced with additional risks and challenges associated with responding to the increasing mobile penetration in China. If we do not manage these risks successfully, our operating and financial results may differ materially from our expectations and our business may suffer.

We may not be able to continue to recruit, train and retain a sufficient number of qualified faculty members.

Our faculty members are key to the quality of our educational services, as well as our brand and reputation. Our ability to continue to attract faculty members, including teachers and mentors, with necessary experience and qualifications is a key driver in the success of our business. We seek to recruit qualified faculty members who are dedicated to teaching and are able to communicate with our students in an interactive online setting.

Additionally, given the interactive nature of our live streaming lessons, we tend to hire teachers and mentors with strong education background and good communication skills enabling them to engage and interact with students. The market for recruitment of faculty members in China is competitive. In order to recruit qualified full-time teachers and mentors, we must provide candidates with competitive compensation packages and offer attractive career development opportunities. Although we have not experienced major difficulties in recruiting or training qualified teachers and mentors in the past, we cannot guarantee we will be able to continue to recruit, train and retain a sufficient number of qualified faculty members in the future as we continue to expand our course offerings and business scale, which may have a material adverse effect on our business, financial condition and results of operations.

We may not be able to timely improve or expand our course and educational content offerings in a cost-effective manner to make them appealing to existing and prospective students, or at all.

We regularly and constantly update our existing courses and educational content and develop new courses and educational content to meet student’s demand and the latest market trends. The revisions, improvements and expansions of our existing course and content offerings and the development of new course and content offerings may not be accepted by existing or prospective students. Even if we are able to develop acceptable new course and educational content offerings, we may not be able to introduce them as quickly as students require or as quickly as our competitors introduce competing offerings. The process of performing detailed market research and recruiting qualified faculty for new course and educational content offerings could be costly and time-consuming. Furthermore, offering new courses or content or upgrading existing ones may require us to make significant investments in educational content development, increase sales and marketing efforts and reallocate

 

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resources from other uses, all of which may not be successful. If we are unsuccessful in pursuing course and educational content development and upgrading opportunities due to the financial constraints, failure to attract qualified faculty, or other factors, our ability to attract and retain students could be impaired and our financial results could suffer.

We face risks associated with our online live streaming course delivery model.

The online live streaming industry in China remains relatively young and untested, and there are limited proven methods to project user demand or preference or available industry standards on which we can rely. In the PRC, few institutions with large student enrollments have in the past adopted a live streaming course delivery model, and some of our target students may be inclined to choose traditional face-to-face lessons offered by offline learning centers as they find more familiar and reliable. We cannot assure you that our live streaming course delivery format will continue to be attractive to our students in the future. If our live streaming course delivery model becomes less appealing to our students, our business and prospects may be affected. In addition, as we continue to increase our student enrollments, there is no assurance that our live streaming capacity will be able to support a growing number of students accessing our courses online without any service interruptions. Furthermore, we cannot assure that we will be able to address PRC regulatory and legislative developments relating to online streaming business.

We rely on third-party service providers to support our online live streaming course delivery.

Currently, we rely upon certain third-party vendors to provide live streaming services to support our online course delivery. Because the live streaming technologies and infrastructure are owned and managed by third parties, any problems with the reliability and performance of such technologies and infrastructure could result in unanticipated delays and unscheduled service interruption could further cause us to be unable to deliver our courses in a live streaming format, forcing us to resort to using prerecorded lectures. Our inability to deliver live streaming courses during service interruptions may damage the quality of our education service and student engagement and experience and negatively impact our reputation, financial condition and results of operations.

We do not maintain long-term arrangements with our live streaming service providers. The term of the service agreements we enter into with third-party live streaming service providers are generally one year. If we cannot renew such agreements upon their expirations or terminations on commercially reasonable terms, or at all, or if the live streaming service providers become unwilling or unable to provide us with live streaming services at any time for any reasons, our ability to deliver live streaming online courses will be severely impacted, and our students’ learning experience and our reputation will be harmed.

We are currently in the process of developing our own proprietary live streaming platforms and applications, which are expected to be completed in 2018. There is, however, no assurance that we will succeed. If the development of proprietary live streaming technologies does not achieve the anticipated results, we may have to continue to rely on third-party vendors to provide us with the technologies and infrastructure necessary for the delivery of our online livestreaming courses, which may negatively impact our business and prospects.

Failure to adequately and promptly respond to changes in the exams our students must take to pursue their desired degrees, diplomas or certifications could cause our education services to be less attractive to our students.

There have been continuous changes in the curriculum requirements associated with, and the format of, the exams our existing and prospective students must take to pursue their desired degrees, diplomas or certifications, the manner in which the exams are administered, as well as topics frequently tested in the exams. These changes require us to continually update and enhance our course offerings, our educational content and our teaching methods. Any inability to track and respond to these changes in a timely and cost-effective manner would make our education services less attractive to students, which may materially and adversely affect our reputation and

 

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ability to continue to attract students without a significant decrease in our tuition. In addition, as we further expand our course offerings, we cannot assure that we will be able to adapt our existing educational content and methods to new courses that we have limited experience in teaching.

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

In 2015, we launched 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. 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 between the borrowing student and the lending credit provider, the borrowing student is obligated to repay the loan principal in installments over a period ranging from three to 12 months. Under the cooperation agreement between us and each credit provider, we are obligated to pay the full amount of interest payable under a loan, as financial service fees, to the credit provider. We generally do not provide any guarantees for the repayment of student loans in favor of the credit providers. In 2015 and 2016 and for the six months ended June 30, 2017, 4.8%, 32.3% and 68.2%, respectively, of our gross billings were received from third-party credit providers. For the same periods, we made interest payments of RMB2.0 million, RMB20.2 million (US$3.0 million) and RMB39.4 million (US$5.8 million), respectively, to the credit providers.

As part of our long-term sales and marketing strategy, we plan to continue to make the interest payments for our students under their loans and pay service fees to the credit providers, which may place significant strains on our financial resources as our student enrollments continue to grow. We may be subject to risks associated with an increase in interest rates to the extent that we continue to make interest payments for the loans taken by our students. If we cease to do so due to increases in interest rates or for other reasons, our course packages may become more costly for our students to purchase, which could in turn negatively impact our business, financial condition and reputation.

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.

Disruption to or failures of our IT infrastructure could reduce student satisfaction and could harm our operations.

The performance and reliability of our IT infrastructure is critical to our operations and reputation. We provide our course offerings and educational content to our students and faculty primarily through our applications and platforms built upon Genesis, our proprietary IT infrastructure. In addition, our employees, including our faculty and sales and marketing personnel, rely on our integrated IT infrastructure to carry out their marketing, sales, operation and teaching functions. As part of their educational experience, our students interact with their peers and our faculty via our platforms on a frequent basis. Accordingly, any errors, defects, disruptions or other performance problems with our IT infrastructure could damage our reputation, decrease student satisfaction and retention, adversely impact our ability to attract new students and expand our course offerings, and materially disrupt our operations. If any of these occur, our business operations, reputation and prospects could be harmed.

 

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Our business depends on the continued success of our brand “Sunlands,” and if we fail to maintain and enhance recognition of our brand, we may face difficulty enrolling new students, and our reputation and operating results may be harmed.

We believe that market awareness of our brand “Sunlands” has contributed significantly to the success of our business. Maintaining and enhancing our brand are critical to our efforts to grow our student enrollments and gross billings. Failure to maintain and enhance our brand recognition could have a material and adverse effect on our business, operating results and financial condition. We have devoted significant resources to our brand promotion efforts in recent years, but we cannot assure you that these efforts will be successful. If we are unable to further enhance our brand recognition, or if we incur excessive marketing and promotion expenses, or if our brand image is negatively impacted by any negative publicity, our business and results of operations may be materially and adversely affected.

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 course and educational content offerings, which may adversely affect our business, financial condition, results of operations and reputation.

The success of our business depends on our ability to deliver high-quality learning experiences and help students achieve their learning objectives. We may not always be able to meet our students’ expectations in terms of academic performance due to a variety of reasons, many of which are outside of our control. We may face increased dropout rates and student dissatisfaction due to our students’ perceptions of our failure to help them achieve their anticipated academic goals, our students’ overall dissatisfaction with the quality of our course and educational content offerings and our faculty, as well as changing views of the value of the diplomas, degrees and qualifications they are pursuing through taking our courses. These factors may contribute to reduced student engagement and increased challenges in attracting and enrolling prospective students, all of which may adversely affect our prospects, business, financial condition, results of operations and reputation.

We face risks associated with our reliance on our STE course offerings, including risks resulting from changes in government policies or requirements relating to STE exams.

Our course offerings are concentrated to our STE course offerings, namely post-secondary courses designed for students pursuing associate diplomas or bachelor’s degrees by taking the STE exams. STE course offerings represent a significant portion of our net revenues, gross billings and new student enrollments. Our STE course offerings accounted for approximately 57.4%, 66.3% and 76.8%, respectively, of our net revenues and approximately 71.0%, 79.0% and 86.9%, respectively, of our gross billings in 2015, 2016 and the six months ended June 30, 2017. During the same periods, our STE course offerings accounted for approximately 55.4%, 61.7% and 77.0%, respectively, of our new student enrollments.

Our reliance on STE course offerings may expose us to concentration risks. If there are significant reductions in the perceived value of degrees or diplomas our students are pursuing through the STE exams, or if the PRC government releases substantial updates to the requirements or formats of the STE exams and we are unable to upgrade our course or educational content offerings to address such developments in a timely manner, the demand for and attractiveness of our STE course offerings may be adversely affected, which could have an adverse impact on our financial condition and results of operations.

If we fail to effectively identify, pursue and consummate strategic alliances or acquisitions, our ability to grow and to achieve profitability could be impacted.

We may from time to time engage in evaluations of, and discussions with, possible domestic and international acquisition or alliance candidates. We may not be able to identify suitable strategic alliances or acquisition opportunities, complete such transactions on commercially favorable terms, or successfully integrate

 

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business operations, infrastructure and management philosophies of acquired businesses and companies. There may be particular complexities, regulatory or otherwise, associated with our expansion into new markets, and our strategies may not succeed beyond our current markets. If we are unable to effectively address these challenges, our ability to execute acquisitions as a component of our long-term strategy will be impaired, which could have an adverse effect on our growth.

We face intense competition in our industry, which could divert student to our competitors, lead to pricing pressure and loss of market share, and significantly reduce our gross billings and net revenues.

China’s post-secondary and professional education market is intensely competitive. We compete with other online education service providers or traditional offline players, for student enrollments and engagement, high-quality academic and administrative faculty, and sales and marketing personnel, among other things. Some of our current and future competitors may have substantially greater name recognition and financial and other resources than we do, which may enable them to compete more effectively for potential students and decrease our market share. We also expect to face competition as a result of new entrants to the post-secondary and professional education market.

We may not be able to compete successfully against current or future competitors and may face competitive pressures that could adversely affect our business or results of operations. For example, increased competition may result in pricing pressure for us in terms of the tuition we are able to negotiate to receive from a student. In addition, online education is characterized by rapid changes in students’ technological requirements and expectations and evolving market standards, and our competitors may develop platforms or other technologies that are superior to the platform and technology we use. These differences may affect our ability to recruit and retain students, which may render our online delivery format less competitive. The increasingly competitive landscape may also result in longer and more complex sales cycles with a prospective student or a decrease in our market share, any of which could negatively affect our gross billings and net revenues and our ability to grow our business.

If our security measures are breached or fail and result in unauthorized disclosure of data by our employees or our third-party agents, we could lose existing students, fail to attract new students and be exposed to protracted and costly litigation.

Maintaining platform security is of critical importance to our students because the platform stores and transmits proprietary and confidential information, which may include sensitive personally identifiable information that may be subject to stringent legal and regulatory obligations. As an online education service provider, we face an increasing number of threats to our IT infrastructure, including unauthorized activity and access by our employees or third-party agents, system viruses, worms, malicious code and organized cyberattacks, which could breach our security and disrupt our business. For example, we have introduced data security and confidentiality protocols into the cooperation agreements we enter into with third-party sales agents with whom we share prospective students’ contact information, and we have made technical improvements in our IT infrastructure to prevent unauthorized access of confidential or sensitive personal information by our employees and third-party sales agents in the process of engaging prospectus students. These measures, however, may not be as effective as we anticipate. In addition, there is no assurance that our third-party sales agents will comply with contractual and legal requirements with respect to data privacy when they collect data from our prospective students. If our security measures are breached or fail as a result of third-party action, employee error, malfeasance or otherwise, we could be subject to liability or our business could be interrupted, potentially over an extended period of time. Any or all of these issues could harm our reputation, adversely affect our ability to attract and enroll prospective students, 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 against the threat of these disruptions and security breaches or to alleviate problems caused by such disruptions or breaches.

 

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Privacy concerns could limit our ability to collect and leverage our user data and disclosure of user data could adversely impact our business and reputation.

In the ordinary course of our business and in particular in connection with conducting sales and marketing activities with our existing and prospective students, we collect and utilize data supplied by our users. We currently face certain legal obligations regarding the manner in which we treat such information. Increased regulation of data utilization practices, including self-regulation or findings under existing laws that limit our ability to collect, transfer and use data, could have an adverse effect on our business. In addition, if we were to disclose data about our users 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. Internationally, we may become subject to additional and/or more stringent legal obligations concerning our treatment of customer and other personal information, such as laws regarding data localization and/or restrictions on data export. 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.

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

We offer different tuition refund options to our students depending on the time of enrollment and subject to certain conditions and restrictions in the service contract between us and each of our students. Generally, a student is offered a full, unconditional refund within 24 hours upon enrollment. If the student makes a refund request after taking at least one trial course lasting 30 minutes by reason of any material academic issue of our courses within certain refund period, we would offer such student a partial refund excluding the registration fees and the relevant academic fees for the trial lesson upon our confirmation. In addition, at our discretion, a partial refund may also be granted to the student who withdraws at any other time during his or her enrollment, subject to special approval by us. When 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 course packages for such period. See “Business—Our Tuition and Fees.”

In 2015 and 2016 and the six months ended June 30, 2017, we had made RMB53.7 million, RMB61.3 million (US$9.0 million) and RMB53.2 million (US$7.8 million) of refund payments, respectively. 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 course and educational content offerings, privacy concerns relating to our online platforms, 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 education providers like us. See “We face risks associated with our lack of private school operating permit for our online education services as well as uncertainties surrounding PRC laws and regulations governing the education industry, including the Law for Promoting Private Education and its Implementing Rules. ”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 gross billings, net revenues, liquidity and financial condition. A high volume of refunds and refund disputes may also generate negative publicity that could harm our reputation. We have experienced in the past, and may experience in the future, negative publicity in relation to refund disputes between us and our students, which may significantly harm our brand name and divert our attention from operating our business.

Our success depends on the continuing efforts of our senior management team and other key employees.

We depend on the continued contributions of our senior management and other key employees, including, in particular, Mr. Jianhong Yin, also known as Peng Ou, our founder and the chairman of our Board of Directors, and Mr. Tongbo Liu, our director and Chief Executive Officer. The loss of the services of any of our senior management or other key employees could harm our business. Competition for qualified talents in China is

 

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intense. If one or more of our senior management or other key employees are unable or unwilling to continue in their present positions, we may not be able to find replacements in a timely manner, or at all, and our business may be disrupted. Moreover, if any member of our senior management team or any of our other key personnel joins a competitor or forms or invests in a competing business, we may lose student enrollments, qualified teaching faculty members and other key sales and marketing personnel to our competitors. Our future success is also dependent on our ability to attract a significant number of qualified employees and retain existing key employees. If we are unable to do so, our business and growth may be materially and adversely affected. Our need to significantly increase the number of our qualified employees and retain key employees may cause us to materially increase compensation-related costs, including share-based compensation.

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 innovations and has roots in a deep understanding of our students and 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 from time to time be subject to infringement claims relating to intellectual properties of third parties.

We cannot assure you that our course offerings and educational contents and our IT technologies and platforms do not or will not infringe upon copyrights or other intellectual property rights held by third parties. We may encounter disputes from time to time over rights and obligations concerning intellectual properties, and we may not prevail in those disputes.

We have adopted policies and procedures to prohibit our students and employees from infringing upon third-party copyright or intellectual property rights. However, we cannot ensure that they will not, against our policies, use third-party copyrighted materials or intellectual property without proper authorization in our classes or via any medium through which we provide our services. We may incur liability for unauthorized duplication or distribution of materials posted on our websites or used in our classes. We have been involved in claims against us alleging our infringement of third-party intellectual property rights and we may be subject to such claims in the future. For example, our quiz banks designed for students pursuing the STE exams contain a pool of over 973,000 quizzes as of December 31, 2017, and we have not entered into any licensing arrangements with, or otherwise obtained any consent from, the government agencies administering the STE exams for using these questions. Although we have never been subject to any legal or administrative penalties or proceedings relating to our use of these sample questions, we cannot assure you that we will not be subject to infringement claims associated with our use of real STE questions in the future. Any such intellectual property infringement claim could result in costly litigation and divert our management attention and resources, which in turn could negatively affect our business, financial condition and prospect.

If we fail to protect our intellectual property rights, our brand and business may suffer.

We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. Although we seek to obtain copyright or patent protection for our intellectual property when applicable, it is possible that we may not be able to do so successfully or that the copyright or patent we have obtained may not be sufficient to protect all of our intellectual property rights. In particular, we rely, to the great extent, upon our educational content developed in-house, including course syllabi and outlines, quiz banks, teaching notes, and learning outcomes trees, to provide high-quality online education services. Despite our efforts to protect our proprietary education contents and other intellectual property rights, unauthorized parties may attempt to copy or duplicate our intellectual property or otherwise use our intellectual

 

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properties without obtaining our consent. Monitoring unauthorized use of our intellectual property is difficult and costly, and we cannot be certain that the steps we have taken will effectively prevent misappropriation of our intellectual properties. If we are not successful in protecting our intellectual property rights, our business and results of operations may be adversely affected.

Our students, employees and third-party vendors may engage in intentional or negligent misconduct or other improper activities or misuse our platform, which could harm our brand and reputation.

We are exposed to the risk of fraud or other misconducts committed by our students, employees and vendors, including certain third-party sales and marketing agencies. For example, in some instances, our students and our faculty members may post to our platform articles or other third-party content for use in class discussions. The PRC laws governing the fair use of these third-party materials are imprecise and adjudicated on a case-by-case basis, which makes it challenging for us to adopt and implement policies governing these practices. We could, as a result, incur liability to third parties for the unauthorized duplication, distribution or other use of these materials. Any such claims could subject us to costly litigation and impose a significant strain on our financial resources and attention of management personnel regardless of whether the claims have merit. Additionally, we may be required to alter or cease our uses of such materials, which may include changing or removing content from courses or altering the functionality of our platform, or to pay monetary damages. Fraud or other misconducts by our students, employees or third parties may also involve engaging in unauthorized misrepresentation to our potential students and misappropriating third-party intellectual property and other propitiatory rights during marketing activities, misusing sensitive personal information of our students, and engaging in bribery or other unlawful payments, any of which could result in customer complaints, regulatory and legal liabilities, as well as serious harm to our brand and reputation.

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.

Our user metrics and other estimates are subject to inaccuracy in measuring our operating performance, which may harm our reputation.

We continually review number of students, new student enrollments, gross billings per new student enrollment, and other operating metrics to evaluate growth trends, measure our performance and make strategic decisions. These metrics are calculated using internal data, have not been validated by an independent third party and may not be indicative of our future operating performance. While these numbers are based on what we believe to be reasonable estimates for the applicable period of measurement, there are inherent challenges in measuring how our website and mobile application are used across a large student base. For example, we may not be able to identify individual students who have multiple accounts from multiple students who share one account on our website or mobile application. In addition, we collect student reviews to measure student

 

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satisfaction rate and other student engagement metrics, but these reviews may not be representative of our entire student population. Errors or inaccuracies in our metrics or data could result in incorrect business decisions and inefficiencies. For instance, if a significant understatement or overstatement of student satisfaction or student acquisition costs were to occur, we might expend resources to implement unnecessary business measures or fail to take required actions to remedy an unfavorable trend. If investors do not perceive our operating metrics to accurately represent our operating performance, or if we discover material inaccuracies in our operating metrics, our reputation may be harmed.

If we fail to implement and maintain an effective system of internal controls, we may be unable to accurately or timely report our results of operations or prevent fraud, and investor confidence and the market price of our ADSs may be materially and adversely affected.

Prior to this offering, we were a private company with limited accounting personnel and other resources with which to address our internal controls and procedures. Our management has not completed an assessment of the effectiveness of our internal control over financial reporting, and our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting. In the course of auditing our consolidated financial statements as of December 31, 2016 and for the year ended December 31, 2016, we and our independent registered public accounting firm identified two material weaknesses in our internal control over financial reporting and other control deficiencies as of December 31, 2016. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The material weaknesses identified relate to (i) the lack of sufficient financial reporting and accounting personnel with appropriate knowledge of U.S. GAAP, and (ii) lack of comprehensive accounting policies and procedures manual in accordance with U.S. GAAP. We have taken measures and plan to continue to take measures to remedy these material weaknesses. For details, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Internal Control over Financial Reporting.” The implementation of these measures may not fully address the material weaknesses in our internal control over financial reporting, and we cannot conclude that they have been fully remedied. Our failure to correct theses material weaknesses or our failure to discover and address any other material weaknesses could result in inaccuracies in our financial statements and could also impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis.

Upon the completion of this offering, we will 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, will require 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, 2018. 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 controls 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, after we become 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 weaknesses and 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 accordance with Section 404.

 

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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 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 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. However, we have elected to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted for public companies. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.

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.

We have granted, and may continue to grant, share incentives, which may result in increased share based compensation expenses.

We adopted an equity incentive plan in October 2017, or the 2017 Plan, 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.

We account for compensation costs for all share-based awards using a fair-value based method and recognize expenses in our consolidated statements of comprehensive income in accordance with U.S. GAAP. Under the 2017 Plan, we are authorized to grant options, restricted stock units and other types of awards the administrator of the 2017 Plan decides. Under the 2017 Plan, the maximum aggregate number of shares which may be issued pursuant to all awards is 483,846 shares. As of the date of this prospectus, options to purchase a total of 61,253 ordinary shares were outstanding under the 2017 Plan. We believe the granting of share-based

 

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awards is of significant importance to our ability to attract and retain key personnel and employees, and we will continue to grant share-based awards in the future. As a result, our expenses associated with share-based compensation may increase, which may have an adverse effect on our 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. 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.

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

The currently effective PRC Labor Contract Law was first adopted on June 29, 2007 and 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.

In addition, we are required by PRC laws and regulations to make social insurance registration and open housing fund account with relevant governmental authorities and pay various statutory employee benefits, including pensions, housing fund, medical insurance, work-related injury insurance, unemployment insurance and maternity insurance to designated government agencies for the benefit of our employees. The relevant government agencies may examine whether an employer has made adequate payments of the requisite statutory employee benefits, and those employers who fail to make adequate payments may be subject to late payment fees, fines and/or other penalties. If we fail to make adequate social insurance and housing fund contributions, we may be subject to fines and legal sanctions, and our business, financial condition and results of operations may be adversely affected. 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 increasing the prices of our products and services, our financial conditions and results of operations would be materially and adversely affected.

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

We lease real properties from third parties primarily for our office use in China, and the lease agreements for most of these leased properties have not been registered with the PRC governmental authorities as required

 

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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 approximately 125 of our lease agreements that have not been registered with the relevant PRC governmental authorities.

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 imposed fines on us due to our failure to register any of our lease agreements, which may negatively impact our financial condition.

We lease real properties from third parties in China for marketing and providing offline consultation related to our online services for potential students or existing students. 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.

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. Our platform regularly serves a large number of users and advertisers. 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 platform. 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 access fees or other charges to internet users increase, our user traffic may decline and our business may be harmed.

We currently do not have any business insurance coverage.

Insurance companies in China currently do not offer as extensive an array of insurance products as insurance companies in more developed economies. Currently, we do not have any business liability or disruption insurance to cover our operations. 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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We face risks related to natural disasters, extreme weather conditions, health epidemics and other catastrophic incidents, which could significantly disrupt our operations.

China has in the past experienced significant natural disasters, including earthquakes, extreme weather conditions, as well as health scares related to epidemic diseases, and any similar event could materially impact our business in the future. If a disaster or other disruption were to occur in the future that affects the regions where we operate our business, our operations could be materially and adversely affected due to loss of personnel and damages to property. Even if we are not directly affected, such a disaster or disruption could affect the operations or financial condition of our ecosystem participants, which could harm our results of operations.

In addition, our business could be affected by public health epidemics, such as the outbreak of avian influenza, severe acute respiratory syndrome, or SARS, Zika virus, Ebola virus or other disease. If any of our employees is suspected of having contracted a contagious disease, we may be required to apply quarantines or suspend our operations. Furthermore, any future outbreak may restrict economic activities in affected regions, resulting in reduced business volume, temporary closure of our offices or otherwise disrupt our business operations and adversely affect our results of operations.

Risks Related to Our Corporate Structure

If the PRC government finds that the agreements that establish the structure for operating some 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 investment in the value-added telecommunication services industry in China is extensively regulated and subject to numerous restrictions. Pursuant to the Foreign Investment Industries Guidance Catalog (2017 Revisions), or the Guidance Catalog, with a few exceptions, foreign investors are not allowed to own more than 50% of the equity interests in a value-added telecommunication service provider and any such foreign investor must have experience in providing value-added telecommunications services overseas and maintain a good track record.

We are a Cayman Islands company and our wholly-owned PRC subsidiaries are currently considered foreign-invested enterprise. Accordingly, our PRC subsidiaries are not eligible to provide value-added telecommunication services in China. To ensure strict compliance with the PRC laws and regulations, we conduct such business activities through Beijing Sunlands, our consolidated variable interest entity, or VIE, and its subsidiaries. Wuhan Zhibo, our wholly owned subsidiary in China, has entered into a series of contractual arrangements with our VIE, its shareholders and certain of our VIE’s subsidiaries, which enable us to (i) exercise effective control over our VIE, (ii) receive substantially all of the economic benefits of our VIE, and (iii) have an exclusive option to purchase all or part of the equity interests and assets in our VIE when and to the extent permitted by PRC law. As a result of these contractual arrangements, we have control over and are the primary beneficiary of our VIE and hence consolidate its financial results as our VIE under U.S. GAAP. See “Corporate History and Structure” for further details.

If the PRC government finds that our contractual arrangements do not comply with its restrictions on foreign investment in the value-added telecommunication services, or if the PRC government otherwise finds that we, our VIE, or any of its subsidiaries are in violation of PRC laws or regulations or lack the necessary permits or licenses to operate our business, the relevant PRC regulatory authorities, including the MIIT and SAIC, would have broad discretion in dealing with such violations or failures, including, without limitation:

 

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

 

    discontinuing or placing restrictions or onerous conditions on our operation through any transactions between our PRC subsidiary and our VIE;

 

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    imposing fines, confiscating the income from our PRC subsidiary or our VIE, or imposing other requirements with which we or our VIE may not be able to comply;

 

    requiring us to restructure our ownership structure or operations, including terminating the contractual arrangements with our VIE and deregistering the equity pledges of our VIE, which in turn would affect our ability to consolidate, derive economic interests from, or exert effective control over our VIE; or

 

    restricting or prohibiting our use of the proceeds of this offering to finance our business and operations in China.

Any of these actions 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 any of these occurrences results in our inability to direct the activities of our VIE that most significantly impact its economic performance and/or our failure to receive the economic benefits from our VIE, we may not be able to consolidate the entity in our consolidated financial statements in accordance with U.S. GAAP.

Our business may be significantly affected by the Draft Foreign Investment Law, if implemented as proposed.

On January 19, 2015, the PRC Ministry of Commerce, or MOFCOM, published the Draft Foreign Investment Law. At the same time, MOFCOM published an accompanying explanatory note of the draft Foreign Investment Law, which contains important information about the draft Foreign Investment Law, including its drafting philosophy and principles, main table of contents, plans to transition to the new legal regime and treatment of business in China controlled by foreign invested enterprises. The Draft Foreign Investment Law proposes significant changes to the PRC foreign investment legal regime and, when implemented, may have a significant impact on businesses in China controlled by foreign invested enterprises primarily through contractual arrangements, such as our business. Please refer to “Regulation—Regulations Relating to Foreign Investment” for further details. MOFCOM solicited comments on the Draft Foreign Investment Law in 2015, but no new draft has been published since then. There is substantial uncertainty with respect to its final content, interpretation, adoption timeline and effective date. It is anticipated, however, that the draft Foreign Investment Law will reflect regulations on variable interest entities. MOFCOM suggests both registration and approval as potential options for the regulation of variable interest entity structures, depending on whether they are “Chinese” or “foreign controlled.” One of the core concepts of the draft Foreign Investment Law is “de facto control,” which emphasizes substance over form in determining whether an entity is “Chinese” or “foreign-controlled. ” “Chinese investors” are individuals who are Chinese nationals, Chinese government agencies and any domestic enterprise controlled by Chinese nationals or government agencies. “Foreign investors” are foreign citizens, foreign governments, international organizations and entities controlled by foreign citizens and entities.

It is unclear whether our current corporate structure will be considered “Chinese” under the scheme of the Draft Foreign Investment Law, though the fact that two Chinese nationals, Mr. Peng Ou and Mr. Tongbo Liu, jointly own a majority of our outstanding shares increases the likelihood that we will be treated as a Chinese controlled company. In the event that our contractual arrangements under which we operate our value-added telecommunication services are not treated as a domestic investment and/or our operation of online education services are classified as a “prohibited business” in the Prohibited List under the Draft Foreign Investment Law when officially enacted, such contractual arrangements may be deemed as invalid and illegal and we may be required to unwind the contractual arrangements and/or dispose of such business.

We rely on contractual arrangements with our VIE and its shareholders for a large portion of 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 Beijing Sunlands, or our VIE, its shareholders and certain of its subsidiaries to operate our online education services business in China. These contractual arrangements may not be as effective as direct ownership in providing us with control over our

 

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VIE. For example, our VIE and its shareholders could breach their contractual arrangements with us by, among other things, failing to conduct their operations in an acceptable manner or taking other actions that are detrimental to our interests. The revenues contributed by our VIE and its subsidiaries constituted substantially all of our net revenues in 2015, 2016 and the first half of 2017.

If we had direct ownership of our VIE, we would be able to exercise our rights as a shareholder to effect changes in the board of directors of our VIE, 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 VIE and its shareholders of their obligations under the contracts to exercise control over our VIE. The shareholders of our consolidated VIE 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 portions of our business through the contractual arrangements with our VIE. If any disputes relating to these contracts remain 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. Therefore, our contractual arrangements with our VIE 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 VIE or its shareholders to perform their obligations under our contractual arrangements with them would have a material and adverse effect on our business.

If our VIE or its 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 claiming damages, which we cannot assure will be effective under PRC law. For example, if the shareholders of our VIE refuse to transfer their equity interest in our VIE to us or our designee if we exercise the purchase option pursuant to these contractual arrangements, or if they otherwise act in bad faith toward us, then we may have to take legal actions to compel them to perform their contractual obligations. In addition, if any third parties claim any interest in such shareholders’ equity interests in our VIE, our ability to exercise shareholders’ rights or foreclose the share pledge according to the contractual arrangements may be impaired. If these or other disputes between the shareholders of our VIE and third parties were to impair our control over our VIE, our ability to consolidate the financial results of our VIE would be affected, which would in turn result in a material adverse effect on our business, operations and financial condition.

Our contractual arrangements are governed by PRC law. Accordingly, these contracts would be interpreted in accordance with PRC law, and any disputes would be resolved in accordance with PRC legal procedures.

The legal system in the PRC is not as developed as in 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 VIE 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, which would require additional expenses and delay. In the event we are unable to enforce these contractual arrangements, or if we suffer significant delays or other obstacles in the process of enforcing these contractual arrangements, we may not be able to exert effective control over our VIE, and our ability to conduct our business may be negatively affected.

 

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The shareholders of our VIE 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 VIE may have actual or potential conflicts of interest with us. These shareholders may refuse to sign or breach, or cause our VIE to breach, or refuse to renew, the existing contractual arrangements we have with them and our VIE, which would have a material and adverse effect on our ability to effectively control our VIE and receive economic benefits from it. For example, the shareholders may be able to cause our agreements with our VIE 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. If we cannot resolve any conflict of interest or dispute between us and these shareholders, 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 VIE may be subject to scrutiny by the PRC tax authorities and they may determine that we or our VIE 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 within ten years after the taxable year when the transactions are conducted. We could face material and adverse tax consequences if the PRC tax authorities determine that the VIE contractual arrangements 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 the income of our VIE 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 VIE for PRC tax purposes, which could in turn increase its tax liabilities without reducing our PRC subsidiary’s tax expenses. In addition, the PRC tax authorities may impose late payment fees and other penalties on our VIE for the adjusted but unpaid taxes according to the applicable regulations. Our financial position could be materially and adversely affected if our VIE’s tax liabilities increase or if it is required to pay late payment fees and other penalties.

We may lose the ability to use, or otherwise benefit from, the licenses, approvals and assets held by our VIE, which could severely disrupt our business, render us unable to conduct some or all of our business operations and constrain our growth.

As part of our contractual arrangements with our VIE, our VIE holds certain assets, licenses and permits that are material to our business operations, such as the ICP License and the License for the Production and Operation of Radio and Television Program. The contractual arrangements contain terms that specifically obligate VIE’s shareholders to ensure the valid existence of the VIE and restrict the disposal of material assets of the VIE. However, in the event the VIE’s shareholders breach the terms of these contractual arrangements and voluntarily liquidate our VIE, or our VIE declares bankruptcy and all or part of its assets become subject to liens or rights of third-party creditors, or are otherwise disposed of without our consent, we may be unable to conduct some or all of our business operations or otherwise benefit from the assets held by the VIE, which could have a material adverse effect on our business, financial condition and results of operations. Furthermore, if our VIE undergoes a voluntary or involuntary liquidation proceeding, its shareholders or unrelated third-party creditors may claim rights to some or all of the assets of the VIE, thereby hindering our ability to operate our business as well as constrain our growth.

Certain of our existing shareholders have substantial influence over our company, and their interests may not be aligned with the interests of our other stockholders.

Mr. Peng Ou, our founder and the chairman of our Board of Directors, owns approximately 45.3% of our voting power and Mr. Tongbo Liu, our director and our Chief Executive Officer, owns approximately 16.8% of

 

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our voting power as of the date of this prospectus, on a fully diluted basis. In addition, immediately upon the completion of this offering, Mr. Peng Ou, Mr. Tongbo Liu and certain of our senior management and employees will collectively beneficially own all of our issued and outstanding Class C ordinary shares which will constitute approximately % of the aggregate voting power of our total issued and outstanding share capital immediately upon the completion of this offering, assuming the underwriters do not exercise their over-allotment option. In addition, upon the completion of this offering, up to 120,394 ordinary shares reserved and issuable upon the exercise of options granted pursuant to our equity incentive plan adopted in October 2017 shall be, upon issuance of such ordinary shares, designated as Class C ordinary shares, the voting power of which will be held by certain of our senior employees. See “ - Risks Related to the ADSs and This Offering - Our triple-class share structure with different voting rights will limit your ability to influence corporate matters and could discourage others from pursuing any change of control transactions that holders of our Class A ordinary shares and ADSs may view as beneficial.” As a result, Mr. Peng Ou, Mr. Tongbo Liu and certain of our senior management and employees have significant influence over our business, including decisions regarding mergers, consolidations, liquidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. This concentration of ownership may also have the effect of discouraging, delaying or preventing a future change of control, which could deprive our stockholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ADSs.

Risks Related to Doing Business in China

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

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

While the Chinese economy has experienced significant growth over past decades, growth has been uneven, both geographically and among various sectors of the economy. Any adverse changes in economic conditions in China, in the policies of the Chinese 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 a reduction in demand for our services and adversely affect our competitive position. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures may benefit the overall Chinese economy, but may have a negative effect on us. For example, our financial condition 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 Chinese government has implemented certain measures, including interest rate adjustment, to control the pace of economic growth. These measures may cause decreased economic activity in China, which may adversely affect our business and operating results.

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

The PRC legal system is a civil law system based on written statutes. Unlike the common law system, prior court decisions under the civil law system may be cited for reference but have limited precedential value.

 

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In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general. The overall effect of legislation over the past three decades has significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system, and recently enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, the interpretation and enforcement of these laws and regulations involve uncertainties. Since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory provisions and contractual terms, it may be difficult to evaluate the outcome of administrative and court proceedings and the level of legal protection we enjoy. These uncertainties may affect our judgment on the relevance of legal requirements and our ability to enforce our contractual rights or tort claims. In addition, the regulatory uncertainties may be exploited through unmerited or frivolous legal actions or threats in attempts to extract payments or benefits from us.

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 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.

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 a company incorporated under the laws of the Cayman Islands, we conduct substantially all of our operations in China, and substantially all of our assets are located in China. In addition, all our senior executive officers reside within China for a significant portion of the time and most are PRC nationals. As a result, it may be difficult for our shareholders to effect service of process upon us or those persons inside China. In addition, China does not have treaties providing for the reciprocal recognition and enforcement of judgments of courts with the Cayman Islands and many other countries and regions. Therefore, recognition and enforcement in China of judgments of a court in any of these non-PRC jurisdictions in relation to any matter not subject to a binding arbitration provision may be difficult or impossible.

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 for services of any debt we may incur. Our PRC subsidiary’s ability to distribute dividends is based upon its distributable earnings. Current PRC regulations permit our PRC subsidiaries to pay dividends to its respective shareholders only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, each of our PRC subsidiary, our VIE and its subsidiaries are required to set aside at least 10% of its after-tax profits each year, if any, to fund a statutory reserve until such reserve reaches 50% of its registered capital. Each of our PRC subsidiaries as a Foreign Invested Enterprise, or FIE, is also required to further set aside a portion of its after-tax profits to fund the employee welfare fund, although the amount to be set aside, if any, is determined at its discretion. These reserves are not distributable as cash dividends. If our PRC subsidiaries incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other payments to us. Any limitation on the ability of our PRC subsidiaries to distribute dividends or other payments to their respective shareholders could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our businesses, 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

 

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unless otherwise 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.

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 industry and commerce 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 consolidated VIEs. 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.

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

Any funds we transfer to our PRC subsidiary, either as a shareholder loan or as an increase in registered capital, are subject to approval by or registration with relevant governmental authorities in China. According to the relevant PRC regulations on foreign-invested enterprises, or FIEs, in China, capital contributions to our PRC subsidiaries are subject to the approval of or filing with the MOFCOM or its local branches and registration with a local bank authorized by the State Administration of Foreign Exchange, or SAFE. In addition, (i) any foreign loan procured by our PRC subsidiaries is required to be registered with SAFE or its local branches and (ii) our PRC subsidiaries may not procure loans which exceed the difference between its total investment amount and registered capital. For the restriction and limitation on the amount of loans, please see “Regulation—Regulations on loans to and direct investment in the PRC entities by offshore holding companies” for details. Any medium or long-term loan to be provided by us to our VIE must be registered with the NDRC and the SAFE or its local branches. We may not be able to complete such registrations on a timely basis, with respect to future capital contributions or foreign loans by us to our PRC subsidiary. If we fail to complete such registrations, our ability to use the proceeds of this offering and to capitalize our PRC operations may be negatively affected, which could adversely affect our liquidity and our ability to fund and expand our business.

On March 30, 2015, the SAFE promulgated the Circular on Reforming the Management Approach Regarding the Foreign Exchange Capital Settlement of Foreign-Invested Enterprises, or SAFE Circular 19, which took effect as of June 1, 2015. SAFE Circular 19 launched a nationwide reform of the administration of the settlement of the foreign exchange capitals of FIEs and allows FIEs to settle their foreign exchange capital at their discretion, but continues to prohibit FIEs from using the Renminbi fund converted from their foreign exchange capital for expenditure beyond their business scopes, providing entrusted loans or repaying loans between nonfinancial enterprises. The SAFE issued the Circular on Reforming and Regulating Policies on the Control over Foreign Exchange Settlement of Capital Accounts, or SAFE Circular 16, effective in June 2016.

 

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Pursuant to SAFE Circular 16, enterprises registered in China may also convert their foreign debts from foreign currency to Renminbi on a self-discretionary basis. SAFE Circular 16 provides an integrated standard for conversion of foreign exchange under capital account items (including but not limited to foreign currency capital and foreign debts) on a self-discretionary basis which applies to all enterprises registered in China. SAFE Circular 16 reiterates the principle that Renminbi converted from foreign currency-denominated capital of a company may not be directly or indirectly used for purposes beyond its business scope or prohibited by PRC laws or regulations, while such converted Renminbi shall not be provided as loans to its non-affiliated entities. As this circular is relatively new, there remains uncertainty as to its interpretation and application and any other future foreign exchange related rules. Violations of these Circulars could result in severe monetary or other penalties. SAFE Circular 19 and SAFE Circular 16 may significantly limit our ability to use Renminbi converted from the net proceeds of this offering to fund the establishment of new entities in China by our VIE or its subsidiaries, to invest in or acquire any other PRC companies through our PRC subsidiaries, or to establish new consolidated VIEs in China, which may adversely affect our business, financial condition and results of operations.

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

The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions and the foreign exchange policy adopted by the PRC government. On July 21, 2005, the PRC government changed its policy of pegging the value of the Renminbi to the U.S. dollar. Following the removal of the U.S. dollar peg, the Renminbi appreciated more than 20% against the U.S. dollar over the following three years. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the Renminbi and the U.S. dollar remained within a narrow band. Since June 2010, the Renminbi has started to appreciate slowly against the U.S. dollar, though there have been periods when the U.S. dollar has appreciated against the RMB. On August 11, 2015, the PBOC allowed the Renminbi to depreciate by approximately 2% against the U.S. dollar. Since then and until the end of 2016, the Renminbi has depreciated against the U.S. dollar by approximately 10%. It is difficult to predict how long such depreciation of RMB against the U.S. dollar may last and when and how the relationship between the RMB and the U.S. dollar may change again.

All of our revenue and substantially all of our costs are denominated in Renminbi. We are a holding company and we rely on dividends paid by our operating subsidiaries in China for our cash needs. Any significant revaluation of Renminbi may materially and adversely affect our results of operations and financial position reported in Renminbi when translated into U.S. dollars, and the value of, and any dividends payable on, the ADSs in U.S. dollars. 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. 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.

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

The PRC government imposes controls on the convertibility of the Renminbi into foreign currencies and, in certain cases, the remittance of currency out of China. We receive substantially all of our revenues in Renminbi. Under our current corporate structure, our Cayman Islands holding company primarily relies on dividend payments from our 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 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

 

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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 VIE 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. The PRC government may at its discretion restrict access to foreign currencies for current account transactions in the future. If the foreign exchange control system prevents us from obtaining sufficient foreign currencies to satisfy our foreign currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs.

Certain PRC regulations may make it more difficult for us to pursue growth through acquisitions.

Among other things, the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rules, adopted by six PRC regulatory agencies in 2006 and amended in 2009, established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex. Such regulation requires, among other things, that the MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor acquires control of a PRC domestic enterprise or a foreign company with substantial PRC operations, if certain thresholds under the Provisions on Thresholds for Prior Notification of Concentrations of Undertakings, issued by the State Council in 2008, are triggered. Moreover, the Anti-Monopoly Law promulgated by the Standing Committee of the NPC which became effective in 2008 requires that transactions which are deemed concentrations and involve parties with specified turnover thresholds must be cleared by the MOFCOM before they can be completed. In addition, PRC national security review rules which became effective in September 2011 require acquisitions by foreign investors of PRC companies engaged in military related or certain other industries that are crucial to national security be subject to security review before consummation of any such acquisition. We may pursue potential strategic acquisitions that are complementary to our business and operations. Complying with the requirements of these regulations to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval or clearance from the 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.

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

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, to replace the Notice on Relevant Issues Concerning Foreign Exchange Administration for Domestic Residents’ Financing and Roundtrip Investment Through Offshore Special Purpose Vehicles, or SAFE Circular 75, which ceased to be effective upon the promulgation of SAFE Circular 37. SAFE Circular 37 requires PRC residents (including PRC individuals and PRC corporate entities) to register with SAFE or its local branches in connection with their direct or indirect offshore investment activities. 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.

Under SAFE Circular 37, PRC residents who make, or have prior to the implementation of SAFE Circular 37 made, direct or indirect investments in offshore special purpose vehicles, or SPVs, will be required to register such investments with SAFE or its local branches. In addition, any PRC resident who is a direct or indirect shareholder of an SPV is required to update its filed registration with the local branch of SAFE with respect to that SPV, to reflect any material change. Moreover, any subsidiary of such SPV in China is required to urge the PRC resident shareholders to update their registration with the local branch of SAFE. If any PRC shareholder of

 

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such SPV fails to make the required registration or to update the previously filed registration, the subsidiary of such SPV in China may be prohibited from distributing its profits or the proceeds from any capital reduction, share transfer or liquidation to the SPV, and the SPV may also be prohibited from making additional capital contributions into its subsidiary in China. On February 13, 2015, the SAFE promulgated a Notice on Further Simplifying and Improving Foreign Exchange Administration Policy on Direct Investment, or SAFE Notice 13, which became effective on June 1, 2015. Under SAFE Notice 13, applications for foreign exchange registration of inbound foreign direct investments and outbound overseas direct investments, including those required under SAFE Circular 37, will be filed with qualified banks instead of SAFE. The qualified banks will directly examine the applications and accept registrations under the supervision of SAFE.

Most of our shareholders that we are aware of being subject to SAFE regulations, and we expect all of these shareholders will have completed all necessary registrations with the local SAFE branch or qualified banks as required by SAFE Circular 37 immediately before the completion of this offering. We cannot assure you, however, that all of these individuals may continue to make required filings or updates on a timely manner, or at all. We can provide no assurance that we are or will in the future continue to be informed of identities of all PRC residents holding direct or indirect interest in our company. Any failure or inability by such individuals to comply with SAFE regulations may subject us to fines or legal sanctions, such as restrictions on our cross-border investment activities or our PRC subsidiary’s ability to distribute dividends to, or obtain foreign exchange-denominated loans from, our company or prevent us from making distributions or paying dividends. As a result, our business operations and our ability to make distributions to you could be materially and adversely affected.

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

Any failure to comply with PRC regulations regarding the registration requirements for employee stock incentive plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.

In February 2012, 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 who participate in any stock incentive plan of an overseas publicly listed company, subject to a few exceptions, 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. 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 who reside in the PRC for a continuous period of not less than one year and who have been granted options will be subject to these regulations when our company becomes an overseas-listed company upon the completion of this offering. Failure to complete the SAFE registrations may subject them to fines and legal sanctions, there may be additional restrictions on the ability of them to exercise their stock options or remit proceeds gained from sale of their stock into the PRC. 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—Regulations on Foreign Exchange—Regulations on Stock Incentive Plans.”

 

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

Under the PRC Enterprise Income Tax Law and its implementation rules, an enterprise established outside of the PRC with its “de facto management body” within the PRC is considered a “resident enterprise” and will be 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 SAT, issued a circular, known as 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 the 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 the PRC; (ii) decisions relating to the enterprise’s financial and human resource matters are made or are subject to approval by organizations or personnel in the PRC; (iii) the enterprise’s primary assets, accounting books and records, company seals, and board and shareholder resolutions are located or maintained in the PRC; and (iv) at least 50% of voting board members or senior executives habitually reside in the PRC.

We believe our company is not 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 is a PRC resident enterprise for enterprise income tax purposes, we will be subject to PRC enterprise income on our worldwide income at the rate of 25%. Furthermore, we 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 our ADS holders) may be subject to PRC tax on gains realized on the sale or other disposition of ADSs or ordinary shares, if such income is treated as sourced from within the PRC. Furthermore, if we are deemed a PRC resident enterprise, dividends paid to our non-PRC individual shareholders (including our ADS holders) and any gain realized on the transfer of ADSs or ordinary shares by such shareholders may be subject to PRC tax at a rate of 20% (which, in the case of dividends, may be withheld at source by us). These rates may be reduced by an applicable tax treaty, but 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 ordinary shares.

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

On February 3, 2015, the SAT issued the Public Notice Regarding Certain Corporate Income Tax Matters on Indirect Transfer of Properties by Non-Tax Resident Enterprises, or SAT Bulletin 7. SAT Bulletin 7 extends its tax jurisdiction to transactions involving the transfer of taxable assets through offshore transfer of a foreign intermediate holding company. In addition, SAT Bulletin 7 has introduced safe harbors for internal group restructurings and the purchase and sale of equity through a public securities market. SAT Bulletin 7 also brings challenges to both foreign transferor and transferee (or other person who is obligated to pay for the transfer) of taxable assets.

On October 17, 2017, the SAT issued the Announcement 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

 

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into effect on December 1, 2017. The SAT Bulletin 37 further clarifies the practice and procedure of the withholding of non-resident enterprise income tax.

Where a non-resident enterprise transfers taxable assets indirectly by disposing of the equity interests of an overseas holding company, which is an Indirect Transfer, the non-resident enterprise as either transferor or transferee, or the PRC entity that directly owns the taxable assets, may report such Indirect Transfer to the relevant tax authority. Using a “substance over form” principle, the PRC tax authority may disregard the existence of the overseas holding company if it lacks a reasonable commercial purpose and was established for the purpose of reducing, avoiding or deferring PRC tax. As a result, gains derived from such Indirect Transfer may be subject to PRC 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. Both the transferor and the transferee may be subject to penalties under PRC tax laws if the transferee fails to withhold the taxes and the transferor fails to pay the taxes.

We face uncertainties as to the reporting and other implications of certain past and future transactions where PRC taxable assets are involved, such as offshore restructuring, sale of the shares in our offshore subsidiaries and investments. Our company may be subject to filing obligations or taxed if our company is transferor in such transactions, and may be subject to withholding obligations if our company is transferee in such transactions, under SAT Bulletin 7 and/or SAT Bulletin 37. For transfer of shares in our company by investors who are non-PRC resident enterprises, our PRC subsidiaries may be requested to assist in the filing under SAT Bulletin 7 and/or SAT Bulletin 37. As a result, we may be required to expend valuable resources to comply with SAT Bulletin 7 and/or SAT Bulletin 37 or to request the relevant transferors from whom we purchase taxable assets to comply with these circulars, or to establish that our company should not be taxed under these circulars, which may have a material adverse effect on our financial condition and results of operations.

The audit report included in this prospectus is prepared by an auditor who is not inspected by the Public Company Accounting Oversight Board and, as such, you are deprived of the benefits of such inspection.

Our independent registered public accounting firm that issues the audit report included in this prospectus, as an auditor of companies that are traded publicly in the United States and a firm registered with the Public Company Accounting Oversight Board, or the PCAOB, is required by the laws of the United States to undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards. Since our auditors are located in China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities, our auditors are not currently inspected by the PCAOB.

Inspections of other firms that the PCAOB has conducted outside of China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. The lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating our auditors’ audits and its quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.

The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditors’ audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.

Proceedings instituted by the SEC against Chinese affiliates of the “big four” accounting firms, including our independent registered public accounting firm, could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act.

Starting in 2011 the Chinese affiliates of the “big four” accounting firms, including our independent registered public accounting firm, were affected by a conflict between U.S. and Chinese law. Specifically, for

 

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certain U.S.-listed companies operating and audited in mainland China, the SEC and the PCAOB sought to obtain from the Chinese firms access to their audit work papers and related documents. The firms were, however, advised and directed that under Chinese law, they could not respond directly to the U.S. regulators on those requests, and that requests by foreign regulators for access to such papers in China had to be channeled through the CSRC.

In late 2012, this impasse led the SEC to commence administrative proceedings under Rule 102E of its Rules of Practice and also under the Sarbanes-Oxley Act of 2002 against the Chinese accounting firms, including our independent registered public accounting firm. A first instance trial of the proceedings in July 2013 in the SEC’s internal administrative court resulted in an adverse judgment against the firms. The administrative law judge proposed penalties on the firms including a temporary suspension of their right to practice before the SEC, although that proposed penalty did not take effect pending review by the Commissioners of the SEC. On February 6, 2015, before a review by the Commissioner had taken place, the firms reached a settlement with the SEC. Under the settlement, the SEC accepts that future requests by the SEC for the production of documents will normally be made to the CSRC. The firms will receive matching Section 106 requests, and are required to abide by a detailed set of procedures with respect to such requests, which in substance require them to facilitate production via the CSRC. If they fail to meet specified criteria, the SEC retains authority to impose a variety of additional remedial measures on the firms depending on the nature of the failure. Remedies for any future noncompliance could include, as appropriate, an automatic six-month bar on a single firm’s performance of certain audit work, commencement of a new proceeding against a firm, or, in extreme cases, the resumption of the current proceeding against all four firms. If additional remedial measures are imposed on the Chinese affiliates of the “big four” accounting firms, including our independent registered public accounting firm, in administrative proceedings brought by the SEC alleging the firms’ failure to meet specific criteria set by the SEC with respect to requests for the production of documents, we could be unable to timely file future financial statements in compliance with the requirements of the Exchange Act.

In the event that the SEC restarts the administrative proceedings, depending upon the final outcome, listed companies in the United States 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 our common stock may be adversely affected.

If our independent registered public accounting firm was 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 financial statements, our 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 delisting of our ADSs from the New York Stock Exchange or deregistration from the SEC, or both, which would substantially reduce or effectively terminate the trading of our ADSs in the United States.

Regulation and censorship of information disseminated over the internet in China may adversely affect our business and reputation and subject us to liability for information displayed on our website.

The PRC government has adopted regulations governing internet access and the distribution of news and other information over the internet. Under these regulations, internet content providers and internet publishers are prohibited from posting or displaying over the internet content that, among other things, violates PRC laws and regulations, impairs the national dignity of China, or is reactionary, obscene, superstitious, fraudulent or defamatory. Failure to comply with these requirements may result in the revocation of licenses to provide internet content and other licenses, and the closure of the concerned websites. The website operator may also be held liable for such censored information displayed on or linked to the websites. If our website is found to be in violation of any such requirements, we may be penalized by relevant authorities, and our operations or reputation could be adversely affected.

 

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Risks Related to the ADSs and This Offering

An active trading market for our ordinary shares or the ADSs may not develop and the trading price for our ADSs may fluctuate significantly.

We have applied to list the ADSs on the New York Stock Exchange. We have no current intention to seek a listing for our ordinary shares on any stock exchange. Prior to the completion of this offering, there has been no public market for the ADSs or our ordinary shares, and we cannot assure you that a liquid public market for the ADSs will develop. If an active public market for the ADSs does not develop following the completion of this offering, the market price and liquidity of the ADSs may be materially and adversely affected. The initial public offering price for our ADSs will be determined by negotiation between us and the underwriters based upon several factors, and we can provide no assurance that the trading price of the ADSs after this offering will not decline below the initial public offering price. As a result, investors in our securities may experience a significant decrease in the value of their ADSs.

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 our ADSs may be highly volatile for factors specific to our own operations, including the following:

 

    variations in our revenues, earnings and cash flows;

 

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

 

    announcements of new offerings, solutions and expansions by us or our competitors;

 

    changes in financial estimates by securities analysts;

 

    detrimental adverse publicity about us, our services or our industry;

 

    announcements of new regulations, rules or policies relevant for our business;

 

    additions or departures of key personnel;

 

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

 

    potential litigation or regulatory investigations.

Any of these factors may result in large and sudden changes in the volume and price at which our ADSs will trade.

In the past, shareholders of public companies have often brought securities class action suits against those 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.

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

 

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and substantial dilution of approximately US$             per ADS. See “Dilution” for a more complete description of how the value of your investment in our ADSs will be diluted upon the completion of this offering.

If securities or industry analysts do not 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.

The sale or availability for sale of substantial amounts of ADSs could adversely affect their market price.

Sales of substantial amounts of the ADSs in the public market after the completion of this offering, or the perception that these sales could occur, could adversely affect the market price of the ADSs and could materially impair our ability to raise capital through equity offerings in the future. The ADSs sold in this offering will be freely tradable without restriction or further registration under the Securities Act, and shares held by our existing shareholders may also be sold in the public market in the future subject to the restrictions in Rule 144 and Rule 701 under the Securities Act and the applicable lockup agreements. There will be              ADSs (representing              Class A ordinary shares) outstanding immediately after this offering, or              ADSs (representing              Class A ordinary shares) if the underwriters exercise their over-allotment option in full. In connection with this offering, we[, our directors, executive officers and existing shareholders] have agreed, subject to certain exceptions, not to sell any ordinary shares or ADSs for 180 days after the date of this prospectus without the prior written consent of the representatives of the underwriters. However, the underwriters may release these securities from these restrictions at any time, subject to applicable regulations of the Financial Industry Regulatory Authority, Inc. We cannot predict what effect, if any, market sales of securities held by our significant shareholders or any other shareholder or the availability of these securities for future sale will have on the market price of the ADSs. See “Underwriting” and “Shares Eligible for Future Sale” for a more detailed description of the restrictions on selling our securities after this offering.

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

 

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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.

Because we do not expect to pay dividends in the foreseeable future after this offering, you must rely on a price appreciation of the ADSs for a 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 the 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 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 the ADSs will likely depend entirely upon any future price appreciation of the ADSs. There is no guarantee that the 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 the ADSs.

The approval of the China Securities Regulatory Commission may be required in connection with this offering under PRC law.

The M&A Rules purport to require offshore special purpose vehicles that are controlled by PRC companies or individuals and that have been formed for the purpose of seeking a public listing on an overseas stock exchange through acquisitions of PRC domestic companies or assets to obtain CSRC approval prior to publicly listing their securities on an overseas stock exchange. In September 2006, the CSRC published a notice on its official website specifying documents and materials required to be submitted to it by a special purpose vehicle seeking CSRC approval of its overseas listings. The interpretation and application of the regulations remain unclear. If CSRC approval is required, it is uncertain whether it would be possible for us to obtain the approval, and 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.

Tian Yuan Law Firm, our PRC legal counsel, has advised us that, based on its understanding of the current PRC laws and regulations, we will not be required to submit an application to the CSRC for the approval of the listing and trading of our ADSs on the New York Stock Exchange because (i) we established the WFOE by means of direct investment and not through a merger or acquisition of the equity or assets of a “PRC domestic company” as such term is defined under the M&A Rules; and (ii) no provision in the M&A Rules classifies the contractual arrangements under the VIE Agreements as a type of acquisition transaction falling under the M&A 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

 

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summarized above are subject to any new laws, rules and regulations 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, and hence we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory agencies. These regulatory agencies may impose fines and penalties on our operations in China, limit our ability to pay dividends outside of China, limit our operating privileges in China, delay or restrict the repatriation of the proceeds from this offering into China or take other actions that could have a material adverse effect on our business, financial condition, results of operations and prospects, as well as the trading price of the ADSs. The CSRC or other PRC regulatory agencies also may take actions requiring us, or making it advisable for us, to halt this offering before settlement and delivery of the ADSs offered hereby. Consequently, if you engage in market trading or other activities in anticipation of and prior to settlement and delivery, you do so at the risk that settlement and delivery may not occur. 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, if and when procedures are established to obtain such a waiver. Any uncertainties and/or negative publicity regarding such approval requirement could have a material adverse effect on the trading price of the ADSs.

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 memorandum and articles of association, the Companies Law (2016 Revision) 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 precedent in some jurisdictions in the United States. In particular, the Cayman Islands have 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 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 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 our management, members of the 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 Law 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.”

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

We are a Cayman Islands company and substantially all of our assets are located outside of the United States. Substantially all of our current operations are conducted in China. In addition, most of our current

 

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directors and officers are nationals and residents of countries other than the United States. Substantially all of the assets of these persons are located outside 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.”

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 your Class A ordinary shares underlying your ADSs.

Holders of ADSs do not have the same rights as our registered shareholders. As a holder of our 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 which attach to the Class A ordinary shares underlying your ADSs indirectly by giving voting instructions to the depositary in accordance with the provisions of the deposit agreement. Under the deposit agreement, you may vote only by giving voting instructions to the depositary, as holder of the Class A ordinary shares underlying your ADSs. Upon receipt of your voting instructions, the depositary may try to vote the Class A ordinary shares underlying your ADSs in accordance with your instructions. If we ask for your instructions, then upon receipt of your voting instructions, the depositary will try to vote the underlying Class A ordinary shares in accordance with those instructions. If we do not instruct the depositary to ask for your instructions, the depositary may still vote in accordance with instructions you give, but it is not required to do so. You will not be able to directly exercise any right to vote with respect to the underlying Class A ordinary shares unless you 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 enable you to withdraw the shares underlying your ADSs and become the registered holder of such shares prior to the record date for the general meeting 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 fourth amended and restated 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 Class A ordinary shares underlying your ADSs and 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, the depositary will notify you of the upcoming vote and to deliver our voting materials to you. We cannot assure you that you will receive the voting material in time to ensure you can direct the depositary to vote your shares. 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 shares underlying your ADSs are voted and you may have no legal remedy if the shares underlying your ADSs are not voted as you requested.

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

We have adopted a multi-class share structure such that our ordinary shares will consist of Class A ordinary shares, Class B ordinary shares and Class C ordinary shares, which will become effective immediately upon the completion of this offering. In respect of matters requiring the votes of shareholders, each Class A ordinary share is entitled to one vote, each Class B ordinary share is entitled to seven votes, and each Class C ordinary share is entitled to ten votes. Each Class B ordinary share or Class C ordinary share is convertible into one Class A ordinary share at any time by the holder thereof. Class A ordinary shares are not convertible into Class B ordinary shares or Class C ordinary shares, Class B ordinary shares are not convertible into Class C ordinary

 

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shares, and Class C ordinary shares are not convertible into Class B ordinary shares under any circumstances. We will sell Class A ordinary shares represented by our ADSs in this offering.

Mr. Peng Ou, our founder and chairman of our Board of Directors, Mr. Tongbo Liu, our chief executive officer and director, and certain of our senior management and employees will collectively beneficially own all of our issued and outstanding Class C ordinary shares immediately upon the completion of this offering. These Class C ordinary shares will constitute approximately         % of our total issued and outstanding share capital and         % of the aggregate voting power of our total issued and outstanding share capital immediately upon the completion of this offering, assuming the underwriters do not exercise their over-allotment option. In addition, upon the completion of this offering, up to 120,394 ordinary shares (constituting approximately         % of our total issued and outstanding share capital and         % of the aggregate voting power of our total issued and outstanding share capital immediately upon the completion of this offering) reserved and issuable upon the exercise of options granted pursuant to our equity incentive plan adopted in October 2017 shall be, upon issuance of such ordinary shares, designated as Class C ordinary shares, the voting power of which will be held by certain of our senior employees. Immediately upon the completion of this offering, PV PLUTO LIMITED, an entity wholly owned and controlled by Primavera Capital Fund, will beneficially own all of our issued and outstanding Class B ordinary shares, which will constitute approximately         % of our total issued and outstanding share capital and         % of the aggregate voting power of our total issued and outstanding share capital immediately after the completion of this offering, assuming the underwriters do not exercise their over-allotment option.

As a result of this triple-class share structure and the concentration of ownership, Mr. Peng Ou, Mr. Tongbo Liu and certain of our senior management and employees will have significant influence over our business, including decisions regarding mergers, consolidations, liquidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. They 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.

You may experience dilution of your holdings due to the 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 be subject to limitations on the 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 it expedient in connection with the performance of its duties. The depositary may close its books in emergencies, and on weekends and public holidays. The depositary may refuse to deliver, transfer or register transfers of our 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.

 

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

We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from requirements applicable to other public companies that are not emerging growth companies, including, most significantly, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 for so long as we remain an emerging growth company. As a result, if we elect not to comply with such auditor attestation requirements, our investors may not have access to certain information they may deem important.

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; and

 

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

We will be required to file an annual report on Form 20-F within four months of the end of each fiscal year. In addition, we intend to publish our results on a quarterly basis as press releases, distributed pursuant to the rules and regulations of the 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.

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 New York Stock Exchange corporate governance listing standards. These practices may afford less protection to shareholders than they would enjoy if we complied fully with the New York Stock Exchange corporate governance listing standards.

As a Cayman Islands company listed on the New York Stock Exchange, we are subject to New York Stock Exchange corporate governance listing standards. However, New York Stock Exchange 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 New York Stock Exchange corporate governance listing standards. We intend to follow Cayman Islands corporate governance practices in lieu of the corporate governance requirements of the New York Stock Exchange that listed companies must have: (i) a majority of independent directors; (ii) a nominating/corporate governance committee composed entirely of independent directors; and (iii) a compensation committee composed entirely of independent directors. To the extent we choose to follow home country practice in the future, our shareholders may be afforded less protection than they otherwise would enjoy under New York Stock Exchange corporate governance listing standards applicable to U.S. domestic issuers.

 

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

In general, a non-U.S. corporation is a PFIC for U.S. federal income tax purposes for any taxable year in which (i) 75% or more of its gross income consists of passive income or (ii) 50% or more of the average quarterly value of its assets consists of assets that produce, or are held for the production of, passive income. For purposes of the above calculations, a non-U.S. corporation that owns at least 25% by value of the shares of another corporation is treated as if it held its proportionate share of the assets of the other corporation and received directly its proportionate share of the income of the other corporation. Cash is a passive asset for these purposes. Based on the expected composition of our income and assets and the value of our assets, including goodwill, which is based on the expected price of our ADSs in this offering, we do not expect to be a PFIC for our current taxable year. However, it is not entirely clear how the contractual arrangements between our wholly-owned PRC subsidiary Wuhan Zhibo, our consolidated affiliated entity and the shareholders of our consolidated affiliated entity will be treated for purposes of the PFIC rules. Because the treatment of the contractual arrangements is not entirely clear, because we will hold a substantial amount of cash following this offering, and because our PFIC status for any taxable year can be determined only after the end of such year and will depend on the composition of our income and assets and the value of our assets from time to time (which may be determined, in part, by reference to the market price of the ADSs or ordinary shares, which could be volatile), there can be no assurance that we will not be a PFIC for our current or any future taxable year. If we were a PFIC for any taxable year during which a U.S. investor holds ADSs or ordinary shares, certain adverse U.S. federal income tax consequences could apply to such U.S. investor. See “Taxation—Material U.S. Federal Income Tax Considerations—Passive Foreign Investment Company Rules.”

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that involve risks and uncertainties. All statements other than statements of historical facts are forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements.

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

 

    our goals and growth strategies;

 

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

 

    our ability to retain and increase our student enrollments;

 

    our ability to offer new courses and educational content;

 

    our ability to engage, train and retain new faculty members;

 

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

 

    our ability to maintain and improve technology infrastructure necessary to operate our business;

 

    competition in the online education industry in China;

 

    relevant government policies and regulations relating to our corporate structure, business and industry;

 

    our expectation regarding the use of proceeds from this offering;

 

    general economic and business condition in China; and

 

    assumptions underlying or related to any of the foregoing.

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

You should not rely upon forward-looking statements as predictions of future events. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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LETTER FROM OUR FOUNDER AND CHAIRMAN

At Sunlands, we are proud of what we do and what we have accomplished. Started in 2003 as an offline, classroom-based education company, we have now become China’s largest online post-secondary and professional education service provider, powered by China’s internet boom that has driven our operating results and established the foundation for our future growth.

I am particularly confident about our business due to the “flywheel effect” we enjoy—our investments in people, technology and education research and development generate strong organic momentum and propel us toward continuous growth and innovation, creating a virtuous cycle. As a public company, we will continue to invest prudently in our business to maintain our leading position and ensure our future success.

What inspires me every day is seeing our education services empower and enrich lives of our students.

Make high-quality education available to everyone

Everyone, no matter their station in life, should have access to high-quality education. Our online education platform makes education more accessible, removing the obstacles of traditional offline model that have made education unattainable for a vast number of people. We aim to meet China’s expanding education needs and previously unserved student population by continuing to offer high-quality online courses and building a vast library of educational resources that can be easily accessed through the internet.

Provide education that elevates and enriches lives

Today’s higher education has been influenced by two distinct models—Newman’s theory of a liberal education and Humboldt’s model of specialized education. While specialized professionals are necessary, we need more generalists, especially as many jobs become outdated faster than we realize as our technology continues to transform our society. I hope to instill the essence of a liberal education in our course offerings, through our own innovations and business partnerships. This will have a positive and lasting impact on our students’ lives, not only by helping them obtain diplomas and degrees that can help them achieve short-term career goals, but also by elevating and enriching their lives by teaching them to think critically and solve complex problems.

Nurture and spread new ideas

The core purpose of education is to spur innovation and generate ideas. I want to encourage and support our future faculty to spread knowledge and ideas, to research and innovate, and to promote science and humanities. Strengthening our leadership and fulfilling the core purpose of education requires us to motivate the smartest among us to explore and expand the boundaries of what we know.

There is a saying that the two most important days in one’s life is the day you are born and the day you discover your mission. The challenges and endless possibilities of fulfilling our mission is what excites me about our future. As we continue to create value for our students, employees and shareholders, we will strive to make the world better through the combined powers of education and technology.

Peng Ou

Founder and Chairman of Sunlands

December 13, 2017

 

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USE OF PROCEEDS

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

We plan to use the net proceeds of this offering primarily for the following purposes: (i) approximately US$             million for our course and educational content development, (ii) approximately US$             million for our research and development relating to our IT systems, (iii) approximately US$             million for our marketing and branding activities, (iv) approximately US$             million for potential selective investment and acquisition opportunities, and (v) approximately US$             million for general corporate purpose. If an unforeseen event occurs or business conditions change, we may use the proceeds of this offering differently than as described in this prospectus. In utilizing the proceeds from this offering, we are permitted under PRC laws and regulations to provide funding to our PRC subsidiaries only through loans or capital contributions, and to our consolidated VIE only through loans, and only if we satisfy the applicable government registration and approval requirements. We cannot assure you that we will be able to meet these requirements on a timely basis, if at all. See “Risk Factors—Risks Related 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 us from using the proceeds of this offering to make loans or additional capital contributions to our PRC subsidiary, which could materially and adversely affect our liquidity and our ability to fund and expand our business.”

Pending use of the net proceeds, we intend to hold our net proceeds in short-term, interest-bearing, financial instruments or demand deposits.

 

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DIVIDEND POLICY

We have not previously declared or paid cash dividends and we have no plan to declare or pay any dividends in the near future on our shares or the ADSs representing our ordinary shares. 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 rely principally on dividends from our PRC subsidiaries 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 “PRC Regulation—Regulations on Foreign Exchange—Dividend Distribution.”

Our Board of Directors has 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 Board of Directors. Under Cayman Islands law, a 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 pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant. If we pay any dividends on our ordinary shares, we will pay those dividends which are payable in respect of the ordinary shares underlying the ADSs to the depositary, as the registered holder of such ordinary shares, and the depositary then will pay such amounts to the ADS holders in proportion to the ordinary shares underlying 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.”

 

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CAPITALIZATION

The following table sets forth our capitalization as of December 31, 2017:

 

    on an actual basis;

 

    on a pro forma basis to reflect the conversion of              Series A preferred shares into Class A ordinary shares,              Series B preferred shares into Class B ordinary shares,              Series B+ preferred shares into Class A ordinary shares,              ordinary shares held by DIAMOND TOWER INVESTMENTS LIMITED into Class A ordinary shares, and the remaining              ordinary shares into Class C ordinary shares, in each case on a one-for-one basis immediately upon the completion of this offering; and

 

    on a pro forma as adjusted basis to reflect (i) the conversion of              Series A preferred shares into Class A ordinary shares,              Series B preferred shares into Class B ordinary shares,              Series B+ preferred shares into Class A ordinary shares,              ordinary shares held by DIAMOND TOWER INVESTMENTS LIMITED into Class A ordinary shares, and the remaining              ordinary shares into Class C ordinary shares, in each case on a one-for-one basis immediately upon the completion of this offering, and (ii) the issuance and sale of              Class A ordinary shares in the form of ADSs by us in this offering at an assumed initial public offering price of US$             per ADS, the midpoint of the estimated range of the initial public offering price shown on the front cover of this prospectus, 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 December 31, 2017  
    Actual     Pro forma     Pro forma as adjusted(1)  
    RMB     US$     RMB     US$     RMB     US$  
    (in thousands)  

Mezzanine equity

           

Series A convertible redeemable preferred shares

           
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total mezzanine equity

           

Shareholders’ deficit:

           

Ordinary shares (US$0.00005 par value; 1,000,000,000 shares authorized;              shares issued and outstanding as of December 31, 2017 on an actual basis;              Class A ordinary shares,              Class B ordinary shares and              Class C ordinary shares issued and outstanding on a pro forma basis as of December 31, 2017; and              Class A ordinary shares,              Class B ordinary shares and              Class C ordinary shares issued and outstanding on a pro forma as adjusted basis as of December 31, 2017)

           

Additional paid-in capital(2)

           

Accumulated deficit

           

Noncontrolling interest

           
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total shareholders’ deficit

           
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total mezzanine equity and shareholders’ deficit

           
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Notes:

(1) The pro forma as adjusted information discussed above is illustrative only. Our additional paid-in capital, total shareholders’ (deficit)/equity and total capitalization following the completion of this offering are subject to adjustment based on the actual initial public offering price and other terms of this offering determined at pricing.
(2) Assuming the number of ADSs offered by us as set forth on the cover page of this prospectus remains the same, and after deduction of underwriting discounts and commissions and the estimated offering expenses payable by us, a $1.00 change in the assumed initial public offering price of US$             per ADS would, in the case of an increase, increase and, in the case of a decrease, decrease each of additional paid-in capital, total shareholders’ (deficit)/equity and total capitalization by US$             million.

 

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DILUTION

If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per ADS and our net tangible book value per ADS after this offering. Dilution results from the fact that the initial public offering price per Class A 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 June 30, 2017 was approximately US$             per ordinary share and US$             per ADS. Net tangible book value per ordinary share represents the amount of total tangible assets, minus the amount of total liabilities, divided by the total number of ordinary shares outstanding. Dilution is determined by subtracting net tangible book value per ordinary share from the public offering price per Class A ordinary share.

Without taking into account any other changes in such net tangible book value after June 30, 2017, other than to give effect to (i) the conversion of all of our preferred shares into ordinary shares on a one-to-one basis, which will occur automatically immediately upon the completion of this offering and (ii) our issuance and sale of ADSs, representing             Class A ordinary shares, offered in this offering at an initial public offering price of US$             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 June 30, 2017 would have been approximately US$             million, or US$             per ordinary share and US$             per ADS, to existing shareholders and an immediate dilution in net tangible book value of US$             per ordinary share, or US$             per ADS, to purchasers of ADSs in this offering.

The following table illustrates the dilution on a per ordinary share basis at the initial public offering price per Class A ordinary share is US$             and all ADSs are exchanged for ordinary shares:

 

Initial public offering price per ordinary share

   US$               

Net tangible book value per ordinary share

   US$               

Pro forma net tangible book value per ordinary share after giving effect to the automatic conversion of all of our outstanding preferred shares

   US$               

Pro forma net tangible book value per ordinary share as adjusted to give effect to the automatic conversion of all of our outstanding preferred shares and this offering as of June 30, 2017

   US$               

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

   US$               
  

 

 

 

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

   US$               
  

 

 

 

The pro forma information discussed above is illustrative only.

The following table summarizes, on a pro forma basis as of June 30, 2017, the differences between the existing shareholders and the new investors with respect to the number of ordinary shares purchased from us in this offering, the total consideration paid and the average price per ordinary share paid at the initial public offering price of US$             per ADS before deducting estimated underwriting discounts and commissions and estimated offering expenses. The total number of ordinary shares does not include ordinary shares underlying the ADSs issuable upon the exercise of the over-allotment option granted to the underwriters.

 

     Ordinary shares Purchased      Total Consideration      Average Price
Per Ordinary
Share
     Average Price
Per ADS
 
        Amount (in
thousands of
US$)
     Percent        
     Number      Percent            US$      US$  

Existing shareholders

                 

New investors

                 

Total

                 

 

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The discussion and tables above also assume no exercise of any stock options outstanding as of the date of this prospectus. As of the date of this prospectus, there are 61,253 ordinary shares issuable upon exercise of outstanding stock options with an exercise price of US$84.75 per ordinary share, and there are a total of 120,394 ordinary shares available for future issuance upon the exercise of grants under the 2017 Plan. To the extent that any of these options are exercised, there will be further dilution to new investors.

 

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EXCHANGE RATE INFORMATION

Our reporting currency is the Renminbi because our business is mainly conducted in China and all of our revenues are denominated in Renminbi. This prospectus contains translations of Renminbi amounts into U.S. dollars at specific rates solely for the convenience of the reader. The conversion of Renminbi into U.S. dollars in this prospectus is based on the rate certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this prospectus are made at RMB6.7793 to US$1.00, the exchange rate set forth in the H.10 statistical release of the Federal Reserve Board on June 30, 2017. We make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any particular rate, the rates stated below, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of Renminbi into foreign exchange and through restrictions on foreign trade. On January 12, 2018, the rate was RMB6.4607 to US$1.00.

The following table sets forth information concerning exchange rates between the Renminbi and the U.S. dollar for the periods indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this prospectus or will use in the preparation of our periodic reports or any other information to be provided to you.

 

     Noon Buying Rate  

Period

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

2013

     6.0537        6.1412        6.2438        6.0537  

2014

     6.2046        6.1704        6.2591        6.0402  

2015

     6.4778        6.2869        6.4896        6.1870  

2016

     6.9430        6.6549        6.9580        6.4480  

2017

           

August

     6.5888        6.6670        6.7272        6.5888  

September

     6.6533        6.5690        6.6591        6.4773  

October

     6.6328        6.6254        6.6533        6.5712  

November

     6.6090        6.6200        6.6385        6.5967  

December

     6.5063        6.5932        6.6210        6.5063  

2018

           

January

     6.2841        6.4233        6.5263        6.2841  

February (through February 16)

     6.3438        6.3118        6.3438        6.2649  

 

Source: Federal Reserve Statistical Release

Notes:

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

 

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ENFORCEABILITY OF CIVIL LIABILITIES

We were incorporated in the Cayman Islands in order to enjoy the following benefits:

 

    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 following:

 

    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; 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.

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

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

Maples and Calder (Hong Kong) LLP, our counsel as to Cayman Islands law, and Tian Yuan Law Firm, our counsel as to PRC law, have advised us, respectively, that there is uncertainty as to whether the courts of the Cayman Islands and China, respectively, would:

 

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

 

    entertain original actions brought in 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.

Maples and Calder (Hong Kong) LLP has informed us that it is uncertain whether the courts of the Cayman Islands will allow shareholders of our company to originate actions in the Cayman Islands based upon securities laws of the United States. In addition, there is uncertainty with regard to Cayman Islands law related to whether a judgment obtained from the U.S. courts under civil liability provisions of U.S. securities laws will be determined by the courts of the Cayman Islands as penal or punitive in nature. If such a determination is made, the courts of the Cayman Islands will not recognize or enforce the judgment against a Cayman Islands company, such as our company. As the courts of the Cayman Islands have yet to rule on making such a determination in relation to judgments obtained from U.S. courts under civil liability provisions of U.S. securities laws, it is uncertain whether such judgments would be enforceable in the Cayman Islands. Maples and Calder (Hong Kong) LLP has further informed us that although there is no statutory enforcement in the Cayman Islands of judgments obtained

 

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in the federal or state courts of the United States (and the Cayman Islands are not a party to any treaties for the reciprocal enforcement or recognition of such judgments), a judgment obtained in such jurisdiction will be recognized and enforced in the courts of the Cayman Islands at common law, without any reexamination of the merits of the underlying dispute, by an action commenced on the foreign judgment debt in the Grand Court of the Cayman Islands, provided such judgment (a) is given by a foreign court of competent jurisdiction, (b) imposes on the judgment debtor a liability to pay a liquidated sum for which the judgment has been given, (c) is final, (d) is not in respect of taxes, a fine or a penalty, and € 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.

We have been advised by Tian Yuan Law Firm, our PRC legal counsel, that there is uncertainty as to whether the courts of the PRC would enforce judgments of United States courts or Cayman courts obtained against us or these persons predicated upon the civil liability provisions of the United States federal and state securities laws. Tian Yuan Law Firm has further advised us that the recognition and enforcement of foreign judgments are provided for under PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on 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.

 

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CORPORATE HISTORY AND STRUCTURE

Corporate History

We commenced our education service business in August 2003. We remained an offline, classroom-based education service provider until we transitioned to an exclusively online education model in 2014.

In December 2013, we entered into a series of contractual arrangements, which we refer to original VIE arrangements in this prospectus, with Beijing Shangde Jiaxun Education Technology Co., Ltd., or Sunlands Jiaxun, and its shareholders. The original VIE arrangements enabled us to exercise effective control over Sunlands Jiaxun and its operating subsidiaries in the PRC, including the predecessor of Beijing Shangde Online Education Technology Co., Ltd., or Beijing Sunlands, a limited liability company through which we currently conduct substantially all of our business in the PRC. During 2015 and 2016, as part of our plan to obtain equity financing in the PRC, we terminated the original VIE arrangements through a series of transactions.

In September 2015, Studyvip Online Education International Limited, our current ultimate holding company, was incorporated under the laws of the Cayman Islands. In October 2017, Studyvip Online Education International Limited was renamed as Sunlands Online Education Group, or Sunlands Cayman. In October 2015, Sunlands Online Education HK Limited, or Sunlands HK, was incorporated in Hong Kong. Sunlands HK is a wholly owned subsidiary of Sunlands Cayman.

In July 2016, Beijing Sunlands issued equity interests for an aggregate consideration of RMB365 million to certain investors, which were repurchased by Beijing Sunlands in 2017.

In 2017, we entered into the following transactions to establish our current VIE and offshore holding structures to facilitate offshore financing:

 

    In August 2017, Sunlands HK established Wuhan Studyvip Online Education Co. Limited, or Wuhan Zhibo, our wholly owned subsidiary in the PRC;

 

    In August 2017, Wuhan Zhibo entered into a series of contractual agreements with Beijing Sunlands and its shareholders. These contractual arrangements enable us to have effective control over, and receive the economic benefits of, Beijing Sunlands. Accordingly, we are considered the primary beneficiary of Beijing Sunlands and are able to consolidate Beijing Sunlands and its operating subsidiaries in the PRC. See “—Contractual Arrangements with Beijing Sunlands”;

 

    In August 2017, Sunlands Cayman issued an aggregate of 477,137 Series A preferred shares to certain investors for a total consideration equivalent to approximately RMB242 million and issued an aggregate of 413,194.5 Series B preferred shares to an investor for a consideration of US$90 million;

 

    In September 2017, Sunlands Cayman issued an aggregate of 70,632 Series B+ preferred shares to an investor for an aggregate consideration of US$20 million; and

 

    In October 2017, Sunlands Cayman effectuated a one-for-two share split, pursuant to which each of its issued and outstanding ordinary shares and preferred shares was split into two ordinary shares or preferred shares, as the case may be.

We conduct our business in the PRC primarily through Beijing Sunlands and its PRC subsidiaries which generated substantially all of our net revenues in 2015 and 2016 and for the six months ended June 30, 2017. Beijing Sunlands and its PRC subsidiaries hold our ICP license and other licenses and permits necessary for our business operations in the PRC.

 

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Corporate Structure

The following diagram illustrates our corporate structure immediately following the completion of this offering, assuming no exercise of the over-allotment option granted to the underwriters:

 

LOGO

 

 

LOGO

   Equity interest

LOGO

   Contractual arrangements, including the exclusive technical consultation and service agreement, the business operation agreement, the equity interest pledge agreement, the option agreement, the powers of attorney and the spousal consent letters. See “—Contractual Arrangements with Beijing Sunlands.”

 

(1) The Founder Holding Platform is Pingxiang Miniewa Asset Management Consultancy Center (Limited Partnership), whose general partner is Mr. Peng Ou, our founder and Chairman of our Board of Directors.
(2) The Senior Management Holding Platforms consist of Pingxiang Wuerken Asset Management Consultancy Center (Limited Partnership), Pingxiang Saiersi Asset Management Consultancy Center (Limited Partnership), Pingxiang Xisailuo Asset Management Consultancy Center (Limited Partnership) and Pingxiang Bosaidong Asset Management Consultancy Center (Limited Partnership). The general partner of each of these entities is Mr. Tongbo Liu, our chief executive officer and a director.

Contractual Arrangements with Beijing Sunlands

Currently, our online education service business in China is operated primarily through Beijing Sunlands and its subsidiaries due to PRC legal restrictions on foreign ownership in value-added telecommunication services and other internet related business, and we have effective control over, and are the primary beneficiary of, Beijing Sunlands through a series of contractual arrangements by and among our wholly owned PRC subsidiary Wuhan Zhibo, Beijing Sunlands, the shareholders of Beijing Sunlands, and certain operating subsidiaries of Beijing Sunlands.

The following is a summary of these contractual arrangements. In the summary, we refer to the subsidiaries of Beijing Sunlands as signing parties to the VIE contractual arrangements collectively as Beijing Sunlands Subsidiaries.

 

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Exclusive Technical Consultation and Service Agreement. Under the exclusive technical consultation and service agreement among Wuhan Zhibo, and Beijing Sunlands and Beijing Sunlands Subsidiaries, Wuhan Zhibo has the exclusive right to provide, among other things, technical consultation and services to Beijing Sunlands and Beijing Sunlands Subsidiaries, and Beijing Sunlands and Beijing Sunlands Subsidiaries agree to accept all the consultation and services provided by Wuhan Zhibo. Without Wuhan Zhibo’s prior written consent, Beijing Sunlands and Beijing Sunlands Subsidiaries are prohibited from engaging any third party to provide any services contemplated by this agreement. In addition, Wuhan Zhibo has exclusive and proprietary ownership, rights and interests in any and all intellectual properties arising out of or created during the performance of this agreement. Beijing Sunlands and Beijing Sunlands Subsidiaries agree to pay a quarterly service fee to Wuhan Zhibo at an aggregate amount of a certain percentage ranging from 10% to 100% of the monthly revenue of Beijing Sunlands and Beijing Sunlands Subsidiaries in such quarter. Unless terminated by Wuhan Zhibo, this agreement will remain effective until the dissolution of Beijing Sunlands and Beijing Sunlands Subsidiaries. Without Wuhan Zhibo’s prior written consent, Beijing Sunlands and the Beijing Sunlands Subsidiaries do not have the right to terminate this exclusive technical consultation and service agreement.

Business Operation Agreement. Under the business operation agreement, each of Beijing Sunlands, the Beijing Sunlands Subsidiaries and the shareholders of Beijing Sunlands confirmed and agreed that, without Wuhan Zhibo’s prior written consent, it shall not engage in any transaction or conduct that has a material adverse effect on the assets, business, personnel, obligations, rights or operations of Beijing Sunlands and the Beijing Sunlands Subsidiaries, including but not limited to sale or purchase of any assets or rights with a price exceeding RMB50,000, incurrence of any encumbrance on any of its assets, including intellectual property rights, in favor of a third party, amendment to its articles of association or business scope, or change of its normal operation procedures. Beijing Sunlands, Beijing Sunlands Subsidiaries and the shareholders of Beijing Sunlands shall accept and execute opinions and instructions of Wuhan Zhibo in connection with the employee engagement and dismissal, daily operations and financial management systems. The shareholders of Beijing Sunlands shall elect or appoint the candidates recommended by Wuhan Zhibo as Beijing Sunlands’ directors and supervisors, and procure the appointment of Beijing Sunlands’ chairman of the board and senior management pursuant to Wuhan Zhibo’s designation. The agreement also provides that if any of the agreements among Wuhan Zhibo, Beijing Sunlands and Beijing Sunlands Subsidiaries is terminated, Wuhan Zhibo is entitled to terminate all of the other agreements among itself, the Beijing Sunlands and Beijing Sunlands Subsidiaries. This agreement was entered into on August 15, 2017 and became effective on November 3, 2017 and will remain binding until dissolution of Beijing Sunlands and all of the Beijing Sunlands Subsidiaries.

Equity Interest Pledge Agreement. Under the equity interest pledge agreement among Wuhan Zhibo, the shareholders of Beijing Sunlands and Beijing Sunlands, the shareholders of Beijing Sunlands pledged all of their equity interests in Beijing Sunlands to Wuhan Zhibo as security for performance of the obligations of Beijing Sunlands and its shareholders under the exclusive technical consultation and service agreement, the option agreement and the business operation agreement. The shareholders of Beijing Sunlands shall instruct Beijing Sunlands not to distribute any dividends and shall not approve any profit distribution plan. If any of the specified events of default occurs, Wuhan Zhibo may exercise the right to enforce the pledges after giving a notice of default to the shareholders of Beijing Sunlands. Wuhan Zhibo may assign any and all of its rights and obligations under the equity interest pledge agreement to its designee(s) at any time. The equity interest pledge agreement is binding on the shareholders of Beijing Sunlands and their successors. The equity interest pledge agreement became effective on November 3, 2017 and the pledges under the equity interest pledge agreement became effective on November 29, 2017 and will remain in effect until the fulfillment of all obligations under the exclusive technical consultation and service agreement, the option agreement and the business operation agreement.

Option Agreement. Under the option agreement among Wuhan Zhibo, the shareholders of Beijing Sunlands and Beijing Sunlands, each of the shareholders irrevocably granted Wuhan Zhibo a right to purchase, or designate a third party to purchase, equity interests in Beijing Sunlands then held by each shareholder at once or at multiple times at any time in part or in whole at Wuhan Zhibo’s sole and absolute discretion to the extent

 

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permitted by PRC law. The shareholders of Beijing Sunlands shall promptly donate all considerations they received from the exercise of the options to Wuhan Zhibo or the designated third party free of charge. Without Wuhan Zhibo’s prior written consent, the shareholders of Beijing Sunlands shall not, individually or collectively, make or procure Beijing Sunlands to engage in any transaction or conduct that has a material adverse effect on the assets, liabilities, operations, equity and other legal rights of Beijing Sunlands. Without Wuhan Zhibo’s prior written consent, Beijing Sunlands shall not enter into any contract with a price exceeding RMB50,000, except for contracts in the ordinary course of business. Beijing Sunlands shall not be dissolved or liquidated without prior written consent by Wuhan Zhibo. The shareholders of Beijing Sunlands waive their rights of pre-emption in regard to the transfer of equity interest by any other shareholder of Beijing Sunlands to Wuhan Zhibo as instructed. These agreements were entered into on August 15, 2017 and became effective on November 3, 2017 and shall remain in effect until all equity interests in Beijing Sunlands held by the shareholders have been transferred or assigned to Wuhan Zhibo in accordance with this agreement.

Powers of Attorney. Pursuant to the powers of attorney executed by the shareholders of Beijing Sunlands, the shareholders of Beijing Sunlands each irrevocably authorized Wuhan Zhibo to act on their respective behalf as exclusive agent and attorney, to the extent permitted by law, with respect to all rights of shareholders concerning all equity interests held by each of them in Beijing Sunlands, including but not limited to propose to convene shareholder meetings, accept any notice with respect to the convening and proceeding of the shareholder meeting, attend shareholder meetings, sign the shareholders resolutions on behalf of the authorizing parties, exercise all the shareholder’s rights (including but not limited to voting rights and right to sell, transfer, pledge or dispose of all equity interests held in part or in whole) and designate and appoint on their respective behalf the president, directors, supervisors, chief executive officer, chief financial officer and other senior management members of Beijing Sunlands.

Spousal Consent Letters. Pursuant to the spousal consent letters executed by the spouses of the general partners of entities as the shareholders of Beijing Sunlands, the signing spouses confirmed and agreed that the equity interests of Beijing Sunlands are the own property of their spouses and shall not constitute the jointly possessed property of the couples. The spouses also irrevocably waived any potential right or interest that may be granted by operation of applicable law in connection with the equity interests of Beijing Sunlands held by their spouses.

In the opinion of Tian Yuan Law Firm, our PRC legal counsel, the contractual arrangements among Wuhan Zhibo, Beijing Sunlands and its shareholders are valid, binding and enforceable under current PRC law. However, these contractual arrangements may not be as effective in providing control as direct ownership. There are substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations. For a description of the risks related to our corporate structure, please see “Risk Factors—Risks Related to Our Corporate Structure.”

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated statements of operations data for the years ended December 31, 2015 and 2016, summary consolidated balance sheet data as of December 31, 2015 and 2016 and selected consolidated cash flow data for the years ended December 31, 2015 and 2016 and have been derived from our audited consolidated financial statements included elsewhere in this prospectus. Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. The following summary consolidated statements of operations for the six months ended June 30, 2016 and 2017, summary consolidated balance sheet data as of June 30, 2017 and summary consolidated cash flow data for the six months ended June 30, 2016 and 2017 have been derived from our unaudited condensed consolidated financial statements included elsewhere in this prospectus and have been prepared on the same basis as our audited consolidated financial statements and include all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the periods presented. Our historical results are not necessarily indicative of results expected for future periods. You should read this Selected Consolidated Financial 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 Six Months Ended June 30,  
    2015     2016     2016     2017  
    RMB     RMB     US$     RMB     RMB     US$  
    (in thousands, except for share, per share and per ADS data)  

Net revenues

    159,010       418,910       61,793       174,329       361,463       53,319  

Cost of revenues(1)

    (61,713     (70,986     (10,471     (27,778     (46,179     (6,812
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    97,297       347,924       51,322       146,551       315,284       46,507  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

           

Sales and marketing expenses(1)

    (333,253     (503,643     (74,291     (215,057     (492,795     (72,691

Product development expenses(1)

    (5,189     (13,932     (2,055     (6,401     (11,039     (1,628

General and administrative expenses(1)

    (76,022     (89,390     (13,186     (46,483     (46,879     (6,915

Total operating expenses

    (414,464     (606,965     (89,532     (267,941     (550,713     (81,234
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

    (317,167     (259,041     (38,210     (121,390     (235,429     (34,727
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income

    814       3,051       450       1,532       4,053       598  

Other income, net

    770       2,423       357       1,404       —         —    

Loss before income tax expenses

    (315,583     (253,567     (37,403     (118,454     (231,376     (34,129

Income tax expenses

    —         —         —         —         —         —    

Net loss from continuing operations

    (315,583     (253,567     (37,403     (118,454     (231,376     (34,129

Net loss from discontinued operations, net of income tax expenses of nil

    (2,719     —         —         —         —         —    

Loss from equity method investment

    —         —         —         —         (398     (59
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

    (318,302     (253,567     (37,403     (118,454     (231,774     (34,188
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Less: Net loss attributable to noncontrolling interests

    —         —         —         —         (42     (6

Net loss from continuing operations attributable to Sunlands

    (315,583     (253,567     (37,403     (118,454     (231,732     (34,182

Net loss from discontinued operations attributable to Sunlands

    (2,719     —         —         —         —         —    

Net loss per share attributable to ordinary shareholders—basic and diluted

    (83.36     (66.40     (9.79     (31.02     (60.68     (8.95

Income per ADS(2)

           

Basic

           

Diluted

           

 

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Notes:

(1)  Share-based compensation expenses included in:

 

    For the Year Ended December 31,      For the Six Months Ended June 30,  
    2015     2016      2016      2017  
    RMB     RMB     US$      RMB      RMB      US$  
    (in thousands, except for share, per share and per ADS data)  

Cost of revenues

    —         —         —          —          —          —    

Sales and marketing expenses

    2,014       —         —          —          —          —    

Product development expenses

    —         —         —          —          —          —    

General and administrative expenses

    21,643       —         —          —          —          —    
 

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total

    23,657       —         —          —          —          —    
 

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

 

(2)  Each ADS represents              Class A ordinary shares.

The following table presents our selected consolidated balance sheet data as of December 31, 2015 and 2016 and June 30, 2017.

 

     As of December 31,     As of June 30, 2017  
     2015     2016     RMB     US$     US$ Pro
forma(1)
 
     RMB     RMB     US$        
     (in thousands)  

Summary Consolidated Balance Sheet Data:

            

Cash and cash equivalents

     4,446       23,103       3,408       101,048       14,905    

Total assets

     100,098       244,991       36,139       558,215       82,341    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Deferred revenue

     414,077       727,569       107,322       1,269,073       187,198    

Accrued expenses and other current liabilities

     33,765       71,377       10,530       74,671       11,015    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

     471,842       798,946       117,852       1,343,744       198,213    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total mezzanine equity

     —         335,000       49,415       335,000       49,415    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total shareholders’ deficit

     (371,744     (888,955     (131,128     (1,120,529     (165,287  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Notes:

(1)  All of the preferred shares will automatically convert into ordinary shares on a one-on-one basis immediately upon the completion of this offering. The unaudited pro forma balance sheet information assumes the automatic conversion of all of the outstanding preferred shares into ordinary shares on a one-to-one basis, as if conversion would have occurred on December 31, 2017.

 

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The following table presents our selected consolidated cash flow data for the years ended December 31, 2015 and 2016, as well as the six months ended June 30, 2016 and 2017.

 

     For the Year Ended December 31,     For the Six Months Ended June 30,  
     2015     2016     2016      2017  
     RMB     RMB     US$     RMB      RMB     US$  
     (in thousands)  

Net cash provided by operating activities

     445       89,272       13,169       41,193        267,516       39,461  

Net cash (used in)/provided by investing activities

     (26,508     (117,695     (17,361     8,055        (127,733     (18,842

Net cash provided by/(used in) financing activities

     21,771       47,080       6,944       141,977        (61,838     (9,122

Net (decrease)/increase in cash and cash equivalents

     (4,292     18,657       2,752       191,225        77,945       11,497  

Cash and cash equivalents at beginning of the year/period

     8,738       4,446       656       4,446        23,103       3,408  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Cash and cash equivalents at end of the year/period

     4,446       23,103       3,408       195,671        101,048       14,905  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Non-GAAP Financial Measure

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 course packages, net of the total amount of refunds paid in such period. For more details about our refunds, see “Business—Our Tuition and Fees.” Our management uses gross billings as a performance measurement because we generally bill our students for the entire course tuition at the time of sale of our course packages and recognize revenue proportionally over a period generally ranging from 18 to 36 months (with a weighted average of 21 months) for our degree- or diploma-oriented post-secondary courses and a period generally ranging from six to 24 months (with a weighted average of 17 months) for our professional certification preparation and professional skills courses. We believe that gross billings provides valuable insight into the sales of our course packages and the 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 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.

 

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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 gross billings to net revenues for the periods indicated:

 

     For the Year Ended December 31,     For the Six Months Ended June 30,  
     2015     2016     2016     2017  
     RMB     RMB     US$     RMB     RMB     US$  
     (in thousands)  

Net revenues

     159,010       418,910       61,793       174,329       361,463       53,319  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Less: other revenues(1)

     (454     (5,741     (847     (2,340     (2,620     (386

Add: tax and surcharges

     5,517       14,302       2,110       5,699       12,124       1,788  

Add: ending deferred revenue

     414,077       727,569       107,322       553,472       1,269,073       187,198  

Less: beginning deferred revenue

     (132,024     (414,077     (61,080     (414,077     (727,569     (107,322
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross billings (non-GAAP)

     446,126       740,963       109,298       317,083       912,471       134,597  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Note: (1) Including commissions received for providing referral services to third-party education institutions.

 

     For the Three Months Ended  
     March 31,
2016
    June 30,
2016
    September 30,
2016
    December 31,
2016
    March 31,
2017
    June 30,
2017
 
     (RMB in thousands)  

Net revenues

     79,425       94,904       113,392       131,189       155,637       205,826  

Less: other revenues(1)

     (354     (1,986     (1,513     (1,888     (888     (1,732

Add: tax and surcharges

     1,798       3,901       4,064       4,539       5,230       6,894  

Add: ending deferred revenue

     482,718       553,472       628,062       727,569       979,703       1,269,073  

Less: beginning deferred revenue

     (414,077     (482,718     (553,472     (628,062     (727,569     (979,703
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross billings (non-GAAP)

     149,510       167,573       190,533       233,347       412,113       500,358  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Note: (1) Including commissions received for providing referral services to third-party education institutions.

Adjusted net loss represents net loss before share-based compensation expenses. The table below sets forth a reconciliation of our net loss and adjusted net loss for the periods indicated:

 

     For the Year Ended December 31,     For the Six Months Ended June 30,  
     2015     2016     2016     2017  
     RMB     RMB     US$     RMB     RMB     US$  
     (in thousands)  

Net Loss

     (318,302     (253,567     (37,403     (118,454     (231,774     (34,188

Add: Share-based compensation expenses

     23,657       —         —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net loss

     (294,645     (253,567     (37,403     (118,454     (231,774     (34,188
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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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. Our actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.

Overview

We are the leader in China’s online post-secondary and professional education in terms of gross billings in 2017, according to iResearch. We have a deep understanding of the educational needs of our prospective students and offer solutions that help them achieve their aspirations. We currently focus on offering various degree- and diploma-oriented post-secondary courses through our online platforms. In addition, we offer professional education services including courses to help students prepare for professional certification exams and attain professional skills courses.

Started in 2003 as an offline, classroom-based education company, we have transitioned to an exclusively online education delivery model in 2014. Our online education model allows our students to access our educational services anywhere and anytime through participating in live streaming and recorded classes.

We have been successful in addressing the unmet demand of a large, growing market, and served approximately 550,000 students across China since 2014. The number of our students increased from 205,806 in 2015 to 382,805 in 2016, and from 286,899 for the six months ended June 30, 2016 to 407,960 for the six months ended June 30, 2017.

We offer post-secondary and professional education through a vast array of courses and educational content. As of June 30, 2017, we offered STE programs covering 18 majors, MBA-related programs and professional certification and skills programs. We adopt a counseling-oriented sales and marketing approach based on a deep understanding of students’ need as well as the courses and educational content we offer. We provide professional assistance and counseling to help students make informed decisions that best suit their learning needs based on their education background and goals, as well as to help them formulate effective study plans throughout their enrollments in our courses.

Our net revenues for the six months ended June 30, 2017 reached RMB361.5 million (US$53.3 million), representing an increase of 107.3% from RMB174.3 million in the same period in 2016. Our net revenues in 2016 reached RMB418.9 million (US$61.8 million), representing an increase of 163.4% from RMB159.0 million in 2015. Our gross billings for the six months ended June 30, 2017 reached RMB912.5 million (US$134.6 million), representing an increase of 187.8% from RMB317.1 million in the same period in 2016. Our gross billings in 2016 reached RMB741.0 million (US$109.3 million), representing an increase of 66.1% from RMB446.1 million in 2015. Our net loss in 2015 and 2016 and the six months ended June 30, 2016 and 2017 was RMB318.3 million, RMB253.6 million (US$37.4 million), RMB118.5 million and RMB231.8 million (US$34.2 million), respectively. Our deferred revenue was RMB414.1 million, RMB727.6 million (US$107.3 million) and RMB1,269.1 million (US$187.2 million), respectively, as of December 31, 2015 and 2016 and June 30, 2017. Our net cash provided by operating activities was RMB41.2 million and RMB 267.5 million (US$39.5 million), respectively, for the six months ended June 30, 2016 and 2017 and RMB0.4 million and RMB89.3 million (US$13.2 million), respectively, for the years ended December 31, 2015 and 2016.

Major Factors Affecting Our Results of Operations

We operate in China’s online post-secondary and professional education market, and our results of operations and financial condition are significantly affected by general factors affecting this market. Drivers for

 

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our growth include China’s rapid economic growth, continued urbanization, and rising per capita disposable income, all of which have allowed Chinese households, particularly working adults, to spend more disposable income on education. In addition, driven by a strong desire for employment, career promotion, salary increases and local residence qualification, post-secondary and professional education in China has grown rapidly in the past several years and is expected to continue to grow in the future.

Changes to China’s economy and GDP growth also have a material impact on the online post-secondary and professional education market. In addition, the industry we operate in is fragmented, and we face competition from traditional offline players. At the same time, our results are subject to changes in the regulatory regime governing China’s education industry, particularly uncertainties relating to online education services. The PRC government regulates various aspects of our business and operations, including the qualification and licensing requirements for entities that provide online education services and limitations on foreign investments in the online education industry.

Additionally, we believe that our results of operations and financial condition are also affected by company-specific factors, including the factors discussed below.

Our ability to respond to the evolving industry landscape and drive student acceptance of online education format

As an online service provider, we benefited significantly from the increasing proliferation of the internet, in particular the mobile internet, in China. In recent years, driven by the increasing number of internet users and mobile penetration rates, China’s online education industry has experienced an annual growth of more than 20%. China’s online post-secondary and professional education market is expected to grow from approximately RMB33.6 billion in 2017 to RMB130.1 billion in 2022, representing a CAGR of 31.1%, according to iResearch. According to the same source, China’s online STE tutoring market is expected to grow from approximately RMB4.5 billion in 2017 to RMB44.7 billion in 2022, representing a CAGR of 58.3%.

We believe that the online education format, as compared to traditional in-person classroom teaching, is superior as it breaks down the time and location barriers of offline education format and offers students more a flexible, convenient and cost-effective alternative. As a result, online education format has become increasingly popular among students, taking away market share from traditional offline players. See “Industry—Online Post-Secondary and Professional Education in China.” For this reason, we believe our ability to continue to grow our net revenues and gross billings significantly depends on our ability to continue to convert students to embrace online education formats over traditional offline education format.

Our ability to increase the number of our students and new student enrollments at optimal pricing

Our net revenues and gross billings primarily consist of tuition payments from our students and are therefore affected by the number of our students and new student enrollments and the pricing of our educational services.

Our net revenues and gross billings have grown significantly in recent years, primarily driven by the increase in the number of our students and new student enrollments. The number of our students increased from 205,806 in 2015 to 382,805 in 2016, and from 286,899 for the six months ended June 30, 2016 to 407,960 for the six months ended June 30, 2017. Our new student enrollments increased from 179,172 in 2015 to 188,733 in 2016, and from 89,066 for the six months ended June 30, 2016 to 148,573 for the six months ended June 30, 2017. Our ability to continue to increase the number of our students and new student enrollments is primarily driven by factors including the quality of our education services, the range and attractiveness of our course offerings, our brand reputation, our ability to convert leads into student enrollments cost-effectively, and the availability of loans from third-party credit providers to our students. See “Risk Factors—Risks Related to Our Business—We may face risks associated with the installment tuition payment plan we offer to our students.” Our ability to attract prospective students in target markets and expand our course offerings has a direct impact on

 

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maintaining growths in the number of our students and new student enrollments, which in turn is subject to several other factors largely beyond our control, including the perception of the effectiveness of online education as compared to offline, classroom-based courses and the popularity of the degrees, diplomas and professional certifications our students are pursuing.

Our net revenues and gross billings are also dependent on our ability to optimize our pricing. Our net revenues and gross billings growths in recent years have been in part driven by our increased ability to charge higher tuition for our course packages. Our gross billings per new student enrollment were approximately RMB6,141.6 (US$905.9) in the six months ended June 30, 2017, representing an increase of 72.5% from approximately RMB3,560.1 for the same period in 2016. Our pricing is affected by the overall demand, the prices and availability of competing courses, perception of the quality and effectiveness of our course offerings, and the income levels that our students expect to achieve upon passing the exams that they are pursuing through taking our courses.

Our ability to maintain an optimal mix of course length

We typically receive tuition from our students (or third-party credit providers in the case of students taking loans for their tuition) upfront at the time of sale of our course packages. The tuition we collect from a student is initially recorded as deferred revenues and is generally recognized proportionally throughout the duration of the programs that student has enrolled in. The weighted average length of our degree- or diploma-oriented post-secondary courses was approximately 21 months, and the weighted average length of our professional certification preparation and professional skills courses was approximately 17 months. As of December 31, 2015 and 2016 and June 30, 2017, our deferred revenues were RMB414.1 million, RMB727.6 million (US$107.3 million) and RMB1,269.1 million (US$187.2 million), respectively.

We continually evaluate our mix of course length. As we make these evaluations, we may market and sell courses with shorter or longer durations in order to balance among various goals, including satisfying student needs, driving revenue growth, and improving visibility of future earnings, which may affect our ability to increase our net revenues on a continuous basis. For example, if we increase the percentage of courses with longer durations in our total course offerings, our net revenues for a given period may reduce as an increasing part of our revenues may be deferred and recognized across longer periods. Any material change in our mix of course length could have a significant impact on our results of operations.

Our ability to sell and market our services cost-effectively

We depend on our ability to sell and market our services in a cost-effective manner to maintain and improve our operating margins.

Sales and marketing expenses have historically represented a substantial majority of our total operating expenses. In 2015 and 2016 and for the six months ended June 30, 2017, our sales and marketing expenses were RMB333.3 million, RMB503.6 million (US$74.3 million) and RMB492.8 million (US$72.7 million), respectively. Our sales and marketing expenses are primarily composed of student acquisition expenses and employee salaries. Our ability to lower our sales and marketing expenses as a percentage of gross billings depends on our ability to improve sales and marketing efficiency and leverage our existing brand value and word-of-mouth referrals in our sales and marketing efforts. In 2015 and 2016 and for the six months ended June 30, 2016 and 2017, our marketing effectiveness ratio, as measured by dividing our marketing spending by our gross billings, was 28.3%, 24.8%, 24.8% and 22.1%, respectively.

We have acquired many of our existing students through search engine marketing channels, mobile channels and, to a lesser extent, offline channels. Further, we rely on a large sales force to provide counseling-oriented sales services to convert sales leads into enrollments. As such, the cost-effectiveness of our sales and marketing depends heavily on our ability to enhance returns from different marketing channels, as well as to improve the

 

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efficiency of our counseling-oriented sales activities. We also plan to further strengthen our mobile marketing endeavors, which we believe are particularly critical to attracting prospective students who are not yet aware of solutions available to satisfy their desire to pursue post-secondary and professional education. These initiatives have placed, and will continue to place, significant strains on our ability to sell and market our course offerings in an efficient and cost-effective manner.

Key Components of Results of Operations

Net revenues

We derive substantially all of our net revenues from tuition that we charge our students for the course packages that they purchase from us. In 2015 and 2016, we generated net revenues of RMB159.0 million and RMB418.9 million (US$61.8 million), respectively. In the six months ended June 30, 2016 and 2017, we generated net revenues of RMB174.3 million and RMB361.5 million (US$53.3 million), respectively.

We generally bill our students for the entire course tuition upfront at the time of sale of our course packages. The tuition we collect from a student is initially recorded as deferred revenues and is generally recognized proportionally over a weighted average period of 21 months for our degree- or diploma-oriented post-secondary courses and a weighted average period of 17 months for our professional certification preparation and professional skills courses. As of December 31, 2015 and 2016 and June 30, 2017, we had deferred revenues of RMB414.1 million, RMB727.6 million (US$107.3 million) and RMB1,269.1 million (US$187.2 million), respectively. For a reconciliation of our gross billings and net revenues, see “—Non-GAAP Financial Measure.”

The following table sets forth a breakdown of our total net revenues for the periods indicated:

 

    For the Year Ended December 31,     For the Six Months Ended June 30,  
    2015     2016     2016     2017  
    RMB     %     RMB     US$     %     RMB     %     RMB     US$     %  
    (in thousands, except for percentages)  

Degree- or diploma-oriented post-secondary courses

    93,953       59.1       292,653       43,169       69.8       117,695       67.5       292,119       43,091       80.8  

STE courses

    91,294       57.4       277,915       40,995       66.3       112,066       64.3       277,706       40,965       76.8  

Other degree- or diploma-oriented post-secondary courses

    2,659       1.7       14,738       2,174       3.5       5,629       3.2       14,413       2,126       4.0  

Professional certification preparation and professional skills courses

    64,603       40.6       120,516       17,777       28.8       54,294       31.2       66,724       9,842       18.5  

Others(1)

    454       0.3       5,741       847       1.4       2,340       1.3       2,620       386       0.7  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenues

    159,010       100       418,910       61,793       100       174,329       100       361,463       53,319       100  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Note: (1) Including commissions received for providing referral services to third-party education institutions.

Cost of revenues

We recorded cost of revenues of RMB61.7 million and RMB71.0 million (US$10.5 million) in 2015 and 2016, respectively. In the six months ended June 30, 2016 and 2017, we recorded cost of revenues of RMB27.8 million and RMB46.2 million (US$6.8 million), respectively. Our cost of revenues primarily consists of compensation for our teachers and mentors. In 2015 and 2016 and for the six months ended June 30, 2017, the labor costs that we recorded as cost of revenues were RMB38.6 million, RMB52.8 million (US$7.8 million), and RMB36.0 million (US$5.3 million), respectively, accounting for 62.5%, 74.3% and 78.0%, respectively, of our cost of revenues for the same periods. Our cost of revenues also included exams and services expenses, teaching materials costs, and live streaming and related equipment costs. We expect our cost of revenues to increase in an absolute amount in line with our expansion of business and student base growth and to decrease as a percentage of our net revenues through economies of scale and continue to improved operating efficiency.

 

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Operating expenses

Our operating expenses consist of sales and marketing expenses and, to a lesser extent, general and administrative expenses and product development expenses. The following table sets forth our operating expenses, in absolute amounts and as percentages of total operating expenses, for the periods indicated:

 

     For the Year Ended December 31,      For the Six Months Ended June 30,  
     2015      2016      2016      2017  
     RMB      %      RMB      US$      %      RMB      %      RMB      US$      %  
     (in thousands, except for percentages)  

Sales and marketing

     333,253        80.4        503,643        74,291        83.0        215,057        80.3        492,795        72,691        89.5  

General and administrative

     76,022        18.3        89,390        13,186        14.7        46,483        17.3        46,879        6,915        8.5  

Product development

     5,189        1.3        13,932        2,055        2.3        6,401        2.4        11,039        1,628        2.0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total operating expenses

     414,464        100        606,965        89,532        100        267,941        100        550,713        81,234        100  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Our sales and marketing expenses primarily consist of (i) salaries paid to our sales and marketing personnel; (ii) student acquisition expenses, which mainly include expenses relating to our online sales and marketing channels and commissions for our sales and marketing personnel; and (iii) rentals of premises occupied by our sales and marketing personnel. Historically, we had incurred significant sales and marketing expenses as we invested substantially in our sales, branding and marketing efforts and expanding our sales and marketing team to increase student enrollments and gain market share. We expect our sales and marketing expenses to increase in the foreseeable future as we plan to further grow our student enrollments to strengthen our existing leadership in China’s post-secondary and professional education market.

The following table sets forth a breakdown of our sales and marketing expenses, in absolute amounts and as percentages of total sales and marketing expenses, for the periods indicated:

 

     For the Year Ended December 31,      For the Six Months Ended June 30,  
     2015      2016      2016      2017  
     RMB      %      RMB      US$      %      RMB      %      RMB      US$      %  
     (in thousands, except for percentages)  

Employee salaries

     143,203        43.0        211,574        31,209        42.0        94,491        44.0        182,259        26,885        37.0  

Student acquisition expenses

     135,169        40.6        203,760        30,056        40.5        87,187        40.5        220,807        32,571        44.8  

Rentals

     28,240        8.4        43,857        6,469        8.7        21,458        10.0        29,138        4,298        5.9  

Others

     26,641        8.0        44,452        6,557        8.8        11,921        5.5        60,591        8,938        12.3  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total sales and marketing expenses

     333,253        100        503,643        74,291        100        215,057        100        492,795        72,691        100  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Our general and administrative expenses primarily consist of (i) compensation for our senior executives and administrative personnel, (ii) rentals of premises occupied by our senior executives and administrative personnel, and (iii) administrative and other expenses. We expect our general and administrative expenses to increase as we incur additional costs as a result of operating as a public company.

Our product development expenses primarily consist of (i) compensation for our course and educational content development professionals and technology development personnel, and (ii) rentals of premises occupied by our course and educational content development professionals and technology development personnel. We expect our product development expenses to increase in the foreseeable future, as we plan to continue to invest in our course and educational content development efforts to improve our teaching quality and student learning experience.

 

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Taxation

Cayman Islands

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

Hong Kong

Our wholly owned subsidiaries in Hong Kong, Sunlands Online Education HK Limited, is subject to Hong Kong profits tax on their activities conducted in Hong Kong at a uniform tax rate of 16.5%. Payments of dividends by our subsidiaries to us are not subject to withholding tax in Hong Kong.

PRC

Our subsidiaries and our consolidated VIE and its subsidiaries in China are companies incorporated under PRC law and, as such, are subject to PRC enterprise income tax on their taxable income in accordance with the relevant PRC income tax laws. Pursuant to the PRC Enterprise Income Tax Law (the “EIT Law”), which became effective on January 1, 2008, a uniform 25% enterprise income tax rate is generally applicable to both foreign-invested enterprises and domestic enterprises, except where a special preferential rate applies. For example, enterprises qualified as “High and New Technology Enterprises” are entitled to a 15% enterprise income tax rate rather than the 25% uniform statutory tax rate. The enterprise income tax is calculated based on the entity’s global income as determined under PRC tax laws and accounting standards.

Prior to May 2016, our PRC subsidiaries were subject to business tax and related surcharges at a rate of 3.36% and 5.6% on revenues related to educational services and non-educational services, respectively. Our net revenues are presented net of those taxes incurred.

Beginning in May 2016, in accordance with Tax rule (Cai Shui [2016] No. 68), the non-academic educational programs and services are subject to a simple VAT collection method at a rate of 3%. Entities which are subject to the tax rate of 3% are not allowed to offset qualified input VAT paid to suppliers against their output VAT liabilities. Our educational services which were previously subject to business tax, are therefore subject to VAT at the rate of 3%. For non-educational services, the VAT rate is 6%, in accordance with Tax rule, Cai Shui [2016] No. 36.

As a Cayman Islands holding company, we may receive dividends from our PRC subsidiaries through Sunlands Online Education HK Limited. The PRC EIT Law and its implementing rules provide that dividends paid by a PRC entity to a non-resident enterprise for income tax purposes is subject to PRC withholding tax at a rate of 10%, subject to reduction by an applicable tax treaty with China. Pursuant to the Arrangement between Mainland China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and Tax Evasion on Income, the withholding tax rate in respect to the payment of dividends by a PRC enterprise to a Hong Kong enterprise may be reduced to 5% from a standard rate of 10% if the Hong Kong enterprise directly holds at least 25% of the PRC enterprise. Pursuant to the Notice of the State Administration of Taxation on the Issues concerning the Application of the Dividend Clauses of Tax Agreements, or SAT Circular 81, a Hong Kong resident enterprise must meet the following conditions, among others, in order to apply the reduced withholding tax rate: (i) it must be a company; (ii) it must directly own the required percentage of equity interests and voting rights in the PRC resident enterprise; and (iii) it must have directly owned such required percentage in the PRC resident enterprise throughout the 12 months prior to receiving the dividends. In August 2015, the State Administration of Taxation promulgated the Administrative Measures for Non-resident Taxpayers to Enjoy Treatment under Tax Treaties, or SAT Circular 60, which became effective on November 1, 2015. SAT Circular 60 provides that non-resident enterprises are not required to obtain pre-approval from the relevant tax authority in order to enjoy the reduced withholding tax. Instead, non-resident enterprises and their withholding agents may,

 

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by self-assessment and on confirmation that the prescribed criteria to enjoy the tax treaty benefits are met, directly apply the reduced withholding tax rate, and file necessary forms and supporting documents when performing tax filings, which will be subject to post-tax filing examinations by the relevant tax authorities. Accordingly, Sunlands Online Education HK Limited may be able to benefit from the 5% withholding tax rate for the dividends it receives from Wuhan Studyvip Online Education Co. Limited, or Wuhan Zhibo, if it satisfies the conditions prescribed under SAT Circular 81 and other relevant tax rules and regulations. However, according to SAT Circular 81 and SAT Circular 60, if the relevant tax authorities consider the transactions or arrangements we have are for the primary purpose of enjoying a favorable tax treatment, the relevant tax authorities may adjust the favorable withholding tax in the future.

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 EIT 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 enterprise income tax purposes, such classification could result in unfavorable tax consequences to us and our non-PRC shareholders and ADS holders.”

Internal Control Over Financial Reporting

Prior to this offering, we have been a private company with limited accounting personnel and other resources with which to address our internal control over financial reporting. Our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting.

In the course of auditing our consolidated financial statements as of December 31, 2016 and for the year ended December 31, 2016, we and our independent registered public accounting firm identified two material weaknesses in our internal control over financial reporting and other control deficiencies as of December 31, 2016. As defined in the standards established by the U.S. Public Company Accounting Oversight Board, a “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our company’s annual or interim consolidated financial statements will not be prevented or detected on a timely basis.

The material weaknesses identified relate to: (i) the lack of sufficient financial reporting and accounting personnel with appropriate knowledge of U.S. GAAP, and (ii) the lack of comprehensive accounting policies and procedures manual in accordance with U.S. GAAP. We do not believe that these material weaknesses had a significant impact on our financial reporting. To remedy identified material weaknesses, we have implemented, and plan to continue to implement, several measures, including:

 

    hiring additional competent and qualified accounting and reporting personnel with appropriate knowledge and experience of U.S. GAAP and SEC financial reporting requirements;

 

    establishing an ongoing program to provide sufficient and additional appropriate training to our accounting staff, especially trainings related to U.S. GAAP and SEC financial reporting requirements; and

 

    formulating internal accounting and internal control guidance on U.S. GAAP and SEC financial reporting requirements.

The implementation of these measures, however, may not fully address the material weaknesses identified in our internal control over financial reporting, and we cannot conclude that they have been fully remedied. See “Risk Factors—Risks Related to Our Business—If we fail to implement and maintain an effective system of internal controls, we may be unable to accurately or timely report our results of operations or prevent fraud, and investor confidence and the market price of our ADSs may be materially and adversely affected.”

 

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Critical Accounting Policies, Judgments and Estimates

We prepare our financial statements in accordance with U.S. GAAP, which requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the balance sheet dates and the reported amounts of revenues and expenses during the reporting periods. We continually evaluate these judgments and estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and assumptions that we believe to be reasonable, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.

The selection of critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors that should be considered when reviewing our financial statements. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements. You should read the following description of critical accounting policies, judgments and estimates in conjunction with our consolidated financial statements and other disclosures included in this prospectus.

Revenue recognition

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” This standard replaced existing revenue recognition rules with a comprehensive revenue measurement and recognition standard and expanded disclosure requirements. The ASU also includes guidance regarding the accounting for contract acquisition costs, which includes sales commissions. We have early adopted the new standard as of January 1, 2017 using the full retrospective method which requires us to present our financial statements for all periods as if Topic 606 had been applied to all prior periods. We did not apply practical expedients as provided under Topic 606.

We follow five steps for our revenue recognition under Topic 606: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation.

Our revenue is reported net of discount, business tax, value added tax and related surcharges. The primary sources of our revenues are as follows:

Online education services

We provide an integrated online education service package to students, including online live streaming audio-video interactive course content, recorded previous live audio-video course content, quiz banks, online chat rooms, and educational content. The services and goods provided in the package are highly interdependent and interrelated in the context of the contract and are only considered accessory services to the online live streaming and recorded courses which are not distinct and are not sold standalone. Therefore, our integrated online education services package is accounted for as a single performance obligation. The weighted average service period for degree- or diploma-oriented post-secondary courses and professional certification preparation and professional skills courses was 21 months and 17 months, respectively.

The transaction price of the integrated online education service package is determined by the contract amount net of any discounts. Students are offered a full, unconditional refund within 24 hours upon enrollment, and a partial refund for the undelivered courses, excluding registration fees, within seven days.

Online education services consist of two types of revenue models – the non-refundable course model and the refundable course model. Revenues for the non-refundable course model are recognized on a straight line

 

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basis over the service period from the registration day to the day on which the service period ends. For the refundable course model, we provide a student the ability to obtain a refund if the student achieves certain agreed conditions. We estimate the variable consideration to be earned and recognize revenue over time from the registration day to the day on which the service period ends on a straight line basis.

Our contract assets primarily consists of deferred costs, which represents the unamortized incremental sales commission relating to obtaining of customers contract, and the contract liabilities primarily consists of deferred revenue.

Student Financing

We offer an installment payment option to students, under which the students obtain loans, ranging from three months to 12 months, from accredited credit sources (“Loan Companies”) for the purpose of satisfying the student’s tuition payment due. The borrowing student is obligated to repay the loan principal in installments ranging from three months to 12 months to the Loan Companies, while we agree with the Loan Companies to bear the student’s interest expense and service fees. The Loan Companies remit the tuition to us before the student completes the registration. The interest expense and service fees are recorded as a reduction of the transaction price.

Offline education services

Prior to 2016, we provided offline, classroom-based courses (“offline education services”) in relation to test preparation and continuing education to students in the PRC. The average service period was 24 months. We offered a partial refund, for the undelivered offline courses, excluding the registration fees, within 15 days after the course enrollment. The offline education services are accounted for as a single performance obligation. Tuition fees are collected in advance and the revenue, net of any discounts, was recognized proportionally over the service period.

Commission revenue

We earn commission revenue by providing referral services to third-party education institutions. Commission revenue is recognized when the referred students registered at the third-party education institutions and the tuition fees are paid, by when the performance obligation is satisfied.

Adoption of Topic 606

The implementation of Topic 606 had no cumulative effect to the beginning balance of shareholders’ deficit as of January 1, 2015. All incomplete contracts as of December 31, 2014 were related to the Group’s offline, class-room based education service which was accounted for as a single performance obligation, with no variable consideration arrangement and revenue was recognized over the service period. Accordingly, there was no impact upon adopting Topic 606 and we did not apply practical expedients as provided under ASC 606-10-65.

The full retrospective method requires an entity to present financial statements for all periods as if the new revenue standard had been applied to all prior periods. We have assessed the effect of adoption of this standard which relates to (i) variable consideration arrangement, pursuant to ASC606-10-32, of our refundable online education course launched in 2015, as well as (ii) capitalized incremental sales commission relating to obtaining the customer contract pursuant to ASC340-40.

Consolidation of variable interest entity

Our consolidated financial statements include the financial statements of Sunlands Online Education Group, its subsidiaries, its VIE and the VIE’s subsidiaries. All profits, transactions and balances among Sunlands Online Education Group, its subsidiaries, its VIE and the VIE’s subsidiaries have been eliminated upon consolidation.

 

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PRC laws and regulations restrict foreign ownership in value-added telecommunication services and other internet-related business. As Wuhan Zhibo is deemed a foreign legal person under PRC laws, our subsidiary is not eligible to engage in the provision of online education services. Due to these restrictions, we conduct our online education service business in China primarily through contractual arrangements among (i) Wuhan Zhibo, our wholly owned PRC subsidiary, (2) Beijing Sunlands, our VIE, and (3) shareholders of Beijing Sunlands. As a result of these contractual arrangements, the shareholders of our VIE irrevocably granted Wuhan Zhibo the power to exercise all voting rights to which they were entitled. In addition, Wuhan Zhibo has the option to acquire all of the equity interests in the VIE, to the extent permitted by the then-effective PRC laws and regulations, for nominal consideration. Finally, Wuhan Zhibo is entitled to receive service fees for certain services to be provided to the VIE in an amount at Wuhan Zhibo’s discretion. We concluded that Beijing Sunlands is our VIE, of which we are the primary beneficiary. As such, we consolidate the results of operations of the VIE in our consolidated financial statements.

As advised by our PRC legal counsel, our corporate structure in China complies with all existing PRC laws and regulations. However, our PRC legal counsel has also advised us that as there are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, and we cannot assure you that the PRC government would agree that our corporate structure or any of the above contractual arrangements comply with current or future PRC laws or regulations. PRC laws and regulations governing the validity of these contractual arrangements are uncertain and the relevant government authorities may have broad discretion in interpreting these laws and regulations.

Income taxes

Current income taxes are provided in accordance with the laws of the relevant tax authorities. Deferred income taxes are recognized when temporary differences exist between the tax bases of assets and liabilities and their reported amounts in the financial statements. Net operating loss carry forwards and credits are applied using enacted statutory tax rates applicable to future years. Deferred tax assets are reduced by a valuation allowance when it, in the opinion of us, is more-likely-than-not that a portion of or all of the deferred tax assets will not be realized. The impact of an uncertain income tax position is recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant tax authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Interest and penalties on income taxes will be classified as a component of the provisions for income taxes.

Fair value of ordinary shares

Prior to our initial public offering, we were a private company with no quoted market prices for our ordinary shares. We therefore needed to make estimates of the fair value of our ordinary shares at various dates for the purpose of determining the fair value of our ordinary shares at the date of the grant of share-based compensation awards to our employees as one of the inputs into determining the grant date fair value of the award.

The following table sets forth the fair value of our ordinary shares estimated at different times prior to our initial public offering with the assistance from an independent valuation firm:

 

Date

  Fair
Value

per
share
    DLOM     Discount
Rate
   

Type of valuation

  

Purpose of valuation

    (RMB)                       

January 18, 2013

    0.54       40     30   Retrospective    To determine the fair value of share option grant

April 18, 2014

    1.38       30     25   Retrospective    To determine the fair value of share option grant

August 18, 2015

    1.79       25     25   Retrospective    To determine the fair value of share option grant

The valuations of our ordinary shares were performed using methodologies, approaches and assumptions consistent with the American Institute of Certified Public Accountants Audit and Accounting Practice Aid Series:

 

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Valuation of Privately-Held-Company Equity Securities Issued as Compensation, or the AICPA Practice Guide. The determination of the fair value of our ordinary shares requires complex and subjective judgments to be made regarding our projected financial and operating results, our unique business risks, the liquidity of our shares and our operating history and prospects at the time of valuation. The option-pricing method was used to allocate our equity value to preferred shares or other senior securities and ordinary shares, taking into account the guidance prescribed by the AICPA Practice Guide. This method treats ordinary shares and preferred shares or other senior securities as call options on the equity value, with exercise prices based on their respective payoffs upon a liquidity event.

In determining our equity value, we applied the discounted cash flow analysis based on our projected cash flow using our best estimate as of the valuation date. The major assumptions used in calculating the fair value of our equity include:

 

    Discount Rates. The discount rates listed out in the table above were based on the weighted average cost of capital, which was determined based on a number of factors including risk-free rate, comparative industry risk, equity risk premium, company size and non-systemic risk factors.

 

    Comparable Companies. In deriving the weighted average cost of capital used as the discount rates under the income approach, nine publicly traded companies were selected for reference as our guideline companies. The guideline companies were selected based on the following criteria: (i) they operate in the education service industry and (ii) their shares are publicly traded in the United States.

 

    Discount for Lack of Marketability, or DLOM. DLOM was quantified by the Finnerty’s (2012) Average-Strike Put Options model. This model estimates a DLOM as a function of restricted transferability, using the value of an average-strike put option. This option pricing method is one of the methods commonly used in estimating DLOM as it takes into consideration factors like timing of a liquidity event, such as an initial public offering, and estimated volatility of our shares. The further the valuation date is from an expected liquidity event, the higher the put option value and thus the higher the implied DLOM. The lower the DLOM used for the valuation, the higher the determined fair value of the ordinary shares.

Once a public trading market of the ADSs has been established in connection with the completion of this offering, it will no longer be necessary for us to estimate the fair value of our ordinary shares in connection with our accounting for granted share options.

Fair Value of Options

The fair value of the options granted is estimated on the dates of grant using the binomial option pricing model with the following assumptions used.

 

     Grant Date     Option
Modification
Date
 
     January 18, 2013     April 18, 2014     August 18, 2015     December 31,
2015
 

Risk-free interest rate(1)

     2.6     3.4     2.8     2.7%~2.9%  

Expected volatility(2)

     48     47     46     49%~52%  

Expected dividend yield(3)

     0     0     0     0%  

Exercise multiples(4)

     2.8       2.8       2.8       2.8  

Fair value of underlying ordinary shares(5)

     0.54       1.38       1.79       5.62  

 

(1) We estimate risk-free interest rate based on the daily treasury long term rate of U.S. Department of the Treasury with a maturity period close to the expected term of the options.
(2) We estimated expected volatility based on the annualized standard deviation of the daily return embedded in historical share prices of comparable companies with a time horizon close to the expected expiry of the term.

 

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(3) We have never declared or paid any cash dividends on our capital stock, and we do not anticipate any dividend payments on our ordinary shares in the foreseeable future.
(4) The exercise multiple is estimated as the ratio of fair value of underlying shares over the exercise price as at the time the option is exercised, based on a consideration of research study regarding exercise pattern based on historical statistical data.
(5) The estimated fair value of the ordinary shares underlying the options as of the grant dates was mainly determined based on a retrospective valuation with the assistance of a third-party appraiser.

Share-based compensation

Share-based compensation with employees is measured based on the grant date fair value of the equity instrument. Share-based compensation expenses, net of forfeitures, are recognized over the requisite service period based on a straight-line basis with a corresponding impact reflected in additional paid-in capital.

On January 18, 2013, the board of directors of Sunland Education Co. Limited, or Sunlands Education, our previous offshore holding company, adopted an employee share incentive plan, or the 2013 Plan. Under the 2013 Plan, Sunlands Education was authorized to grant options or share purchase rights to purchase up to an aggregate of 33,300,000 ordinary shares of Sunlands Education. Since the options under the 2013 Plan were granted to certain employees of Beijing Shangzhi Jiaye Education Technology Co., Ltd., or Shangzhi Jiaye, share-based compensation was recorded by Shangzhi Jiaye. Shangzhi Jiaye is a wholly owned subsidiary of Beijing Sunlands, our VIE, and we consolidate the results of operations of Shangzhi Jiaye through a series of contractual arrangements between us and Beijing Sunlands. See “ Corporate History and Structure—Contractual Arrangements with Beijing Sunlands.”

Under the 2013 Plan, the board of directors of Sunlands Education granted: (i) options to purchase 28,638,000 shares in the Sunlands Education exercisable at a price per share of RMB0.0006 on January 18, 2013; (ii) options to purchase 2,664,000 shares in Sunlands Education exercisable at a price per share of RMB0.0006 on April 18, 2014, and (iii) options to purchase 1,998,000 shares in Sunlands Education exercisable at a price per share of RMB0.0006 on August 18, 2015.

Under the 2013 Plan, the exercisability of the options granted was subject to an initial public offering, and we did not record any compensation expense in our consolidated statements of operations for options granted under 2013 Plan as the occurrence of an initial public offering is generally not considered to be probable until such initial public offering is complete. On October 20, 2015, in connection with a reorganization, the board of directors of Sunlands Education approved that all of the options under the 2013 Plan that were not vested shall be fully vested as of December 31, 2015 and the exercisability of such options was no longer subject to in initial public offering. We recorded compensation expenses of RMB23.7 million under the 2013 Plan for the year ended December 31, 2015 in the financial statements of Shangzhi Jiaye which received the services of the grantees of the options granted under the 2013 Plan.

We recorded share-based compensation expenses of RMB23.7 million, nil and nil, respectively, for the years ended December 31, 2015 and 2016 and the six months ended June 30, 2017.

Property and equipment, net

Property and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful lives of the assets, as follows:

 

Category

  

Estimated useful life

Leasehold improvement

   Shorter of lease term or expected useful life

Electronic and office equipment

   3 years-5 years

 

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Repair and maintenance costs are charged to expense as incurred, whereas the costs of renewals and betterment that extend the useful lives of property and equipment capitalized as additions to the related assets. Retirements, sales and disposals of assets are recorded by removing the cost and accumulated depreciation from the asset and accumulated depreciation accounts with any resulting gain or loss reflected in the consolidated statements of operations.

Results of Operations

The following table sets forth our consolidated results of operations for the periods indicated, both in absolute amounts and as percentages of total net revenues. This information should be read together with our consolidated financial statements and related notes included elsewhere in this prospectus. The operating results in any period are not necessarily indicative of the results that may be expected for any future period.

 

     For the Year Ended December 31,     For the Six Months Ended June 30,  
     2015     2016     2016     2017  
     RMB     RMB     US$     RMB     RMB     US$  
     (in thousands, except for share, per share and per ADS data)  

Net revenues

     159,010       418,910       61,793       174,329       361,463       53,319  

Cost of revenues(1)

     (61,713     (70,986     (10,471     (27,778     (46,179     (6,812
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     97,297       347,924       51,322       146,551       315,284       46,507  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

            

Sales and marketing expenses(1)

     (333,253     (503,643     (74,291     (215,057     (492,795     (72,691

Product development expenses(1)

     (5,189     (13,932     (2,055     (6,401     (11,039     (1,628

General and administrative expenses(1)

     (76,022     (89,390     (13,186     (46,483     (46,879     (6,915

Total operating expenses

     (414,464     (606,965     (89,532     (267,941     (550,713     (81,234
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (317,167     (259,041     (38,210     (121,390     (235,429     (34,727
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income

     814       3,051       450       1,532       4,053       598  

Other income, net

     770       2,423       357       1,404       —         —    

Loss before income tax expenses

     (315,583     (253,567     (37,403     (118,454     (231,376     (34,129

Income tax expenses

     —         —         —         —         —         —    

Net loss from continuing operations

     (315,583     (253,567     (37,403     (118,454     (231,376     (34,129

Net loss from discontinued operations, net of income tax expenses of nil

     (2,719     —         —         —         —         —    

Loss from equity method investment

     —         —         —         —         (398     (59
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (318,302     (253,567     (37,403     (118,454     (231,774     (34,188
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Less: Net loss attributable to noncontrolling interests

     —         —         —         —         (42     (6

Net loss from continuing operations attributable to Sunlands

     (315,583     (253,567     (37,403     (118,454     (231,732     (34,182

Net loss from discontinued operations attributable to Sunlands

     (2,719     —         —         —         —         —    

Net loss per share attributable to ordinary shareholders—basic and diluted

     (83.36     (66.40     (9.79     (31.02     (60.68     (8.95

Income per ADS(2)

            

Basic

            

Diluted

            

 

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Notes:
(1)  Share-based compensation expenses included in:

 

     For the Year Ended
December 31,
     For the Six Months
Ended June 30,
 
     2015      2016      2016      2017  
     RMB      RMB      US$      RMB      RMB      US$  
     (in thousands, except for share, per share and
per ADS data)
 

Cost of revenues

     —          —          —          —          —          —    

Sales and marketing expenses

     2,014        —          —          —          —          —    

Product development expenses

     —          —          —          —          —          —    

General and administrative expenses

     21,643        —          —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     23,657        —          —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(2)  Each ADS represents              Class A ordinary shares.

Six Months Ended June 30, 2017 Compared to Six Months Ended June 30, 2016

Net revenues

Our net revenues increased by 107.3% from RMB174.3 million in the six months ended June 30, 2016 to RMB361.5 million (US$53.3 million) in the six months ended June 30, 2017, mainly driven by the increase in our gross billings, which was in turn attributable to increases in both the number of our new student enrollments and gross billings per new student enrollment. The number of new student enrollments grew by approximately 66.8% from 89,066 in the six months ended June 30, 2016 to 148,573 in the six months ended June 30, 2017, primarily as a result of our increased investment in improving the quality of our course and educational content offerings and sales, branding and marketing spending. Our gross billings per new student enrollment grew by 72.5% from RMB3,560.1 in the six months ended June 30, 2016 to RMB6,141.6 (US$905.9) in the six months ended June 30, 2017, primarily as a result of our increased ability to charge higher tuition for our course packages as we continued to improve our service quality and gained popularity among students.

Cost of revenues

Our cost of revenues increased by 66.2% from RMB27.8 million in the six months ended June 30, 2016 to RMB46.2 million (US$6.8 million) in the six months ended June 30, 2017, primarily due to the increase in the compensation for our faculty members, which mainly include teachers and mentors, as we continued to attract new and retain our existing faculty members. The total amount of compensation for such personnel increased by 82.7% from RMB19.7 million in the six months ended June 30, 2016 to RMB36.0 million (US$5.3 million) in the six months ended June 30, 2017. The total number of our faculty was 350 and 687, respectively, as of June 30, 2016 and 2017.

Gross profit

As a result of the foregoing, our gross profit increased by 115.1% from RMB146.6 million in the six months ended June 30, 2016 to RMB315.3 million (US$46.5 million) in the six months ended June 30, 2017. Our gross margin increased from 84.1% in the six months ended June 30, 2016 to 87.2% in the six months ended June 30, 2017.

Operating expenses

Our operating expenses increased by 105.6% from RMB267.9 million for the six months ended June 30, 2016 to RMB550.7 million (US$81.2 million) in the six months ended June 30, 2017.

 

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Sales and marketing expenses

Our sales and marketing expenses increased by 129.1% from RMB215.1 million in the six months ended June 30, 2016 to RMB492.8 million (US$72.7 million) in the six months ended June 30, 2017, mainly driven by increases in (i) salaries paid to our sales and marketing personnel, (ii) student acquisition expenses, which mainly included expenses relating to our online sales and marketing channels and commissions paid to our sales and marketing personnel, and (iii) rentals of premises occupied by our sales and marketing personnel. Employee compensation increased by 92.9% from RMB94.5 million in the six months ended June 30, 2016 to RMB182.3 million (US$26.9 million) in the six months ended June 30, 2017, primarily as a result of the increase in the number of our sales and marketing personnel. As of June 30, 2016 and 2017, we had 2,316 and 4,098 sales and marketing personnel, respectively. Student acquisition expenses increased by 153.3% from RMB87.2 million in the six months ended June 30, 2016 to RMB220.8 million (US$32.6 million) in the six months ended June 30, 2017, primarily driven by our increased spending on sales, branding and marketing activities, including investments in broadening our search engine and mobile application channels. Rentals increased by 35.3% from RMB21.5 million in the six months ended June 30, 2016 to RMB29.1 million (US$4.3 million) in the six months ended June 30, 2017, which is generally in line with growth in the number of our sales and marketing employees.

General and administrative expenses

Our general and administrative expenses increased by 0.9% from RMB46.5 million in the six months ended June 30, 2016 to RMB46.9 million (US$6.9 million) in the six months ended June 30, 2017, primarily due to increases in (i) compensation for our senior executives and administrative staff, and (ii) recruitment expenses, both of which were primarily attributable to the hiring of new senior executives in 2017.

Product development expenses

Our product development expenses increased by 71.9% from RMB6.4 million in the six months ended June 30, 2016 to RMB11.0 million (US$1.6 million) in the six months ended June 30, 2017, primarily due to the increase in the compensation for our course and educational content professionals and technology development personnel during the same period. The compensation for our course and educational content professionals and technology development personnel which increased by 96.1% from RMB5.1 million in the six months ended June 30, 2016 to RMB10.0 million (US$1.5 million) in the six months ended June 30, 2017.

Net loss

As a result of the foregoing, our net loss increased by 95.6% from RMB118.5 million in the six months ended June 30, 2016 to RMB231.8 million (US$34.2 million) in the six months ended June 30, 2017.

Year Ended December 31, 2016 Compared to Year Ended December 31, 2015

Net revenues

Our net revenues increased by 163.4% from RMB159.0 million in 2015 to RMB418.9 million (US$61.8 million) in 2016, mainly driven by the increase in our gross billings, which was in turn attributable to the increase in our gross billings per new student enrollment. Our gross billings per new student enrollment grew by 57.7% from RMB2,489.9 in 2015 to RMB3,926.0 (US$579.1) in 2016, primarily as a result of our increased ability to charge higher tuition for our course packages as we continued to improve the quality of our education services and gained popularity among students.

Cost of revenues

Our cost of revenues increased by 15.1% from RMB61.7 million in 2015 to RMB71.0 million (US$10.5 million) in 2016, primarily due to the increase in the compensation for our faculty members, which mainly

 

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include teachers and mentors, as we continued to attract new and retain our existing faculty members. The total amount of compensation for such personnel increased by 36.8% from RMB38.6 million in 2015 to RMB52.8 million (US$7.8 million) in 2016. The total number of our faculty members which primarily include teachers and mentors was 240 and 399, respectively, as of December 31, 2015 and 2016.

Gross profit

As a result of the foregoing, our gross profit increased by 257.6% from RMB97.3 million in 2015 to RMB347.9 million (US$51.3 million) in 2016. Our gross margin increased from 61.2% in 2015 to 83.1% in 2016.

Operating expenses

Our operating expenses increased by 46.4% from RMB414.5 million in 2015 to RMB607.0 million (US$89.5 million) in 2016.

Sales and marketing expenses

Our sales and marketing expenses increased by 51.1% from RMB333.3 million in 2015 to RMB503.6 million (US$74.3 million) in 2016, mainly driven by increases in (i) salaries paid to our sales and marketing personnel, (ii) student acquisition expenses, which mainly included expenses relating to our online sales and marketing channels and commissions paid to our sales and marketing personnel, and (iii) rentals of premises occupied by our sales and marketing personnel. Employee compensation increased by 47.8% from RMB143.2 million in 2015 to RMB211.6 million (US$31.2 million) in 2016, primarily as a result of the increase in the number of our sales and marketing personnel. As of December 31, 2015 and 2016, we had 912 and 2,359 sales and marketing personnel, respectively. Student acquisition expenses increased by 50.7% from RMB135.2 million in 2015 to RMB203.8 million (US$30.1 million) in 2016, mainly driven by our increased spending on sales, branding and marketing activities, including the investment in broadening our search engine and mobile application channels. Rentals increased by 55.7% from RMB28.2 million in 2015 to RMB43.9 million (US$6.5 million) in 2016, primarily due to the lease of our headquarter offices in 2016, which is generally in line with the growth in the number of our sales and marketing personnel.

General and administrative expenses

Our general and administrative expenses increased by 17.6% from RMB76.0 million in 2015 to RMB89.4 million (US$13.2 million) in 2016, primarily due to (i) the increase in the compensation for our senior executives and administrative staff, mainly as a result of the hiring of new senior executives in 2016, and (ii) increased rentals of premises occupied by our senior executives and administrative staff. The amount of compensation paid to our senior executives and administrative staff increased from RMB36.8 million in 2015 to RMB56.0 million (US$8.3 million) in 2016.

Product development expenses

Our product development expenses increased by 168.5% from RMB5.2 million in 2015 to RMB13.9 million (US$2.1 million) in 2016, primarily due to the increase in the compensation paid to our course and educational content professionals and IT support staff. The compensation for our course and educational content professionals and technology development personnel increased by 152.9% from RMB4.7 million in 2015 to RMB11.8 million (US$1.7 million) in 2016.

Net loss

As a result of the foregoing, our net loss decreased from RMB318.3 million in 2015 to RMB253.6 million (US$37.4 million) in 2016.

 

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Table of Contents

Selected Quarterly Results of Operations

The following table sets forth our unaudited consolidated quarterly results of operations for the periods indicated. You should read the following table in conjunction with our consolidated financial statements and related notes included elsewhere in this prospectus. We have prepared the unaudited consolidated quarterly financial information on the same basis as our consolidated financial statements. The unaudited consolidated quarterly financial information includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair representation of our operating results for the quarters presented.

 

     For the Three Months Ended  
     March 31,
2016
    June 30,
2016
    September 30,
2016
    December 31,
2016
    March 31,
2017
    June 30,
2017
 
     (RMB in thousands)  

Net revenues

     79,425       94,904       113,392       131,189       155,637       205,826  

Cost of revenues

     (11,697     (16,081     (22,507     (20,701     (19,426     (26,753
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     67,728       78,823       90,885       110,488       136,211       179,073  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

            

Sales and marketing expenses

     (99,140     (115,917     (131,289     (157,297     (210,184     (282,611

Product development expenses

     (3,028     (3,373     (3,569     (3,962     (4,725     (6,314

General and administrative expenses

     (21,855     (24,628     (19,871     (23,036     (21,172     (25,707

Total operating expenses

     (124,023     (143,918     (154,729     (