424B4 1 ea124592-424b4_wimihologram.htm PROSPECTUS

Filed Pursuant to Rule 424(b)(4)

Registration No. 333-240097 and

Registration No. 333-40109

 

7,560,000 American Depositary Shares

 

 

 

WiMi Hologram Cloud Inc.

Representing 15,120,000 Class B ordinary shares

 

 

 

This is a public offering of American depositary shares, or ADSs, of WiMi Hologram Cloud Inc., or WiMi. WiMi is offering on a best-efforts basis a maximum of  7,560,000 ADSs. Each ADS represents two of our Class B ordinary shares, par value US$0.0001 per share. 

Our ADSs are listed on the Nasdaq Global Market, or the NASDAQ, under the symbol “WiMi”. On July 27, 2020, the closing trading price for our ADSs, as reported on the NASDAQ, was US$7.29 per ADS.

The underwriters are selling our ADSs in this offering on a best-efforts basis. The offering is being made without a firm commitment by the underwriters, who have no obligations or commitments to purchase any securities. Following the completion of this offering, our issued and outstanding share capital will consist of 20,115,570 Class A ordinary shares and 113,453,843 Class B ordinary shares. Jie Zhao will beneficially own all of our issued Class A ordinary shares and will be able to exercise approximately 78.5% of the total voting power of our issued and outstanding share capital immediately following the completion of this offering. Holders of Class A ordinary shares and Class B ordinary shares have the same rights except for voting and conversion rights. Each Class A ordinary share is entitled to ten (10) votes and is convertible into one Class B ordinary share at any time at the option of the holder thereof, and each Class B ordinary share is entitled to one (1) vote. Class B ordinary shares are not convertible into Class A ordinary shares under any circumstances. 

Our issued and outstanding share capital consists of Class A ordinary shares and Class B ordinary shares. We are, and following the completion of this offering will continue to be a “controlled company” as defined under the Nasdaq Listing Rules because Jie Zhao, our Chairman, will beneficially own 100% of our issued and outstanding Class A ordinary shares and approximately 40.5% of our issued and outstanding Class B ordinary shares. Accordingly, Mr. Zhao will be able to exercise approximately 78.5% of our total voting power following the completion of this offering. Holders of Class A ordinary shares and Class B ordinary shares have the same rights except for voting and conversion rights. See “Principal Shareholders.” 

 

 

See “Risk Factors” beginning on page 17 for factors you should consider before buying the ADSs. 

PRICE US$8.18 PER ADS 

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$8.18   US$61,840,800.00 
Underwriting discounts and commissions(1)  US$0.42   US$3,153,880.80 
Proceeds, before expenses, to us  US$7.76   US$58,686,919.20 

  

(1)Does not include additional compensation payable to the underwriters. We have also agreed to issue to the representatives of the underwriters a warrant to purchase ADSs representing 2.5% of the number of Series B ordinary shares sold in this offering at an exercise price equal to 125% of the public offering price. In addition, we have agreed to reimburse the underwriters for certain expenses. The registration statement of which this prospectus forms a part also covers the Class B ordinary shares representing the ADSs that are issuable upon exercise of the representatives’ warrant. See “Underwriting” on page 156 for additional disclosure regarding underwriting discounts and commissions and reimbursement of expenses.

 

The underwriters expect to deliver the ADSs against payment in U.S. dollars in New York, NY on July 29, 2020.

 

Joint Book-Running Managers

 

The Benchmark Company, LLC FT Global Capital, Inc.

 

Book Running Manager – Asia

 

Valuable Capital Limited

 

 

 

The date of this prospectus is July 27, 2020.

 

 

 

 

TABLE OF CONTENTS

 

  Page
Prospectus Summary 1
Our Corporate Information 11
Conventions Which Apply to this Prospectus 12
The Offering 13
Summary Consolidated Financial Data and Operating Data 15
Risk Factors 17
Special Note Regarding Forward-Looking Statements 48
Use of Proceeds 49
Dividend Policy 50
Capitalization 51
Dilution 52
Enforceability of Civil Liabilities 53
Corporate History and Structure 55
Selected Consolidated Financial Data 59
Management’s Discussion and Analysis of Financial Condition and Results of Operations 60
Industry Overview 79
Business 91
PRC Regulation 105
Management 117
Principal Shareholders 123
Related Party Transactions 126
Description of Share Capital 128
Description of American Depositary Shares 137
Shares Eligible for Future Sale 149
Taxation 151
Underwriting 156
Expenses Relating to this Offering 163
Legal Matters 164
Experts 165
Where You Can Find Additional Information 166
Index to Consolidated Financial Statements F-1

 

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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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 the 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 the ADSs. Investors should note that WiMi Hologram Cloud Inc. (“WiMi Cayman”), our ultimate Cayman Islands holding company, does not directly own any substantive business operations in the PRC and the businesses described in this prospectus are operated through our variable interest entity. This prospectus contains information from an industry report, dated July 15, 2019, commissioned by us and prepared by Frost & Sullivan, an independent research firm, to provide information regarding our industry and our market position in China and globally. We refer to this report as the “Frost & Sullivan Report.”

 

Our Business

 

We offer augmented reality (“AR”)-based holographic services and products to cater to our customers’ needs, all centered upon providing an innovative, immersive and interactive holographic augmented reality experience for our customers and end users. Our service and product offerings primarily consist of holographic AR advertising services and holographic AR entertainment products. Approximately 69.3%, 80.5%, and 83.8% of our revenues were generated from our holographic AR advertising services for the years ended December 31, 2017, 2018, and 2019, respectively. Approximately 30.7%, 19.5%, and 16.2% of our revenues were generated from our holographic AR entertainment products for the years ended December 31, 2017, 2018, and 2019, respectively. The core of our business is holographic AR technologies used in software engineering, content production, cloud and big data. By leveraging our strong technological capabilities and infrastructure, we are able to deliver superior products and services and conduct our operations in a highly efficient manner.

 

Holographic AR Advertising Services

 

Our holographic AR advertising software enables users to insert into video footages real or animated three dimensional (“3D”) objects that integrate seamlessly within the scene of such footages. Our online holographic AR advertising solution embeds holographic AR ads into films and shows that are hosted by leading online streaming platforms in China. For the year ended December 31, 2018, holographic AR ads produced using our software generated a total of approximately 6.6 billion views, representing an increase of 34.7% from approximately 4.9 billion views for the year ended December 31, 2017. For the year ended December 31, 2019, holographic AR ads produced using our advertising solutions generated approximately 9.7 billion views, representing an increase of 47.0% from approximately 6.6 billion views for the year ended December 31, 2018. View” is also known as “impression”. Each time an advertisement is fetched, it is counted as one impression or one view. CPM, or cost per thousand impressions, is a term used in traditional, online advertising and marketing related to web traffic, which refers to the cost or expense incurred for every thousand potential customers who view the advertisement.

 

Our customers are those who have entered into contracts with us and used our services pursuant to such contracts during the relevant period. Customers typically enter into a master agreement with us for a term of one year, although they do not necessarily purchase products or services from us during each quarter of such year. A separate request is submitted by a customer for each order of products or services. The number of our customers for advertising services increased from 97 for the year ended December 31, 2017, to 121 for the year ended December 31, 2018 and further increased to 153 for the year ended December 31, 2019. Average revenue per customer for AR advertising services increased from approximately RMB1.4 million for the year ended December 31, 2017, to approximately RMB1.5 for the year ended December 31, 2018 and further increased to approximately RMB1.7 million for the year ended December 31, 2019.

 

Through our proprietary image and video recognition technologies, our software enables users to analyze the underlying video footages at a pixel level to identify ad spaces that can be augmented by 3D objects. Advertisers and their agencies purchase these ad spaces through application programming interfaces, or APIs, integrated with our systems, specifying their target audience and budgets and typically providing the 3D models to be embedded in the videos. When the ad space is detected and 3D objects are generated, the 3D objects are embedded into the underlying streaming videos automatically on a batch-processing basis as determined by our software.

 

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Holographic AR Entertainment Products

 

Our holographic AR entertainment products consist primarily of payment middleware software, game distribution platform and holographic mixed reality (“MR”) software.

 

Payment middleware is a software solution that connects mobile apps to payment channels, giving mobile app users convenient access to a wide range of online payment options. We have cooperated with more than 55 app developers and our payment middleware has been embedded to over 1,100 marketed mobile apps of over 300 customers in 2018, most of which were featured by AR functions.

 

Our advanced payment middleware streamlines the often time-consuming mobile payment process. Our mobile payment middleware facilitates app developers to build an in-app payment infrastructure that allows micropayments to be made or received through an efficient, secure system, without any interface redirection. Such mobile payment middleware enables app developers to store users’ payment credentials in a trusted and safe environment and eases user’s burden of repeatedly entering and authenticating payment information for each transaction.

 

Our payment middleware can be fully integrated with various types of mobile apps, especially those employing AR technologies, such as live streaming, gaming, selfie, photo editing, and video-sharing apps. Currently, our payment middleware supports substantially all of the major online payment channels in China, and is compatible with the mainstream mobile operating systems.

 

Recent Developments

 

Strategic plan to develop the application of holographic AR technologies in the semiconductor industry

 

We believe that the application demand of holographic 3D vision in the semiconductor industry is growing rapidly, representing promising market potentials. In order to develop the application of holographic AR technologies in the semiconductor industry, we, through our Hong Kong subsidiary WiMi Hologram Cloud Limited, or WiMi HK, entered into an agreement on May 24, 2020 to set up a joint venture to develop our business and the relevant applications of holographic 3D vision in the semiconductor industry. We believe that the establishment of the joint venture is conducive to the expansion of the semiconductor industry and the rapid integration of market resources. Furthermore, it could facilitate our strategies of extending the holographic 3D vision software from the application layer to the chip field and combining software and hardware through the holographic 3D vision software solution, namely, the strategic derivative upgrade to the semiconductor industry. We plan to invest in the semiconductor industry, acquire semiconductor-related assets and cooperate with chip factory in the future, so as to enhance the our technical service capability and retain current customers.

 

Coronavirus (COVID-19) Update

 

The ongoing outbreak of the noval coronavirus (COVID-19) has spread rapidly to many parts of the world. In March 2020, the World Health Organization declared the COVID-19 as a pandemic. Given the rapidly expanding nature of the COVID-19 pandemic. The pandemic has resulted in quarantines, travel restrictions, and the temporary closure of stores and business facilities in China for the past few months. Given the rapidly expanding nature of the COVID-19 pandemic, and because substantially all of our business operations and our workforce are concentrated in China, we believe there is a substantial risk that our business, results of operations, and financial condition will be adversely affected. Potential impact to our results of operations will also depend on future developments and new information that may emerge regarding the duration and severity of the COVID-19 and the actions taken by government authorities and other entities to contain the COVID-19 or mitigate its impact, almost all of which are beyond our control.

 

The impacts of COVID-19 on our business, financial condition, and results of operations include, but are not limited to, the following:

 

We temporally closed our offices and implemented work from-home policy beginning in February 2020, as required by relevant PRC regulatory authorities. Since March 16, 2020, our offices have reopened and are fully operational.

 

Due to the nature of our business, the impact of the closure on our operational capabilities was not significant, as most of our work force continued working offsite during such closure.

 

Our customers could potentially be negatively impacted by the outbreak, which may reduce their budgets for online advertising and marketing in 2020. As a result, our revenue and income may be negatively impacted in 2020. However, to date, none of our customers have terminated contracts with us.

 

The situation may worsen if the COVID-19 outbreak continues. Certain of our customers have requested, and additional customers may request, additional time to pay us or fail to pay us on time, or at all, which may require us to record additional allowances. We are currently working with customers on finalizing payment schedules and have not experienced significant collection issues so far. We will continue to closely monitor our collections throughout 2020.

 

The global stock markets have experienced, and may continue to experience, significant decline from the COVID-19 outbreak. It is possible that the price of our ADSs will decline significantly after the consummation of this offering, in which case you may lose your investment.

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While many of the restrictions on movement within China have been relaxed as of the date of this prospectus, there is great uncertainty as to the future progress of the pandemic. Because of the uncertainty surrounding the COVID-19 pandamic, the business disruption and the related financial impact of and response to the pandamic cannot be reasonably estimated at this time. For a detailed description of the risks associated with the novel coronavirus, see “Risk Factors—Risks Related to Our Business—Our business could be materially harmed by the ongoing coronavirus (COVID-19) pandemic.”

 

Our Technology

 

We have developed powerful, cutting-edge holographic AR technologies.

 

Software Engineering

 

Since our inception, we have devoted the majority of our research and development resources to software development. Our software engineering team is responsible for building the company-wide software platform, supporting the integration of our products and applications within our cloud infrastructure, as well as producing the holographic AR-related and MR-related software and solutions we license to our entertainment industry customers.

 

 

 

Content Production

 

Our leading holographic AR content production capabilities are built around image acquisition, object recognition, automated image process, and computer vision technologies. Our software engineering team and visualization design team work closely to consistently advance such visualization-related technologies, and harness them to design and produce innovative holographic AR contents. Through real-time computer vision algorithms which provide an accurate pose estimation, we are able to perform scene recognition and tracking within seconds. Such cutting-edge algorithms also allow us to perform visualization of photorealistic high-resolution renderings of products on a pixel basis. While most peer companies may identify and capture 40 to 50 blocks of image data within a specific space unit, the number of data blocks we can collect reaches 500 to 550, according to Frost & Sullivan. According to Frost & Sullivan, our speed of image processing is 80% faster than the industry average, leading to improved operation efficiency. In the course of scene reconstruction, our automated image processing tools can perform noise cleaning and feature enhancement on the image we initially captured, enabling us to create best-in-class holographic AR designs with an industry-leading simulation degree.

 

We have built a comprehensive holographic AR content library as compared to our peers in China, according to Frost & Sullivan. The formats of our holographic AR contents range from 3D models to holographic short videos. As of December 31, 2019, we owned over 4,600 ready-to-use AR holographic contents that were available to be adapted to our holographic AR products and solutions, including animals, cartoon characters, vehicles and foods. Our AR holographic contents can be applied in various scenarios, such as education, tourism, arts and entertainment, and popular science. In addition, our content library is also enriched by copyrighted contents that we have licensed from third parties. We cooperate with various content owners, including brands, film producers and talent agencies, to adapt high-quality, popular IPs into holographic AR formats.

 

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Cloud

 

We believe that the next-generation cloud delivery technology provides the flexibility and scalability necessary for holographic AR experience. Cloud technology is of high importance to build our comprehensive holographic AR ecosystem. We have developed our cloud architecture to work effectively in a flexible cloud environment that has a high degree of elasticity. Meanwhile, benefiting from our cloud storage and connecting capabilities, users of our integrated holographic AR software are able to access our large-size holographic AR content library on their native devices.

 

Big Data

 

We have developed advanced data analytics capabilities to derive actionable insights from the large amounts of data we collected from our products and third party sources. Currently, we have infiltrated a solid end-user base of approximately 350 million from which we are able to collect raw data. Our processing capabilities enable us to manage extremely large volumes of data and deliver real-time analysis at scale, making it possible for us to continue to improve and innovate our products and services. Our data mining and user behavioral data analytics technologies allow us to build and segment context-rich user profiles and apply such analysis in numerous applications. For instance, we have created over 2,000 user tags by analyzing user data we collected through our holographic AR advertising services. We are also in the process of developing ads performance tracking and evaluation tools.

 

Our Strengths

 

We have developed an innovative business model with fundamental strengths that positions us for continued leadership.

 

Leading Holographic Augmented Reality Application Platform in China

 

We were the largest holographic AR application platform in China, in terms of the total revenue in 2018, according to Frost & Sullivan. In addition, we have built the most comprehensive and diversified holographic AR content library among all holographic AR solution providers in China, according to Frost & Sullivan.

 

Market Potential Across the Holographic AR Value Chain

 

As holography and AR continue to proliferate, China’s holographic AR market is fast-growing and evolving. According to Frost & Sullivan, the total market size of China’s holographic AR industry in terms of total revenues is expected to grow from RMB 3.6 billion in 2017 to RMB 454.8 billion in 2025.

 

Cutting-edge Technology Capabilities and High-Quality User Experience

 

We have developed the professional media player in China specifically designed for holographic AR contents. It has built in a comprehensive set of setting parameters and editing tools used for holographic AR content playback and allows end-users to playback complex high-fidelity simulations quickly and cost-effectively. End-users are able to adjust the contrast, saturation and vibrancy of the displayed holographic AR content and create their own custom visual effect.

 

Experienced Management Team

 

We benefit significantly from the experience of our founder and senior management team, who have been successfully riding the growth wave in China’s booming holographic AR industry. Our chairman, Mr. Jie Zhao, has been with our company since our inception and possesses deep entrepreneurship and extensive expertise in the internet industry. Prior to establishing our company, Mr. Zhao founded Weixun Yitong, a mobile internet platform in China. Mr. Fanhua Meng, our Chief Executive Officer, has over ten years of senior management experience in internet companies. Mr. Shuo Shi, our Chief Operations Officer, is experienced in sales marketing, internet management and culture media. Mr. Yanghua Yang, the Chief Financial Officer of our company, has over ten years of experience in audit and finance. Mr. Chengwei Yi, our Chief Technology Officer, has over 15 years of experience focusing on video processing technology, artificial intelligence and signal processing technology. We believe that our management team’s collective experience and insights have paved and will continue to pave the way for our success. Our management team is supported by a research and development team with strong academic background and industry expertise in audio/video processing, 3D modeling and cloud computing.

 

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Our Industry

 

China has a large number of Internet users and mobile Internet users. With the introduction of the underlying tool platform by system vendors such as Apple and Google, it is much more convenient for developers to create and apply diverse AR contents, enabling AR technology to quickly reach a large number of users. In addition, stores offering AR experiences are penetrating rapidly into shopping malls in China, which have enabled consumers to enjoy the AR experience at a low cost and promoted consumers’ acceptance of AR.

 

Currently, advertisement is the biggest vertical of AR. According to Frost & Sullivan, the market size was estimated at RMB1.5 billion in 2016, and is expected to be at RMB7.8 billion by 2020, with a compound annual growth rate (“CAGR”) of 71.6%, much higher than the growth of total online advertising market, which has a CAGR of 32.4% from 2014 to 2018. As AR technology keeps evolving to satisfy the advertisers’ growing need, AR is expected to be largely used in advertisement. According to Frost & Sullivan, in 2025, the market will be valued at RMB143.9 billion with a CAGR of 79.1%, indicating a larger market share in total online advertising market in the next five years. Entertainment, including gaming and video, takes a huge share of AR sector as well, and it is expected to have a higher growth rate. In 2016 the market size was estimated at RMB0.6 billion and is expected to be at RMB6.8 billion by 2020, with a CAGR of 83.5%. Driven by the availability of AR SDK, improvement in smart phone performance, prospect of gaming industry, AR entertainment is expected to have a promising future, with a market size of RMB180 billion by 2025, indicating a CAGR of 92.6%, and surpassing advertisement to be the biggest application scenario of AR.

 

There are four key drivers in the China holographic AR industry:

 

Ultimate goal for visual display medium;

 

Advancement in technology;

 

Diversifying customer base and expanding application field; and

 

Government and policy support.

 

Our Strategies

 

We seek to build our AR ecosystem through collaboration with partners and customers. We intend to pursue the following strategies:

 

Bring holographic AR experience to broader mass market;

 

Continue to invest in technology and innovations;

 

Develop the application of holographic AR technologies in the semiconductor industry and invest in the seminiconductor industry through setting up a joint venture;

 

Strengthen our AR content development capabilities and enrich our content library; and

 

Explore acquisition or investment opportunities.

 

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Our Challenges

 

We face risks and uncertainties in realizing our business objectives and executing our strategies, including those relating to:

 

operating in a relatively new and rapidly evolving market;

 

our ability to compete effectively;

 

our ability to sustain our rapid growth, effectively manage our growth or implement our business strategies;

 

our ability to keep up with industry trends or technological developments;

 

our ability to continue to develop, acquire, market and offer new products and services or enhancements to existing products and services that meet customer requirements;

 

our ability to achieve expected returns of our significant investments;

 

our ability to optimize our monetization strategies;

 

our ability to obtain sufficient pricing to enable us to meet our profitability expectations;

 

our ability to obtain sufficient capital to fund our research and development investments;

 

our ability to adapt and manage the impact caused by the global outbreak of COVID-19; and

 

our ability to maintain continued and collaborative efforts of our senior management and key employees.

 

Moreover, we face risks and uncertainties related to our corporate structure and regulatory environment in China, including:

 

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

 

changes in the political and economic policies of the PRC government.

 

Corporate History and Structure

 

We commenced our commercial operations in May 2015 through Beijing WiMi Hologram Cloud Software Co., Ltd. (previously under the name “WiMi Lightspeed Capital Investment Management (Beijing) Co., Ltd.”), or Beijing WiMi. In February 2016, Beijing WiMi formed a wholly-owned subsidiary, Micro Beauty Lightspeed Investment Management HK Limited in Hong Kong. In addition, Beijing WiMi acquired 100% equity interest in Shenzhen Yidian Internet Technology Co., Ltd, or Shenzhen Yidian, on October 21, 2015, Shenzhen Yitian Hulian Internet Technology Co., Ltd., or Shenzhen Yitian, on August 20, 2015 and Shenzhen Kuxuanyou Technology Co., Ltd., or Shenzhen Kuxuanyou on August 26, 2015.

 

We incorporated WiMi Cayman under the laws of the Cayman Islands as our offshore holding company in August 2018 to facilitate offshore financing. In September 2018, we established WiMi Hologram Cloud Limited, or WiMi HK, our wholly-owned Hong Kong subsidiary, and WiMi HK established a wholly-owned PRC subsidiary, Beijing Hologram WiMi Cloud Internet Technology Co., Ltd., or Hologram WiMi, which is also referred to as WiMi WFOE in this prospectus.

 

Due to restrictions imposed by PRC laws and regulations on foreign ownership of companies that engage in internet and other related business, Hologram WiMi later entered into a series of contractual arrangements with Beijing WiMi, which we also refer to as our VIE in this prospectus, and its shareholders. We depend on these contractual arrangements with our VIE, in which we have no ownership interests, and its shareholders to conduct most aspects of our operations. We have relied and expect to continue to rely on these contractual arrangements to conduct our business in China. For more details, see “—Contractual Arrangements with Our VIE and Its Shareholders.” The shareholders of our VIE may have potential conflicts of interest with us. See “Risk Factors—Risks Related to Our Corporate Structure—Our shareholders or the shareholders of our VIE may have potential conflicts of interest with us, which may materially and adversely affect our business.”

 

Under PRC laws and regulations, our PRC subsidiary may pay cash dividends to us out of its respective accumulated profits. However, the ability of our PRC subsidiary to make such distribution to us is subject to various PRC laws and regulations, including the requirement to fund certain statutory funds, as well as potential restriction on currency exchange and capital controls imposed by the PRC government. For more details, see “Risk Factors—Risks Related to Doing Business in China—Our PRC subsidiary and VIE are subject to restrictions on paying dividends or making other payments to us, which may restrict our ability to satisfy our liquidity requirements, conduct our business and to pay dividends to holders of the ADSs and our ordinary shares” and “PRC Regulation—Regulation on Dividend Distributions.”

 

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As a result of our direct ownership in WiMi WFOE and the variable interest entity contractual arrangements, we are regarded as the primary beneficiary of our VIE. We treat it and its subsidiaries as our consolidated affiliated entities under generally accepted accounting principles in the United States of America (“U.S. GAAP”), and have consolidated the financial results of these entities in our consolidated financial statements in accordance with U.S. GAAP.

 

Implication of Being a Foreign Private Issuer and a Controlled Company

 

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 of the securities rules and regulations in the United States that are applicable to U.S. domestic issuers. Moreover, the information we are required to file with or furnish to the U.S. Securities and Exchange Commission (“SEC”) will be less extensive and less timely compared to that required to be filed with the SEC by U.S. domestic issuers. In addition, 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 Nasdaq listing standards. These practices may afford less protection to shareholders than they would enjoy if we complied fully with the Nasdaq listing standards.

 

Our issued and outstanding share capital consists of Class A ordinary shares and Class B ordinary shares. We are, and following the completion of this offering will continue to be, a “controlled company” as defined under the Nasdaq Stock Market Rules because Jie Zhao, our Chairman, will beneficially own 100% of our issued and outstanding Class A ordinary shares and 40.5% of our issued and outstanding Class B ordinary shares. Accordingly, Mr. Zhao will be able to exercise 78.5% of our total voting power following the completion of this offering. Holders of Class A ordinary shares and Class B ordinary shares have the same rights except for voting and conversion rights. Under the Nasdaq Stock Market Rules, a “controlled company” may elect not to comply with certain corporate governance requirements. Currently, we do not plan to utilize the “controlled company” exemptions with respect to our corporate governance practice after we complete this offering.

 

Contractual Arrangements and Corporate Structure

 

Currently, substantially all of our users and business operations are located in the PRC and our primary focus is the PRC hologram market, which we believe possesses tremendous growth potential and attractive monetization opportunities. In addition, we plan to grow our presence in international markets and become a global holographic enterprise. We believe that our hologram technology is applicable to global markets and anticipates expanding our business to new markets.

 

Current PRC laws and regulations impose certain restrictions or prohibitions on foreign ownership of companies that engage in value-added telecommunication services, internet audio-video program services and certain other businesses. The Special Administrative Measures for Entrance of Foreign Investment (Negative List) (2018 Version) provides that foreign investors are generally not allowed to own more than 50% of the equity interests in a value-added telecommunication service provider other than an e-commerce service provider, and the Provisions on the Administration of Foreign-Invested Telecommunications Enterprises (2016 Revision) require that the major foreign investor in a value-added telecommunication service provider in China must have experience in providing value-added telecommunications services overseas and maintain a good track record. In addition, foreign investors are prohibited from investing in companies engaged in certain online and culture related businesses. See “PRC Regulation—Regulation on Foreign Investment Restrictions.” We are an exempted company incorporated in the Cayman Islands. Hologram WiMi, our PRC subsidiary, is considered foreign-invested enterprise. To comply with the foregoing PRC laws and regulations, we primarily conduct our business in China through Beijing WiMi, our VIE and its subsidiaries in the PRC, based on a series of contractual arrangements. As a result of these contractual arrangements, we exert effective control over our VIE and its subsidiaries and consolidate their operating results in our consolidated financial statements under GAAP. These contractual arrangements may not be as effective as direct ownership in providing us with control over our VIE and its subsidiaries. If our VIE or its respective shareholders fail to perform their respective obligations under the contractual arrangements, we could be limited in our ability to enforce the contractual arrangements that give us effective control over our business operations in the PRC and 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 details of these and other risks associated with our VIE structure, see “Risk Factors—Risks Related to Our Corporate Structure.”

 

On November 6, 2018, WiMi Cayman completed a reorganization of entities under common control of its shareholders, who collectively owned all of the equity interests of WiMi Cayman prior to the reorganization. WiMi Cayman and WiMi HK were established as the holding companies of Hologram WiMi. Hologram WiMi is the primary beneficiary of Beijing WiMi and its subsidiaries. All of the direct and indirect subsidiaries of WiMi Cayman are under common control. Consequently, the consolidation of Beijing WiMi and its subsidiaries has been accounted for as a reorganization of entities under common control at carrying value. The consolidated financial statements are prepared on the basis as if the reorganization became effective as of the beginning of the first period presented in the accompanying consolidated financial statements of WiMi Cayman.

 

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The following diagram illustrates our corporate structure, including our significant subsidiaries and our VIE as of the date of this prospetus.

 

 

 

The principal shareholders of Beijing Wimi are Jie Zhao and Minwen Wu. Jie Zhao, our Chairman, beneficially owns 100% of our outstanding Class A ordinary shares, 40.5% of our outstanding Class B ordinary shares immediately after this offering, and 82.05% of the outstanding capital stock of Beijing Wimi. Minwen Wu, the controlling person of Sensefuture Holdings Limited and Sensebright Holdings Limited, beneficially owns approximately 9.9% of our issued and outstanding Class B ordinary shares, immediately after this offering, and 11.32% of the outstanding capital stock of Beijing Wimi.

 

Contractual Arrangements with Our VIE and Its Shareholders

 

The following is a summary of the currently effective contractual arrangements by and among our wholly-owned subsidiary, Hologram WiMi, our VIE and its shareholders. These contractual arrangements enable us to (i) exercise effective control over our VIE; (ii) receive substantially all of the economic benefits of our VIE; (iii) have an exclusive option to purchase the equity interests in our VIE, and (iv) have an exclusive option to purchase all or part of the assets of our VIE when and to the extent permitted by PRC law.

 

Agreements that provide us effective control over our VIE

 

Power of Attorney. Pursuant to the power of attorney dated November 6, 2018, by Hologram WiMi and each shareholder of Beijing WiMi, respectively, each shareholder of Beijing WiMi irrevocably authorized Hologram WiMi or any person(s) designated by Hologram WiMi to exercise such shareholder’s voting rights in Beijing WiMi, including, without limitation, the power to participate in and vote at shareholder’s meetings, the power to nominate directors and appoint senior management, the power to sell or transfer such shareholder’s equity interest in Beijing WiMi, and other shareholders’ voting rights permitted by PRC law and the Articles of Association of Beijing WiMi. The power of attorney remains irrevocable and continuously valid from the date of execution so long as each shareholder remains as a shareholder of Beijing WiMi.

 

Equity Interest Pledge Agreement. Pursuant to the equity interest pledge agreement dated November 6, 2018, by and among Hologram WiMi, Beijing WiMi and the shareholders of Beijing WiMi, the shareholders of Beijing WiMi pledged all of their equity interests in Beijing WiMi to Hologram WiMi to guarantee their and Beijing WiMi’s obligations under the contractual arrangements including the exclusive consulting and services agreement, the exclusive option agreement, the exclusive asset purchase agreement and the power of attorney and this equity interest pledge agreement, as well as any loss incurred due to events of default defined therein and all expenses incurred by Hologram WiMi in enforcing such obligations of Beijing WiMi or its shareholders. The shareholders of Beijing WiMi agree that, without Hologram WiMi’s prior written approval, during the term of the equity interest pledge agreement, they will not dispose of the pledged equity interests or create or allow any other encumbrance on the pledged equity interests. We have completed the registration of the equity pledges with the relevant office of the State Administration for Industry and Commerce (“SAIC”) in accordance with the PRC Property Rights Law.

 

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Spousal Consent Letters. Pursuant to these letters, the spouses of the applicable shareholders of Beijing WiMi unconditionally and irrevocably agreed that the equity interest in Beijing WiMi held by them and registered in their names will be disposed of pursuant to the equity interest pledge agreement, the exclusive option agreement, the exclusive asset purchase agreement and the power of attorney. Each of their spouses agreed not to assert any rights over the equity interest in Beijing WiMi held by their respective spouses. In addition, in the event that any spouse obtains any equity interest in Beijing WiMi held by his or her spouse for any reason, he or she agreed to be bound by the contractual arrangements.

 

Agreements that allow us to receive economic benefits from our VIE

 

Exclusive Business Cooperation Agreement. Under the exclusive business cooperation agreement between Hologram WiMi and Beijing WiMi, dated November 6, 2018, Hologram WiMi has the exclusive right to provide to Beijing WiMi consulting and services related to, among other things, use of software, operation maintenance, product development, and management and marketing consulting. Hologram WiMi has the exclusive ownership of intellectual property rights created as a result of the performance of this agreement. Beijing WiMi agrees to pay Hologram WiMi service fee at an amount equal to the consolidated net profit after offsetting previous year’s loss (if any). This agreement will remain effective until the date when it is terminated by WiMi WFOE.

 

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

 

Exclusive Share Purchase Option Agreement. Pursuant to the exclusive share purchase option agreement dated November 6, 2018, by and among Hologram WiMi, Beijing WiMi and each of the shareholders of Beijing WiMi, each of the shareholders of Beijing WiMi irrevocably granted Hologram WiMi an exclusive call option to purchase, or have its designated person(s) to purchase, at its discretion, all or part of their equity interests in Beijing WiMi, and the purchase price shall be the lowest price permitted by applicable PRC law. Each of the shareholders of Beijing WiMi undertakes that, without the prior written consent of Hologram WiMi or us, they may not increase or decrease the registered capital, amend its articles of association or change registered capital structure. This agreement will remain effective for ten years and can be renewed at Hologram WiMi’s sole discretion. Any transfer of shares pursuant to this agreement would be subject to PRC regulations and to any changes required thereunder.

 

Agreements that provide us with the option to purchase the assets in our VIE

 

Exclusive Asset Purchase Agreement. Pursuant to the exclusive asset purchase agreement dated November 6, 2018 by Hologram WiMi and Beijing WiMi, Beijing WiMi irrevocably granted Hologram WiMi an exclusive call option to purchase, or have its designated person(s) to purchase, at its discretion, all or part of Beijing WiMi’s current or future assets (including intellectual property rights), and the purchase price shall be the lowest price permitted by applicable PRC law. Beijing WiMi undertakes that, without the prior written consent of Hologram WiMi, it may not sell, transfer, pledge, dispose of its assets, incur any debts or guarantee liabilities. It will notify Hologram WiMi any potential litigation, arbitration or administrative procedures regarding the assets, and defend the assets if necessary. This agreement will remain effective for ten years and can be renewed at Hologram WiMi’s sole discretion. Any transfer of assets pursuant to this agreement would be subject to PRC regulations and to any changes required thereunder.

 

In the opinion of Jingtian & Gongcheng Law Firm, our PRC legal counsel:

 

the ownership structures of Hologram WiMi and Beijing WiMi, both currently and immediately after giving effect to this offering, are not in any violation of PRC laws or regulations currently in effect; and

 

the contractual arrangements among Hologram WiMi and Beijing WiMi and its shareholders governed by PRC law both currently and immediately after giving effect to this offering are legal, valid, binding and enforceable in accordance with its terms and applicable PRC laws, and do not and will not result in any violation of PRC laws or regulations currently in effect.

 

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However, we have been further advised by our PRC legal counsel that there are substantial uncertainties regarding the interpretation and application of current and future PRC laws, regulations and rules. If the PRC government finds that the agreements that establish the structure for operating our hologram business do not comply with PRC government restrictions on foreign investment in our businesses, we could be subject to severe penalties including being prohibited from continuing operations. See “Risk Factors—Risks Related to Our Corporate Structure—If the PRC government finds that the agreements that establish the structure for operating our businesses in China do not comply with PRC regulations relating to the relevant industries, or if these regulations or their interpretation change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations.”

 

Emerging Growth Company Status

 

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act (the “JOBS Act”), and we are eligible to take advantage of certain exemptions from various reporting and financial disclosure requirements that are applicable to other public companies that are not emerging growth companies, including, but not limited to, (1) presenting only two years of audited financial statements and only two years of related management’s discussion and analysis of financial condition and results of operations in this prospectus, (2) not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) and (3) reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements. We intend to take advantage of these exemptions. As a result, investors may find investing in our ordinary shares less attractive.

 

In addition, Section 107 of the JOBS Act also provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended (the “Securities Act”), for complying with new or revised accounting standards. As a result, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies.

 

We could remain an emerging growth company for up to five years, or until the earliest of (1) the last day of the first fiscal year in which our annual gross revenues exceed $1.07 billion, (2) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, which would occur if the market value of our ordinary shares that is held by non-affiliates exceeds US$700 million as of the last business day of our most recently completed second fiscal quarter and we have been publicly reporting for at least 12 months, or (3) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three-year period.

 

Foreign Private Issuer Status

 

We are a foreign private issuer within the meaning of the rules under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As such, we are exempt from certain provisions applicable to United States domestic public companies. For example:

 

We are not required to provide as many Exchange Act reports, or as frequently, as a domestic public company;

 

Subject to Nasdaq rules, for interim reporting, we are permitted to comply solely with our home country requirements, which are less rigorous than the rules that apply to domestic public companies;

 

We are not required to provide the same level of disclosure on certain issues, such as executive compensation;

 

We are exempt from provisions of Regulation Fair Disclosure (“Regulation FD”) aimed at preventing issuers from making selective disclosures of material non-public information;

 

We are not required to comply with the sections of the Exchange Act regulating the solicitation of proxies, consents or authorizations in respect of a security registered under the Exchange Act; and

 

Our insiders are not required to comply with Section 16 of the Exchange Act requiring such insiders to file public reports of their share ownership and trading activities and establishing insider liability for profits realized from any “short-swing” trading transaction.

 

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OUR CORPORATE INFORMATION

 

The principal executive offices of our main operations are located at No. 6, Xiaozhuang, #101A, Chaoyang District, Beijing, the People’s Republic of China. Our telephone number at this address is +86-10-5338-4913. Our registered office in the Cayman Islands is located at the office 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 Puglisi & Associates, located at 850 Library Avenue, Suite 204, Newark, DE 19711.

 

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CONVENTIONS WHICH APPLY TO THIS PROSPECTUS

 

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

 

“ADS” refers to the American depositary share, each representing two Class B ordinary shares;

 

“AR” refers to augmented reality, a technology that enhances the real world through the use of sensory information (visual, audio, or otherwise), which is added to the actual view of the real world;

 

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

 

“CPM” refers to cost per thousand impressions, a term used in traditional online advertising and marketing related to web traffic that measures the cost or expense incurred for every thousand potential customers who view the advertisement;

 

“GAAP” refers to the generally accepted accounting principles in the United States;

 

“HK$”, “HKD” or “Hong Kong dollars” refers to the legal currency of the Hong Kong Special Administrative Region;

 

“IPO” refers to our initial public offering, in which we offered and sold an aggregate of 9,500,000 Class B ordinary shares in the form of 4,750,000 ADSs at an offering price of US$5.50 per ADS, and the exercise of the over-allotment option of 338,280 Class B ordinary shares in the form of 169,140 ADSs;

 

“ordinary shares” refers to our Class A ordinary shares of par value US$0.0001 per share and Class B ordinary shares of par value US$0.0001 per share;

 

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

 

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

 

“View”, refers to the number of time an advertisement is fetched (each time an advertisement is fetched, it is counted as one impression or one view or one impression); and

 

“WIMI,” “we,” “us,” “our company,” “the company,” “our,” or similar terms used in this prospectus refer to WiMi Hologram Cloud Inc., a Cayman Islands exempted company, including its wholly owned subsidiaries and, in the context of describing our operations and consolidated financial information, its VIE and its subsidiaries.

 

Our reporting currency is the Renminbi. Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this prospectus are made at RMB6.9762 to US$1.00, representing the mid-point reference rate set forth by the Peoples’ Bank of China on December 31, 2019. 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 July 17, 2020, the mid-point rate for Renminbi was RMB6.9912 to US$1.00.

 

This prospectus contains information derived from various public sources and certain information from an industry report commissioned by us and prepared by Frost & Sullivan, a third-party industry research firm, to provide information regarding our industry and market position in China. 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.

 

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THE OFFERING

  

Offering price US$8.18 per ADS.
   
ADSs offered by us in this offering 7,560,000 ADSs.
   
Ordinary shares outstanding immediately after this offering 133,569,413 ordinary shares, comprised of 20,115,570 Class A ordinary shares of par value US$0.0001 per share and 113,453,843 Class B ordinary shares of par value US$0.0001 per share.
   
ADSs outstanding immediately after this offering 12,479,140 ADSs.
   
The ADSs Each ADS represents two Class B ordinary shares, par value US$0.0001 per share. The depositary will hold the underlying Class B ordinary shares represented by the 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 B ordinary shares, the depositary will pay you the cash dividends and other distributions it receives on our Class B ordinary shares, after deducting its fees and expenses in accordance with the terms set forth in the deposit agreement.
   
  You may turn in the ADSs to the depositary in exchange for Class B 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 the 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.

 

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Ordinary shares We will issue 15,120,000 Class B ordinary shares represented by the ADSs in this offering.
   
  Our ordinary shares are divided into Class A ordinary shares and Class B ordinary shares. Holders of Class A ordinary shares and Class B ordinary shares have the same rights except for voting and conversion rights. In respect of matters requiring a shareholder vote, each Class B ordinary share is entitled to one vote, and each Class A ordinary share is entitled to 10 votes. Each Class A ordinary share is convertible into one Class B ordinary share at any time by the holder thereof. Class B ordinary shares are not convertible into Class A ordinary shares under any circumstances. Upon any sale, transfer, assignment or disposition of any Class A ordinary shares by a holder thereof to any non-affiliate to such holder or upon a change of ultimate beneficial ownership of any Class A ordinary share to any person who is not an affiliate of such holder, each of such Class A ordinary shares will be automatically and immediately converted into one Class B ordinary share.
   
  All share-based compensation awards, regardless of grant dates, will entitle holders to the equivalent number of Class B ordinary shares once the vesting and exercising conditions on such share-based compensation awards are met.
   
  See “Description of Share Capital.”
   
Use of proceeds

We expect to receive net proceeds of approximately US$57.7 million in the aggregate from this offering, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

   
  We plan to use (i) approximately 40% of the net proceeds for operating expenses and the research and development of the application of holographic AR technologies in the semiconductor industry, (ii) approximately 40% of the net proceeds for strategic acquisitions and investments in complementary business, and (iii) approximately 20% of the net proceeds for other general corporate purposes, including working capital, operating expenses, and capital expenditures.
   
  See “Use of Proceeds.”
   
Lock-up We, certain of our directors, executive officers, and certain of our existing shareholders have agreed with the underwriters, subject to certain exceptions, not to sell, transfer or dispose of, directly or indirectly, any of the ADSs or ordinary shares or securities convertible into or exercisable or exchangeable for the ADSs or ordinary shares for a period of 90 days after the date of this prospectus. See “Shares Eligible for Future Sale” and “Underwriting” for more information.
   
Listing Our ADSs are listed on the Nasdaq Global Market. Our ordinary shares will not be listed on any other stock exchange or quoted for trading on any over-the-counter trading system.
   
Nasdaq trading symbol WIMI
   
Payment and settlement The underwriters expect to deliver the ADSs against payment therefor through the facilities of The Depository Trust Company on July 29, 2020.
   
Depositary JPMorgan Chase Bank, N.A.
   
Taxation For the Cayman Islands, PRC and U.S. federal income tax considerations with respect to the ownership and disposition of the ADSs, see “Taxation.”
   
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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SUMMARY CONSOLIDATED FINANCIAL DATA

 

The following tables summarize our consolidated financial date for the periods and as of the dates indicated. The summary consolidated statement of income and comprehensive income data for the years ended December 31, 2017, 2018 and 2019, the summary consolidated balance sheet data as of December 31, 2018 and 2019, and summary consolidated cash flow data for the years ended December 31, 2017, 2018 and 2019 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. Our summary consolidated balance sheet data as of December 31, 2017 has been derived from our audited consolidated financial statements not included in this prospectus.

 

The consolidated financial statements are prepared in accordance with U.S. GAAP. Our historical results are not necessarily indicative of the results that may be expected in the future. The following summary consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements included elsewhere in this prospectus.

 

Summary Consolidated Statements of Income
and Comprehensive Income:

  For the Years Ended December 31, 
   2017   2018   2019   2019 
   RMB   RMB   RMB   USD 
                 
Operating revenues   192,029,524    225,271,564    319,181,424    45,752,906 
Cost of revenues   (79,180,187)   (85,414,061)   (146,167,843)   (20,952,358)
Gross profit   112,849,337    139,857,503    173,013,581    24,800,548 
Operating expenses   (35,550,993)   (39,054,908)   (60,162,041)   (8,623,899)
Income from operations   77,298,344    100,802,595    112,851,540    16,176,649 
Other expenses, net   (3,432,362)   (3,509,207)   (7,517,988)   (1,077,663)
Provision for income taxes   (528,011)   (8,075,596)   (3,129,080)   (448,536)
Net income   73,337,971    89,217,792    102,204,472    14,650,450 
Other comprehensive income (loss)   (250,623)   1,759,288    1,589,076    227,785 
Comprehensive income   73,087,348    90,977,080    103,793,548    14,878,235 
WEIGHTED AVERAGE NUMBER OF ORDINARY SHARES                    
Basic   100,000,000    100,000,000    100,000,000    100,000,000 
Diluted   100,000,000    100,922,621    108,611,133    108,611,133 
EARNINGS PER SHARE                    
Basic   0.73    0.89    1.02    0.15 
Diluted   0.73    0.88    0.94    0.13 

 

The following table presents our summary consolidated balance sheet as of December 31, 2017, 2018 and 2019.

 

   As of December 31, 
Summary Consolidated Balance Sheet Data:  2017   2018   2019   2019 
   RMB   RMB   RMB   USD 
Current assets   52,030,035    213,295,430    177,511,440    25,445,291 
Other assets   405,451,567    394,187,996    385,987,073    55,329,130 
Total assets   457,481,602    607,483,426    563,498,513    80,774,421 
Total liabilities   367,275,213    288,561,957    140,783,496    20,180,542 
Total shareholders’ equity   90,206,389    318,921,469    422,715,017    60,593,879 

 

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The following table presents our summary consolidated cash flow data for the years indicated.

 

   For the Years Ended December 31 
Summary Consolidated Cash Flow Data:  2017   2018   2019   2019 
   RMB   RMB   RMB   USD 
Net cash provided by operating activities   108,057,941    99,452,205    143,955,544    20,635,238 
Net cash used in investing activities   (118,364,263)   (98,597,356)   (126,479,892)   (18,130,198)
Net cash (used in) provided by financing activities   (3,800,000)   137,493,993    (40,974,000)   (5,873,398)
Effect of exchange rate change on cash and cash equivalents   (234,124)   937,466    599,384    85,917 
Net change in cash and cash equivalents   (14,340,446)   139,286,308    (22,898,964)   (3,282,441)
Cash and cash equivalents, beginning of year   27,002,080    12,661,634    151,947,942    21,780,904 
Cash and cash equivalents, end of year   12,661,634    151,947,942    129,048,978    18,498,463 

 

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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 the information in our consolidated financial statements and related notes, before making an investment in the 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 the 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 Relating to Our Business and Industry

 

We operate in a relatively new and rapidly evolving market.

 

Our business and prospects primarily depend on the continuing development and growth of the holographic AR industry in China. Growth of the holographic AR industry in China is affected by numerous factors, including but not limited to technological innovations, user experience, development of internet and internet-based services, regulatory environment, and macroeconomic environment. The markets for our products and services are relatively new and rapidly developing and are subject to significant challenges. In addition, our continued growth depends, in part, on our ability to respond to changes in the holographic AR industry, including rapid technological evolution, continued shifts in customer demands, introductions of new products and services and emergence of new industry standards and practices. Developing and integrating new content, products, services or infrastructure could be expensive and time-consuming, and these efforts may not yield the benefits we expect to achieve.

 

In addition, as the holographic AR industry in China is relatively young, there are few proven methods of projecting customer demand or available industry standards on which we can rely. Some of our current monetization methods are also in a relatively preliminary stage. We cannot assure you that our attempts to monetize our current offerings will continue to be successful, profitable or accepted, and therefore the profit potential of our business is difficult to gauge. Our growth prospects should be considered in light of the risks and uncertainties that fast-growing early-stage companies with limited operating history in an evolving industry may encounter, including, among others, risks and uncertainties regarding our ability to:

 

continue to develop new software and related solutions that are appealing to end users;

 

enrich our holographic AR content portfolio;

 

maintain stable relationships with other key participants in the holographic AR value chain;

 

expand our products and services into more use cases; and

 

expand into new geographic markets with high growth potential.

 

Addressing these risks and uncertainties will require significant capital expenditures and allocation of valuable management and employee resources. We cannot assure you that we will succeed in any of these aspects or that the holographic AR industry in China will continue to grow at a rapid pace. If we fail to successfully address any of the above risks and uncertainties, the size of our user base, our revenue and profits may decline.

 

Our competitive position and results of operations could be harmed if we do not compete effectively.

 

The markets for our products and services are characterized by intense competition, new industry standards, limited barriers to entry, disruptive technology developments, short product life cycles, customer price sensitivity and frequent product introductions (including alternatives with limited functionality available at lower costs or free of charge). Any of these factors could create downward pressure on pricing and profitability and could adversely affect our ability to attract new customers. Our future success will depend on our continued ability to enhance our existing products and services, introduce new products and services in a timely and cost-effective manner, meet changing customer expectations and needs, extend our core technology into new applications, and anticipate emerging standards, business models, software delivery methods and other technological developments. Furthermore, we are a small-size company as compared to some of the well-established enterprises that could potentially enter the holographic AR market. Some of our current and potential competitors enjoy competitive advantages such as greater financial, technical, sales, marketing and other resources, broader brand awareness, and access to larger customer bases. As a result of these advantages, potential and current customers might select the products and services of our competitors, causing a loss of our market share.

 

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We are a relatively young company, and we may not be able to sustain our rapid growth, effectively manage our growth or implement our business strategies.

 

Our business was launched in 2015 and we have a limited operating history. Although we have experienced significant growth since our business was launched, our historical growth rate may not be indicative of our future performance. We may not be able to achieve similar results or grow at the same rate as we had in the past. As our business and the holographic AR market in China continue to develop, we may need to adjust our product and service offerings or modify our business model. These adjustments may not achieve expected results and may have a material and adverse impact on our financial conditions and results of operations.

 

In addition, our rapid growth and expansion have placed, and continue to place, a significant strain on our management and resources. This level of significant growth may not be sustainable or achievable at all in the future. We believe that our continued growth will depend on many factors, including our ability to develop new sources of revenues, diversify monetization methods, attract and retain customers, continue developing innovative hologram-related technologies, increase brand awareness, expand into new market segments, and adjust to the rapidly changing regulatory environment in China. We cannot assure you that we will achieve any of the above, and our failure to do so may materially and adversely affect our business and results of operations.

 

If we fail to keep up with industry trends or technological developments, our business, results of operations and financial condition may be materially and adversely affected.

 

The holographic AR industry is rapidly evolving and subject to continuous technological changes. Our success depends on our ability to continue to develop and implement services and solutions that anticipate and respond to rapid and continuing changes in technology and industry developments and offerings to serve the evolving needs of our customers. Our growth strategy is focused on responding to these types of developments by driving innovation that will enable us to expand our business into new growth areas. If we do not sufficiently invest in new technology and industry developments, or evolve and expand our business at sufficient speed and scale, or if we do not make the right strategic investments to respond to these developments and successfully drive innovation, our services and solutions, our results of operations, and our ability to develop and maintain a competitive advantage and continue to grow could be negatively affected. In addition, we operate in a quickly evolving environment, in which there currently are, and we expect will continue to be, new technology entrants. New services or technologies offered by competitors or new entrants may make our offerings less differentiated or less competitive, when compared to other alternatives, which may adversely affect our results of operations. Technological innovations may also require substantial capital expenditures in product development as well as in modification of products, services or infrastructure. We cannot assure you that we can obtain financing to cover such expenditure. Failure to adapt our products and services to such changes in an effective and timely manner could materially and adversely affect our business, financial condition and results of operations.

 

If we cannot continue to develop, acquire, market and offer new products and services or enhancements to existing products and services that meet customer requirements, our operating results could suffer.

 

The process of developing and acquiring new technology products and services and enhancing existing offerings is complex, costly and uncertain. If we fail to anticipate customers’ rapidly changing needs and expectations, our market share and results of operations could suffer. We must make long-term investments, develop, acquire or obtain appropriate intellectual property and commit significant resources before knowing whether our predictions will accurately reflect customer demand for our products and services. If we misjudge customer needs in the future, our new products and services may not succeed and our revenues and earnings may be harmed. Additionally, any delay in the development, acquisition, marketing or launch of a new offering or enhancement to an existing offering could result in customer attrition or impede our ability to attract new customers, causing a decline in our revenue or earnings.

 

We make significant investments in new products and services that may not achieve expected returns.  

 

We have made and will continue to make significant investments in research, development, and marketing for existing products, services, and technologies, including holographic AR advertising solutions, mobile payment middleware, integrated holographic AR software and other AR-based holographic offerings, as well as new technology or new applications of existing technology. Investments in new technology are speculative. Commercial success depends on many factors, including but not limited to innovativeness, developer support, and effective distribution and marketing. If customers do not perceive our latest offerings as providing significant new functionality or other value, they may reduce their purchases of our services or products, unfavorably affecting our revenue and profits. We may not achieve significant revenue from new product, service or distribution channel investments, or new applications of existing new product, service or distribution channel investments, for several years, if at all. New products and services may not be profitable, and even if they are profitable, operating margins for some new products and businesses may not be as high as the margins we have experienced historically. Furthermore, developing new technologies is complex and can require long development and testing periods. Significant delays in new releases or significant problems in creating new products or offering new services could adversely affect our revenue and profits.

 

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We cannot guarantee our monetization strategies will be successfully implemented or generate sustainable revenues and profit.

 

Our monetization model is evolving. We currently generate a substantial majority of our revenues from holographic AR advertising services and payment middleware licensing. We plan to increase revenue contribution from our other hologram-related monetization methods including, for example, holographic AR IP licensing. If our strategic initiatives do not enhance our monetization ability or enable us to develop new approaches to monetization, we may not be able to maintain or increase our revenues or profits or recover any associated costs. In addition, we may in the future introduce new services to further diversify our revenue streams, including services with which we have little or no prior development or operating experience. If these new or enhanced services fail to engage customers, we may fail to attract or retain users or to generate sufficient revenues or profits to justify our investments, and our business and operating results may suffer as a result.

 

Our results of operations could materially suffer if we are not able to obtain sufficient pricing to enable us to meet our profitability expectations.

 

If we are not able to obtain sufficient pricing for our services and solutions, our revenues and profitability could materially suffer. The rates we are able to charge for our services and solutions are affected by a number of factors, including:

 

general economic and political conditions;

 

the competitive environment in our industry;

 

our customers’ desire to reduce their costs; and

 

our ability to accurately estimate, attain and sustain contract revenues, margins and cash flows over the full contract period.

 

In addition, our profitability with respect to our services and solutions for new technologies may be different when compared to the profitability of our current business, due to factors such as the use of alternative pricing, the mix of work and the number of service providers, among others.

 

The competitive environment in our industry affects our ability to obtain favorable pricing in a number of ways, any of which could have a material negative impact on our results of operations. The less we are able to differentiate our services and solutions and/or clearly convey the value of our services and solutions, the more risk we have that they will be seen as commodities, with price being the driving factor in selecting a service provider. In addition, the introduction of new services or products by competitors could reduce our ability to obtain favorable pricing for the services or products we offer. Competitors may be willing, at times, to price contracts lower than us in an effort to enter new markets or increase market share. Further, if competitors develop and implement methodologies that yield greater efficiency and productivity, they may be better positioned to offer services similar to ours at lower prices.

 

We require a significant amount of capital to fund our research and development investments. If we cannot obtain sufficient capital on favorable terms or at all, our business, financial condition and prospects may be materially and adversely affected.

 

Operating our holographic AR business requires significant, continuous investment in acquiring, maintaining and upgrading content and technology. Historically, we have financed our operations primarily with net cash generated from operating activities, financial support from our shareholders and equity financings and loans from third parties. As part of our growth strategy, we plan to continue to invest substantial capital in our research and development activities in the future, which may require us to obtain additional equity or debt financing. Our ability to obtain additional financing in the future is subject to a number of uncertainties, including but not limited to those relating to:

 

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

 

general market conditions for financing activities; and

 

macro-economic and other conditions in China and elsewhere.

 

19

 

 

Although we expect to rely increasingly on net cash provided by operating activities and financing through capital markets for our liquidity needs as our business continues to grow and after we become a public company, we cannot assure you that we will be successful in our efforts to diversify our sources of liquidity. If we raise additional funds through future issuances of equity or convertible debt securities, our existing shareholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our ordinary shares. Any debt financing that we secure in the future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters, including the ability to pay dividends. This may make it more difficult for us to obtain additional capital to fund our research and pursue business opportunities, including potential acquisitions. If we cannot obtain sufficient capital to meet our capital needs, we may not be able to implement our growth strategies, and our business, financial condition and prospects may be materially and adversely affected.

 

If we fail to attract, retain and engage appropriately skilled personnel, including senior management and technology professionals, our business may be harmed.

 

Our future success depends on our retention of highly skilled executives and employees. Competition for well-qualified and skilled employees is intense, and our future success also depends on our continuing ability to attract, develop, motivate and retain highly qualified and skilled employees, including, in particular, software engineers, artificial intelligence scientists and AR technology professionals. Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate existing employees. All of our senior management and key personnel are employees at will and, as a result, any of these employees could leave with little or no prior notice. If any member of our senior management team or other key employees leave our company, our ability to successfully operate our business and execute our business strategy could be adversely affected. In particular, such individuals are free to compete with us in the event that they leave. Furthermore, under PRC law, certain of our employees may have ownership rights to our intellectual property, which rights would continue in the event they left our company. We may also have to incur significant costs in identifying, hiring, training and retaining replacements of departing employees.

 

If existing or new customers are less willing to cooperate with us, our revenues and profits may be adversely affected.

 

We offer holographic AR advertising solutions primarily through contracts entered into with advertisers or third-party advertising agencies and middleware services primarily through contracts entered into with app developers and content providers. We promote our products and services directly through our experienced and creative sales and marketing team by making direct office visits, attending conferences and industry exhibitions, and through word-of-mouth referral. Our ability to retain existing customers or attract new customers depends on many factors, some of which are out of our control, including:

 

Our ability to innovate and rapidly respond to customer needs;

 

The competiveness of our pricing and payment terms for our clients, which may, in turn, be constrained by our capital and financial resources;

 

Sufficient capital support;

 

Our ability to acquire complementary technologies, products and businesses to enhance the features and functionality of our applications; and

 

Brand awareness and reputation.

 

We cannot assure you that we will be able to continue retain these customers or attract new customers. If we fail to retain and enhance our business relationships with new and existing customers, our business and results of operations may be materially and adversely affected.

 

If we fail to successfully compete with other advertising platforms, media companies, AR or traditional advertisement producers, our revenues and profits may be adversely affected.

 

Revenue generated from our advertising business is affected by the online advertising industry in China and advertisers’ allocation of budgets to Internet advertising and promotion in general, and specifically with respect to online holographic AR advertising. Companies that decide to advertise or promote online may utilize more established methods or channels for online advertising and promotion, such as key words advertising on established Chinese search engines, over in-video holographic AR advertising. In addition, we compete with media companies, AR or traditional advertisement producers. If the holographic AR advertising market size does not increase from current levels, if we are unable to capture and retain a sufficient share of that market, or if we are unable to compete effectively with our competitors, our ability to maintain or increase our current level of advertisement revenue and our profitability and prospects could be adversely affected.

 

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Our products and software are highly technical and may contain undetected software bugs or vulnerabilities, which could manifest in ways that could seriously harm our reputation and our business.

 

Our products and software are highly technical and complex. Our software or any of our products may contain undetected software bugs, hardware errors, and other vulnerabilities. These bugs and errors can manifest in any number of ways in our products, including through diminished performance, security vulnerabilities, malfunctions, or even permanently disabled products. We have a practice of regularly updating our products and some errors in our products may be discovered only after a product has been used by users, and may in some cases be detected only under certain circumstances or after extended use. Any errors, bugs or other vulnerabilities discovered in our code or backend after release could damage our reputation, drive away users, allow third parties to manipulate or exploit our software, lower revenue and expose us to claims for damages, any of which could seriously harm our business.

 

Our business could be materially harmed by the ongoing coronavirus (COVID-19) pandemic.

 

The outbreak of COVID-19 starting from late January 2020 has spread rapidly to many parts of the world. In March 2020, the World Health Organization declared the COVID-19 as a pandemic. The pandemic has resulted in quarantines, travel restrictions, and the temporary closure of stores and business facilities in China for the past few months. Given the rapidly expanding nature of the COVID-19 pandemic, and because substantially all of our business operations and our workforce are concentrated in China, we believe there is a substantial risk that our business, results of operations, and financial condition may be materially and adversely affected. Potential impact to our results of operations will also depend on future developments and new information that may emerge regarding the duration and severity of the COVID-19 and the actions taken by government authorities and other entities to contain the COVID-19 or mitigate its impact, almost all of which are beyond our control.

 

The impacts of COVID-19 on our business, financial condition, and results of operations include, but are not limited to, the following:

 

  We temporarily closed our offices and implemented work from-home policy beginning from February until mid-March 2020, as required by relevant PRC regulatory authorities.

 

  Our customers could potentially be negatively impacted by the outbreak, which may reduce their budgets for online advertising and marketing in 2020. As a result, our revenue, gross profit and net income may be negatively impacted in 2020.

 

  The situation may worsen if the COVID-19 outbreak continues. Certain of our customers have requested, and additional customers may request, additional time to pay us or fail to pay us on time, or at all, which may require us to record additional allowances.

 

  The global stock markets have experienced, and may continue to experience, significant decline from the COVID-19 outbreak. It is possible that the price of our ADSs will decline significantly, in which case you may lose your investment.

 

While many of the restrictions on movement within China have been relaxed as of the date of this prospectus, there is great uncertainty as to the future progress of the disease. Because of the uncertainty surrounding the COVID-19 pandemic, the business disruption and the related financial impact related to the pandemic of and response to the pandemic cannot be reasonably estimated at this time.

 

Our failure to protect our intellectual property rights may undermine our competitive position.

 

We believe that our patents, copyrights, trademarks and other intellectual property are essential to our success. Please see “Business—Intellectual Property” for more details. We depend to a large extent on our ability to develop and maintain the intellectual property rights relating to AR technology and our hologram content. We have devoted considerable time and energy to the development and improvement of our software, middleware, websites, and our hologram IPs.

 

21

 

 

We rely primarily on a combination of patents, copyrights, trademarks and trade secrets laws, and contractual restrictions for the protection of the intellectual property used in our business. Nevertheless, these provide only limited protection and the actions we take to protect our intellectual property rights may not be adequate. Our trade secrets may become known or be independently discovered by our competitors. We may have no or limited rights to stop others’ use of our information. Moreover, to the extent that our employees or third parties with whom we do business use intellectual property owned by others in their work for us, disputes may arise as to the rights to such intellectual property. Furthermore, it is often difficult to maintain and enforce intellectual property rights in China. Statutory laws and regulations are subject to judicial interpretation and enforcement, and may not be applied consistently due to the lack of clear guidance on statutory interpretation. Contractual restrictions may be breached by counterparties, and there may not be adequate remedies available to us for any such breach. Accordingly, we may not be able to effectively protect our intellectual property rights or to enforce our contractual rights in China. Preventing any unauthorized use of our intellectual property is difficult and costly and the steps we take may be inadequate to prevent the misappropriation of our intellectual property. In the event that we resort to litigation to enforce our intellectual property rights, such litigation could result in substantial costs and a diversion of our managerial and financial resources. We can provide no assurance that we will prevail in such litigation. Any failure in protecting or enforcing our intellectual property rights could have a material adverse effect on our business, financial condition and results of operations.

 

We may not be able to protect our source code from copying if there is an unauthorized disclosure.

 

Source code, the detailed program commands for our middleware and software programs, is critical to our business. Although we license portions of our application and operating system source code to several licensees, we take significant measures to protect the secrecy of large portions of our source code. If our source code leaks, we might lose future trade secret protection for that code. It may then become easier for third parties to compete with our products by copying functionality, which could adversely affect our revenue and operating margins.

 

As our patents may expire and may not be extended, our patent applications may not be granted and our patent rights may be contested, circumvented, invalidated or limited in scope, our patent rights may not protect us effectively. In particular, we may not be able to prevent others from developing or exploiting competing technologies, which could have a material and adverse effect on our business operations, financial condition and results of operations.

 

In China, the validity period of utility model patent rights or design patent rights is ten years and not extendable. As of December 31, 2019, we had 145 registered patents, 68 patent applications pending in China and no additional patent applications under the patent cooperation treaty. For our pending application, we cannot assure you that we will be granted patents pursuant to our pending applications. Even if our patent applications succeed, it is still uncertain whether these patents will be contested, circumvented or invalidated in the future. In addition, the rights granted under any issued patents may not provide us with sufficient protection or competitive advantages. The claims under any pending patents that issue from our patent applications may not be broad enough to prevent others from developing technologies that are similar to or that achieve results similar to ours. It is also possible that the intellectual property rights of others will bar us from licensing and from exploiting any patents that issue from our pending applications. Numerous U.S. and foreign issued patents and pending patent applications owned by others exist in the fields in which we have developed and are developing our technology. These patents and patent applications might have priority over our patent applications and could subject our patent applications to invalidation. Finally, in addition to those who may claim priority, any of our existing or pending patents may also be challenged by others on the basis that they are otherwise invalid or unenforceable.

 

Our services or solutions could infringe upon the intellectual property rights of others or we might lose our ability to utilize the intellectual property of others.

 

We cannot be sure that our services and solutions do not infringe on the intellectual property rights of third parties, and these third parties could claim that we or our clients are infringing upon their intellectual property rights. These claims could harm our reputation, cause us to incur substantial costs or prevent us from offering some services or solutions in the future. Any related proceedings could require us to expend significant resources over an extended period of time. Any claims or litigation in this area could be time-consuming and costly, damage our reputation and/or require us to incur additional costs to obtain the right to continue to offer a service or solution to our clients. If we cannot secure this right at all or on reasonable terms, or we cannot substitute alternative technology, our results of operations could be materially adversely affected. The risk of infringement claims against us may increase as we expand our industry software solutions.

 

In the operation of our AR holographic ads business, we do not enter into any agreements directly with the copyright owners of the videos in which ads are placed using our software. Consequently, there is no assurance that we will not be affected by disputes between platform operators, on the one hand, and copyright owners of such videos, on the other hand.

 

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Additionally, in recent years, individuals and firms have purchased intellectual property assets in order to assert claims of infringement against technology providers and customers that use such technology. Any such action naming us or our clients could be costly to defend or lead to an expensive settlement or judgment against us. Moreover, such an action could result in an injunction being ordered against our client or our own services or operations, causing further damages.

 

In addition, we rely on third-party software in providing some of our services and solutions. If we lose our ability to continue using such software for any reason, including in the event that the software is found to infringe the rights of others, we will need to obtain substitute software or seek alternative means of obtaining the technology necessary to continue to provide such services and solutions. Our inability to replace such software, or to replace such software in a timely or cost-effective manner, could materially adversely affect our results of operations.

 

Third parties may register trademarks or domain names or purchase internet search engine keywords that are similar to our trademarks, brands or websites, or misappropriate our data and copy our platform, all of which could cause confusion to our users, divert online customers away from our products and services or harm our reputation.

 

Competitors and other third parties may purchase (i) trademarks that are similar to our trademarks and (ii) keywords that are confusingly similar to our brands or websites in internet search engine advertising programs and in the header and text of the resulting sponsored links or advertisements in order to divert potential customers from us to their websites. Preventing such unauthorized use is inherently difficult. If we are unable to prevent such unauthorized use, competitors and other third parties may continue to drive potential online customers away from our platform to competing, irrelevant or potentially offensive platform, which could harm our reputation and cause us to lose revenue.

 

Our business is highly dependent on the proper functioning and improvement of our information technology systems and infrastructure. Our business and operating results may be harmed by service disruptions, or by our failure to timely and effectively scale up and adjust our existing technology and infrastructure.

 

Our business depends on the continuous and reliable operation of our information technology (“IT”) systems. Our IT systems are vulnerable to damage or interruption as a result of fires, floods, earthquakes, power losses, telecommunications failures, undetected errors in software, computer viruses, hacking and other attempts to harm our IT systems. Disruptions, failures, unscheduled service interruptions or a decrease in connection speeds could damage our reputation and cause our customers and end-users to migrate to our competitors’ platforms. If we experience frequent or constant service disruptions, whether caused by failures of our own IT systems or those of third-party service providers, our user experience may be negatively affected, which in turn may have a material and adverse effect on our reputation and business. We may not be successful in minimizing the frequency or duration of service interruptions. As the number of our end-users increases and more user data are generated on our platform, we may be required to expand and adjust our technology and infrastructure to continue to reliably store and process content.

 

Our operations depend on the performance of the Internet infrastructure and fixed telecommunications networks in China, which may experience unexpected system failure, interruption, inadequacy or security breaches.

 

Almost all access to the Internet in China is maintained through state-owned telecommunication operators under the administrative control and regulatory supervision of the Ministry of Industry and Information Technology, or the MIIT. Moreover, we primarily rely on a limited number of telecommunication service providers to provide us with data communications capacity through local telecommunications lines and Internet data centers to host our servers. 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 fixed telecommunications networks provided by telecommunication service providers. Web traffic in China has experienced significant growth during the past few years. Effective bandwidth and server storage at Internet data centers in large cities such as Beijing are scarce. 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. We cannot assure you that the Internet infrastructure and the fixed telecommunications networks in China will be able to support the demands associated with the continued growth in Internet usage. If we cannot increase our capacity to deliver our online services, we may not be able to expand customer base, and the adoption of our services may be hindered, which could adversely impact our business and profitability.

 

In addition, we have no control over the costs of the services provided by telecommunication service providers. If the prices we pay for telecommunications and Internet services rise significantly, our results of operations may be materially and adversely affected. Furthermore, if Internet access fees or other charges to Internet users increase, some users may be prevented from accessing the mobile Internet and thus cause the growth of mobile Internet users to decelerate. Such deceleration may adversely affect our ability to continue to expand our user base.

 

We use third-party services and technologies in connection with our business, and any disruption to the provision of these services and technologies to us could result in adverse publicity and a slowdown in the growth of our users, which could materially and adversely affect our business, financial condition and results of operations.

 

Our business partially depends on services provided by, and relationships with, various third parties. Some third-party software we use in our operations is currently publicly available and free of charge. If the owner of any such software decides to charge users or no longer makes the software publicly available, we may need to incur significant costs to obtain licensing, find replacement software or develop it on our own. If we are unable to obtain licensing, find or develop replacement software at a reasonable cost, or at all, our business and operations may be adversely affected.

 

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We exercise no control over the third parties with whom we have business arrangements. If such third parties increase their prices, fail to provide their services effectively, terminate their service or agreements or discontinue their relationships with us, we could suffer service interruptions, reduced revenues or increased costs, any of which may have a material adverse effect on our business, financial condition and results of operations.

 

If we are unable to collect our receivables or unbilled services, our results of operations, financial condition and cash flows could be adversely affected.

 

Our business depends on our ability to successfully and timely obtain payment from our customers of the amounts they owe us for work performed. We evaluate the financial condition of our clients and usually bill and collect on 30 to 60 day cycles. We have established allowances for losses of receivables and unbilled services. Actual losses on client balances could differ from those that we currently anticipate, and, as a result, we might need to adjust our allowances. We might not accurately assess the creditworthiness of our clients. Macroeconomic conditions could also result in financial difficulties for our customers, including bankruptcy and insolvency. This could cause customers to delay payments to us, request modifications to their payment arrangements that could increase our receivables balance, or default on their payment obligations to us. Recovery of customer financing and timely collection of client balances also depend on our ability to complete our contractual commitments and bill and collect our contracted revenues. If we are unable to meet our contractual requirements, we might experience delays in collection of and/or be unable to collect our customer balances, and if this occurs, our results of operations and cash flows could be adversely affected. In addition, if we experience an increase in the time to bill and collect for our services, our cash flows could be adversely affected.

 

If we fail to obtain or maintain the required licenses and approvals or if we fail to comply with laws and regulations applicable to our industry, our business, financial condition and results of operations may be materially and adversely affected.

 

The Internet industry in China is highly regulated, which requires certain licenses, permits, filings and approvals to conduct and develop business. Currently, we have obtained Business Performance Permit, Telecom Value-added Service License and Network Culture Operation License Business Performance Permit.

 

Due to the uncertainties of interpretation and implementation of existing and future laws and regulations, the licenses we held may not be sufficient to meet regulatory requirements, which may restrain our ability to expand our business scope and may subject us to fines or other regulatory actions by relevant regulators if our practice is deemed as violating relevant laws and regulations. As we further develop and expand our business scope, we may need to obtain additional qualifications, permits, approvals or licenses. Moreover, we may be required to obtain additional licenses or approvals if the PRC government adopts more stringent policies or regulations for our industry.

 

As the Internet industry in China is still at a relatively early stage of development, new laws and regulations may be adopted from time to time to address new issues that come to the authorities’ attention. Considerable uncertainties still exist with respect to the interpretation and implementation of existing and future laws and regulations governing our business activities. We cannot assure you that we will not be found in violation of any future laws and regulations or any of the laws or regulations currently in effect due to changes in the relevant authorities’ interpretation of these laws and regulations.

 

In accordance with the Notice on Adjusting the Scope and Standardizing the Examination and Approval Process of Network Culture Operation License (“Notice”) of the Ministry of Culture and Tourism, dated May 14, 2019, any network culture operation licenses whose business scope contains online-games related activities remains valid, although such licenses may not be renewed by the Ministry of Culture and Tourism upon expiration thereof. It is not clear yet whether new licenses could be issued by an alternative governmental authority. As a result, there is risk that we may not have a valid license to conduct online-gaming activities after the expiration of such license.

 

As of the date of this prospectus, we have not received any material penalties from the relevant government authorities for our past business operations. We cannot assure you, however, that the government authorities will not do so in the future. In addition, we may be required to obtain additional license or permits, and we cannot assure you that we will be able to timely obtain or maintain all the required licenses or permits or make all the necessary filings in the future. If we fail to obtain, hold or maintain any of the required licenses or permits or make the necessary filings on time or at all, we may be subject to various penalties, such as confiscation of the net revenues that were generated through the unlicensed activities, the imposition of fines and the discontinuation or restriction of our operations. Any such penalties may disrupt our business operations and materially and adversely affect our business, financial condition and results of operations.

 

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We may be materially and adversely affected by the complexity, uncertainties and changes in PRC regulation of the Internet industry and companies.

 

The PRC government extensively regulates the Internet industry, including foreign ownership of, and the licensing and permit requirements pertaining to, companies in the Internet industry. These Internet-related laws and regulations are relatively new and evolving, and their interpretation and enforcement involve significant uncertainty. As a result, in certain circumstances it may be difficult to determine what actions or omissions may be deemed to be in violations of applicable laws and regulations. Issues, risks and uncertainties relating to PRC regulation of the Internet business include, but are not limited to, the following:

 

There are uncertainties relating to the regulation of the Internet business in China, including evolving licensing practices and the requirement for real-name registrations. Permits, licenses or operations at some of our subsidiaries and PRC variable interest entity levels may be subject to challenge, we may not be able to timely obtain or maintain all the required licenses or approvals, permits, or to complete filing, registration or other formalities necessary for our present or future operations, and we may not be able to renew certain permits or licenses or renew certain filing or registration or other formalities. See “—If we fail to obtain or maintain the required licenses and approvals or if we fail to comply with laws and regulations applicable to our industry, our business, financial condition and results of operations may be materially and adversely affected” and “PRC Regulation.”

 

The evolving PRC regulatory system for the Internet industry may lead to the establishment of new regulatory agencies. For example, in May 2011, the State Council announced the establishment of a new department, the State Internet Information Office. The primary role of this new agency is to facilitate the policy-making and legislative development in this field to direct and coordinate with the relevant departments in connection with online content administration and to deal with cross-ministry regulatory matters in relation to the Internet industry. We are unable to determine what policies this new agency or any new agencies to be established in the future may have or how they may interpret existing laws, regulations and policies and how they may affect us. Further, new laws, regulations or policies may be promulgated or announced that will regulate Internet activities, including online video and online advertising businesses. If these new laws, regulations or policies are promulgated, additional licenses may be required for our operations. If our operations do not comply with these new regulations after they become effective, or if we fail to obtain any licenses required under these new laws and regulations, we could be subject to penalties.

 

The interpretation and application of existing PRC laws, regulations and policies and possible new laws, regulations or policies relating to the Internet industry have created substantial uncertainties regarding the legality of existing and future foreign investments in, and the businesses and activities of, Internet businesses in China, including our business. There are also risks that we may be found to violate the existing or future laws and regulations given the uncertainty and complexity of China’s regulation of Internet business.

 

Our business generates and processes a large amount of data, and we are required to comply with PRC laws and regulations relating to cyber security. These laws and regulations could create unexpected costs, subject us to enforcement actions for compliance failures, or restrict portions of our business or cause us to change our data practices or business model.

 

Our business generates and processes a large quantity of data. We face risks inherent in handling and protecting large volume of data. In particular, we face a number of challenges relating to data we collect through our game distribution platform and integrated holographic AR software offering, including:

 

protecting the data in and hosted on our system, including against attacks on our system by outside parties or fraudulent behavior or improper use by our employees;

 

addressing concerns related to privacy and sharing, safety, security and other factors; and

 

complying with applicable laws, rules and regulations relating to the collection, use, storage, transfer, disclosure and security of personal information, including any requests from regulatory and government authorities relating to this data.

 

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Governments around the world, including the PRC government, have enacted or are considering legislation related to online businesses. There may be an increase in legislation and regulation related to the collection and use of anonymous internet user data and unique device identifiers, such as IP address or mobile unique device identifiers, and other data protection and privacy regulation. The PRC regulatory and enforcement regime with regard to data security and data protection is evolving. We may be required by Chinese governmental authorities to share personal information and data that we collect to comply with PRC laws relating to cybersecurity. All these laws and regulations may result in additional expenses to us and any non-compliance may subject us to negative publicity which could harm our reputation and negatively affect the trading price of our ADSs. There are also uncertainties with respect to how these laws will be implemented in practice. PRC regulators have been increasingly focused on regulation in the areas of data security and data protection. We expect that these areas will receive greater attention and focus from regulators, as well as attract continued or greater public scrutiny and attention going forward, which could increase our compliance costs and subject us to heightened risks and challenges associated with data security and protection. If we are unable to manage these risks, we could become subject to penalties, fines, suspension of business and revocation of required licenses, and our reputation and results of operations could be materially and adversely affected. In addition, regulatory authorities around the world have recently adopted or are considering a number of legislative and regulatory proposals concerning data protection. These legislative and regulatory proposals, if adopted, and the uncertain interpretations and application thereof could, in addition to the possibility of fines, result in an order requiring that we change our data practices, which could have an adverse effect on our business and results of operations.

 

Our business depends on the market recognition of our brand, and if we are unable to maintain and enhance brand recognition, or promote or maintain our brand in a cost-effective manner, our business, financial conditions and results of operations may be materially and adversely affected.

 

We believe that maintaining and enhancing our brand is of significant importance to the success of our business. A well-recognized brand is important to attract customers, especially in this novel and evolving market. We promote our brand though marketing team and word-of-mouth referrals. Successful promotion of our brand will depend on the effectiveness of our marketing efforts and amount of word-of-mouth referrals we received from satisfied customers. We may incur extra expenses in promoting our brand. However, our brand promotion activities and marketing efforts may not yield increased revenues, and even if they do, any increased revenues may not offset the expenses we incurred in promoting our brand. Since we operate in a highly competitive industry, our brand recognition directly affects our ability to maintain our market position. If we fail to successfully promote and maintain our brand, or if we incur extra expenses in an unsuccessful attempt to promote and maintain our brand, we may fail to attract enough new customers or retain our existing customers, and our business and results of operations may be materially and adversely affected.

 

Our success depends on the interoperability of our products and services with next-generation AR hardware.

 

The success of our products depends upon the cooperation of AR hardware manufactures to ensure interoperability with our products and offer compatible products and services to end users. To the extent that hardware manufactures perceive that their products and services compete with ours, they may have an incentive to withhold their cooperation, decline to share access or sell to us their proprietary application programming interfaces (“APIs”), protocols or formats, or engage in practices to actively limit the functionality, compatibility and certification of our products. If any of the foregoing occurs, our product development efforts may be delayed or foreclosed and it may be difficult and more costly for us to achieve functionality and service levels that would make our services attractive to end users, any of which could negatively impact our business and operating results.

 

Future litigation could have a material and adverse impact on our business, financial condition and results of operations.

 

From time to time, we have been, and may in the future be, subject to lawsuits brought by our competitors, individuals, or other entities against us, in matters relating to intellectual property rights, contractual disputes and competition claims. The outcomes of actions we institute may not be successful or favorable to us. Lawsuits against us may also generate negative publicity that significantly harms our reputation, which may adversely affect our user base. In addition to the related cost, managing and defending litigation and related indemnity obligations can significantly divert our management’s attention from operating our business. We may also need to pay damages or settle lawsuits with a substantial amount of cash. While we do not believe that any currently pending proceedings are likely to have a material adverse effect on us, if there were adverse determinations in legal proceedings against us, we could be required to pay substantial monetary damages or adjust our business practices, which could have an adverse effect on our business, financial condition and results of operations.

 

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Negative media coverage could adversely affect our business.

 

Negative publicity about us and our business, shareholders, affiliates, directors, officers, and other employees, as well as the industry in which we operate, can harm our operations. Negative publicity concerning these parties could be related to a wide variety of matters, including:

 

alleged misconduct or other improper activities committed by our shareholders, affiliates, directors, officers and other employees;

 

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

 

user complaints about the quality of our products and services;

 

copyright or patent infringements involving us and contents offered on our platforms; 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, social media websites and other forms of internet-based communications that provide individuals with access to a broad audience of users 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.

 

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

 

We are subject to the reporting requirements of the Exchange Act of 1934, or Exchange Act, the Sarbanes-Oxley Act of and the rules and regulations of the Nasdaq Stock Market. Our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting, as we are not required to provide a report of management’s assessment on our internal control over financial reporting due to a transition period established by the rules of the SEC for newly public companies. However, in the course of auditing our consolidated financial statements for the financial statements included elsewhere in this prospectus, we and our independent registered public accounting firm identified one material weakness in our internal control over financial reporting. As defined in standards established by the Public Company Accounting Oversight Board (“PCAOB”), 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 annual or interim financial statements will not be prevented or detected on a timely basis. The material weakness identified relates to our lack of sufficient skilled staff with U.S. GAAP knowledge and the SEC reporting knowledge for the purpose of financial reporting as well as the lack in formal accounting policies and procedures manual to ensure proper financial reporting in accordance with U.S. GAAP and SEC reporting requirements.

 

We have already taken some steps and have continued to implement measures to remediate the material weakness identified, including but not limited to (i) streamline our accounting department structure and enhance our staff’s U.S. GAAP expertise on a continuous basis; (2) hire a new reporting manager who has sufficient expertise in U.S. GAAP to improve the quality of U.S. GAAP reports; (3) make an overall assessment on the current finance and accounting resources and have plans to hire new finance team members with U.S. GAAP qualification in order to strengthen our U.S. GAAP reporting framework; (4) participate in trainings and seminars provided by professional services firms on a regular basis to gain knowledge on regular accounting/SEC reporting updates; and (5) provide internal training to our current accounting team on US GAAP knowledge. We are also in the process of completing a systematic accounting manual for US GAAP and financial closing process. However, we cannot assure you that we will not identify additional material weaknesses or significant deficiencies in the future. In addition, if we are unable to meet the requirements of Section 404 of the Sarbanes-Oxley Act, our ADSs may not be able to remain listed on the NASDAQ Global Market.

 

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Section 404 of the Sarbanes-Oxley Act of 2002 requires that we include a report of 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, 2020. In addition, once we cease to be an “emerging growth company” as such term is defined under 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, as we are 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 of the Sarbanes- Oxley Act of 2002, we may identify other 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. 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 shares. Additionally, ineffective internal control over financial reporting could expose us to increased risk of fraud or misuse of corporate assets and subject us to potential delisting from the stock exchange on which we list, regulatory investigations and civil or criminal sanctions. We may also be required to restate our financial statements from prior periods.

 

Future strategic alliances or acquisitions may have a material and adverse effect on our business, financial condition and results of operations.

 

We may enter into strategic alliances, including joint ventures or minority equity investments, with various third parties to further our business purpose from time to time. These alliances could subject us to a number of risks, including risks associated with sharing proprietary information, non-performance by the third party and increased expenses in establishing new strategic alliances, any of which may materially and adversely affect our business. We may have limited ability to monitor or control the actions of these third parties and, to the extent any of these strategic third parties suffers negative publicity or harm to their reputation from events relating to their business, we may also suffer negative publicity or harm to our reputation by virtue of our association with any such third party.

 

In addition, when appropriate opportunities arise, we may acquire additional assets, products, technologies or businesses that are complementary to our existing business. In addition to possible shareholders’ approval, we may also have to obtain approvals and licenses from relevant government authorities for the acquisitions and to comply with any applicable PRC laws and regulations, which could result in increased delay and costs, and may derail our business strategy if we fail to do so. Furthermore, past and future acquisitions and the subsequent integration of new assets and businesses require significant attention from our management and could result in a diversion of resources from our existing business, which in turn could have an adverse effect on our business operations. Acquired assets or businesses may not generate the financial results we expect. Acquisitions could result in the use of substantial amounts of cash, potentially dilutive issuances of equity securities, the occurrence of significant goodwill impairment charges, amortization expenses for other intangible assets and exposure to potential unknown liabilities of the acquired business. Moreover, the costs of identifying and consummating acquisitions may be significant. Furthermore, our equity investees may generate significant losses, a portion of which will be shared by us in accordance with U.S. GAAP. Any such negative developments could have a material adverse effect on our business, reputation, results of operations and financial condition.

 

We have limited business insurance coverage.

 

Insurance companies in China offer limited business insurance products. We do not have any business liability or disruption insurance coverage for our operations in China. Any business disruption may result in our incurring substantial costs and the diversion of our resources, which could have an adverse effect on our results of operations and financial condition.

 

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We have adopted an equity incentive plan and may grant share-based awards under our equity incentive plan, which may result in increased share-based compensation expenses.

 

We adopted our 2020 Equity Incentive Plan, or the 2020 Plan, in July 2020 for purposes of granting share-based compensation awards to employees, directors, officers, and consultants to incentivize their performance and align their interests with ours. Under our 2020 Plan, we are authorized to grant restricted Class B ordinary shares, options to purchase Class B ordinary shares of our company and restricted share units to receive Class B ordinary shares. The maximum number of Class B ordinary shares which may be issued pursuant to all awards under the 2020 Plan is 17,500,000. As of the date of this prospectus, we have not granted any awards under our 2020 Plan. We believe the grant of share incentive awards is of significant importance to our ability to attract and retain employees, and we will grant share incentive awards to employees in the future. As a result, we will incur expenses associated with share-based compensation, which may have an adverse effect on our results of operations and financial condition.

 

Risks Related to Our Corporate Structure

 

We are subject to changing law and regulations regarding regulatory matters, corporate governance and public disclosure that have increased both our costs and the risk of non-compliance.

 

We are subject to rules and regulations by various governing bodies, including, for example, the SEC, which are charged with the protection of investors and the oversight of companies whose securities are publicly traded, and to new and evolving regulatory measures under applicable law. Our efforts to comply with new and changing laws and regulations have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities.

 

Moreover, because these laws, regulations and standards are subject to varying interpretations, their application in practice may evolve over time as new guidance becomes available. This evolution may result in continuing uncertainty regarding compliance matters and additional costs necessitated by ongoing revisions to our disclosure and governance practices. If we fail to address and comply with these regulations and any subsequent changes, we may be subject to penalty and our business may be harmed.

 

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

 

Foreign ownership of the telecommunication business and certain other businesses in China is extensively regulated and subject to numerous restrictions. Pursuant to the Special Administrative Measures for Access of Foreign Investment (Negative List) (2018 Edition), or the Negative List, and Administrative Provisions on Foreign-Invested Telecommunications Enterprises (Revised in 2016) , foreign investors are generally not allowed to own more than 50% of the equity interests in a commercial internet content provider or other value-added telecommunication service provider other than operating e-commerce, and the major foreign investor in a value-added telecommunication service provider in China must have experience in providing value-added telecommunications services overseas and maintain a good track record in accordance with the Negative List, Administrative Provisions on Foreign-Invested Telecommunications Enterprises (Revised in 2016) and other applicable laws and regulations. In addition, foreign investors are prohibited from investing in companies engaged in online operating business, internet audio-visual programs business, internet culture business and radio and television program production business.

 

We are a Cayman Islands company and our PRC subsidiary is currently considered foreign-invested enterprises. Accordingly, none of our PRC subsidiary are eligible to operate internet content service, online culture activities or other businesses which foreign-owned companies are prohibited or restricted from conducting in China. To ensure strict compliance with the PRC laws and regulations, we conduct such business activities through our VIE and its subsidiaries. Our wholly owned subsidiary in China, Hologram WiMi, has entered into a series of contractual arrangements with our VIE and its shareholders, which enables 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 their financial results as our VIE under U.S. GAAP. See “Corporate History and Structure” for details.

 

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If the PRC government finds that our contractual arrangements do not comply with its restrictions on foreign investment in the telecommunication business and certain other businesses, or if the PRC government otherwise finds that we, our VIE, or any of its subsidiaries is in violation of PRC laws or regulations or lacks the necessary permits or licenses to operate our business, the relevant PRC regulatory authorities, including the MIIT and the Ministry of Commerce of the People’s Republic of China (“MOFCOM”), would have broad discretion in dealing with such violations or failures, including:

 

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;

 

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

 

Substantial uncertainties exist with respect to the enactment timetable, interpretation and implementation of PRC Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations.

 

In March 2019, the Standing Committee of the National People’s Congress of the PRC passed the Foreign Investment Law of the People’s Republic of China (“Foreign Investment Law”). Among other things, the Foreign Investment Law defines the “foreign investment” as the investment activities in China conducted by foreign individuals, enterprises and other organizations (collectively, the “Foreign Investors”) in a direct or indirectly manner, including any of the following circumstances: (1) the foreign investor establishes a foreign-invested enterprise within the territory of China, independently or jointly with any other investor; (2) the foreign investor acquires shares, equities, property shares or any other similar rights and interests of an enterprise within the territory of China; (3) the foreign investor makes investment to initiate a new project within the territory of China, independently or jointly with any other investor; and (4) the foreign investor makes investment in any other way stipulated by laws, administrative regulations or provisions of the State Council. The Foreign Investment Law leaves uncertainty with respect to whether Foreign Investors control PRC onshore variable interest entities via contractual arrangements will be recognized as “foreign investment”. PRC governmental authorities will administrate foreign investment by applying the principal of pre-entry national treatment together with a “negative list” (the “Negative List”, which shall be promulgated by or promulgated with approval by the State Counsel), to be specific, Foreign Investors are prohibited from making any investments in the fields which are catalogued into prohibited industries for foreign investment based on the Negative List, while Foreign Investors are allowed to make investments in the restricted industries provided that all the requirements and conditions as set forth in the Negative List have been satisfied; when Foreign Investors make investments in the fields other than those included in the Negative List, the national treatment principle shall apply. Besides, certain approval and/or filing requirements shall be fulfilled in accordance with applicable foreign investment laws and regulations.

 

The internet content service and online culture activities that we conduct through our VIE are subject to Special Management Measures for the Market Entry of Foreign Investment (Negative List) (2018 Version) (the “2018 Negative List”) issued by MOFCOM and the National Development and Reform Commission. It is unclear whether any new “negative list” to be issued under the Foreign Investment Law will be different from the 2018 Negative List. If our control over our VIE through contractual arrangements are deemed as foreign investment in the future, and any business of our VIE is restricted or prohibited from foreign investment under the “negative list” effective at the time, we may be deemed to be in violation of the Foreign Investment Law, the contractual arrangements that allow us to have control over our VIE may be deemed as invalid and illegal, and we may be required to unwind such contractual arrangements and/or restructure our business operations, any of which may have a material adverse effect on our business operation.

 

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

 

We have relied and expect to continue to rely on contractual arrangements with Beijing WiMi, or our VIE, and its shareholders, and certain of its subsidiaries to operate our business in China. These contractual arrangements may not be as effective as direct ownership in providing us with control over our 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 revenues in 2017, 2018 and 2019.

 

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 respective obligations under the contracts to exercise control over our VIE. The shareholders of our 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 portion of our business through the contractual arrangements with our VIE. If any dispute relating to these contracts remains unresolved, we will have to enforce our rights under these contracts through arbitration, litigation or 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 controlling our business operations as direct ownership.

 

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 its equity interest in our VIE to our PRC subsidiary or its designee after we exercise the purchase option pursuant to these contractual arrangements, or if they otherwise act in bad faith or otherwise fail to fulfill their contractual obligations, 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 shareholders or the shareholders of our VIE may have potential conflicts of interest with us, which may materially and adversely affect our business.

 

The shareholders of our VIE may have actual or potential conflicts of interest with us. These shareholders may 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 them. 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.

 

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All the agreements under our contractual arrangements with our VIE and its equity owners are governed by PRC law and provide for the resolution of disputes through arbitration in China. Accordingly, these contracts would be interpreted in accordance with PRC law, and any disputes would be resolved in accordance with PRC legal procedures.

 

All the agreements under our contractual arrangements with our VIE and its equity owners are governed by PRC law and provide for the resolution of disputes through arbitration in China. 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 through arbitration award recognition proceedings, which would require additional expenses and delay. In the event we are unable to enforce these contractual arrangements, or if we suffer significant delay or other obstacles in the process of enforcing these contractual arrangements, we may not be able to exert effective control over our VIE, and our ability to conduct our business may be negatively affected.

 

We may lose the ability to use and enjoy assets held by our VIE and its subsidiaries that are important to our business if our VIE and its subsidiaries declare bankruptcy or become subject to a dissolution or liquidation proceeding.

 

As part of our contractual arrangements with our VIE, the entity holds certain assets that are material to the operation of certain portion of our business. If our VIE goes bankrupt and all or part of its assets become subject to liens or rights of third-party creditors, we may be unable to continue some or all of our business activities, which could materially and adversely affect our business, financial condition and results of operations. Under the contractual arrangements, our VIE may not, in any manner, sell, transfer, mortgage or dispose of its assets or legal or beneficial interests in the business without our prior consent. If our VIE undergoes a voluntary or involuntary liquidation proceeding, the independent third-party creditors may claim rights to some or all of these assets, thereby hindering our ability to operate our business, which could materially and adversely affect our business, financial condition and results of operations

 

Contractual arrangements we have entered into with our VIE may be subject to scrutiny by the PRC tax authorities. A finding that we owe additional taxes 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 contractual arrangements between us and our VIE 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.

 

If the chops of our PRC subsidiary, our VIE and its subsidiaries, are not kept safely, are stolen or are used by unauthorized persons or for unauthorized purposes, the corporate governance of these entities could be severely and adversely compromised.

 

In China, a company chop or seal serves as the legal representation of the company towards third parties even when unaccompanied by a signature. Each legally registered company in China is required to maintain a company chop, which must be registered with the local Public Security Bureau. In addition to this mandatory company chop, companies may have several other chops which can be used for specific purposes. The chops of our PRC subsidiary and VIE are generally held securely by personnel designated or approved by us in accordance with our internal control procedures. To the extent those chops are not kept safely, are stolen or are used by unauthorized persons or for unauthorized purposes, the corporate governance of these entities could be severely and adversely compromised and those corporate entities may be bound to abide by the terms of any documents so chopped, even if they were chopped by an individual who lacked the requisite power and authority to do so. In addition, if the chops are misused by unauthorized persons, 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 while distracting management from our operations.

 

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Risks Related to Doing Business in China

 

Adverse changes in China’s economic, political or social conditions or government policies could have a material adverse effect on our business, financial condition and results of operations.

 

The majority of our revenues are sourced from China. Accordingly, our results of operations, financial condition and prospects are influenced by economic, political and legal developments in China. Economic reforms begun in the late 1970s have resulted in significant economic growth. However, any economic reform policies or measures in China may from time to time be modified or revised. China’s economy differs from the economies of most developed countries in many respects, including with respect to the amount 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 PRC economy has experienced significant growth in the past 30 years, growth has been uneven across different regions and among different economic sectors. The Chinese government has implemented measures to encourage economic growth and guide the allocation of the 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.

 

Although the PRC economy has grown significantly in the past decade, that growth may not continue, as evidenced by the slowing of the growth of the PRC economy since 2012. In addition, China’s economic condition has been, and may continue to be, impacted by the recent global outbreak of COVID-19 and the corresponding government-mandated quarantine measures. Any adverse changes in economic conditions in China, in the policies of the PRC government or in the laws and regulations in China could have a material adverse effect on the overall economic growth of China. Such developments could adversely affect our business and operating results, lead to reduction in demand for our services and adversely affect our competitive position.

 

A severe or prolonged downturn in the PRC or global economy and political tensions between the United States and China could materially and adversely affect our business and our financial condition.

 

The global macroeconomic environment is facing challenges, including the end of quantitative easing by the U.S. Federal Reserve, the economic slowdown in the Eurozone since 2014 and uncertainties over the impact of Brexit. The Chinese economy has shown slower growth compared to the previous decade since 2012 and the trend may continue. There is considerable uncertainty over the long-term effects of the expansionary monetary and fiscal policies adopted by the central banks and financial authorities of some of the world’s leading economies, including the United States and China. There have been concerns over unrest and terrorist threats in the Middle East, Europe and Africa, which have resulted in market volatility. There have also been concerns over the relationship between China and other countries, including the surrounding Asian countries and the United States. In March 2018, U.S. President Donald J. Trump announced the imposition of tariffs on steel and aluminum entering the United States and in June 2018 announced further tariffs targeting goods imported from China. Subsequently, both China and the U.S. have each imposed tariffs that have adversely affected trade between the two countries. In October 2019, U.S. President Donald J. Trump announced that China and the United States had reached a tentative agreement for the first phase of a trade deal, under which China has agreed to buy up to US$50.0 billion of American products and services, while the United States has agreed to suspend new tariffs. Such agreement was signed in January 2020. It is not yet clear what impact these tariff negotiations may have or what further actions the governments may take. Political tensions between the United States and China have escalated since the COVID-19 outbreak and the PRC National People’s Congress’ decision on Hong Kong national security legislation. Rising political tensions could reduce levels of trades, investments, technological exchanges and other economic activities between the two major economies, which would have a material adverse effect on global economic conditions and the stability of global financial markets. Any of these factors could have a material adverse effect on our business, prospects, financial condition and results of operations.

 

Furthermore, there have been recent media reports U.S. governments’ proposed legislation which potentially limits or restricts China-based companies’ access to U.S. capital markets. If such proposed legislation were to be enacted, it may have a material and adverse impact on the stock performance of China-based companies listed in the United States. In addition, the recent market panics over the global outbreak of COVID-19 materially and negatively affected the global financial markets in March 2020, which may cause potential slowdown of the global economy. Economic conditions in China are sensitive to global economic conditions, as well as changes in domestic economic and political policies and the expected or perceived overall economic growth rate in China. Any severe or prolonged slowdown in the global or Chinese economy and the political tensions between the United States and China may materially and adversely affect our business, financial condition, results of operations and prospects.

 

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

 

The PRC legal system is based on written statutes and prior court decisions have limited value as precedents. Since these laws and regulations are relatively new and the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involves uncertainties. From time to time, we may have to resort to administrative and court proceedings to enforce our legal rights. However, since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to evaluate the outcome of administrative and court proceedings and the level of legal protection we enjoy than in more developed legal systems. Furthermore, the PRC legal system is based in part on government policies and internal rules (some of which are not published in a timely manner or at all) that may have retroactive effect. As a result, we may not be aware of our violation of these policies and rules until sometime after the violation. Such uncertainties, including uncertainty over the scope and effect of our contractual, property (including intellectual property) and procedural rights, could materially and adversely affect our business and impede our ability to continue our operations.

 

Under the PRC enterprise income tax law, we may be classified as a PRC ‘resident enterprise,’ which could result in unfavorable tax consequences to us and our shareholders and have a material adverse effect on our results of operations and the value of your investment.

 

Under the PRC enterprise income tax law that became effective on January 1, 2008, an enterprise established outside the PRC with “de facto management bodies” within the PRC is considered a “resident enterprise” for PRC enterprise income tax purposes and is generally subject to a uniform 25% enterprise income tax rate on its worldwide income. On April 22, 2009, the State Administration of Taxation, or the SAT, issued the Notice Regarding the Determination of Chinese-Controlled Overseas Incorporated Enterprises as PRC Tax Resident Enterprise on the Basis of De Facto Management Bodies, or SAT Circular 82, which provides certain specific criteria for determining whether the “de facto management body” of a PRC-controlled enterprise that is incorporated offshore is located in China. Further to SAT Circular 82, on August 3, 2011, the SAT issued the Administrative Measures of Enterprise Income Tax of Chinese-Controlled Offshore Incorporated Resident Enterprises (Trial), or SAT Bulletin 45, which became effective on September 1, 2011, to provide more guidance on the implementation of SAT Circular 82.

 

According to SAT Circular 82, an offshore incorporated enterprise controlled by a PRC enterprise or a PRC enterprise group will be considered a PRC tax resident enterprise by virtue of having its “de facto management body” in China and will be subject to PRC enterprise income tax on its worldwide income only if all of the following conditions are met: (a) the senior management and core management departments in charge of its daily operations function have their presence mainly in the PRC; (b) its financial and human resources decisions are subject to determination or approval by persons or bodies in the PRC; (c) its major assets, accounting books, company seals, and minutes and files of its board and shareholders’ meetings are located or kept in the PRC; and (d) not less than half of the enterprise’s directors or senior management with voting rights habitually reside in the PRC. SAT Bulletin 45 further clarifies the resident status determination, post-determination administration as well as competent tax authorities.

 

Although SAT Circular 82 and SAT Bulletin 45 only apply to offshore incorporated enterprises controlled by PRC enterprises or PRC enterprise group instead of those controlled by PRC individuals or foreigners, Jingtian & Gongcheng Law Firm, our legal adviser as to PRC law, has advised us that the determination criteria set forth therein may reflect SAT’s general position on how the term “de facto management body” could be applied in determining the tax resident status of offshore enterprises, regardless of whether they are controlled by PRC enterprises, individuals or foreigners.

 

We do not meet all of the conditions above; therefore, we believe that we should not be treated as a “resident enterprise” for PRC tax purposes even if the standards for “de facto management body” prescribed in the SAT Circular 82 are applicable to us.

 

However, it is possible that the PRC tax authorities may take a different view. Jingtian & Gongcheng Law Firm, our legal adviser as to PRC law, has advised us that if the PRC tax authorities determine that our Cayman Islands holding company is a PRC resident enterprise for PRC enterprise income tax purposes, our world-wide income could be subject to PRC tax at a rate of 25%, which could reduce our net income. In addition, we will also be subject to PRC enterprise income tax reporting obligations.

 

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Although dividends paid by one PRC tax resident to another PRC tax resident should qualify as “tax-exempt income” under the enterprise income tax law, we cannot assure you that dividends by our PRC subsidiary to our Cayman Islands holding company will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax on dividends, and the PRC tax authorities have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes.

 

Non-PRC resident ADS holders may also be subject to PRC withholding tax on dividends paid by us and PRC tax on gains realized on the sale or other disposition of ADSs or Class B ordinary shares, if such income is sourced from within the PRC. The tax would be imposed at the rate of 10% in the case of non-PRC resident enterprise holders and 20% in the case of non-PRC resident individual holders. In the case of dividends, we would be required to withhold the tax at source. Any PRC tax liability may be reduced under applicable tax treaties or similar arrangements. Although our holding company is incorporated in the Cayman Islands, it remains unclear whether dividends received and gains realized by our non-PRC resident ADS holders will be regarded as income from sources within the PRC if we are classified as a PRC resident enterprise. Any such tax will reduce the returns on your investment in our ADSs.

 

We cannot assure you that the PRC tax authorities will not, at their discretion, adjust any capital gains and impose tax return filing and withholding or tax payment obligations with respect to any internal restructuring, and our PRC subsidiary may be requested to assist in the filing. Any PRC tax imposed on a transfer of our shares not through a public stock exchange, or any adjustment of such gains would cause us to incur additional costs and may have a negative impact on the value of your investment in our company.

 

We may not be able to obtain certain benefits under relevant tax treaty on dividends paid by our PRC subsidiary to us through our Hong Kong subsidiary.

 

We are an exempted limited liability company, used as holding company, incorporated under the laws of the Cayman Islands and as such rely on dividends and other distributions on equity from our PRC subsidiary, as paid to us through our Hong Kong subsidiary, to satisfy part of our liquidity requirements. Pursuant to the PRC Enterprise Income Tax Law, a withholding tax rate of 10% currently applies to dividends paid by a PRC ‘resident enterprise’ to a foreign enterprise investor, unless any such foreign investor’s jurisdiction of incorporation has a tax treaty with China that provides for preferential tax treatment. Pursuant to the Arrangement between the Mainland China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and Tax Evasion on Income, or the Double Tax Avoidance Arrangement, and Circular 81 issued by the State Administration of Taxation, such withholding tax rate may be lowered to 5% if the PRC enterprise is at least 25% held by a Hong Kong enterprise throughout the 12 months prior to distribution of the dividends and is determined by the relevant PRC tax authority to have satisfied other requirements. Furthermore, under the Administrative Measures for Non-Resident Enterprises to Enjoy Treatments under Tax Treaties, which became effective in August 2015, the non-resident enterprises shall determine whether they are qualified for preferential tax treatment under the tax treaties and file relevant reports and materials with the tax authorities. There are also other conditions for benefiting from the reduced withholding tax rate according to other relevant tax rules and regulations. We cannot assure you that our determination regarding our Hong Kong subsidiary’ qualification to benefit from the preferential tax treatment will not be challenged by the relevant PRC tax authority or that we will be able to complete the necessary filings with the relevant PRC tax authority and benefit from the preferential withholding tax rate of 5% under the Double Taxation Avoidance Arrangement with respect to dividends to be paid by our PRC subsidiary to our Hong Kong subsidiary.

 

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

 

We face uncertainties regarding the reporting on and consequences of previous private equity financing transactions involving the transfer and exchange of shares in our company by non-resident investors.

 

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In February 2015, the SAT issued the Bulletin on Issues of Enterprise Income Tax on Indirect Transfers of Assets by Non-PRC Resident Enterprises, or SAT Bulletin 7, as amended in 2017. Pursuant to this bulletin, an “indirect transfer” of assets, including equity interests in a PRC resident enterprise, by non-PRC resident enterprises may be re-characterized and treated as a direct transfer of PRC taxable assets, if such arrangement does not have a reasonable commercial purpose and was established for the purpose of avoiding payment of PRC enterprise income tax. As a result, gains derived from such indirect transfer may be subject to PRC enterprise income tax. According to SAT Bulletin 7, “PRC taxable assets” include assets attributed to an establishment in China, immovable properties located in China, and equity investments in PRC resident enterprises, in respect of which gains from their transfer by a direct holder, being a non-PRC resident enterprise, would be subject to PRC enterprise income taxes. When determining whether there is a “reasonable commercial purpose” of the transaction arrangement, features to be taken into consideration include: whether the main value of the equity interest of the relevant offshore enterprise derives from PRC taxable assets; whether the assets of the relevant offshore enterprise mainly consist of direct or indirect investment in China or if its income mainly derives from China; whether the offshore enterprise and its subsidiaries directly or indirectly holding PRC taxable assets have real commercial nature which is evidenced by their actual function and risk exposure; the duration of existence of the business model and organizational structure; the replicability of the transaction by direct transfer of PRC taxable assets; and the tax situation of such indirect transfer and applicable tax treaties or similar arrangements. In respect of an indirect offshore transfer of assets of a PRC establishment, the resulting gain is to be included with the enterprise income tax filing of the PRC establishment or place of business being transferred, and would consequently be subject to PRC enterprise income tax at a rate of 25%. Where the underlying transfer relates to the immovable properties located in China or to equity investments in a PRC resident enterprise, which is not related to a PRC establishment or place of business of a non-resident enterprise, a PRC enterprise income tax of 10% would apply, subject to available preferential tax treatment under applicable tax treaties or similar arrangements, and the party who is obligated to make the transfer payments has the withholding obligation. SAT Bulletin 7 does not apply to transactions of sale of shares by investors through a public stock exchange where such shares were acquired from a transaction through a public stock exchange.

 

There is uncertainty as to the application of SAT Bulletin 7. 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 or 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. For transfer of shares in our company by investors that are non-PRC resident enterprises, our PRC subsidiary may be requested to assist in the filing under SAT Bulletin 7. As a result, we may be required to expend valuable resources to comply with SAT Bulletin 7 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.

 

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

 

We are a Cayman Islands exempted company and substantially all of our current operations are conducted in China. In addition, most of our current directors and officers are nationals and residents of countries other than the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the United States in the event that you believe that your rights have been infringed under the U.S. federal securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers.

 

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

 

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

 

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

 

Maples and Calder (Hong Kong) LLP has informed us that although there is no statutory enforcement in the Cayman Islands of judgments obtained in the federal or state courts of the United States (and the Cayman Islands are not a party to any treaties for the reciprocal enforcement or recognition of such judgments), the courts of the Cayman Islands will, at common law, recognize and enforce a foreign money judgment of a foreign court of competent jurisdiction without any re-examination of the merits of the underlying dispute based on the principle that a judgment of a competent foreign court imposes upon the judgment debtor an obligation to pay the liquidated sum for which such judgment has been given, provided such judgment (i) is final and conclusive, (ii) is not in respect of taxes, a fine or a penalty; and (iii) was not obtained in a manner and is not of a kind the enforcement of which is contrary to natural justice or the public policy of the Cayman Islands. However, the Cayman Islands courts are unlikely to enforce a judgment obtained from the U.S. courts under civil liability provisions of the U.S. federal securities law if such judgment is determined by the courts of the Cayman Islands to give rise to obligations to make payments that are penal or punitive in nature. A Cayman Islands court may stay enforcement proceedings if concurrent proceedings are being brought elsewhere. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities.”

 

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Implementation of labor laws and regulations in China may adversely affect our business and results of operations.

 

Pursuant to the labor contract law that took effect in January 2008, its implementation rules that took effect in September 2008 and its amendment that took effect in July 2013, employers are subject to stricter requirements in terms of signing labor contracts, minimum wages, paying remuneration, determining the term of employees’ probation and unilaterally terminating labor contracts. Due to lack of detailed interpretative rules and uniform implementation practices and broad discretion of the local competent authorities, it is uncertain as to how the labor contract law and its implementation rules will affect our current employment policies and practices. Our employment policies and practices may violate the labor contract law or its implementation rules, and we may thus be subject to related penalties, fines or legal fees. Compliance with the labor contract law and its implementation rules may increase our operating expenses, in particular our personnel expenses. In the event that we decide to terminate some of our employees or otherwise change our employment or labor practices, the labor contract law and its implementation rules may also limit our ability to effect those changes in a desirable or cost-effective manner, which could adversely affect our business and results of operations. According to the Social Insurance Law and the Regulations on the Management of Housing Fund, employees must participate in pension insurance, work-related injury insurance, medical insurance, unemployment insurance and maternity insurance and housing funds, and the employers must, together with their employees or separately, pay the social insurance premiums and housing funds for such employees.

 

As the interpretation and implementation of these laws and regulations are still evolving, we cannot assure you that our employment practice will at all times be deemed in full compliance with labor-related laws and regulations in China, which may subject us to labor disputes or government investigations. If we are deemed to have violated relevant labor laws and regulations, we could be required to provide additional compensation to our employees and our business, financial condition and results of operations could be materially and adversely affected.

 

Further, labor disputes, work stoppages or slowdowns at our company or any of our third-party service providers could significantly disrupt our daily operation or our expansion plans and have a material adverse effect on our business.

 

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

 

The Regulations on Mergers and Acquisitions of Domestic Companies by Foreign Investors, or the M&A Rules, adopted by six PRC regulatory agencies in 2006 and amended in 2009, and some other regulations and rules concerning mergers and acquisitions established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time consuming and complex, including requirements in some instances that the anti-monopoly law enforcement agency be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise. Moreover, the Anti-Monopoly Law requires that the anti-monopoly law enforcement agency shall be notified in advance of any concentration of undertaking if certain thresholds are triggered. In addition, the security review rules issued by the MOFCOM, that became effective in September 2011 specify that mergers and acquisitions by foreign investors that raise “national defense and security” concerns and mergers and acquisitions through which foreign investors may acquire de facto control over domestic enterprises that raise “national security” concerns are subject to strict review by the MOFCOM, and the rules prohibit any activities attempting to bypass a security review, including by structuring the transaction through a proxy or contractual control arrangement. In the future, we may grow our business by acquiring complementary businesses. Complying with the requirements of the above-mentioned regulations and other relevant rules to complete such transactions could be time consuming, and any required approval processes, including obtaining approval from the MOFCOM or its local counterpart or anti-monopoly law enforcement agency 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 offshore investment activities by PRC residents may limit our PRC subsidiary’s ability to increase their registered capital or distribute profits to us or otherwise expose us to liability and penalties under PRC law.

 

The State Administration of Foreign Exchange (“SAFE”) promulgated the Circular on Relevant Issues Relating to PRC Resident’s Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, in July 2014 that requires PRC residents or entities to register with SAFE or its local branch in connection with their establishment or control of an offshore entity established for the purpose of overseas investment or financing. In addition, such PRC residents or entities must update their SAFE registrations when the offshore special purpose vehicle undergoes material events relating to any change of basic information (including change of such PRC residents or entities, name and operation term), increases or decreases in investment amount, transfers or exchanges of shares, or mergers or divisions.

 

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SAFE Circular 37 is issued to replace the Circular on Relevant Issues Concerning Foreign Exchange Administration for PRC Residents Engaging in Financing and Roundtrip Investments through Overseas Special Purpose Vehicles.

 

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

 

However, we may not be informed of the identities of all the PRC residents or entities holding direct or indirect interest in our company, nor can we compel our shareholders to comply with the requirements of SAFE Circular 37. As a result, we cannot assure you that all of our shareholders who are PRC residents or entities have complied with, and will in the future make or obtain any applicable registrations or approvals required by, SAFE Circular 37. Failure by such shareholders to comply with SAFE Circular 37, or failure by us to amend the foreign exchange registrations of our PRC subsidiary, could subject us to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our PRC subsidiary’s ability to make distributions or pay dividends to us or affect our ownership structure, which could adversely affect our business and prospects.

 

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

 

Any transfer of funds by us to our PRC subsidiary, either as a shareholder loan or as an increase in registered capital, are subject to approval by or registration or filing with relevant governmental authorities in China. According to the relevant PRC regulations on foreign-invested enterprises in China, capital contributions to our PRC subsidiary are subject to the approval of or filing with the Ministry of Commerce in its local branches and registration with a local bank authorized by SAFE. In addition, (i) any foreign loan procured by our PRC subsidiary is required to be registered with SAFE or its local branches or filed with SAFE in its information system; and (ii) our PRC subsidiary may not procure loans which exceed the difference between its total investment amount and registered capital or, as an alternative, only procure loans subject to the calculation approach and limitation as provided in the People’s Bank of China Notice No. 9 (“PBOC Notice No. 9”). Any medium- or long-term loan to be provided by us to our VIE must be registered with the National Development and Reform Commission and SAFE or its local branches. We may not be able to obtain these government approvals or complete such registrations on a timely basis, if at all, with respect to future capital contributions or foreign loans by us to our PRC subsidiary. If we fail to receive such approvals or complete such registration or filing, 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. There is, in effect, no statutory limit on the amount of capital contribution that we can make to our PRC subsidiary. This is because there is no statutory limit on the amount of registered capital for our PRC subsidiary, and we are allowed to make capital contributions to our PRC subsidiary by subscribing for their initial registered capital and increased registered capital, provided that the PRC subsidiary completes the relevant filing and registration procedures. With respect to loans to the PRC subsidiary by us, (i) if the PRC subsidiary adopt the traditional foreign exchange administration mechanism, or the Current Foreign Debt Mechanism, the outstanding amount of the loans shall not exceed the difference between the total investment and the registered capital of the PRC subsidiary; and (ii) if the PRC subsidiary adopt the foreign exchange administration mechanism as provided in Notice of the People’s Bank of China on Matters concerning the Macro-Prudential Management of Full-Covered Cross-Border Financing, or the PBOC Notice No. 9, the risk-weighted outstanding amount of the loans, which shall be calculated based on the formula provided in PBOC Notice No. 9, shall not exceed 200% of the net asset of the PRC subsidiary. For example, the maximum amount of the loans that WiMi WFOE may acquire from outside China as of December 31, 2019 was (i) approximately RMB 698 million (USD 100 million) under the total investment minus registered capital approach; or (ii) approximately RMB 296 million (USD 42.4 million) under the net asset approach. According to the PBOC Notice No. 9, after a transition period of one year since the promulgation of PBOC Notice No. 9, the PBOC and SAFE will determine the cross-border financing administration mechanism for the foreign-invested enterprises after evaluating the overall implementation of PBOC Notice No. 9. As of the date hereof, neither the PBOC nor SAFE has promulgated and made public any further rules, regulations, notices or circulars in this regard. It is uncertain which mechanism will be adopted by the PBOC and SAFE in the future and what statutory limits will be imposed on us when providing loans to our PRC subsidiaries. Currently, our PRC subsidiary has the flexibility to choose between the Current Foreign Debt Mechanism and the Notice No. 9 Foreign Debt Mechanism. However, if a more stringent foreign debt mechanism becomes mandatory, our ability to provide loans to our PRC subsidiary or our consolidated affiliated entities may be significantly limited, which may adversely affect our business, financial condition and results of operations.

 

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The Circular on Reforming the Administration of Foreign Exchange Settlement of Capital of Foreign-Invested Enterprises, or SAFE Circular 19, effective as of June 1, 2015, as amended by Circular of the State Administration of Foreign Exchange on Reforming and Regulating Policies on the Control over Foreign Exchange Settlement under the Capital Account, or SAFE Circular 16, effective on June 9, 2016, 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 capitals for expenditure beyond their business scopes, and also prohibit FIEs from using such Renminbi fund to provide loans to persons other than affiliates unless otherwise permitted under its business scope. As a result, we are required to apply Renminbi funds converted from the net proceeds we received from this offering within the business scopes of our PRC subsidiaries. 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 subsidiary, or to establish new consolidated VIEs in China, which may adversely affect our business, financial condition and results of operations.

 

Our PRC subsidiary and VIE are subject to restrictions on paying dividends or making other payments to us, which may restrict our ability to satisfy our liquidity requirements, conduct our business and to pay dividends to holders of the ADSs and our ordinary shares.

 

We are a holding company incorporated in the Cayman Islands. We rely on dividends from our PRC subsidiary which in turn relies on consulting and other fees paid by our VIE for our cash and financing requirements, such as the funds necessary to pay dividends and other cash distributions to our shareholders, including holders of our ADSs, and service any debt we may incur. Current PRC regulations permit our PRC subsidiary to pay dividends to us only out of their accumulated after-tax profits upon satisfaction of relevant statutory condition and procedures, if any, determined in accordance with Chinese accounting standards and regulations. In addition, our PRC subsidiary is required to set aside at least 10% of its accumulated profits each year, if any, to fund certain reserve funds until the total amount set aside reaches 50% of its registered capital. Furthermore, if our PRC subsidiary, our VIE and its 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, which may restrict our ability to satisfy our liquidity requirements.

 

In addition, the Enterprise Income Tax Law of the PRC, or the PRC EIT Law, and its implementation rules provide that withholding tax rate of 10% will be applicable to dividends payable by Chinese companies to non-PRC-resident enterprises 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.

 

Fluctuations in exchange rates could have a material 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 is affected by changes in China’s political and economic conditions and China’s foreign exchange policies, among other things. In 2005, the PRC government changed its decades-old policy of pegging the value of the Renminbi to the U.S. dollar, and 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 Renminbi and the U.S. dollar remained within a narrow band. Since June 2010, Renminbi has fluctuated against the U.S. dollar, at times significantly and unpredictably. With the development of the foreign exchange market and progress towards interest rate liberalization and Renminbi internationalization, the PRC government may in the future announce further changes to the exchange rate system and we cannot assure you that Renminbi will not appreciate or depreciate significantly in value against the U.S. dollar in the future. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between Renminbi and the U.S. dollar in the future.

 

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

 

The PRC government imposes controls on the convertibility of the Renminbi into foreign currencies and, in certain cases, the remittance of currency out of China. We receive substantially all of our revenues in Renminbi. Under our current corporate structure, our Cayman Islands holding company may rely on dividend payments from our PRC subsidiary 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 subsidiary 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 subsidiary and consolidated affiliated entities to pay off their respective debt in a currency other than Renminbi owed to entities outside China, or to make other capital expenditure payments outside China in a currency other than Renminbi.

 

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In light of the flood of capital outflows of China in 2016 due to the weakening Renminbi, the PRC government has imposed more restrictive foreign exchange policies and stepped up scrutiny of major outbound capital movement including overseas direct investment. More restrictions and substantial vetting process are put in place by SAFE to regulate cross-border transactions falling under the capital account. If any of our shareholders regulated by such policies fails to satisfy the applicable overseas direct investment filing or approval requirement timely or at all, it may be subject to penalties from the relevant PRC authorities. The PRC government may at its discretion further restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currencies to satisfy our foreign currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs.

 

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

 

Pursuant to SAFE Circular 37, PRC residents who participate in share incentive plans in overseas non-publicly-listed companies may submit applications to SAFE or its local branches for the foreign exchange registration with respect to offshore special purpose companies. In the meantime, our directors, executive officers and other employees who are PRC citizens or who are non-PRC residents residing in the PRC for a continuous period of not less than one year, subject to limited exceptions, and who have been granted incentive share awards by us, may follow the Notices on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly-Listed Company, or 2012 SAFE notices, promulgated by the SAFE in 2012. Pursuant to the 2012 SAFE notices, 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 and may also limit our ability to contribute additional capital into our PRC subsidiary and limit our PRC subsidiary’s ability to distribute dividends to us. We also face regulatory uncertainties that could restrict our ability to adopt additional incentive plans for our directors, executive officers and employees under PRC law.

 

The SAT has issued certain circulars concerning employee share options and restricted shares. Under these circulars, our employees working in China who exercise share options or are granted restricted shares will be subject to PRC individual income tax. Our PRC subsidiary has obligations to file documents related to employee share options or restricted shares with relevant tax authorities and to withhold individual income taxes of those employees who exercise their share options. If our employees fail to pay or we fail to withhold their income taxes according to relevant laws and regulations, we may face sanctions imposed by the tax authorities or other PRC governmental authorities.

 

Our leased property interests may be defective and our right to lease the properties affected by such defects may be challenged, which could adversely affect our business.

 

According to the PRC Land Administration Law, land in urban districts is owned by the state. The owner of a property built on state-owned land must possess the proper land and property title certificate to demonstrate that it is the owner of the premises and that it has the right to enter into lease contracts with the tenants or to authorize a third party to sublease the premises. Some of the landlords of our learning center locations have failed to provide the title certificates to us. Our right to lease the premises may be interrupted or adversely affected if our landlords are not the property owners and the actual property owners should appear.

 

In addition, the title certificate usually records the approved use of the state-owned land by the government and the property owner is obligated to follow the approved use requirement when making use of the property. In the case of failure to utilize the property in accordance with the approved use, the land administration authorities may order the tenant to cease utilizing the premises or even invalidate the contract between the landlord and the tenant. If our use of the leased premises is not in full compliance with the approved use of the land, we may be unable to continue to use the property, which may cause disruption to our business.

 

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Risks Related to the ADSs and This Offering

 

The market price for our ADSs have fluctuated and may be volatile.

 

The trading price of our ADSs have fluctuated since we first listed our ADSs on NADSAQ. The trading price of our ADSs has been volatile and has ranged from US$3.20 to US$29.50 since our ADSs started to trade on NADSAQ on April 1, 2020. The trading price of our ADSs 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, cash flow and data related to our user base or user engagement;

 

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

 

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

 

changes in financial estimates by securities analysts;

 

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

 

additions or departures of key personnel;

 

release of lock-up 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 public offering price is substantially higher than our net tangible book value per share, you will experience immediate and substantial dilution.

 

If you purchase ADSs in this offering, you will pay more for your ADSs than the amount paid by our existing shareholders for their ordinary shares on a per ADS basis. As a result, you will experience immediate and substantial dilution of US$6.86 per ADS, representing the difference between the public offering price of US$8.18 per ADS and our net tangible book value per ADS as of December 31, 2019, after giving effect to the net proceeds to us from this offering. See “Dilution” for a more complete description of how the value of your investment in our ADSs will be diluted upon 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 our 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 our ADSs, the market price for our 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 our ADSs to decline.

 

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The sale or availability for sale of substantial amounts of the 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. As of the date of this prospectus, we had 20,115,570 Class A ordinary shares and 98,333,843 Class B ordinary shares outstanding. 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 lock-up agreements. There will be 12,479,140 ADSs (representing 24,958,280 Class B ordinary shares) outstanding immediately after this offering. In connection with this offering, we and certain of our directors, executive officers, and certain of our existing shareholders have agreed, subject to certain exceptions, not to sell any ordinary shares or ADSs for 90 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.

 

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 limited by shares incorporated under the laws of the Cayman Islands. Our corporate affairs are governed by our memorandum and articles of association, the Companies Law of the Cayman Islands, as amended from time to time, and the common law of the Cayman Islands. The rights of shareholders to take action against the directors, actions by 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 and Wales, 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 has a less developed body of securities laws than the United States. Some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands. In addition, Cayman Islands companies may not have 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 (other than the memorandum and articles of association) or to obtain copies of lists of shareholders of these companies. Our directors have discretion under our second amended and restated memorandum and articles of association we expect to adopt, 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 resolution or to solicit proxies from other shareholders in connection with a proxy contest.

 

As a result of all of the above, our public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of 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 (2020 Revision) 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.”

 

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 and allegations 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. If we were to become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we could have to expend a significant amount of resources to investigate such allegations and/or defend ourselves. While we would strongly defend against any such short seller attacks, we may be constrained in the manner in which we can proceed against the relevant short seller by principles of freedom of speech, applicable state law or issues of commercial confidentiality.

 

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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 our ADSs as a source for any future dividend income.

 

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

 

You may not receive dividends or other distributions on our ordinary shares and you may not receive any value for them, if it is illegal or impractical to make them available to you.

 

The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on ordinary shares or other deposited securities underlying our ADSs, after deducting its fees and expenses. You will receive these distributions in proportion to the number of ordinary shares your ADSs represent. However, the depositary is not responsible if it decides that it is unlawful or impractical to make a distribution available to any holders of ADSs. For example, it would be unlawful to make a distribution to a holder of ADSs if it consists of securities that require registration under the Securities Act but that are not properly registered or distributed under an applicable exemption from registration. The depositary may also determine that it is not feasible to distribute certain property through the mail. Additionally, the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may determine not to distribute such property. We have no obligation to register under U.S. securities laws any ADSs, ordinary shares, rights or other securities received through such distributions. We also have no obligation to take any other action to permit the distribution of ADSs, ordinary shares, rights or anything else to holders of ADSs. This means that you may not receive distributions we make on our ordinary shares or any value for them if it is illegal or impractical for us to make them available to you. These restrictions may cause a material decline in the value of our ADSs.

 

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

 

The deposit agreement governing the ADSs representing our Class B ordinary shares provides that, to the fullest extent permitted by law, ADS holders waive the right to a jury trial for any claim they may have against us or the depositary arising out of or relating to our shares, the ADSs or the deposit agreement, including any claim under the U.S. federal securities laws.

 

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

 

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

 

Nevertheless, if this jury trial waiver is not permitted by applicable law, an action could proceed under the terms of the deposit agreement with a jury trial. No condition, stipulation or provision of the deposit agreement or the ADSs serves as a waiver by any holder or beneficial owner of ADSs or by us or the depositary of compliance with any substantive provision of the U.S. federal securities laws and the rules and regulations promulgated thereunder.

 

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 ordinary shares underlying the ADSs.

 

Holders of ADSs do not have the same rights as our registered shareholders. As a holder of the 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 underlying Class B ordinary shares represented by 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 underlying Class B ordinary shares represented by your ADSs. Upon receipt of your voting instructions, the depositary will try, as far as is practicable, to vote the ordinary shares represented by 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 B ordinary shares represented by your ADSs in accordance with these 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 B ordinary shares unless you withdraw such 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 underlying Class B ordinary shares represented by 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 second amended and restated memorandum and articles of association, for the purposes of determining those shareholders who are entitled receive notice of, to attend or vote at any general meeting, our directors may close our register of members for a stated period not exceeding thirty calendar days and/or fix in advance a record date for determining those shareholder that are entitled to receive notice of, attend or vote at such meeting, and such closure of our register of members or the setting of such a record date may prevent you from withdrawing the underlying Class B ordinary shares represented by 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 use its best endeavors to 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 underlying Class B ordinary shares represented by your ADSs are voted and you may have no legal remedy if the underlying Class B ordinary shares represented by your ADSs are not voted as you requested.

 

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.

 

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

 

Your ADSs are transferable on the books of the depositary. However, the depositary may close its books at any time or from time to time when it deems expedient in connection with the performance of its duties. The depositary may close its books from time to time for a number of reasons, including in connection with corporate events such as a rights offering, during which time the depositary needs to maintain an exact number of ADS holders on its books for a specified period. The depositary may also close its books in emergencies, and on weekends and public holidays. The depositary may refuse to deliver, transfer or register transfers of 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 that 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 in accordance with the terms of the deposit agreement. As a result, you may be unable to transfer your ADSs when you wish to.

 

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

 

We haved adopted the second amended and restated memorandum and articles of association, which contains certain provisions to limit the ability of others to acquire control of our company or cause us to engage in change-of-control transactions, including a provision that grants authority to our board of directors to establish and issue from time to time one or more series of preferred shares without action by our shareholders and to determine, with respect to any series of preferred shares without action by our shareholders and to determine, with respect to any series of preferred shares, the terms and rights of that series. These provisions could have the effect of depriving our shareholders and ADSs holders of the opportunity to sell their shares or ADSs at a premium over the prevailing market price by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transactions.

 

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

 

The M&A Rules requires an overseas special purpose vehicle formed for listing purposes through acquisitions of PRC domestic companies and controlled by PRC companies or individuals to obtain the approval of the China Securities Regulatory Commission, or the CSRC, prior to the listing and trading of such special purpose vehicle’s securities on an overseas stock exchange. The interpretation and application of the regulations remain unclear, and this offering may ultimately require approval from the CSRC. In addition, it is reported that the CSRC intended to propose a pre-approval regime that requires all offshore listings by China-based companies with variable interest entity structures, such as ours, that operate in industry sectors subject to foreign investment restrictions to obtain CSRC’s approval. 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.

 

Our PRC counsel, Jingtian & Gongcheng Law Firm, has advised us based on their understanding of the current PRC law, rules and regulations that the CSRC’s approval is not required for the listing and trading of our ADSs on Nasdaq in the context of this offering, given that:

 

the CSRC currently has not issued any definitive rule or interpretation concerning whether offerings like ours under this prospectus are subject to this regulation; and

 

no provision in this regulation clearly classifies contractual arrangements as a type of transaction subject to its regulation.

 

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

 

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You must rely on the judgment of our management as to the use of the net proceeds from this offering, and such use may not produce income or increase our ADS price.

 

Our management will have considerable discretion in the application of the net proceeds received by us. You will not have the opportunity, as part of your investment decision, to assess whether proceeds are being used appropriately. The net proceeds may be used for corporate purposes that do not improve our efforts to achieve or maintain profitability or increase our ADS price. The net proceeds from this offering may be placed in investments that do not produce income or that lose value.

 

We are an emerging growth company and 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 various 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 Sarbanes-Oxley Act of 2002 for so long as we are 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.

 

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. We plan to take advantage of such exemptions afforded to an emerging growth company. As a result, our operating results and financial statements may not be comparable to the operating results and financial statements of other companies who have adopted the new or revised accounting standards.

 

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 Nasdaq corporate governance listing standards. These practices may afford less protection to shareholders than they would enjoy if we complied fully with Nasdaq corporate governance listing standards.

 

As an exempted company incorporated in the Cayman Islands that is listed on Nasdaq, we are subject to Nasdaq corporate governance listing standards. However, Nasdaq 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 Nasdaq corporate governance listing standards. Currently, we do not plan to rely on home country practice with respect to our corporate governance after we complete this offering. However, if we choose to follow home country practice in the future, our shareholders may be afforded less protection than they otherwise would enjoy under Nasdaq corporate governance listing standards applicable to U.S. domestic issuers.

 

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

 

We are a “controlled company” within the meaning of the rules of the Nasdaq Stock Market and, as a result, can rely on exemptions from certain corporate governance requirements that provide protection to shareholders of other companies.

 

We are a “controlled company” within the meaning of the Nasdaq Stock Market corporate governance rules because Jie Zhao, our Chairman, beneficially owns more than 50% of the total voting power of our outstanding ordinary shares. For so long as we remain a controlled company under that definition, we are permitted to elect to rely, and may rely, on certain exemptions from corporate governance rules, including an exemption from the rule that a majority of our board of directors must be independent directors or that we have to establish a nominating committee and a compensation committee composed entirely of independent directors. As a result, you will not have the same protection afforded to shareholders of companies that are subject to these corporate governance requirements.

 

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Our Chairman controls, and will control, following the completion of this offering, more than 50% of the total voting power of our outstanding ordinary shares and thus his interest may differ from other shareholders and holders of our ADSs, as he will be able to exert significant control over certain actions requiring a shareholder vote.

 

Jie Zhao, our Chairman, controls, and will control, following the completion of this offering, more than 50% of the total voting power of our outstanding ordinary shares. Consequently, he will be able to exert significant control over certain actions requiring a shareholder vote. As our majority shareholder, Mr. Zhao is able to elect our board of directors, and determine the outcome of all matters requiring the approval of the holders of a majority of our outstanding shares, including the sale of our assets or an acquisition of assets. This concentration of ownership in our shares by Mr. Zhao limits your ability to influence corporate matters and may have the effect of delaying or preventing a third party from acquiring control over us. Consequently, his interest in such matters may differ from the interest of other shareholders and holders of our ADSs.

 

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 Nasdaq, impose various requirements on the corporate governance practices of public companies. We expect these rules and regulations to increase our legal and financial compliance costs and to make some corporate activities more time-consuming and costly. We expect to incur significant expenses and devote substantial management effort toward ensuring compliance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 and the other rules and regulations of the SEC. 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.

 

In the past, shareholders of a public company often brought securities class action suits against the company following periods of instability in the market price of that company’s 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, which could harm our results of operations and require us to incur significant expenses to defend the suit. 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.

 

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 ordinary shares.

 

In general, a non-U.S. corporation is a PFIC 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, directly or indirectly, 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. Passive income generally includes dividends, interest, rents, royalties and certain gains. Cash is a passive asset for these purposes. Goodwill is generally characterized as active or passive asset based on the nature of the income produced in the activity to which the goodwill is attributable. 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 the 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 subsidiaries, our VIE and the shareholders of our VIE will be treated for purposes of the PFIC rules. In addition, the extent to which our goodwill should be characterized as an active asset is not entirely clear. Furthermore, we will hold a substantial amount of cash following this offering and our PFIC status for any taxable year 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, which could be volatile). Accordingly, 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. taxpayer holds ADSs or ordinary shares, the U.S. taxpayer generally will be subject to adverse U.S. federal income tax consequences, including increased tax liability on disposition gains and “excess distributions” and additional reporting requirements. See “Taxation—U.S. Federal Income Taxation—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:

 

general economic, political, demographic and business conditions globally and in China;

 

fluctuations in inflation and exchange rates in China;

 

our ability to implement our growth strategy;

 

our ability to retain, grow and engage our user base and expand our product offering;

 

changes in consumer tastes and preferences;

 

the availability of qualified personnel and the ability to retain such personnel;

 

changes in content-related costs and other operating costs;

 

changes in government regulation and tax matters;

 

other factors that may affect our business, financial condition and results of operations; and

 

other risk factors discussed under “Risk Factors.”

 

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.

 

This prospectus also contains statistical data and estimates that we obtained from industry publications and reports generated by third-party providers of market intelligence. These industry publications and reports generally indicate that the information contained therein was obtained from sources believed to be reliable, but do not guarantee the accuracy and completeness of such information. Although we believe that the publications and reports are reliable, we have not independently verified the data.

 

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USE OF PROCEEDS

 

We expect to receive net proceeds of approximately US$57.7 million in the aggregate from this offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

 

We plan to use (i) approximately 40% of the net proceeds for operating expenses and the research and development of the application of holographic AR technologies in the semiconductor industry, (ii) approximately 40% of the net proceeds for strategic acquisitions and investments in complementary business, and (iii) approximately 20% of the net proceeds for other general corporate purposes, including working capital, operating expenses, and capital expenditures.

 

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 subsidiary only through loans or capital contributions, and to our VIE only through loans, and only if we satisfy the applicable government registration and approval requirements. The relevant filing and registration processes for capital contributions typically take approximately eight weeks to complete. The filing and registration processes for loans typically take approximately four weeks or longer to complete. While we currently see no material obstacles to completing the filing and registration procedures with respect to future capital contributions and loans to our PRC subsidiary or our VIE, we cannot assure you that we will be able to complete these filings and registrations on a timely basis, or at all. 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 or prevent us from using the proceeds of this offering to make loans or make additional capital contributions to our PRC subsidiaries, which could materially and adversely affect our liquidity and our ability to fund and expand our business.” Additionally, while there is no statutory limit on the amount of capital contribution that we can make to our PRC subsidiaries, loans provided to our PRC subsidiaries and consolidated VIEs in the PRC are subject to certain statutory limits. For example, the maximum amount of the loans that WiMi WFOE may acquire from outside China was (i) approximately RMB 698 million (USD 100 million) under the total investment minus registered capital approach as of December 31, 2019; or (ii) approximately RMB 296 million (USD 42.4 million) under the net asset approach as of December 31, 2019. “PRC Regulation—Loans by Foreign Companies to their PRC Subsidiaries.”

 

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 declared and currently have no plan to declare or pay any dividends in the near future on our shares or ADSs, as 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 subsidiary for our cash requirements, including any payment of dividends to our shareholders. PRC regulations may restrict the ability of our PRC subsidiary to pay dividends to us. See “Risk Factors—Risks Related to Doing Business in China—Governmental control of currency conversion may limit our ability to utilize our revenues effectively and affect the value of your investment.”

 

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 underlying Class B ordinary shares represented by the ADSs to the depositary, as the registered holder of such Class B ordinary shares, and the depositary then will pay such amounts to the ADS holders in proportion to the underlying Class B ordinary shares represented by the ADSs held by such ADS holders, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares.”

 

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CAPITALIZATION

 

The following table sets forth our capitalization as of December 31, 2019:

 

on an actual basis;

 

on a pro forma basis to reflect the automatic conversion of 8,611,133 of our issued and outstanding Series A preferred shares into 8,611,133 Class B ordinary shares on a one-for-one basis and the issuance and sale of 9,500,000 Class B ordinary shares in the form of ADSs in connection with our initial public offering which closed in April 2020 and the exercise of over-allotment option of 338,280 Class B ordinary shares in the form of 169,140 ADSs;

 

and on a pro forma as adjusted basis to reflect (i)  the automatic conversion of 8,611,133 of our issued and outstanding Series A preferred shares into 8,611,133 Class B ordinary shares and the issuance and sale of 9,500,000 Class B ordinary shares in the form of ADSs in connection with our initial public offering which closed in April 2020 and the exercise of over-allotment option of 338,280 Class B ordinary shares in the form of 169,140 ADSs; and (ii) the issuance and sale of 15,120,000 Class B ordinary shares in the form of ADSs by us in this offering, at the public offering price of US$8.18 per ADS, resulting in the net proceeds of US$57.7 million, after deducting estimated underwriting discounts and commissions and estimated issuance expenses.

 

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, 2019 
   Actual   Pro Forma   Pro Forma as
Adjusted(1)
 
   RMB   US$   RMB   US$   RMB   US$ 
   (in thousands) 
Equity:                        
Series A convertible preferred shares, USD 0.0001 par value, 12,916,700 shares authorized, 8,611,133 shares issued and outstanding, actual, and 0 shares outstanding, pro forma and pro forma as adjusted   6    1    -    -    -    - 
Class A ordinary shares, USD 0.0001 par value, 20,115,570 shares authorized, 20,115,570 shares issued and
outstanding
   13    2    13    2    13    2 
Class B ordinary shares, USD 0.0001 par value, 466,967,730 shares authorized, 79,884,430 shares issued and outstanding, actual, 98,333,843 shares outstanding, pro forma, and 113,453,843 shares outstanding, pro forma as adjusted   52    8    65    10    75    11 
Additional paid-in capital   168,167    24,106    335,331    48,060    737,892    105,747 
Retained earnings   229,178    32,851    229,178    32,851    229,178    32,851 
Statutory reserves   22,201    3,182    22,201    3,182    22,201    3,182 
Accumulated other comprehensive income   3,098    444    3,098    444    3,098    444 
Total shareholders’ equity   422,715    60,594    589,886    84,549    992,457    142,237 

 

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DILUTION

 

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

 

Our net tangible book value as of December 31, 2019 was approximately US$0.06 per ordinary share and US$0.12 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. Pro forma net tangible book value per ordinary share is calculated after giving effect to the automatic conversion of all of our issued and outstanding convertible Series A preferred shares and issuance and sale of 9,500,000 Class B ordinary shares in the form of ADSs in connection with our initial public offering in April 2020 and the exercise of the over-allotment option of 338,280 Class B ordinary shares in the form of 169,140 ADSs. Our pro forma net tangible book value as of December 31, 2019 was US$30.1 million, or US$0.25 per share of our common stock. Pro forma net tangible book value per share represents pro forma net tangible book value divided by the total number of shares outstanding as of December 31, 2019, after giving effect to the pro forma adjustments described above. Dilution is determined by subtracting net tangible book value per ordinary share from the public offering price per ordinary share.

 

Without taking into account any other changes in such net tangible book value after December 31, 2019, other than to give effect to (i) the automatic conversion of all our issued and outstanding convetible Series A preferred shares and the issuance and sale of 9,500,000 Class B ordinary shares in the form of ADS in connection with our initial public offering in April 2020 and the exercise of the over-allotment option of 338,280 Class B ordinary shares in the form of 169,140 ADSs; and (ii) our issuance and sale of 7,560,000 ADSs offered in this offering at the offering price of US$8.18 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 December 31, 2019 would have been approximately US$87.8 million, or US$0.66 per ordinary share and US$1.32 per ADS to existing shareholders and an immediate dilution in net tangible book value of US$3.43 per ordinary share, or US$6.86 per ADS, to purchasers of ADSs in this offering.

 

The following table illustrates the dilution at the public offering price per ordinary share is US$ and all ADSs are exchanged for ordinary shares.

 

Public offering price per ordinary share  US$ 4.09
Net tangible book value per ordinary share  US$ 0.06
Pro forma net tangible book value per ordinary share as adjusted to give effect to this offering  US$ 0.66
Amount of dilution in net tangible book value per ordinary share to new investors in this offering  US$ 3.43
Amount of dilution in net tangible book value per ADS to new investors in this offering  US$ 6.86

 

The following table summarizes, on a pro forma basis as of December 31, 2019, 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 public offering price of US$8.18 per ADS, before deducting estimated underwriting discounts and commissions and estimated offering expenses.

 

   Ordinary Shares
Purchased
   Total Consideration   Average Price
Per Ordinary
   Average Price 
   Number   Percent   Amount   Percent   Share   Per ADS 
                   US$   US$ 
Existing shareholders   118,449,413    88.7%   51,171,945    45.3%   0.43    0.86 
New investors from public offering   15,120,000    11.3%   61,840,800    54.7%   4.09    8.18 
Total   133,569,413    100.0%   113,012,745    100.0%          

 

As of the date of this prospectus, we have not granted any share-based awards to our employees, directors, officers and consultants, and there are 17,500,000 Class B ordinary shares available for future issuance upon the grant of share-based awards under our 2020 Equity incentive plan. To the extent that any of awards are granted or exercised, there will be further dilution to new investors.

 

52

 

 

ENFORCEABILITY OF CIVIL LIABILITIES

 

Cayman Islands

 

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.

 

Substantially all of our operations are conducted in China, and substantially all of our assets are located in China. A majority of our directors and executive 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 Puglisi & Associates 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, has advised us that there is uncertainty as to whether the courts of the Cayman Islands would:

 

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

 

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

 

Maples and Calder (Hong Kong) LLP has informed us that although there is no statutory enforcement in the Cayman Islands of judgments obtained in the federal or state courts of the United States (and the Cayman Islands are not a party to any treaties for the reciprocal enforcement or recognition of such judgments), the courts of the Cayman Islands will, at common law, recognize and enforce a foreign money judgment of a foreign court of competent jurisdiction without any re-examination of the merits of the underlying dispute based on the principle that a judgment of a competent foreign court imposes upon the judgment debtor an obligation to pay the liquidated sum for which such judgment has been given, provided such judgment (i) is final and conclusive, (ii) is not in respect of taxes, a fine or a penalty; and (iii) was not obtained in a manner and is not of a kind the enforcement of which is contrary to natural justice or the public policy of the Cayman Islands. However, the Cayman Islands courts are unlikely to enforce a judgment obtained from the U.S. courts under civil liability provisions of the U.S. federal securities law if such judgment is determined by the courts of the Cayman Islands to give rise to obligations to make payments that are penal or punitive in nature. A Cayman Islands court may stay enforcement proceedings if concurrent proceedings are being brought elsewhere.

 

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PRC

 

Jingtian & Gongcheng Law Firm, our PRC legal counsel, has advised us that there is uncertainty as to whether the courts of China would:

 

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

 

entertain original actions brought in each respective jurisdiction against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States.

 

Jingtian & Gongcheng 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. Under the PRC Civil Procedures Law, foreign shareholders may originate actions based on PRC law against us in the PRC, if they can establish sufficient nexus to the PRC for a PRC court to have jurisdiction, and meet other procedural requirements, including, among others, the plaintiff must have a direct interest in the case, and there must be a concrete claim, a factual basis and a cause for the suit. However, it would be difficult for foreign shareholders to establish sufficient nexus to the PRC by virtue only of holding the ADSs or our ordinary shares.

 

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CORPORATE HISTORY AND STRUCTURE

 

Our Corporate History

 

We commenced our commercial operations in May 2015 through Beijing WiMi (previously under the name “WiMi Lightspeed Capital Investment Management (Beijing) Co., Ltd.”). In February 2016, Beijing WiMi formed a wholly-owned subsidiary, Micro Beauty Lightspeed Investment Management HK Limited in Hong Kong. In addition, Beijing WiMi acquired 100% equity interest in Shenzhen Yidian on October 21, 2015, Shenzhen Yitian on August 20, 2015 and Shenzhen Kuxuanyou on August 26, 2015.

 

We incorporated WiMi Cayman under the laws of the Cayman Islands as our offshore holding company in August 2018 to facilitate offshore financing. In September 2018, we established WiMi HK, our wholly-owned Hong Kong subsidiary, and WiMi HK established a wholly-owned PRC subsidiary, Hologram WiMi.

 

On April 1, 2020, our ADSs commenced trading on NASDAQ under the symbol “WIMI”.

 

Due to restrictions imposed by PRC laws and regulations on foreign ownership of companies that engage in internet and other related business, Hologram WiMi later entered into a series of contractual arrangements with Beijing WiMi, or our VIE, and its shareholders. We depend on these contractual arrangements with our VIE, in which we have no ownership interests, and its shareholders to conduct most aspects of our operations. We have relied and expect to continue to rely on these contractual arrangements to conduct our business in China. For more details, see “—Contractual Arrangements with Our VIE and Its Shareholders.” The shareholders of our VIE may have potential conflicts of interest with us. See “Risk Factors—Risks Related to Our Corporate Structure—Our shareholders or the shareholders of our VIE may have potential conflicts of interest with us, which may materially and adversely affect our business.”

 

Under PRC laws and regulations, our PRC subsidiary may pay cash dividends to us out of its respective accumulated profits. However, the ability of our PRC subsidiary to make such distribution to us is subject to various PRC laws and regulations, including the requirement to fund certain statutory funds, as well as potential restriction on currency exchange and capital controls imposed by the PRC government. For more details, see “Risk Factors—Risks Related to Doing Business in China—Our PRC subsidiary and VIE are subject to restrictions on paying dividends or making other payments to us, which may restrict our ability to satisfy our liquidity requirements, conduct our business and to pay dividends to holders of the ADSs and our ordinary shares” and “PRC Regulation—Regulation on Dividend Distributions.”

 

As a result of our direct ownership in WiMi WFOE and the variable interest entity contractual arrangements, we are regarded as the primary beneficiary of our VIE. We treat it and its subsidiaries as our consolidated affiliated entities under U.S. GAAP, and have consolidated the financial results of these entities in our consolidated financial statements in accordance with U.S. GAAP.

 

Recent Share Issuances

 

In the last quarter of 2018, in connection with the reorganization of our company, we issued a total of 20,115,570 Class A ordinary shares to our Chairman for an aggregate consideration of approximately US$2,011.56 and a total of 79,885,430 Class B ordinary shares to the equity holders of Beijing WiMi for an aggregate consideration of approximately US$7,988.54, in each case under Regulation S under the Securities Act of 1933.

 

In November 2018, we issued a total of 8,611,133 Series A preferred shares to two investors for an aggregate consideration of approximately RMB 137 million (US$20 million), in each case under Regulation S under the Securities Act of 1933.

 

In April 2020, at the closing of our initial public offering, we issued and sold a total of 9,500,000 Class B ordinary shares in the form of 4,750,000 ADSs at the public offering price of US$5.50 per ADS. In May 2020, we issued and sold an additional 338,280 Class B ordinary shares in the form of 169,140 ADSs at the public offering price of US$5.50 per ADS, in connection with the underwriters' partial exercise of their option to purchase additional ADSs.

 

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Corporate Structure

 

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

 

 

The Principal shareholders of Beijing Wimi are Jie Zhao and Minwen Wu. Jie Zhao, our Chairman, beneficially owns 100% of our outstanding Class A ordinary shares, 40.5% of our outstanding Class B ordinary shares immediately after this offering, and 82.05% of the outstanding capital stock of Beijing Wimi. Minwen Wu, the controlling person of Sensefuture Holdings Limited and Sensebright Holdings Limited, beneficially owns approximately 9.9% of our issued and outstanding Class B ordinary shares, immediately after this offering, and 11.32% of the outstanding capital stock of Beijing Wimi.

 

Contractual Arrangements with Our VIE and Its Respective Shareholders

 

Currently, substantially all of our users and business operations are located in the PRC and our primary focus is the PRC hologram market, which we believe possesses tremendous growth potential and attractive monetization opportunities. In addition, we plan to grow our presence in international markets and become a global holographic enterprise. We believe that our hologram technology is applicable to global markets and anticipates expanding our business to new markets.

 

Current PRC laws and regulations impose certain restrictions or prohibitions on foreign ownership of companies that engage in value-added telecommunication services, internet audio-video program services and certain other businesses. The Special Administrative Measures for Entrance of Foreign Investment (Negative List) (2018 Version) provides that foreign investors are generally not allowed to own more than 50% of the equity interests in a value-added telecommunication service provider other than an e-commerce service provider, and the Provisions on the Administration of Foreign-Invested Telecommunications Enterprises (2016 Revision) require that the major foreign investor in a value-added telecommunication service provider in China must have experience in providing value-added telecommunications services overseas and maintain a good track record. In addition, foreign investors are prohibited from investing in companies engaged in certain online and culture related businesses. See “Risk Factors—Risks Related to Our Corporate Structure—We are subject to changing law and regulations regarding regulatory matters, corporate governance and public disclosure that have increased both our costs and the risk of non-compliance” and “PRC Regulation—Regulations on Foreign Direct Investment in Value Added Telecommunications Companies.” We are a company incorporated in the Cayman Islands. Hologram WiMi, our PRC subsidiary, is considered foreign-invested enterprises. To comply with the foregoing PRC laws and regulations, we primarily conduct our business in China through Beijing WiMi, our VIE and its subsidiaries in the PRC, based on a series of contractual arrangements. As a result of these contractual arrangements, we exert effective control over our VIE and its subsidiaries, and consolidate their operating results in our consolidated financial statements under GAAP. These contractual arrangements may not be as effective as direct ownership in providing us with control over our VIE. If our VIE or its respective shareholders fail to perform their respective obligations under the contractual arrangements, we could be limited in our ability to enforce the contractual arrangements that give us effective control over our business operations in the PRC and 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 details of these and other risks associated with our VIE structure, see “Risk Factors—Risks Related to Our Corporate Structure.”

 

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On November 6, 2018, WiMi Cayman completed a reorganization of entities under common control of its shareholders, who collectively owned all of the equity interests of WiMi Cayman prior to the reorganization. WiMi Cayman, and WiMi HK were established as the holding companies of Hologram WiMi. Hologram WiMi is the primary beneficiary of Beijing WiMi and its subsidiaries. All of the direct and indirect subsidiaries of WiMi Cayman are under common control. Consequently, the consolidation of Beijing WiMi and its subsidiaries has been accounted for as a reorganization of entities under common control at carrying value. The consolidated financial statements are prepared on the basis as if the reorganization became effective as of the beginning of the first period presented in the accompanying consolidated financial statements of WiMi Cayman.

 

Contractual Arrangements with Our VIE and Its Shareholders

 

The following is a summary of the currently effective contractual arrangements by and among our wholly-owned subsidiary, Hologram WiMi, our VIE and its shareholders. These contractual arrangements enable us to (i) exercise effective control over our VIE; (ii) receive substantially all of the economic benefits of our VIE; (iii) have an exclusive option to purchase the equity interests in our VIE, and (iv) have an exclusive option to purchase all or part of the assets of our VIE when and to the extent permitted by PRC law.

 

Agreements that provide us effective control over our VIE

 

Power of Attorney. Pursuant to the power of attorney dated November 6, 2018, by Hologram WiMi and each shareholder of Beijing WiMi, respectively, each shareholder of Beijing WiMi irrevocably authorized Hologram WiMi or any person(s) designated by Hologram WiMi to exercise such shareholder’s voting rights in Beijing WiMi, including, without limitation, the power to participate in and vote at shareholder’s meetings, the power to nominate directors and appoint senior management, the power to sell or transfer such shareholder’s equity interest in Beijing WiMi, and other shareholders’ voting rights permitted by PRC law and the Articles of Association of Beijing WiMi. The power of attorney remains irrevocable and continuously valid from the date of execution so long as each shareholder remains as a shareholder of Beijing WiMi.

 

Equity Interest Pledge Agreement. Pursuant to the equity interest pledge agreement dated November 6, 2018, by and among Hologram WiMi, Beijing WiMi and the shareholders of Beijing WiMi, the shareholders of Beijing WiMi pledged all of their equity interests in Beijing WiMi to Hologram WiMi to guarantee their and Beijing WiMi’s obligations under the contractual arrangements including the exclusive consulting and services agreement, the exclusive option agreement, the exclusive asset purchase agreement and the power of attorney and this equity interest pledge agreement, as well as any loss incurred due to events of default defined therein and all expenses incurred by Hologram WiMi in enforcing such obligations of Beijing WiMi or its shareholders. The shareholders of Beijing WiMi agree that, without Hologram WiMi’s prior written approval, during the term of the equity interest pledge agreement, they will not dispose of the pledged equity interests or create or allow any other encumbrance on the pledged equity interests. We have completed the registration of the equity pledges with the relevant office of SAIC in accordance with the PRC Property Rights Law.

 

Spousal Consent Letters. Pursuant to these letters, the spouses of the applicable shareholders of Beijing WiMi unconditionally and irrevocably agreed that the equity interest in Beijing WiMi held by them and registered in their names will be disposed of pursuant to the equity interest pledge agreement, the exclusive option agreement, the exclusive asset purchase agreement and the power of attorney. Each of their spouses agreed not to assert any rights over the equity interest in Beijing WiMi held by their respective spouses. In addition, in the event that any spouse obtains any equity interest in Beijing WiMi held by his or her spouse for any reason, he or she agreed to be bound by the contractual arrangements.

 

Agreements that allow us to receive economic benefits from our VIE

 

Exclusive Business Cooperation Agreement. Under the exclusive business cooperation agreement between Hologram WiMi and Beijing WiMi, dated November 6, 2018, Hologram WiMi has the exclusive right to provide to Beijing WiMi consulting and services related to, among other things, use of software, operation maintenance, product development, and management and marketing consulting. Hologram WiMi has the exclusive ownership of intellectual property rights created as a result of the performance of this agreement. Beijing WiMi agrees to pay Hologram WiMi service fee at an amount equal to the consolidated profit minus the loss (if any). This agreement will remain effective till the date when it is terminated by WiMi WFOE.

 

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

 

Exclusive Share Purchase Option Agreement. Pursuant to the exclusive share purchase option agreement dated November 6, 2018, by and among Hologram WiMi, Beijing WiMi and each of the shareholders of Beijing WiMi, each of the shareholders of Beijing WiMi irrevocably granted Hologram WiMi an exclusive call option to purchase, or have its designated person(s) to purchase, at its discretion, all or part of their equity interests in Beijing WiMi, and the purchase price shall be the lowest price permitted by applicable PRC law. Each of the shareholders of Beijing WiMi undertakes that, without the prior written consent of Hologram WiMi or us, they may not increase or decrease the registered capital, amend its articles of association or change registered capital structure. This agreement will remain effective for ten years and can be renewed at Hologram WiMi’s sole discretion. Any transfer of shares pursuant to this agreement would be subject to PRC regulations and to any changes required thereunder.

 

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Agreements that provide us with the option to purchase the assets in our VIE

 

Exclusive Asset Purchase Agreement. Pursuant to the exclusive asset purchase agreement dated November 6, 2018 by Hologram WiMi and Beijing WiMi, Beijing WiMi irrevocably granted Hologram WiMi an exclusive call option to purchase, or have its designated person(s) to purchase, at its discretion, all or part of Beijing WiMi’s current or future assets (including intellectual property rights), and the purchase price shall be the lowest price permitted by applicable PRC law. Beijing WiMi undertakes that, without the prior written consent of Hologram WiMi, it may not sell, transfer, pledge, dispose of its assets, incur any debts or guarantee liabilities. It will notify Hologram WiMi any potential litigation, arbitration or administrative procedures regarding the assets, and defend the assets if necessary. This agreement will remain effective for ten years and can be renewed at Hologram WiMi’s sole discretion. Any transfer of assets pursuant to this agreement would be subject to PRC regulations and to any changes required thereunder.

 

In the opinion of Jingtian & Gongcheng Law Firm, our PRC legal counsel:

 

the ownership structures of Hologram WiMi and Beijing WiMi, both currently and immediately after giving effect to this offering, are not in any violation of PRC laws or regulations currently in effect; and

 

the contractual arrangements among Hologram WiMi and Beijing WiMi and its shareholders governed by PRC law both currently and immediately after giving effect to this offering are legal, valid, binding and enforceable in accordance with its terms and applicable PRC laws, and do not and will not result in any violation of PRC laws or regulations currently in effect.

 

However, we have been further advised by our PRC legal counsel that there are substantial uncertainties regarding the interpretation and application of current and future PRC laws, regulations and rules. If the PRC government finds that the agreements that establish the structure for operating our hologram business do not comply with PRC government restrictions on foreign investment in our businesses, we could be subject to severe penalties including being prohibited from continuing operations. See “Risk Factors—Risks Related to Our Corporate Structure—If the PRC government finds that the agreements that establish the structure for operating our businesses in China do not comply with PRC regulations relating to the relevant industries, or if these regulations or their interpretation change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations.”

 

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SELECTED CONSOLIDATED FINANCIAL DATA

 

The following selected consolidated statement of income and comprehensive income data for the years ended December 31, 2017, 2018 and 2019, selected consolidated balance sheet data as of December 31, 2018 and 2019, and selected consolidated cash flow data for the years ended December 31, 2017, 2018 and 2019 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. Our selected consolidated balance sheet data as of December 31, 2017 has been derived from our audited consolidated financial statements not included in this prospectus. The consolidated financial statements are prepared in accordance with U.S. GAAP. Our historical results are not necessarily indicative of the results that may be expected in the future. The following summary consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements included elsewhere in this prospectus.

 

Selected Consolidated Statements of Income and  For the Years Ended December 31, 
Comprehensive Income:  2017   2018   2019   2019 
   RMB   RMB   RMB   USD 
                 
Operating revenues   192,029,524    225,271,564    319,181,424    45,752,906 
Cost of revenues   (79,180,187)   (85,414,061)   (146,167,843)   (20,952,358)
Gross profit   112,849,337    139,857,503    173,013,581    24,800,548 
Operating expenses   (35,550,993)   (39,054,908)   (60,162,041)   (8,623,899)
Income from operations   77,298,344    100,802,595    112,851,540    16,176,649 
Other expenses, net   (3,432,362)   (3,509,207)   (7,517,988)   (1,077,663)
Provision for income taxes   (528,011)   (8,075,596)   (3,129,080)   (448,536)
Net income   73,337,971    89,217,792    102,204,472    14,650,450 
Other comprehensive income (loss)   (250,623)   1,759,288    1,589,076    227,785 
Comprehensive income   73,087,348    90,977,080    103,793,548    14,878,235 
WEIGHTED AVERAGE NUMBER OF ORDINARY SHARES                    
Basic   100,000,000    100,000,000    100,000,000    100,000,000 
Diluted   100,000,000    100,922,621    108,611,133    108,611,133 
EARNINGS PER SHARE                    
Basic   0.73    0.89    1.02    0.15 
Diluted   0.73    0.88    0.94    0.13 

 

The following table presents our selected consolidated balance sheet as of December 31, 2017, 2018 and 2019.

 

   As of December 31, 
Selected Consolidated Balance Sheet Data:  2017   2018   2019   2019 
   RMB   RMB   RMB   USD 
Current assets   52,030,035    213,295,430    177,511,440    25,445,291 
Other assets   405,451,567    394,187,996    385,987,073    55,329,130 
Total assets   457,481,602    607,483,426    563,498,513    80,774,421 
Total liabilities   367,275,213    288,561,957    140,783,496    20,180,542 
Total shareholders’ equity   90,206,389    318,921,469    422,715,017    60,593,879 

 

The following table presents our selected consolidated cash flow data for the years indicated.

 

   For the Years Ended December 31 
Selected Consolidated Cash Flow Data:  2017   2018   2019   2019 
   RMB   RMB   RMB   USD 
Net cash provided by operating activities   108,057,941    99,452,205    143,955,544    20,635,238 
Net cash used in investing activities   (118,364,263)   (98,597,356)   (126,479,892)   (18,130,198)
Net cash (used in) provided by financing activities   (3,800,000)   137,493,993    (40,974,000)   (5,873,398)
Effect of exchange rate change on cash and cash equivalents   (234,124)   937,466    599,384    85,917 
Net change in cash and cash equivalents   (14,340,446)   139,286,308    (22,898,964)   (3,282,441)
Cash and cash equivalents, beginning of year   27,002,080    12,661,634    151,947,942    21,780,904 
Cash and cash equivalents, end of year   12,661,634    151,947,942    129,048,978    18,498,463 

 

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

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this prospectus. This discussion and analysis and other parts of this prospectus contain forward-looking statements based upon current beliefs, plans and expectations that involve risks, uncertainties and assumptions. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those set forth under “Risk Factors” and elsewhere in this prospectus. You should carefully read the “Risk Factors” section of this prospectus to gain an understanding of the important factors that could cause actual results to differ materially from our forward-looking statements.

 

Overview

 

We were the largest holographic AR application platform in China, in terms of the total revenues in 2018, according to Frost & Sullivan. By leveraging our strong technological capabilities and infrastructure, we are able to deliver superior products and services and conduct our operations in a highly efficient manner. We offer AR-based holographic services and products to cater to our customers’ needs, all centered upon providing an innovative, immersive and interactive holographic AR experience for our customers and end users. Our offerings primarily consist of holographic AR advertising services and holographic AR entertainment products. Approximately 69.3%, 80.5%, and 83.8% of our revenues were generated from our holographic AR advertising services for the years ended December 31, 2017, 2018, and 2019, respectively. Approximately 30.7%, 19.5%, and 16.2% of our revenues were generated from our holographic AR entertainment products for the years ended December 31, 2017, 2018, and 2019, respectively. The core of our business is holographic AR technologies used in software engineering, content production, cloud and big data. By leveraging our strong technological capabilities and infrastructure, we are able to deliver superior products and services and conduct our operations in a highly efficient manner.

 

We have grown rapidly since our inception. We generate revenues primarily from holographic AR advertising services and holographic AR entertainment products. Our total revenues increased by RMB 33,242,040, or 17.3%, from RMB 192,029,524 for the year ended December 31, 2017 to RMB 225,271,564 for the year ended December 31, 2018, and further increased by RMB 93,909,860, or 41.7%, to RMB 319,181,424 for the year ended December 31, 2019. Our net income increased by RMB 15,879,821, or 21.7%, from RMB 73,337,971 for the year ended December 31, 2017, to RMB 89,217,792 for the year ended December 31, 2018, and further increased by RMB 12,986,680, or 14.6%, to RMB 102,204,472 for the year ended December 31, 2019.

 

We expect that our revenues would grow at a slower rate in the first quarter of 2020, as our business, financial condition, and results of operations may be adversely affected by the outbreak of COVID-19. For a detailed description of the risks associated with COVID-19, see Recent Developments and “Risk Factors—Risks Related to Our Business and industry—Our business could be materially harmed by the ongoing conronavirus (COVID-19) pandemic.” Due to the significant uncertainties surrounding the outbreak of COVID-19, the extent of the business disruption and the related financial impacts on our business cannot be reasonably estimated at this time.

 

Key Factors that Affect Operating Results

 

Our results of operations are affected by the factors discussed below. 

 

Our ability to increase number of customers and average revenue for AR advertising services

 

Approximately 69.3%, 80.5%, and 83.8% of our revenues were generated by our AR advertising services for the years ended December 31, 2017, 2018, and 2019, respectively. The number of our customers for our AR advertising services increased from 97 for the year ended December 31, 2017, to 121 for the year ended December 31, 2018, and further increased to 153 for the year ended December 31, 2019. In addition, average revenue per customer for AR advertising services was approximately RMB 1.4 million, RMB 1.5 million, and RMB1.7 million for the years ended December 31, 2017, 2018 and 2019, respectively. Our ability to increase our revenues and our profitability will depend on our ability to continue to increase our customer base and revenue per customer for our AR advertising services. To achieve this, we strive to increase our marketing efforts and to enhance the quality and capabilities of our technologies.

 

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Investment in technology and talent

 

We believe that a core element of the competitiveness of the holographic AR industry is research and development related to technology development. The advancement of technology related to holographic AR will take the holographic AR experience, new services, products and capabilities, to newer stages of development. To retain and attract existing and potential customers, we must continue to innovate to keep pace with the growth of our business and bring forward cutting-edge technologies. Our current research and development efforts are primarily focused on enhancing our artificial intelligence technology, holographic AR and image processing technology, intelligent hardware technology, and photosensitive signal transmission technology to create novel service and product offerings.

 

China’s per capita expenditure on education, culture and recreation

 

According to Frost & Sullivan, China's per capita expenditure on education, culture and recreation rose at a CAGR of 9.7% from RMB1,536 in 2014 to RMB2,226 in 2018. Our business and results of operations are affected by a number of general factors affecting China’s holographic AR industry, which include the per capita expenditure on education, culture and recreation in China. According to Frost & Sullivan, China's per capita expenditure on education, culture and recreation is predicted to reach RMB3,300 in 2023, representing a CAGR of 8.2% from 2018 to 2023 The increase in expenditure on education, culture and recreation boosts the growth of relevant markets, such as entertainment market and consuming electronic device market, which in turn will increase the market demand of our services and products.

 

Our ability to pursue strategic opportunities for growth

 

We intend to continue to pursue strategic acquisitions and investments in selective technologies and businesses in the holographic AR industry that will enhance our technology capabilities. We believe that a solid acquisition and investment strategy may be critical for us to accelerate our growth and strengthen our competitive position in the future. Our ability to identify and execute strategic acquisitions and investments will likely have an effect on our operating results over time.

 

Our ability to expand our application fields and diversify customer base

 

Currently, the existing applications of holographic AR include primarily the entertainment and advertising industries, which are the industries we are currently focused on. With increasing awareness and acceptance of this technology, we expect that more applications will be identified to magnify the value of this technology, such as assistance in surgery and tele-diagnosis, and assistance in training and education. Our ability to expand our application fields and diversify our customer base may affect our operating results in the future.

 

Operating Efficiency

 

Our ability to maintain and increase profitability also depends on our ability to effectively control our costs and expenses. Significant components of our cost of revenues are the cost paid to channel providers, cost paid to third-party consultants and cost of salaries (including social security and benefits). Salaries primarily include compensation to our software engineers and operating staff. Our ability to negotiate better pricing with channel providers in desktop applications and decrease the use of third-party consultants has enabled us to keep a relatively high gross margin for the three years 2017, 2018 and 2019. Our operating expenses consist of selling expenses, general and administrative expenses and research and development expenses. For the years ended December 31, 2017, 2018 and 2019, our total operating expenses as a percentage of our total revenues were 18.5%, 17.3% and 18.8%, respectively. We expect that our expenses will increase as our business continues to grow, and we may incur additional expenses associated with being a public company. However, we believe that our expenses will grow at a lower rate compared to the growth rate of our revenues.

 

Key Components of Our Results of Operations:

 

Revenues

 

Our revenues consist of AR advertising services revenues and AR entertainment revenues. AR advertising services use holographic AR materials and integrate them into advertisement on the online media platforms or offline displays. We generate revenues when we completed our performance obligation to deliver related services based on the specific terms of the contract, which are commonly based on specific action (i.e. cost per impression”(“CPM”) or cost per action (“CPA”)) for online display and service period for offline display contracts. Over 90% of our contracts with customers are based on CPM. Prior to 2019, our AR advertising markets were mainly in desktop applications. Starting in the second half of 2019, we began to provide AR advertising services to short form mobile video streaming market, namely advertising on Tik-Tok or similar medium.

 

AR entertainment revenues include revenues generated from software development kit (“SDK”) payment channel services, software development, mobile games services and technology developments. We generate related revenues when a user completes the payment transaction for SDK payments, net of payments to content providers. We also generate revenues from sales of software development services. Revenues generated from mobile games include royalty payments from licensee operators of our mobile games and fees collected from game developers for using our game portal.

 

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Our breakdown of revenues for the years ended December 31, 2017, 2018 and 2019, respectively, is summarized below:

 

   For the Years Ended December 31, 
   2017   2018   2019   2019 
   RMB   RMB   RMB   USD 
Revenues                
AR advertising   133,078,464    181,241,346    267,514,061    38,346,673 
AR entertainment   58,951,060    44,030,218    51,667,363    7,406,233 
Total revenue   192,029,524    225,271,564    319,181,424    45,752,906 

 

Cost of Revenues

 

For AR advertising services, the cost of revenues consist of the costs paid to channel providers in accordance with revenue-sharing arrangements. For AR entertainment, the cost of revenues consist of the shared costs with content providers based on the profit sharing arrangements, third-party consulting services expenses and compensation expenses for our professionals.

 

Our breakdown of cost of revenues for the years ended December 31, 2017, 2018 and 2019, respectively, is summarized below:

 

   For the Years Ended December 31, 
   2017   2018   2019   2019 
   RMB   RMB   RMB   USD 
Cost of revenues                
AR advertising   66,148,464    81,437,761    140,716,036    20,170,872 
AR entertainment   13,031,723    3,976,300    5,451,807    781,486 
Total cost of revenues   79,180,187    85,414,061    146,167,843    20,952,358 

 

Operating expenses

 

Operating expenses include selling, general and administrative and research and development expenses. Selling expenses are mainly salary and benefit expenses for our sales team and related travel expenses. General and administrative expenses are mainly salary and benefit of management, professional fees, services fees, rental and other operating expenses of attributable to general and administrative activities. Research and development expenses are mainly salary and benefits for in house software engineers and payments made to outside subcontractors.

 

We anticipate that our operating expenses will continue to increase as we hire additional personnel and incur additional costs in connection with the expansion of our business operations as well as becoming a publicly traded company.

 

Results of Operations

 

Our consolidated results of operations for the years ended December 31, 2017, 2018 and 2019 are summarized below:

 

   For the Years Ended December 31, 
   2017   2018   2019   2019 
   RMB   RMB   RMB   USD 
Revenues   192,029,524    225,271,564    319,181,424    45,752,906 
Cost of revenues   (79,180,187)   (85,414,061)   (146,167,843)   (20,952,358)
Gross profit   112,849,337    139,857,503    173,013,581    24,800,548 
Selling expenses   (1,235,773)   (1,212,400)   (1,924,784)   (275,907)
General and administrative expenses   (24,618,898)   (29,822,426)   (39,881,854)   (5,716,845)
Research and development expenses   (9,696,322)   (8,020,082)   (18,355,403)   (2,631,147)
Income from operations   77,298,344    100,802,595    112,851,540    16,176,649 
Other expense, net   (3,432,362)   (3,509,207)   (7,517,988)   (1,077,663)
Income before provision for income taxes   73,865,982    97,293,388    105,333,552    15,098,986 
Provision for income taxes   (528,011)   (8,075,596)   (3,129,080)   (448,536)
Net income   73,337,971    89,217,792    102,204,472    14,650,450 
Other comprehensive income (loss)   (250,623)   1,759,288    1,589,076    227,785 
COMPREHENSIVE INCOME   73,087,348    90,977,080    103,793,548    14,878,235 

 

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Year Ended December 31, 2019 Compared to Year Ended December 31, 2018

 

Revenues

 

Our revenues increased by approximately RMB 93.9 million, or 41.7%, from approximately RMB 225.3 million for the year ended December 31, 2018 to approximately RMB 319.2 million (USD 45.8 million) for the year ended December 31, 2019, due to an increase of approximately RMB 86.3 million (USD 12.4 million) in AR advertising revenue and an increase of approximately RMB 7.6 million (USD 1.1 million) in AR entertainment revenue.

 

Our AR advertising revenue increased by approximately RMB 86.3 million, or 47.6%, from approximately RMB 181.2 million for the year ended December 31, 2018 to approximately RMB 267.5 million (USD 38.3 million) for the year ended December 31, 2019. The increase was primarily attributable to the increase in the number of advertisers who became our customers as a result of more referrals from existing customers who were satisfied with our services. The number of our customers for advertising services increased by 32, from 121 for the year ended December 31, 2018 to 153 for the year ended December 31, 2019. Average revenue per customer for AR advertising services increased from approximately RMB 1.5 million for the year ended December 31, 2018 to approximately RMB 1.7 million for the year ended December 31, 2019. The increase in average revenue was due to the improvement in technologies, which enabled us to embed more contents in the advertisements. The number of paid impressions through our AR advertising increased by 47.0% from approximately 6.6 billion in 2018 to approximately 9.7 billion 2019 due to an increase in the number of advertisers. The increase was also due to the launch of our advertising services in the short form mobile streaming market, where we derived approximately 15.5% of our AR advertising revenue. Prior to May 2019, most of our AR advertising were from more traditional desktop markets.

 

Our AR entertainment revenue increased by approximately RMB 7.6 million, or 17.3%, from approximately RMB 44.0 million for the year ended December 31, 2018 to approximately RMB 51.7 million (USD 7.6 million) for the year ended December 31, 2019. The increase in AR entertainment revenue was primarily attributable to an increase in mobile games service fee revenue recognized in the second half of 2019 and an increase in MR software revenue due to the upgrade of certain MR software modules during the second half of 2019. Such upgrade is expected to be completed across all MR software modules in 2020.

 

We launched the 233 Game Platform, a mobile game distribution platform, in 2018, by migrating users from our desktop games to such platform. In addition, new users have joined the platform since its launch. As of December 31, 2019, there were over 800 apps operating on such platform and over 260,000 active members. We started generating revenue from such platform in the second quarter of 2019, although revenue recognized in the first half of 2019 was relatively low. As we continued to add popular apps, and certain existing games increased in popularity with users, in the second half of 2019, revenue attributable to mobile games service fees increased.

 

Cost of Revenues

 

Our total cost of revenues increased by approximately RMB 60.8 million, or 71.1%, from approximately RMB 85.4 million for the year ended December 31, 2018 to approximately RMB 146.2 million (USD 21.0 million) for the year ended December 31, 2019.

 

Our cost of revenues for AR advertising services increased by approximately RMB 59.3 million, or 72.8%, from approximately RMB 81.4 million for the year ended December 31, 2018 to approximately RMB 140.7 million (USD 20.2 million) for the year ended December 31, 2019. The increase in cost of revenues was in line with the increase of AR advertising services revenue. Starting in the second half of 2019, we started to provide AR advertising services in short form mobile video streaming market. Due to the nature of the medium, less ad can be placed on a short video based on current technology. In addition, since the market was dominated by a few major channel providers, the average cost of revenue of AR advertising services from short video streaming market was relatively higher, compared with that of other AR advertising channels from desktop applications.

 

Our cost of revenues for AR entertainment increased by approximately RMB 1.5 million, or 37.1%, from approximately RMB 4.0 million for the year ended December 31, 2018 to approximately RMB 5.5 million (USD 0.8 million) for the year ended December 31, 2019. The increase in cost of revenue was in line with increased revenue as we used third party service providers.

 

Gross Profit

 

Our gross profit increased by approximately RMB 33.1 million, from approximately RMB 139.9 million for the year ended December 31, 2018 to approximately RMB 173.0 million (USD 24.8 million) during the year ended December 31, 2019. The increase was mainly due to the significant increase in AR advertising revenues during the year ended December 31, 2019. For the years ended December 31, 2018 and 2019, our overall gross margin was 62.1% and 54.2%, respectively. The decrease in gross margin was primarily caused by the higher average cost of revenue of AR advertising services on short videos market we entered in May 2019.

 

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Our gross profit and gross profit margin from our major business segments are summarized as follows:

 

   For the Years ended December 31,   Variance 
   2018   2019   2019   Amount/% 
   RMB   RMB   USD     
AR advertising                    
Gross profit   99,803,585    126,798,025    18,175,801    26,994,440 
Gross margin   55.1%   47.4%        27.0%
AR entertainment                    
Gross profit   40,053,918    46,215,556    6,624,747    6,161,638 
Gross margin   91.0%   89.4%        15.4%
Total                    
Gross profit   139,857,503    173,013,581    24,800,548    33,156,078 
Gross margin   62.1%   54.2%        23.7%

 

Our gross margin for AR advertising services decreased from 55.1% for the year ended December 31, 2018 to 47.4% for the year ended December 31, 2019 mainly due to higher average cost of revenue for AR advertising services on short videos which we started in May 2019.

 

Our gross margin for AR entertainment services remained relatively stable, at 91.0% and 89.4% for the years ended December 31, 2018 and 2019, respectively.

 

Operating Expenses

 

For the year ended December 31, 2019, we incurred approximately RMB 60.2 million (USD 8.6 million) in operating expenses, representing an increase of approximately RMB 21.1 million, or 54.0%, from approximately RMB 39.1 million for the year ended December 31, 2018, primarily due to significant increases in general and administrative expenses and research and development expenses.

 

Selling expenses increased by approximately RMB 0.7 million, or 58.8%, from approximately RMB 1.2 million for the year ended December 31, 2018 to approximately RMB 1.9 million (USD 0.3 million) for the year ended December 31, 2019. The increase was mainly due to an increase in salary and benefit expenses for our sales team and related travel expenses of approximately RMB 0.7 million. Selling expenses accounted for 1.0% of total revenue for the years ended December 31, 2018 and 2019, respectively.

 

General and administrative expenses increased by approximately RMB 10.1 million, or 33.7%, from RMB 29.8 million for the year ended December 31, 2018 to approximately RMB 39.9 million (USD 5.7 million) for the year ended December 31, 2019. The increase was mainly due to an increase in professional fees, including audit fees and other professional fees of approximately RMB 6.9 million in relation to our initial public offering, an increase of travel expenses of approximately RMB 0.7 million, an increase of allowance for doubtful accounts of approximately RMB 1.6 million and an increase of other office expenses, including rent and salary of approximately RMB 0.7 million in connection with our two leases for our offices in 2019.

 

Research and development expenses increased by approximately RMB 10.3 million, or 128.9%, from approximately RMB 8.0 million for the year ended December 31, 2018 to approximately RMB 18.4 million (USD 2.6 million) for the year ended December 31, 2019, as we continued to focus on developing our technological capabilities in order to maintain our competitive advantage in the AR hologram industry.

 

Other income (expenses), net

 

Total other expenses, net, were approximately RMB 3.5 million and RMB 7.5 million (USD 1.1 million) for the years ended December 31, 2018 and 2019, respectively.

 

Other income included gain from disposal of our investments, government subsidies and input VAT tax credits. For the year ended December 31, 2018, we sold one of the cost-method investments with basis of RMB 50,000 for approximately RMB 0.4 million (USD 51,000), resulting in a gain from disposal of cost-method investment of approximately RMB 0.3 million (USD 44,000). There was no disposal of cost-method investment in 2019.

 

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Other income also included government subsidies, which increased by approximately RMB 0.2 million, from approximately RMB 1.2 million for the year ended December 31, 2018 to approximately RMB 1.4 million (USD 0.2 million) for the year ended December 31, 2019, as we applied for, and received, more government grants for new technology and software.

 

Other income also included approximately RMB 0.9 million (USD 0.1 million) of input VAT credit that we redeemed during the year ended December 31, 2019. As part of VAT reform in 2019, a taxpayer in certain service industries was allowed to reclaim additional 10% of input VAT credit against the amount of VAT payable from April 1, 2019 to December 31, 2021.

 

Finance expenses, net, mainly consisting of amortization of debt discount and currency exchange gain. The amortization of debt discount was RMB 5.1 million and RMB 11.5 million (USD 1.7 million) for the years ended December 31, 2018 and 2019, respectively. The increase in finance expenses was resulted from payment of long-term business acquisition payables. Currency exchange gain amounted to approximately RMB 0.8 million (USD 0.1 million) for the year ended December 31, 2019.

 

Interest income increased from approximately RMB 24,000 for the year ended December 31, 2018 to approximately RMB 1.2 million (USD 0.2 million) for the year ended December 31, 2019. Interest income consisted of bank interest income, which was derived from funds that we received from the issuance of the preferred shares in the November of 2018 that had an annual interest rate of approximately 1.8%.

 

Provision for income taxes

 

Our income tax expenses decreased by approximately RMB 5.0 million, or 61.3%, from approximately RMB 8.1 million for the year ended December 31, 2018 to approximately RMB 3.1 million (USD 0.5 million) for the year ended December 31, 2019. Current income tax decreased by approximately RMB 5.0 million due to the increased taxable income of Shenzhen Yiruan, Shenzhen Yiyun, Shenzhen Yidian and Shenzhen Duodian, which received preferential tax treatment due to their status as High and New Technology Enterprises.

 

Net income

 

As a result of the combination of factors discussed above, our net income increased from approximately RMB 89.2 million for the year ended December 31, 2018 to approximately RMB 102.2 million (USD 14.7 million) for the year ended December 31, 2019.

 

Year Ended December 31, 2018 Compared to Year Ended December 31, 2017

 

Revenues

 

Our total revenues increased by approximately RMB 33.2 million, or 17.3%, from approximately RMB 192.0 million for the year ended December 31, 2017 to approximately RMB 225.3 million for the year ended December 31, 2018, due to an increase of approximately RMB 48.2 million in AR advertising revenue, which was partially offset by a decrease of approximately RMB 14.9 million in AR entertainment revenue.

 

Our AR advertising revenue increased by approximately RMB 48.2 million, or 36.2%, from approximately RMB 133.1 million for the year ended December 31, 2017 to approximately RMB 181.2 million for the year ended December 31, 2018. The increase was primarily attributable to an increase in the number of advertisers who became our customers as a result of more referrals from existing customers who were satisfied with our services. The number of our customers for advertising services increased from 97 for the year ended December 31, 2017 to 121 for the year ended December 31, 2018. Average revenue per customer for advertising services increased from approximately RMB 1.4 million for the year ended December 31, 2017 to approximately RMB 1.5 million for the year ended December 31, 2018, primarily due to the improvement in technologies, which enabled us to embed more contents in the advertisements. The number of paid impressions through our AR advertising increased by 34.7%, from 4.9 billion in 2017 to approximately 6.6 billion 2018 due to an increase in advertisers.

 

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Our AR entertainment revenue decreased by approximately RMB 14.9 million, or 25.3%, from approximately RMB 58.9 million for the year ended December 31, 2017 to approximately RMB 44.0 million for the year ended December 31, 2018. The decrease in AR entertainment revenue was primarily attributable to a decrease in MR software development service fee recognized in the relevant period. In 2018, we planned a major upgrade on software system infrastructure and system coding to update the platform, system and application layers. The upgrade would improve holographic AR simulation and solve certain issues on delay rate, where it would stabilize the software interface with other applications. We intended to continue to upgrade and customize our platform according to customers’ needs and we expected to complete a substantial portion of this upgrade in the third quarter of 2019. We had approximately RMB 19 million of uncompleted contracts and we expected to recognize these revenues in the third quarter of 2019, pending final customers’ acceptance. However, there can be no assurance that we will be successful in completing our upgrade timely, or at all, and fulfilling these contracts and recognizing these revenues within the specific timeframe, if at all.

 

Cost of Revenues

 

Total cost of revenues increased by approximately RMB 6.2 million, or 7.9%, from approximately RMB 79.2 million for the year ended December 31, 2017 to approximately RMB 85.4 million for the year ended December 31, 2018.

 

Our cost of revenues for AR advertising services increased by approximately RMB 15.3 million, or 23.1%, from approximately RMB 66.1 million for the year ended December 31, 2017 to approximately RMB 81.4 million for the year ended December 31, 2018. The increase of cost of revenues in connection with AR advertising was in line with the increase of AR advertising services revenue. However increase in cost of revenues was less than the increase in AR advertising revenue, as we were able to negotiate better cost with our channel providers due to increased sales volume in AR advertising services.

 

Our cost of revenue for AR entertainment services decreased by approximately RMB 9.0 million, or 69.5%, from approximately RMB 13.0 million for the year ended December 31, 2017 to approximately RMB 4.0 million for the year ended December 31, 2018. The decrease in cost of revenues in connection with AR entertainment services was in line with the decrease in AR entertainment revenue, as we used more our professionals rather than third-party consultants.

 

Gross Profit

 

Our gross profit increased by approximately RMB 27.0 million, from approximately RMB 112.8 million for the year ended December 31, 2017 to approximately RMB 139.8 million for the year ended December 31, 2018. The increase was mainly due to the significant increase of AR advertising revenue during the year ended December 31, 2018. For the years ended December 31, 2017 and 2018, our overall gross margin was 58.8% and 62.1%, respectively. The increase in gross margin was due to the increased gross margins of the two segments.

 

Our gross profit and gross profit margin from our major revenue categories are summarized as follows:

 

   For the Years ended
December 31,
   Variance 
   2017   2018   Amount/% 
   RMB   RMB     
AR advertising               
Gross profit   66,930,000    99,803,585    32,873,585 
Gross margin   50.3%   55.1%   4.8%
AR entertainment               
Gross profit   45,919,337    40,053,918    (5,865,419)
Gross margin   77.9%   91.0%   13.1%
Total               
Gross profit   112,849,337    139,857,503    27,008,166 
Gross margin   58.8%   62.1%   3.3%

 

Our gross margin for AR advertising services increased from 50.3% for the year ended December 31, 2017 to 55.1% for the year ended December 31, 2018 mainly due to our ability to increase revenue and effectively control our cost for the year ended December 31, 2018.

 

Our gross margin for AR entertainment increased from 77.9% for the year ended December 31, 2017 to 91.0% for the year ended December 31, 2018, mainly due to an increase in revenues from our SDK payment channel services and mobile games operations, which had higher gross margins.

 

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Operating Expenses

 

For the year ended December 31, 2018, we incurred approximately RMB 39.1 million in operating expenses, representing an increase of approximately RMB 3.5 million, or 9.9%, from approximately RMB 35.6 million for the year ended December 31, 2017.

 

Selling expenses were approximately RMB 1.2 million for the years ended December 31, 2017 and 2018, respectively. Selling expenses were mainly salary and benefit expenses for our sales team and related travel expenses. Selling expenses remained fairly stable, representing approximately 0.64% and 0.54% of our total revenues for the years ended December 31, 2017 and 2018, respectively.

 

General and administrative expenses increased by approximately RMB 5.2 million, or 21.1%, from RMB 24.6 million for the year ended December 31, 2017 to approximately RMB 29.8 million for the year ended December 31, 2018. The increase was mainly due an increase of approximately RMB 2.9 million in professional fees including audit fees and other professional fees in relation to our initial public offering, an increase of approximately RMB 0.8 million in amortization and depreciation expenses, an increase of approximately RMB 0.8 million in salary and benefit expenses attributable to the subsidiaries established during the last quarter of 2017. General and administrative expenses remained fairly consistent, representing approximately 12.8% and 13.2% of our total revenues for the years ended December 31, 2017 and 2018, respectively.

 

Research and development expenses decreased by approximately RMB 1.7 million, or 17.3%, from approximately RMB 9.7 million for the year ended December 31, 2017 to approximately RMB 8.0 million for the year ended December 31, 2018. The decrease was mainly due to our ability to effectively utilize our R&D capabilities.

 

Other income (expenses), net

 

Total other expenses, net were approximately RMB 3.4 million and RMB 3.5 million for the years ended December 31, 2017 and 2018, respectively.

 

Other income included gain from disposal of our investments. For the year ended December 31, 2018, we sold one of the cost-method investments with basis of RMB 50,000 in 2018 for RMB 350,000, resulting in a gain from disposal of cost-method investment of RMB 300,000. We also disposed one of our subsidiaries for RMB 156,225 in November 2017, resulting in RMB 134,774 of gain from disposal of subsidiary.

 

Other income also included government subsidies, which increased by approximately RMB 0.6 million in 2018, as we applied and qualified for more government grants for new technology and software.

 

Finance expenses were mainly amortization of debt discount, and amounted to RMB 4,191,002 and RMB 5,124,715 for the years ended December 31, 2107 and 2018, respectively, which resulted from long-term business acquisition payables.

 

Provision for income taxes

 

Our income tax expenses increased by approximately RMB 7.5 million, or 1,429.4%, from approximately RMB 0.5 million for the year ended December 31, 2017 to approximately RMB 8.1 million for the year ended December 31, 2018.

 

Current income tax increased by approximately RMB 7.6 million due to the increased taxable income of Shenzhen Yiren, Shenzhen Qianhai and Shenzhen Yidian, whose two years of tax exempt status has expired and are now taxed at a reduced income tax rate of 12.5%.

 

Net income

 

As a result of the combination of factors discussed above, our net income increased from approximately RMB 73.3 million for the year ended December 31, 2017, to approximately RMB 89.2 million for the year ended December 31, 2018.

 

Liquidity and Capital Resources

 

In assessing our liquidity, we monitor and analyze our cash on-hand and our operating and capital expenditure commitments. To date, we have financed our working capital requirements from cash flow from operations, debt and equity financings and capital contributions from our existing shareholders.

 

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As of December 31, 2019, we had cash and cash equivalents of approximately RMB 129.0 million (USD 18.5 million). Our working capital was approximately RMB 55.4 million (USD 7.9 million) as of December 31, 2019. In assessing our liquidity, we monitor and analyze our cash on-hand and our operating and capital expenditure commitments. To date, we have financed our working capital requirements through cash flow generated from operations, debt and equity financings and capital contributions from our existing shareholders.

 

We completed our initial public offering in April, 2020 and received net proceeds of approximately USD23.1 million. We believe our current working capital is sufficient to support our operations for the next twelve months. We may, however, need additional cash resources in the future if we experience changes in business conditions or other developments, or if we find and wish to pursue opportunities for investment, acquisition, capital expenditure or similar actions. If we determine that our cash requirements exceed the amount of cash and cash equivalents we have on hand at the time, we may seek to issue equity or debt securities or obtain credit facilities. The issuance and sale of additional equity would result in further dilution to our shareholders. The incurrence of indebtedness would result in increased fixed obligations and could result in operating covenants that would restrict our operations. Our obligation to bear credit risk for certain financing transactions we facilitate may also strain our operating cash flow. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all.

 

Although we consolidate the results of our VIE and its subsidiaries, we only have access to cash balances or future earnings of our VIE and its subsidiaries through our contractual arrangements with our VIE.

 

Current foreign exchange and other regulations in the PRC may restrict our PRC entities in their ability to transfer their net assets to the Company and its subsidiaries in Cayman Islands, and Hong Kong. However, these restrictions have no impact on the ability of these PRC entities to transfer funds to the Company as we have no present plans to declare dividend which we plan to retain our retained earnings to continue to grow our business. In addition, these restrictions have no impact on the ability for us to meet our cash obligations as all of our current cash obligations are due within the PRC.

 

To utilize the proceeds we received from our this offering, we may make additional capital contributions to our PRC subsidiary, establish new PRC subsidiaries and make capital contributions to these new PRC subsidiaries, or make loans to the PRC subsidiaries. However, most of these uses are subject to PRC regulations. Foreign direct investment and loans must be approved by and/or registered in accordance with the Secure and Fair Enforcement for Mortgage Licensing Act of 2008, as amended, and its local branches. The total amount of loans we can make to our PRC subsidiary cannot exceed statutory limits and must be registered with the local counterpart of SAFE. The statutory limit for the total amount of foreign debts of a foreign-invested company is the difference between the amount of total investment as approved by the Ministry of Commerce or its local counterpart and the amount of registered capital of such foreign-invested company.

 

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 VIEs only through loans, and only if we satisfy the applicable government registration and approval requirements. The relevant filing and registration processes for capital contributions typically take approximately eight weeks to complete. The filing and registration processes for loans typically take approximately four weeks or longer to complete. While we currently see no material obstacles to completing the filing and registration procedures with respect to future capital contributions and loans to our PRC subsidiaries or VIEs, we cannot assure you that we will be able to complete these filings and registrations on a timely basis, or 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 or prevent us from using the proceeds of this offering to make loans or make additional capital contributions to our PRC subsidiaries, which could materially and adversely affect our liquidity and our ability to fund and expand our business.” Additionally, while there is no statutory limit on the amount of capital contribution that we can make to our PRC subsidiaries, loans provided to our PRC subsidiaries and consolidated VIEs in the PRC are subject to certain statutory limits. With respect to our PRC subsidiaries, the maximum amount of the loans that they can acquire in aggregate from outside China as of December 31, 2019 was (i) approximately RMB 698 million (USD 100 million) under the total investment minus registered capital approach; or (ii) approximately RMB 296 million (USD 42.4 million) under the net asset approach. We are able to use all of the net proceeds from this offering for investment in our PRC operations by funding our PRC subsidiaries through capital contributions which is not subject to any statutory limit on the amount under PRC laws and regulations. See “PRC Regulation—Loans by Foreign Companies to their PRC Subsidiaries.” We expect the net proceeds from this offering to be used in the PRC will be in the form of RMB and, therefore, our PRC subsidiary and consolidated VIE will need to convert any capital contributions or loans from U.S. dollars into Renminbi in accordance with applicable PRC laws and regulations.

 

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The following table summarizes the key components of our cash flows for the years ended December 31, 2017, 2018 and 2019.

 

   For the Years Ended December 31 
   2017   2018   2019   2019 
   RMB   RMB   RMB   USD 
Net cash provided by operating activities   108,057,941    99,452,205    143,955,544    20,635,238 
Net cash used in investing activities   (118,364,263)   (98,597,356)   (126,479,892)   (18,130,198)
Net cash (used in)/provided by financing activities   (3,800,000)   137,493,993    (40,974,000)   (5,873,398)
Effect of exchange rate change on cash and cash equivalents   (234,124)   937,466    599,384    85,917 
Net change in cash and cash equivalents   (14,340,446)   139,286,308    (22,898,964)   (3,282,411)
Cash and cash equivalents, beginning of year   27,002,080    12,661,634    151,947,942    21,780,904 
cash and cash equivalents, end of year   12,661,634    151,947,942    129,048,978    18,498,463 

 

Operating activities

 

Net cash provided by operating activities was approximately RMB 144.0 million (USD 20.6 million) for the year ended December 31, 2019, as compared to approximately RMB 99.5 million for the year ended December 31, 2018 and approximately RMB 108.1 million for the year ended December 31, 2017.

 

Net cash provided by operating activities for the year ended December 31, 2019 was primarily attributable to net income of approximately RMB 102.2 million (USD 14.7 million) with non-cash depreciation and amortization expenses of approximately RMB 13.9 million (USD 2.0 million), provision for doubtful accounts of approximately RMB 1.6 million (USD 0.2 million) and amortization of debt discount of RMB 11.5 million (USD 1.7 million), which was partially offset by deferred tax benefits of approximately RMB 1.5 million (USD 0.2 million). Cash inflow was also attributable to (i) the collection of accounts receivable of approximately RMB 9.1 million (USD 1.3 million), (ii) the decrease of RMB 5.3 million (USD 0.8 million) in contract costs as we recognized some of the costs incurred for revenue that had not met recognition criteria, (iii) the increase of approximately RMB 5.7 million (USD 0.8 million) in accounts payable, (iv) the increase of approximately RMB 0.3 million (USD 46,000) in deferred revenues, and (v) the increase of other payables and accrued liabilities of approximately RMB 0.4 million (USD 64,000). Cash inflow was partially offset by (i) the increase of prepayments of approximately RMB 3.1 million (USD 0.4 million), as we had to make more advances to secure advertising channels for advertising in short form mobile video streaming market, (ii) the increase of approximately RMB 0.4 million (USD 58,000) in prepaid expenses and deposits, and (iii) the increase of approximately RMB 1.1 million (USD 0.2 million) in taxes payable as we made more tax payments in 2019.

 

Net cash provided by operating activities was approximately RMB 99.5 million for the year ended December 31, 2018. Net cash provided by operating activities for the year ended December 31, 2018 was primarily attributable to net income of approximately RMB 89.2 million with non-cash depreciation and amortization expense of approximately RMB 13.5 million and amortization of debt discount of RMB 5.1 million, which was partially offset by non-cash deferred tax benefits of RMB 1.5 million. The cash inflow was also attributable to (i) the increase of approximately RMB 7.7 million in accounts payable, and (ii) the increase of taxes payable of approximately RMB 8.1 million due to more income tax and VAT incurred as a result of increase in revenues and expiration of tax exempt status for some of our subsidiaries. Cash inflow was offset by (i) the increase of approximately RMB 11.3 million in account receivable, as we expanded our operations by providing more credit sales, (ii) the increase of approximately RMB 2.3 million in prepaid expenses and other current assets, and (iii) the increase of approximately RMB 8.4 million in contract costs.

 

Net cash provided by operating activities was approximately RMB 108.1 million for the year ended December 31, 2017. Net cash provided by operating activities for the year ended December 31, 2017 was primarily attributable to net income of approximately RMB 73.3 million with non-cash depreciation and amortization expense of approximately RMB 12.8 million and amortization of debt discount of RMB 4.2 million, which was partially offset by recovery of doubtful accounts of approximately RMB 0.1 million and deferred tax benefits of RMB 1.5 million. Cash inflow was also attributable to (i) the increase of approximately RMB 5.0 million in prepaid expenses and other current assets, the increase of approximately RMB 17.1 million in accounts payable, and (ii) the increase of approximately RMB 2.9 million in taxes payable. The cash inflow was partially offset by (i) the increase of approximately RMB 2.2 million in accounts receivable, which was consistent with our revenue increase, and (ii) the increase of contract costs of RMB 3.2 million, which were costs incurred for revenues that have not met recognition criteria.

 

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Investing activities

 

Net cash used in investing activities was approximately RMB 126.5 million (USD 18.1 million) for the year ended December 31, 2019, compared to net cash used in investing activities of approximately RMB 98.6 million for the year ended December 31, 2018 and approximately RMB 118.4 million for the year ended December 31, 2017.

 

Cash used in investing activities for the year ended December 31, 2019 was mainly due to payments for cost method investments of approximately RMB 3.9 million (USD 0.6 million), the repayments for the business acquisition payables to the related parties of approximately RMB 122.4 million (USD 17.6 million), and purchases of property, plant and equipment of approximately RMB 0.2 million (USD 28,000).

 

Cash used in investing activities for the year ended December 31, 2018 was mainly due to the repayments of business acquisition payables to former shareholders of Skystar, Shenzhen Kuxuanyou, Shenzhen Yidian and Shenzhen Yitian in the amount of RMB 98.9 million and purchases of property, plant and equipment of approximately RMB 47,000.

 

Cash used in investing activities for the year ended December 31, 2017 was mainly due to the net payment for the Skystar acquisition of approximately RMB 18.0 million, repayments of business acquisition payables to related parties in the amount of RMB 98.7 million and purchases of property, plant and equipment of approximately RMB 2.0 million. The cash outflow was partially offset by the proceeds from sale of cost method investment of approximately RMB 0.1 million and cash acquired from acquisition in the amount of approximately RMB 0.2 million.

 

Financing activities

 

Cash used in financing activities was approximately RMB 41.0 million (USD 5.9 million) for the year ended December 31, 2019, compared with cash provided by financing activities of approximately RMB 137.5 million for the year ended December 31, 2018 and cash used in financing activities of approximately RMB 3.8 million for the year ended December 31, 2017.

 

For the year ended December 31, 2019, cash used in financing activities was mainly the repayment of approximately RMB 125.3 million (USD 18.0 million) to Jie Zhao, our Chairman, for loans we made from 2016 to 2018, and the repayment of RMB 4.2 million (USD 0.6 million) to Enweiliangzi Investment Co. (which is under common control of Jie Zhao). Cash provided by financing activities for the year ended December 31, 2019 was due to the additional loans we received Jie Zhao in the amount of RMB 13.0 million (USD 1.9 million). The loans are free of interest and collateral, and are due in 2020 and 2021. We also borrowed loans from Shanghai Junei Internet Co. (which is under common control of Jie Zhao) in the amount of RMB 75.5 million (USD 10.8 million), which has an annual interest rate of 7% and is due in 2020 and 2021.

 

For the year ended December 31, 2018, cash provided by financing activities was mainly due to proceeds from issuance of Series A convertible preferred shares of approximately RMB 137.7 million and proceeds from related party loans of approximately RMB 14.6 million, consisting of approximately RMB 10.4 million from Jie Zhao and approximately RMB 4.2 million from Enweiliangzi Investment Co. (which is under common control of Jie Zhao) for cash flow purpose. The loans are free of interest and collateral, and are due in 2020 and 2021. The inflow of cash flow was offset by our repayment to Jie Zhao of approximately RMB 14.8 million.

 

For the year ended December 31, 2017, cash used in financing activities was mainly repayment of RMB 33.8 million to Jie Zhao, our Chairman from a loan we made in 2016. The loans are free of interest and collateral and are due in 2021. Cash provided by financing activities for the year ended December 31, 2017 was mainly due to the capital contribution from our shareholders in the amount of RMB 30.0 million.

 

Commitments and Contingencies

 

In the normal course of business, we are subject to loss contingencies, such as legal proceedings and claims arising out of its business, that cover a wide range of matters, including, among others, government investigations and tax matters. In accordance with ASC No. 450-20, “Loss Contingencies”, we will record accruals for such loss contingencies when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated.

 

Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements including arrangements that would affect our liquidity, capital resources, market risk support and credit risk support or other benefits.

 

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Contractual Obligations

 

As of December 31, 2019, the future minimum payments under certain of our contractual obligations were as follows:

 

       Payments Due In 
   Total
RMB
   Less than 1 year   1 - 2 years   3 - 5 years   Thereafter 
Contractual obligations                         
Operating leases obligations   4,117,685    2,478,329    1,639,356         
Loans—related parties   87,025,789    70,987,603    16,038,186         
Total   91,143,474    73,465,932    17,677,542         

 

Holding Company Structure

 

WiMi Cayman is a holding company with no material operations of its own. We conduct our operations primarily through our PRC subsidiary, our VIE and its subsidiaries in China. As a result, WiMi Cayman’s ability to pay dividends depends upon dividends paid by our PRC subsidiary. If our existing PRC subsidiary or any newly formed ones incur debt on their own behalf in the future, the instruments governing their debt may restrict their ability to pay dividends to us. In addition, our wholly foreign-owned subsidiary in China is permitted to pay dividends to us only out of its retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Under PRC law, each of our PRC subsidiary, our VIE and its subsidiaries in China is required to set aside at least 10% of its after-tax profits each year, if any, to fund certain statutory reserve funds until such reserve funds reach 50% of its registered capital. In addition, our wholly foreign-owned subsidiary in China may allocate a portion of its after-tax profits based on PRC accounting standards to enterprise expansion funds and staff bonus and welfare funds at its discretion, and our variable interest entity may allocate a portion of its after-tax profits based on PRC accounting standards to a discretionary surplus fund at its discretion. The statutory reserve funds and the discretionary funds are not distributable as cash dividends. Remittance of dividends by a wholly foreign-owned company out of China is subject to examination by the banks designated by SAFE. Our PRC subsidiary has not paid dividends and will not be able to pay dividends until it generates accumulated profits and meets the requirements for statutory reserve funds.

 

Inflation

 

Since our inception, inflation in China has not materially affected our results of operations. According to the National Bureau of Statistics of China, the year-over-year percent changes in the consumer price index for December 2017, 2018 and 2019 were increases of 1.8%, 1.9% and 2.5%, respectively. Although we have not been materially affected by inflation in the past, we may be affected if China experiences higher rates of inflation in the future.

 

Taxation

 

Cayman Islands

 

The Cayman Islands currently levy no taxes on individuals or corporations based upon profits, income, gains or appreciation and there is no taxation in the nature of inheritance tax or estate duty. There are no other taxes likely to be material to us levied by the government of the Cayman Islands except for stamp duties, which may be applicable on instruments executed in, or after execution, brought within the jurisdiction of the Cayman Islands. In addition, the Cayman Islands does not impose withholding tax on dividend payments.

 

Hong Kong

 

WiMi HK, our wholly-owned Hong Kong subsidiary, and Micro Beauty, the wholly-owned subsidiary of our VIE, are subject to Hong Kong profits tax at a tax rate of 16.5%. We have not made any provisions for Hong Kong profit tax as there has been no assessable profit derived from or earned in Hong Kong since their respective inceptions. Under Hong Kong tax laws, WiMi HK is exempted from income tax on its foreign-derived income. Hong Kong does not impose a withholding tax on dividends.

 

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Seychelles

 

Skystar, a company incorporated in Seychelles, is not subject to tax on income generated outside of Seychelles under the current tax laws, which do not impose withholding tax upon payments of dividends.

 

PRC

 

Under the Enterprise Income Tax Laws of the PRC”(the “EIT Laws”), domestic enterprises and Foreign Investment Enterprises (the “FIE”) are usually subject to a unified 25% enterprise income tax rate, while preferential tax rates, tax holidays and tax exemption may be granted on case-by-case basis. EIT grants preferential tax treatment to certain High and New Technology Enterprises (“HNTEs”). Under this preferential tax treatment, HNTEs are entitled to an income tax rate of 15%, subject to the requirement that they re-apply for HNTE status every three years. Shenzhen Kuxuanyou obtained the HNTE tax status in October 2015, which reduced its statutory income tax rate to 15% from November 2016 to November 2019. Shengzhen Yiruan, Shenzhen Yiyun, Shenzhen Yidian and Shenzhen Duodian were qualified as software companies by the local taxing authority and obtained two years of tax exemption since their respective inception. After their tax exemption period, they can be taxed at a reduced income tax rate of 12.5% for three years. After the initial 5 years, these companies can apply for the reduced rate on a yearly basis. In addition, 75% of R&D expenses of Shenzhen Kuxuanyou are subject to additional deduction from pre-tax income and 50% of R&D expenses of Shenzhen Yiruan are subject to additional deduction from pre-tax income.

 

Korgas Shengyou, Korgas Wimi, and Korgas 233 were formed and registered in Korgas in Xinjiang Provence, China from 2016 to 2017, and Kashi Duodian was formed and registered in Kashi in Xinjiang Provence, China in 2019. These companies are not subject to income tax for 5 years, and can obtain another two years of tax exempt status and are taxed at reduced income tax rate of 12.5% for three years, due to the local tax policies to attract companies in various industries.

 

Shenzhen Qianhai and Shenzhen Zhiyun were formed and registered in Qianhai District in Guangdong Provence, China in 2015 and 2019, respectively. These companies are subject to income tax at a reduced rate of 15% due to the local tax policies to attract companies in various industries.

 

Certain subsidiaries of our VIE were formed and registered in Korgas and Kashi, China. These companies can enjoy tax exemption for 5 years after their respective inceptions, and can be exempted from income tax for another two years and taxed at a reduced income tax rate of 12.5% for three years, after the initial 5 years’ of tax exemption periods.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our management to make assumptions, estimates and judgments that affect the amounts reported, including the notes thereto, and related disclosures of commitments and contingencies, if any. We have identified certain accounting policies that are significant to the preparation of our financial statements. These accounting policies are important for an understanding of our financial condition and results of operation. Critical accounting policies are those that are most important to the portrayal of our financial conditions and results of operations and require management’s difficult, subjective, or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Certain accounting estimates are particularly sensitive because of their significance to financial statements and because of the possibility that future events affecting the estimate may differ significantly from management’s current judgments. While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements included elsewhere in this prospectus, we believe the following critical accounting policies involve the most significant estimates and judgments used in the preparation of our financial statements.

 

Basis of Presentation and Principals of Consolidation

 

Basis of presentation

 

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for information pursuant to the rules and regulations of the Securities Exchange Commission.

 

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Principles of consolidation

 

The consolidated financial statements include the financial statements of our company and our subsidiaries, which include the wholly- foreign owned enterprise (“WFOE”) and variable interest entities (“VIEs”) over which we exercise control and, when applicable, entities for which we have a controlling financial interest or is the primary beneficiary. All transactions and balances among us and our subsidiaries have been eliminated upon consolidation.

 

Use of Estimates and Assumptions

 

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the periods presented. Significant accounting estimates reflected in our consolidated financial statements include the useful lives of property and equipment and intangible assets, impairment of long-lived assets and goodwill, allowance for doubtful accounts, provision for contingent liabilities, revenue recognition, and deferred taxes and uncertain tax position. Actual results could differ from these estimates.

 

Goodwill Impairment Testing

 

We perform annual goodwill impairment analysis as of December 31 with the assistance of independent valuation expert in accordance with the subsequent measurement provisions of FASB ASC Topic 350, Intangibles—Goodwill and Other. This impairment analysis compares the fair values of our reporting units to their related carrying values. If a reporting unit carrying value exceeds its fair value, we then calculate the reporting unit’s implied fair value of goodwill and impairment charges are recorded for any excess of the goodwill carrying value over the implied fair value of goodwill.

 

The reporting units’ fair values are determined by income approach where projected future cash flows discounted at rates commensurate with the risks involved, (“Discounted Cash Flow” or “DCF” of the income approach). This approach is supplemented by the market approach, (Guideline Company Method) to ensure the typical multiple such as EBITDA was within range of comparable companies.

 

Assumptions used in a DCF analysis require the exercise of significant judgment, including judgment about appropriate discount rates and terminal values, growth rates, and the amount and timing of expected future cash flows. The forecasted cash flows are based on current plans and for years beyond that plan, the estimates are based on assumed growth rates. We believe that our assumptions are consistent with the plans and estimates used to manage the underlying businesses. The discount rates, which are intended to reflect the risks inherent in future cash flow projections, used in a DCF analysis are based on estimates of the weighted-average cost of capital “WACC”) of a market participant. Such estimates are derived from our analysis of peer companies and consider the industry weighted average return on debt and equity from a market participant perspective and adjusted for our specific risks.

 

We have four reporting units that have goodwill. The following table categorizes our goodwill by reporting unit as of December 31, 2019 according to the level of excess between the reporting’ unit’s fair value and carrying value and we believe that no reporting units are at risk of failing “Step 1” of a goodwill impairment analysis.

 

Segment  Reporting
Unit
  Fair Value
Exceeds
Carrying Value
   Net Goodwill as of
December 31,
2018
   Net Goodwill as of
December 31,
2019
 
            (in RMB thousands) 
AR advertising services  AR advertising services unit   148%   137,060    137,060 
AR Entertainment  AR application and technology solutions unit   176%   92,990    92,990 
AR Entertainment  SDK payment services unit   167%   87,909    87,909 
AR Entertainment  MR software unit   174%   33,375    34,121 
            351,334    352,080 

 

We also performed sensitivity analysis on revenue growth rates and discount rates which shows there were no signs of impairment if actual revenue dropped to 80% of the forecast or the discount rate increases to 25% from 18.5% for all our reporting units.

 

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Revenue recognition

 

We adopted Accounting Standards Update (“ASU”) 2014-09 Revenue from Contracts with Customers (ASC Topic 606) for the year ended December 31, 2019, using the modified retrospective method for contracts that were not completed as of December 31, 2018. The ASU requires the use of a new five-step model to recognize revenue from customer contracts. The five-step model requires that we (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, including variable consideration to the extent that it is probable that a significant future reversal will not occur, (iv) allocate the transaction price to the respective performance obligations in the contract, and (v) recognize revenue when (or as) we satisfy our performance obligation.

 

Prior to 2019, we recognize revenue when all of the following have occurred: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the price or fees are fixed or determinable, and (iv) the ability to collect is reasonably assured. Revenue is presented in the consolidated statements of income and comprehensive income net of sales taxes. We do not offer rights of refund of previously paid or delivered amounts, rebates, rights of return or price protection. In all instances, we limit the amount of revenue recognized to the amounts for which we have the right to bill our customers.

 

The application of the five-step model to the revenue streams compared to the prior guidance did not result in significant changes in the way we record our revenue. Upon adoption, we evaluated our revenue recognition policy for all revenue streams within the scope of the ASU under previous standards, using the five-step model under the new guidance, and confirmed that there were no differences in the pattern of revenue recognition.

 

(i) AR Advertising Services

 

AR advertisements are the use holographic materials integrated into advertisement on the online media platforms or offline display. Our performance obligation is to identify advertising spaces and embed holographic AR images or videos into films, shows and short form videos that are hosted by online streaming platforms in China. Revenue is recognized at the time when the related services have been delivered based on the specific terms of the contract, which are commonly based on specific action (i.e. cost per impression (“CPM”) or cost per action (“CPA”) for online display and service period for offline display contracts.

 

We enter into advertising contracts with advertisers where the amounts charged per specific action are fixed and determinable, the specific terms of the contracts were agreed on by us, the advertisers and channel providers, and collectability is probable. Revenue is recognized on a CPM basis as impressions or clicks are delivered while revenue on a CPA basis is recognized once agreed actions are performed or service period is completed.

 

We consider ourselves as provider of the services as we have control of the specified services and products at any time before they are transferred to the customers, which is evidenced by (1) we are primarily responsible to our customers for products and services offered where the products were designed in house and we have customer services team to directly serve the customers; and (2) we have discretion in establish pricing. Therefore, we act as the principal of these arrangements and report revenue earned and costs incurred related to these transactions on a gross basis.

 

(ii) AR Entertainment

 

Our AR entertainment services mainly include three sub categories: SDK payment channel services, software development and mobile games operations and technology developments.

 

a. SDK Payment Channel Services

 

Our SDK payment channel services enable game players and app users to make online payments through Alipay, Unipay or Wechat pay, etc., to various online content providers. When game players and app users make payments in the game or app, the SDK payment channel will automatically populate payment services for the users to fulfill payments.

 

We charge a fee for the payment channel services, the pricing of which is based on the pre-determined rates specified in the contract. Our performance obligation is to facilitate payment services and we recognize SDK payment channel service revenue at the time when a user completes a payment transaction via a payment channel and is entitled to payment. Related fees are generally billed monthly, based on a per transaction basis. We believe that our promise to customer is to facilitate the services of third party, instead of providing the payment services ourselves, as we not have control of the services provided or serve the users directly, and we do not have the discretion in establishing pricing. Therefore, revenue from SDK payment service is recorded on a net basis.

 

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b. MR software development services

 

Our MR software development service contracts are primarily on a fixed price basis, which require us to perform services for MR application design, content development and integrating based on customers’ specific needs. These services also require significant production and customization. The required customization work period is generally less than one year. We currently do not have any modification of contract and the contracts currently do not have any variable consideration.

 

The software customization, application design, upgrades and integration are considered as one performance obligation. The promises to transfer software, customization and upgrades are not separately identifiable as the customers do not obtain benefits from these services on its own.

 

Our MR software development service contracts are generally recognized over time during the contract period as we have no alternative use of the customized software and application without incurring significant additional costs. Revenue is recognized based on our measurement of progress towards completion based on input or output methods. Input methods are used only when there is a direct correlation between hours incurred and the end product delivered, while output method is used when we could appropriately measure the customization progress towards completion. Assumptions, risks and uncertainties inherent in the estimates used to measure progress could affect the amount of revenues, receivables and deferred revenues at each reporting period. We have a long history of developing various MR software, and we believe we can reasonably estimate the progress toward completion on each fixed price customized contracts.

 

c. Mobile Games Services

 

We generate revenue from jointly operated mobile game publishing services and the licensed out games. In accordance with ASC 606, Revenue Recognition: Principal Agent Considerations, we evaluate agreements with the game developers, distribution channels and payment channels in order to determine whether or not we act as the principal or as an agent in the arrangement with each party respectively. The determination of whether to record the revenues gross or net is based on whether our promise to our customers is to provide the products or services, or to facilitate a sale by a third party. The nature of the promise depends on whether we control the products or services prior to transferring it to our customers. Control is evidenced if we are primarily responsible for fulling the provision of services and have discretion in establishing the selling price. When we control the products or services, our promise is to provide and deliver the products and we record the revenues on a gross basis. When we do not control the products, our promise is to facilitate the sale and we record the revenue on a net basis.

 

—Jointly operated mobile game publishing services

 

We offer publishing services for mobile games developed by third-party game developers. We act as a distribution channel that publishes the games on our own app or a third-party owned app or website, named game portals. Through these game portals, game players can download the mobile games to their mobile devices and purchase coins, the virtual currency, for in game premium features to enhance their game playing experience. We enter into contracts with third-party payment platforms for collection services offered to game players who have purchased coins. The third-party game developers, third party payment platforms and the co-publishers are entitled to profit sharing based on a prescribed percentage of the gross amount charged to the game players. Our obligation in the publishing services is completed at the time when the game players makes a payment to purchase coins.

 

With respect to the publishing services arrangements between us and the game developer, we considered that we do not control the services, as (i) developers are responsible for providing the game product desired by the game players; (ii) the hosting and maintenance of game servers for running the online mobile games are the responsibilities of the third party platforms; (iii) the developers or third party platforms have the right to change the pricing of in-game virtual items. Our responsibilities are publishing, providing payment solutions and market promotion services, and thus we view the game developers as our customers and consider ourselves as the facilitator of the game developers in the arrangements with game players. Accordingly, we record the game publishing service revenue from these games, net of amounts paid to the game developers.

 

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—Licensed out mobile games

 

We also license third parties to operate our mobile games developed internally through mobile portal and receives revenue based royalty payments from the third-party licensee operators on a monthly basis. Our performance obligation is to provide mobile games to game operators, which enable players of the mobile games to make in game purchases, and we recognize revenue at the time when game players complete the purchases. We record revenues on a net basis, as we do not have the control of the services provided, nor do we have the primary responsibility for fulfillment or the right to change the pricing of the game services.

 

d. Technology developments

 

Our technology development contract requires us to design applications based on customers’ specific needs. The duration of the design period usually lasts for approximately 3 months or less. Revenues are generally recognized at a point in time where we have transferred control of the asset upon completion of the design and after the acceptance by our customer with no more future obligation of the design project.

 

Contract balances

 

We record receivable related to revenue when we have an unconditional right to invoice and receive payment. Payments received from customers before all of the relevant criteria for revenue recognition are met are recorded as deferred revenues.

 

Contract costs

 

Contract costs represent costs incurred in advance of revenue recognition arising from direct costs in respect of the revenue contracts according to the customer’s requirements prior to the delivery of services, and such deferred costs will be recognized upon the recognition of the related revenue. Estimated contract costs are based on the budgeted service hours, which are updated based on the progress toward completion on a monthly basis. Pursuant to the contract terms, we have an enforceable right on payments for the work performed. Provisions for estimated losses, if any, on uncompleted contracts are recorded in the period in which such losses become probable based on the current contract estimates. We reviewed impairment of contract costs on December 31, 2019 and determined that all contract costs were recoverable.

  

Accounts receivable, net

 

Accounts receivable include trade accounts due from customers. Accounts are considered overdue after 90 days. Management reviews our receivables on a regular basis to determine if the bad debt allowance is adequate, and provides allowance when necessary. The allowance is based on management’s best estimates of specific losses on individual customer exposures, as well as the historical trends of collections. Account balances are charged off against the allowance after all means of collection have been exhausted and the likelihood of collection is not probable.

 

Intangible assets, net

 

Our intangible assets with definite useful lives primarily consist of copyrights, non-compete agreements, and technology know-hows. Identifiable intangible assets resulting from the acquisitions of subsidiaries accounted for using the purchase method of accounting are estimated by management based on the fair value of assets received. We amortize our intangible assets with definite useful lives over their estimated useful lives and reviews these assets for impairment. We typically amortizes our intangible assets with definite useful lives on a straight-line basis over the shorter of the contractual terms or the estimated useful lives of five to ten years.

 

Income taxes

 

We account for current income taxes in accordance with the laws of the relevant tax authorities. The charge for taxation is based on the results for the fiscal year as adjusted for items, which are non-assessable or disallowed. It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.

 

Deferred taxes is accounted for using the asset and liability method in respect of temporary differences arising from differences between the carrying amount of assets and liabilities in the consolidated financial statements and the corresponding tax basis used in the computation of assessable tax profit. In principle, deferred tax liabilities are recognized for all taxable temporary differences. Deferred tax assets are recognized to the extent that it is probable that taxable profit will be available against which deductible temporary differences can be utilized. Deferred tax is calculated using tax rates that are expected to apply to the period when the asset is realized or the liability is settled. Deferred tax is charged or credited in the income statement, except when it is related to items credited or charged directly to equity, in which case the deferred tax is also dealt with in equity. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Current income taxes are provided for in accordance with the laws of the relevant taxing authorities.

 

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An uncertain tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. No penalties and interest incurred related to underpayment of income tax are classified as income tax expense in the period incurred. PRC tax returns filed in 2017 to 2019 are subject to examination by any applicable tax authorities.

 

Internal Control of Financial Reporting

 

Our independent registered public accounting firm, had not conducted an audit of our internal control over financial reporting. However, in connection with the audits of our consolidated financial statements for the two years ended December 31, 2018 and 2019, we and our independent registered public accounting firm identified one “material weakness” in our internal control over financial reporting, as defined in the standards established by the PCAOB, and other control deficiencies. 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 annual or interim financial statements will not be prevented or detected on a timely basis.

 

The material weaknesses identified are related to (1) our lack of sufficient skilled staff with U.S. GAAP and SEC reporting knowledge for the purpose of financial reporting as well as the lack of formal accounting policies and procedures manual to ensure proper financial reporting in accordance with U.S. GAAP and SEC reporting requirements; and (2) the absence of audit committee and internal audit function to establish formal risk assessment process and internal control framework.

 

In response to the material weaknesses identified prior to this offering, we are in the process of implementing a number of measures to address the first material weakness that has been identified, including: (i) streamline our accounting department structure and enhance our staff’s U.S. GAAP expertise on a continuous basis; (2) hire a new reporting manager who has sufficient expertise in U.S. GAAP to improve the quality of U.S. GAAP reports; (3) make an overall assessment on the current finance and accounting resources and have plans to hire new finance team members with U.S. GAAP qualification in order to strengthen our U.S. GAAP reporting framework; (4) participate in trainings and seminars provided by professional services firms on a regular basis to gain knowledge on regular accounting/SEC reporting updates; and (5) provide internal training to our current accounting team on US GAAP knowledge. We are also in the process of completing a systematic accounting manual for US GAAP and financial closing process.

 

For the second identified material weakness, we have established an audit committee headed by audit committee chair, Ms. Shan Cui. Ms. Shan Cui has extensive experience and expertise in finance, investment and capital markets. We will form an internal audit function and have plans to hire internal auditors to strengthen our overall governance. The internal auditor will be independent of our operations and will report directly to the audit committee. We will perform self-assessment of internal control effectiveness on a continuous basis, which will be led by our internal auditor. We will also hire more competent personnel and involve professional service companies to help us implement SOX 404 compliance together with the establishment of our internal audit function.

 

However, we cannot assure you that we will remediate our material weaknesses in a timely manner. See “Risk Factors—Risks Relating to Our Business and Industry—If we fail to implement and maintain an effective system of internal controls, we may be unable to accurately report our results of operations, meet our reporting obligations or prevent fraud, and investor confidence and the market price of our shares may be materially and adversely affected.”

 

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, in the assessment of the emerging growth company’s internal control over financial reporting.

 

Recent Issued Accounting Pronouncements

 

For detailed discussion on recent accounting pronouncements, see Note 2 to the consolidated financial statements included elsewhere in this annual report.

 

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Quantitative and Qualitative Disclosures about Market Risk

 

Credit Risk

 

Credit risk is controlled by the application of credit approvals, limits and monitoring procedures. We manage credit risk through in-house research and analysis of the Chinese economy and the underlying obligors and transaction structures. We identify credit risk collectively based on industry, geography and customer type. In measuring the credit risk of our sales to our customers, we mainly reflect the “probability of default” by the customer on its contractual obligations and considers the current financial position of the customer and the exposures to the customer and its likely future development.

 

Liquidity Risk

 

We are also exposed to liquidity risk which is risk that we are unable to provide sufficient capital resources and liquidity to meet our commitments and business needs. Liquidity risk is controlled by the application of financial position analysis and monitoring procedures. When necessary, we will turn to other financial institutions and related parties to obtain short-term funding to meet the liquidity shortage.

 

Foreign Exchange Risk

 

While our reporting currency is the RMB, we have one operating entity’s functional currency is HK dollar and two operating entities’ functional currency is USD. As a result, we are exposed to foreign exchange risk as our results of operations may be affected by fluctuations in the exchange rate among HK dollar, USD and RMB. If the RMB appreciates against the HK dollar and USD, the value of our HKD or USD revenues, earnings and assets as expressed in our RMB financial statements will decline. We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.

 

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INDUSTRY OVERVIEW

 

All data and information regarding China’s economic growth and the holographic industry contained in this section is from the Frost & Sullivan Report unless otherwise indicated.

 

China’s Economic Ground

 

Nominal GDP in China

 

Driven by a series of economic stimulus policies adopted by the Chinese government, including the Four-Trillion-Yuan Economic Stimulus Package and the Revitalization Plans of Ten Key Industries, China’s nominal gross domestic product (“GDP”) grew rapidly from RMB64.4 trillion in 2014 to RMB90.0 trillion in 2018 at a CAGR of 8.7%. Going forward, the structural adjustment of the economy is predicted to be pushed forward strongly by the Chinese authorities to improve the quality and efficiency of economic development. The economy is likely to maintain a sound and healthy development. The nominal GDP is forecast to grow at a CAGR of 5.9% from 2018 to 2023. The robust economic growth creates a favorable macro environment for the further development of industries like entertainment industry or advertising industry in China.

 

Per capita disposable income of households in China

 

Per capita disposable income of households in China has demonstrated strong growth momentum in the past few years, growing from RMB20.2 thousand in 2014 to RMB28.0 thousand in 2018, representing a CAGR of 8.5% in this period. In view of China’s moderate economic growth outlook, it is estimated that the per capita disposable income of households in China will reach RMB 41.7 thousand in 2023, representing a CAGR of 8.3% from 2018 to 2023. The increase in per capita disposable income is a contributory factor that drives the growth of personal expenditures on entertainment activities and consuming products or services. For example, the increase in disposable income may lead more consumers to be more willing to experience emerging technology products like AR or virtual reality(“VR”) products.

 

China’s per capita expenditure on education, culture and recreation

 

China’s per capita expenditure on education, cultural and recreation rose at a CAGR of 9.7% from RMB1,536 in 2014 to RMB2,226 in 2018. China’s residents are allocating an increasing portion of their expenditures on education, culture and recreation. And China’s per capita expenditure on education, culture and recreation is predicted to reach RMB3,300 in 2023, representing a CAGR of 8.2% from 2018 to 2023. The increase in expenditure on education, culture and recreation boosts the growth of relevant markets, such as entertainment market and consuming electronic device market.

 

Overview of the Global and China Holographic AR Industry

 

Introduction of AR and holographic AR

 

AR is a display concept involving the integration of real-world surroundings and virtual objects, as against the concept of VR, which involves merely artificial objects and space. The AR display of the interaction between reality and virtuality can be achieved via two-dimensional (“2D”) screen, head-mounted devices or 3D space.

 

2D screen-based holographic AR

 

The common example of current 2D screen based holographic AR are smartphone applications created with ARSDK, such as Apple’s ARKit and Google’s ARCore. These applications integrate digital objects into pre-recorded videos or real-time captured surroundings and the objects do not change their relative position against surroundings even if the devices are moved around. Therefore, it creates a perception for viewers that the digital holograms of objects are part of the existing video feeds or surroundings.

 

Head-mounted device-based holographic AR

 

The popular examples of head-mounted, device-based holographic AR include Microsoft HoloLens, Magic Leap, and Google Glass. It works in a similar way as 2D screen based holographic AR, but it utilizes a head-mounted device and relies on the real-time captured surroundings. This has attracted great attentions globally, but is mainly targeting at corporate clients due to high price.

 

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3D space-based holographic AR

 

3D space-based holographic AR does not require 2D smartphone screen or head-mounted devices and viewers are able to experience hologram superimposed on real-time surroundings with unaided eyes. The key component of 3D space-based holographic AR is a flat transparent film made of special material, which is used to reflect and transmit the light field to audience and form a holographic display experience. The popular examples include Japanese virtual singers in concert shows and guides in museums, exhibitions, theme parks and tourism sites, such as DeepFrame by Realfiction. A more sophisticated product involving simultaneous localization and mapping (“SLAM”) is Navion by WayRay, used as head-up display (“HUD”) in automobile for holographic display on the windshield. Another type of 3D space-based holographic AR utilizes a multi-facet transparent screen where hologram is formed in the space centered by the screen, such as HoloPlayer by Looking Glass Factory.

 

Holographic AR utilizes digital holography technology to record a digital hologram of objects and then transfer the recorded information to a computer to analyze and form 3D images, which are subsequently displayed in a two-dimensional (2D) surface or three-dimensional (3D) space.

 

Holographic AR incorporates the characteristics of hologram and augmentation reality. A hologram is a photographic recording of a light field to display a 3D projection of an item in the real world, as if the physical object were actually there.

 

The holographic AR products and solutions provided by the Group are mainly 2D screen based holographic AR and 3D space based holographic AR with flat transparent film made of special material.

 

Description of the Value Chain and Subsectors

 

The holographic AR industry value chain consists of three major segments. The upstream segment refers to key hardware, software, service and providers as well as players related to content production. The midstream participants are holographic AR solution providers, integrating upstream hardware and incorporating software system to form the final products or solutions, such as holographic AR adverting platform and head-mounted display. Downstream refers to end users, including government, enterprises and household/individual consumers.

 

The business models for upstream and midstream participants in holographic AR market are different. While the hardware parts, software and service providers focus on research and development to further their core technology and reduce the production cost, the holographic AR device integrators and content creators also have to identify target users, build brand reputation and enhance the user experience. It is not uncommon that some holographic AR device integrators have strong in-house research capability and undertake the roles in both upstream and midstream segments.

 

We are currently involved in upstream segments, including software development, content production technology provision and content creation & distribution as well as midstream segment, namely holographic AR solution provision.

 

Value Chain of the Holographic AR Industry

 

 

 

Note: The segments in which we are currently involved in have been circled in a dashed red line.

 

Source: Frost & Sullivan

 

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The major forms of final products and services in holographic AR industry include hardware products, software and content products, and solution products and services.

 

Holographic AR hardware products are the display devices providing holographic AR experience, mainly including holographic AR enabled smartphones/tablets and holographic AR head-mounted display. Through these devices, users are able to view the combined projections of reality captured by the camera and virtual objects simulated by the computer. The difference is that users view the projections through the screens of smartphone/tablets or by wearing the head-mounted display. The head-mounted display provides a more immersive experience; however, it requires the users to purchase a separate device.

 

Holographic AR software and content products are the software application and content produced with holographic AR technology and used or played on the holographic AR display devices. These software and content can be either originally created or adapted from its 2D counterparts which have gained popularity in the past. Special holographic AR technology is used to facilitate these software and content, such as cameras which are equipped with 3D sensing and are able to capture the 3D position of objects. These holographic AR software and content products are usually distributed through the distribution platforms, which are either independent, such as Ali Huoyan, or embedded in the holographic AR operating system. Currently, the majority of developers are focusing game and entertainment related software and contents. In addition, the interests in education and utilities related software are also rising.

 

Holographic AR solution products and services are integrated packages provided to government and enterprise clients to meet certain needs in their operation. These integrated packages involve hardware products, software and content products as well as service provided to facilitate clients with the implementation. Currently, the most well-established solution products are the tools for marketing and training. The novel form of marketing with holographic AR elements helps to attract potential customers and enhance their brand awareness. Holographic AR tools also provide great simulation for training, especially in industrial manufacturing and disaster relief.

 

The Role of the Platform Providers

 

Along the holographic AR value chain, our primary role is the middleware platform provider, which connects the fundamental SDK platform providers and application developers.

 

SDK platform is a package of toolkits of various functions which allow its users (middleware providers and application developers) to develop software application, framework and system without programming the code from sketch. Currently, the most well-known SDK platforms are Apple’s ARKit and Google’s ARCore, which provide the fundamental toolkits servicing IOS and Android ecosystem, and subsequently middleware providers and application developers are able to create various applications targeting at end users. In addition, leading Chinese internet companies, including Baidu, Jingdong, Alibaba, Netease, have also built their own ARSDK platforms, mainly for in-house usage.

 

Middleware platform is a package of modules which supplements the fundamental toolkits provided by SDK platform. It allows its users (application developers) to complete their software application without programming the code from sketch. Currently, the major middleware platform providers in China are our company, Sight Plus and Hiscene.

 

Among the China holographic AR integrated solution providers in China, we ranked first with revenues of RMB225.3 million in 2018.

 

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Top Five Holographic AR Integrated Solution Providers in China, By Revenue, 2018

 

 

 

Source: Frost & Sullivan

 

Top Five AR Advertising Service Providers in China, By Revenue, 2018

 

 

 

Source: Frost & Sullivan

 

Market Size, Opportunities and Future Trends

 

As a nascent market, global holographic AR market has a huge growth potential and has attracted large investments contributing to the industry growth since 2016. Several organizations including research and development labs are investing immensely in the technology to develop solutions for enterprise and consumer segments. Mobile augmented reality market has witnessed high adoption over the years across applications including gaming, media and marketing. The increasing scope of applications across different industries, such as advertising, entertainment, education and retail is expected to drive demand over the forecast period.

 

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Global Holographic AR Market Size by Revenue, 2016-2025E

 

 

 

Note: Hardware refers to the revenue of hardware manufacturers, including augmented reality rendering device, such as AR glasses, AR helmets, etc., and holographic imaging devices such as holographic projectors, holographic cabinets, holographic advertising machines, etc. Software & content refers to the revenue of participants who providing AR and holographic contents, ARSDK or technical services.

 

Source: Frost & Sullivan

 

China has a large number of Internet users and mobile Internet users. With the introduction of the underlying tool platform by system vendors such as Apple and Google, it is much more convenient for developers to create and apply diverse AR content, enabling AR technology to quickly reach a large number of users. In addition, stores offering AR experiences are penetrating rapidly into China’s shopping malls. Consumers can enjoy the AR experience at a low cost, which has promoted consumers’ acceptance of AR. AR has been more widely used in beauty industry. A lot of camera software has integrated AR technology which allows simulation of makeup by uploading their photos, as simple as processing software. For example, Bulgari and Meitu Camera jointly launched the AR effect of its necklace.

 

Holographic AR Market Size of PRC by Revenue, 2016-2025E

 

 

 

Note: Hardware refers to the revenue of hardware manufacturers, including augmented reality rendering device, such as AR glasses, AR helmets, etc., and holographic imaging devices such as holographic projectors, holographic cabinets, holographic advertising machines, etc. Software & content refers to the revenue of participants who providing AR and holographic contents, ARSDK or technical services.

 

Source: Frost & Sullivan

 

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Applications

 

AR applications are currently mainly adopted by entertainment, advertisement, and education industries which have relative mature hardware environment and thus facilitate the development of software and content in these fields. In long-term, there will also be applications in social network and communication fields, even though currently such applications are still limited by hardware technologies.

 

Distribution of China’s AR Market

 

 

Entertainment

 

Entertainment industry is the first to enjoy the application of holographic AR. From hologram of TuPac, Hatsune Miku, late singer Teresa Deng, to the heat of Pokemon Go, AR gaming, hologram live concert, fashion shows have warmly embraced holographic AR.

 

The market size of China holographic AR applied in entertainment recorded revenue of RMB0.6 billion in 2016, and it is expected to increase at a CAGR of 83.5% from 2016 to 2020 and at a CAGR of 92.8% from 2020 to 2025, reaching RMB180.0 billion by 2025. The growth is attributed to the increasing popularity of entertainment broadcast programs, especially live broadcast programs, including ceremonies, concerts, gala, and sport events, where AR is greatly potentiated. Besides, the enhanced accessibility of live broadcast, livestream brought by smartphone and other portable digital devices has also contributed to the growth.

 

AR in gaming will move towards interactive games involving multi-players. More popular AR mobile phone games will come to market with strong IP backed. In addition, head-mounted display (“HMD”) based AR games will see rapid growth as HMD price going down. Holographic AR will also be more broadly applied on live broadcast. In the long run, HMD based holographic AR games will become a major form of games, multi-player games and relative arena will come to market. Holography will be applied in more live shows, from PC game in arena to concerts.

 

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Breakdown of China’s AR Industry Market Size, Entertainment, 2016-2025E

 

 

 

Source: Frost & Sullivan

 

Advertisement

 

Holographic AR in advertisement has two types: volumetric and online app. For example, Snapchat and Instagram have developed AR filter styled advertisement, featuring fast-moving consumer goods (“FMCG”) & cosmetic products. Another type of advertisement is “plug-in” advertisement in TV show through manually adding computer generated 3D images to original scene to promote products.

 

 

The market size of China holographic AR applied in advertisement recorded revenue of RMB0.9 billion in 2016, and it is expected to increase at a CAGR of 71.8% from 2016 to 2020 and another 78.9% from 2020 to 2025, reaching RMB143.9 billion by 2025. The growth is mostly driven by the prosperity of advertisement sector and the new retail business. As the advertisers are always pursuing the most cutting-edge visual effect to attract customers, the AR application in advertisement can be considered keeping evolving to be more diversified.

 

Volumetric display will take certain shares of offline advertisement display, as volumetric display has more astonishing effect compared to traditional display, therefore can be vastly applied in retail store. Sponsored filters inside social network app will rise due to the boom of short video apps in China. In the long run, holographic AR advertisement will be more interactive and volumetric display will keep taking more shares and come in larger sized projection. Also, advertisers’ interaction between costumers without head mounted devices and other electronics may be achieved.

 

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Breakdown of China’s AR Industry Market Size, Advertisement, 2016-2025E

 

 

 

Source: Frost & Sullivan

 

Key Drivers

 

Ultimate goal for visual display medium

 

In the past few centuries, the mainstream visual display medium has experienced an extraordinary shift from paper (books) to large screen (TV/PC) and small screen (smartphone). Despite the increasing quality of visual display medium, it is still far from the ultimate goal, which is the perfect integration of virtuality and reality, and human beings have never been closer to that goal with holographic AR technology. Therefore, the motivation to achieve the ultimate goal for visual display medium will drive the continuous endeavor into this field and will guarantee the wide acceptance and adoption once the market condition is mature.

 

Advancement in technology

 

Holographic AR industry is technology-intensive. The holographic AR experience can only be enabled by the combination of hardware and software technologies, and the advancement in technology related to holographic AR will take the holographic AR experience into the next stage. For example, breakthroughs in deep learning AI technology will allow the holographic AR devices to integrate the content captured by camera and simulated by computer in a more seamless way, thus providing a more immersive experience to users. In addition, evolvement of integrated chips will allow image processors to be produced at a lower cost, thus reducing the selling price of holographic AR devices. Wide adoption of 5G network will enable the real-time data transmission between local devices and the internet, thus largely enhancing the content diversity. With enhanced holographic AR experience, reduced selling price and ample contents, the market demand for holographic AR will be driven up significantly.

 

Diversifying customer base and expanding application fields

 

Currently, the relatively mature application fields of holographic AR include entertaining and advertising industry. With increasing awareness and acceptance of this technology, holographic AR advertising will be adopted by more brand owners, and holographic AR shopping will gain popularity among e-commerce platforms. In addition, as the holographic AR technology matures, more application fields will be identified to magnify the value of this technology, such as assistance in surgery and tele-diagnose, and assistance in training and education.

 

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Government and policy support

 

In July 2017, the Ministry of Education (“MOE”) issued the “Notice on the construction of demonstration virtual simulation experiment teaching project in 2017-2020”. The Notice establishes the virtual simulation experimental teaching demonstration in ordinary colleges and universities from 2017 to 2020, on the basis of the experimental teaching reform and the information of experimental teaching projects in colleges and universities. The research and development of virtual simulation experiment teaching project shall aim to meet the teaching requirements with the comprehensive application of multimedia, big data, 3D modeling, artificial intelligence, human-computer interaction, sensors, supercomputing, virtual reality, augmented reality, cloud computing and other technology, enhancing the attraction of the experimental teaching program and teaching effectiveness. In addition, “National science and technology innovation plan”, “Science and technology innovation special plan for health industry”, and “Special plan for scientific and technological innovation of medical devices” under the 13th five-year plan all provided policy support for the development of the holographic AR industry.

 

Restraining Factors

 

Lack of specialized talents for research and development

 

For a technology-intensive industry, capability in research and development is key, which relies on the acquirement of specialized talents. Holographic AR is a relatively new area, emerging only in recent years. As a result, the number of specialists in this field is very limited. Without sufficient talents pool, it would be very challenging to progress in the technology breakthrough.

 

Lack of high-quality content

 

Superior holographic AR experiences reply on both sophisticated display devices and high-quality contents. Without sufficient high-quality contents, the users would not be motivated to purchase the hardware, especially when the current price of holographic AR hardware is not easily affordable.

 

Lack of capital support

 

As holographic AR industry is still in the infant stage when large amount of investment is needed to conduct research and development, to achieve profitability is extremely difficult for most of the incumbents. Without sufficient capital support, the business of these holographic AR companies would soon step into the mire.

 

Policies and Regulations

 

Guidance on further expanding and upgrading information consumption to constantly unleash the potential of domestic demand

 

The primary goal is to develop new types of high-end mobile communication terminals, wearable devices, digital household products, and cutting-edge information products, such as virtual reality, augmented reality, intelligent network vehicles, and intelligent service robots, which are geared toward consumer upgrading; Strengthen the development of core technologies and platforms for “Internet plus” artificial intelligence, promote the development and industrialization of virtual reality and augmented reality products, and support innovation and industrial upgrading of products such as wearable devices, consumer drones and intelligent service robots; Support enterprises to speed up the construction of online and offline experience centers, actively use technologies such as virtual reality, augmented reality and interactive entertainment to enrich consumption experience and cultivate consumers’ information consumption habits.

 

New generation AI development plan

 

The primary goal is to achieve breakthroughs in high-performance software modeling, content generating, augmented reality and human-computer interaction, integration environment and tools; further research on key technologies such as virtual display devices, optical devices, high-performance true 3D display, development engine and other products, set up the standards and evaluation system for virtual reality and augmented reality technology; strengthen the research and development of next-generation social networks, accelerate the popularization and application of technologies such as augmented reality and virtual reality, promote the synergistic integration of virtual environment and physical environment, meet the real-time information needs such as personal perception, analysis, judgment and decision-making, and realize smooth switching in different scenes such as work, study, life and entertainment.

 

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Notice on the Thirteenth Five-Year Plan for the Development of National Education

 

The PRC MOE issued the Notice on the Thirteenth Five-Year Plan for the Development of National Education in 2017, encouraging the application of advanced technology in education in the PRC. The purpose of such technology is to support schools from all stages of education to build smart campuses and explore new models of future education and teaching through applications of the Internet, big data, artificial intelligence and virtual reality technology. Colleges and universities are encouraged to carry out continuing education with or without academic qualifications on the basis of the Internet.

 

Notice on the Construction of Demonstrative Virtual Simulation Experiment Teaching Project in 2017-2020

 

To enhance the quality of higher education, the MOE issued a notice to encourage the application of advanced information technology in experimental projects in higher level education. The notice provides that research and development of virtual simulation experimental teaching projects should aim at fulfilling education requirements and contents by comprehensively applying multimedia, big data, three-dimensional modeling, artificial intelligence, human-computer interaction, sensors, supercomputing, virtual reality, augmented reality, cloud computing and other networked, digital and intelligent technical means to improve the attractiveness and teaching effectiveness of experimental teaching projects. The purpose of such projects is to strengthen the research on the reliability of relevant technology, pay attention to all-round and multi-level protection of students using virtual simulation experimental teaching project and ensure students’ health.

 

Notice on special initiative of innovation capacity building in the field of “Internet +”

 

In order to promote the rapid development of the “Internet +” industry, the NDRC decided to organize and implement the special project of “Internet +” innovation capacity building and incorporate AR/VR technology into the special project.

 

Construct virtual reality/augmented reality technology and application innovation platform to resolve the issues related to virtual reality/augmented reality in China, such as poor user experience. The platform shall support content shooting, data modeling, sensors, tactile feedback, new display, image processing, surround sound, terminal (ultra) high resolution processing performance, such as virtual reality/augmented reality testing technology research and development and engineering, to enhance the service capability.

 

National science and technology innovation plan for the 13th five-year plan

 

The primary goal is to develop new Internet technologies and natural human-computer interaction technologies, with emphasis on intelligent perception and cognition, virtual-real integration and natural interaction; achieve breakthroughs in a number of key technologies such as virtual and real fusion rendering, real and three-dimensional rendering, real-time positioning registration, and human-oriented virtual reality technology, and forms core equipment with independent intellectual property such as high-performance true and three-dimensional display, smart glasses, motion capture and analysis system and personalized virtual reality; form the basic standards for display, interaction, content, interface and other aspects of virtual reality and augmented reality.

 

Competitive Landscape

 

The competition among holographic AR companies is intense. The global holographic AR market is characterized by the presence of international and local market players with giant international players mainly focusing on hardware such as AR display devices or underlying SDK platform and AI technology while local players mainly focusing on the application software development.

 

We ranked first in terms of number of clients, holographic AR contents, as well as the number of holographic AR patents and software copyrights in 2018, in the Chinese holographic AR industry, as shown below.

 

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Top Five Holographic AR Integrated Solution Providers in China, By Number of Clients, 2018

 

 

 

Source: Frost & Sullivan

 

Top Five Holographic AR Integrated Solution Providers in China, By Number of Registered Holographic AR Patents, 2018

 

 

 

Source: Frost & Sullivan

 

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Top Five Holographic AR Integrated Solution Providers in China, By Number of Holographic AR Contents, 2018

 

 

 

Source: Frost & Sullivan

 

Top Five Holographic AR Integrated Solution Providers in China, By Number of Software Copyrights, 2018

 

 

 

Source: Frost & Sullivan

 

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BUSINESS

 

Our Vision

 

Our vision is to become the creator of the largest holographic AR ecosystem in China.

 

Our Business

 

We offer AR-based holographic services and products to cater to our customers’ needs, all centered upon providing an innovative, immersive and interactive holographic augmented reality experience for our customers and end users. Our service and product offerings primarily consist of holographic AR advertising services and holographic AR entertainment products. Approximately 69.3%, 80.5%, and 83.8% of our revenues were generated from our holographic AR advertising services for the years ended December 31, 2017, 2018, and 2019, respectively. Approximately 30.7%, 19.5%, and 16.2% of our revenues were generated from our holographic AR entertainment products for the years ended December 31, 2017, 2018, and 2019, respectively. The core of our business is holographic AR technologies used in software engineering, content production, cloud and big data. By leveraging our strong technological capabilities and infrastructure, we are able to deliver superior products and services and conduct our operations in a highly efficient manner.

 

Holographic AR Advertising Services

 

Our holographic AR advertising software enables users to insert into video footages real or animated three dimensional (“3D”) objects that integrate seamlessly within the scene of such footages. Our online holographic AR advertising solution embeds holographic AR ads into films and shows that are hosted by leading online streaming platforms in China. For the year ended December 31, 2018, holographic AR ads produced using our software generated a total of approximately 6.6 billion views, representing an increase of 34.7% from approximately 4.9 billion views for the year ended December 31, 2017. For the year ended December 31, 2019, holographic AR ads produced using our advertising solutions generated approximately 9.7 billion views, representing an increase of 47.0% from approximately 6.6 billion views for the year ended December 31, 2018. View” is also known as “impression”. Each time an advertisement is fetched, it is counted as one impression or one view. CPM, or cost per thousand impressions, is a term used in traditional, online advertising and marketing related to web traffic, which refers to the cost or expense incurred for every thousand potential customers who view the advertisement.

 

Our customers are those who have entered into contracts with us and used our services pursuant to such contracts during the relevant period. Customers typically enter into a master agreement with us for a term of one year, although they do not necessarily purchase products or services from us during each quarter of such year. A separate request is submitted by a customer for each order of products or services. The number of our customers for advertising services increased from 97 for the year ended December 31, 2017, to 121 for the year ended December 31, 2018 and further increased to 153 for the year ended December 31, 2019. Average revenue per customer for AR advertising services increased from approximately RMB1.4 million for the year ended December 31, 2017, to approximately RMB1.5 for the year ended December 31, 2018 and further increased to approximately RMB1.7 million for the year ended December 31, 2019.

 

Through our proprietary image and video recognition technologies, our software enables users to analyze the underlying video footages at a pixel level to identify ad spaces that can be augmented by 3D objects. Advertisers and their agencies purchase these ad spaces through application programming interfaces, or APIs, integrated with our systems, specifying their target audience and budgets and typically providing the 3D models to be embedded in the videos. When the ad space is detected and 3D objects are generated, the 3D objects are embedded into the underlying streaming videos automatically on a batch-processing basis as determined by our software.

 

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Holographic AR Advertising Services

 

Our holographic AR advertising software enables users to insert into video footages real or animated three dimensional (“3D”) objects that integrate seamlessly within the scene of such footages. Our online holographic AR advertising solution embeds holographic AR ads into films and shows that are hosted by leading online streaming platforms in China. Through our proprietary image and video recognition technologies, our software enables users to analyze the underlying video footages at a pixel level to identify ad spaces that can be augmented by 3D objects. Advertisers and their agencies purchase these ad spaces through application programming interfaces, or APIs, integrated with our systems, specifying their target audience and budgets and typically providing the 3D models to be embedded in the videos. When the ad space is detected and 3D objects are generated, the 3D objects are embedded into the underlying streaming videos automatically on a batch-processing basis as determined by our software. For the year ended December 31, 2018, holographic AR ads produced using our software generated a total of approximately 6.6 billion views, representing an increase of 34.7% from approximately 4.9 billion views for the year ended December 31, 2017. For the year ended December 31, 2019, holographic AR ads produced using our advertising solutions generated approximately 9.7 billion views, representing an increase of 47.0% from approximately 6.6 billion views for the year ended December 31, 2018.

 

Through our proprietary image and video recognition technologies, our software enables users to analyze the underlying video footages at a pixel level to identify ad spaces that can be augmented by 3D objects. Advertisers and their agencies purchase these ad spaces through application programming interface, or APIs, integrated with our systems, specifying their target audience and budgets and typically providing the 3D models to be embedded in the videos. When the ad space is detected and 3D objects are generated, the 3D objects are embedded into the underlying streaming videos automatically on a batch-processing basis as determined by our software.

 

The following diagram illustrates the key steps of our online holographic AR advertising business:

 

 

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The following screenshots are examples of in-video holographic AR ads produced or processed using our software.

 

 

As compared with traditional forms of digital ads, we believe that the ads generated using our holographic AR technology have the following key benefits:

 

Engaging and interactive. Holographic AR ads tend to create a more engaging, memorable experience that likely stimulates the purchase impulse. Holographic AR ads encourage engagement between the consumers and brands, creating a relationship that is more interactive than other forms of ads.

 

Natural and non-disruptive. As compared with traditional banner ads and video-based ads that flash and spin on the screen, holographic AR ads are naturally blended with the scenes in the films or TV shows, which helps to overcome advertising blindness and create a natural, non-disruptive viewing experience.

 

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Cost-effectiveness and flexibility. Our technologies identify appropriate ad space that can be used repeatedly for ads of multiple brands. While video-embedded 3D objects provide substantially the same level of reality as compared to tangible ads, they tend to be more cost-effective as they save the costs associated with shooting a commercial.

 

Holographic AR Entertainment Products

 

Our holographic AR entertainment products consist primarily of payment middleware software, game distribution platform and holographic MR software.

 

Payment middleware is a software solution that connects mobile apps to payment channels, giving mobile app users convenient access to a wide range of online payment options. We have cooperated with more than 55 app developers and our payment middleware has been embedded to over 1,100 marketed mobile apps of over 300 customers in 2018, most of which were featured by AR functions.

 

Our advanced payment middleware streamlines the often time-consuming mobile payment process. Our mobile payment middleware facilitates app developers to build an in-app payment infrastructure that allows micropayments to be made or received through an efficient, secure system, without any interface redirection. Such mobile payment middleware enables app developers to store users’ payment credentials in a trusted and safe environment and eases user’s burden of repeatedly entering and authenticating payment information for each transaction.

 

Our payment middleware can be fully integrated with various types of mobile apps, especially those employing AR technologies, such as live streaming, gaming, selfie, photo editing, and video-sharing apps. Currently, our payment middleware supports substantially all of the major online payment channels in China, and is compatible with the mainstream mobile operating systems.

 

The following graphic illustrates the key steps involved in the holographic AR payment middleware services that we provide to app developers:

 

 

We generate revenues from our mobile payment middleware by sharing revenues with app developers at an agreed-upon percentage. In addition, in 2018, we launched 233 Game Platform, an online game distribution platform. This platform provides game developers with technical support and value-added services that may help them target, reach and monetize their audiences. For the year ended December 31, 2019, over 800 apps were operated on or docked into our 233 Game Platform, which attracted over 260,000 active members, defined as the number of registered accounts that logged in at least once during a specified time period. We started generating revenue from our platform in the second quarter of 2019, as we started adding new apps to the platform that gained polarity with users, and certain existing games became more popular among users.

 

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We also sell MR software, a comprehensive holographic application platform independently developed by our research and development team, which includes holographic audio-visual integrated operation, holographic advertising service, holographic media asset management and holographic data management on the platform level and holographic interactive system, holographic recognition system, holographic labeling system, holographic tracking system, holographic capture system and holographic analysis system. Our MR software also includes multiple modules that allow end-users to edit and display holographic AR contents and create their own custom visual effects.

 

Our AR holographic entertainment business is based on users’ demand for entertainment applications in the field of 3D computer vision. We charge the customers software license fees. With the development and popularization of AR holographic hardware devices, we expect that there will be more applications in the future for our AR holographic entertainment products.

 

 

Competitive Strengths

 

Leading Holographic Augmented Reality Application Platform in China

 

We are the largest holographic AR application platform in China, in terms of total revenues in 2018, according to Frost & Sullivan. In addition, we have built the most comprehensive and diversified holographic AR content library among all holographic AR solution providers in China, and we have been ranked No. 1 in the PRC holographic AR industry in terms of revenues, number of clients, holographic AR contents, as well as the number of holographic AR patents and software copyrights in 2018, according to Frost & Sullivan. As of December 31, 2019, we owned over 4,600 ready-to-use AR holographic contents, 237  software copyrights, and 145 registered patents. We are committed to using hologram technology to address entertainment and business demands of our customers and end-users. According to Frost & Sullivan, the holographic AR application platform that we currently operate covers the broadest types of holographic AR offerings in China. We believe that our comprehensive offerings are a key factor that differentiates us from our competitors.

 

Market Potential Across the Holographic AR Value Chain

 

As holography and AR continue to proliferate, China’s holographic AR market is fast-growing and evolving. According to Frost & Sullivan, the total market size of China’s holographic AR industry in terms of total revenues is expected to grow from RMB 3.6 billion in 2017 to RMB 454.8 billion in 2025.

 

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Holographic AR Industry Pioneer with Extraordinary Advantage

 

AR industry is increasingly attracting more attention from investors. As an industry leader, we have successfully completed a few financing rounds from investors to date. As a first-mover, we enjoy the benefits of economies of scale resulting from the reduction in unit output costs. Our strong capability to provide strong AR contents can assist customers in adopting our AR technologies. We believe that our market position and corresponding marketing capabilities can help us establish a brand image that spans various segments across the entire market.

 

Evolutionary Holo AR Advertisement Solution Provider

 

We are an innovative service provider in AR holographic advertising technology. Compared with the traditional video advertisements, we can advertise advertisements based on video flow/view changes. The process of embedding can be independent of the particular advertisement position and will only be implemented for popular flow videos, which will be superior to traditional advertisement implementation due to its superior customer experience and advertising effectiveness.

 

Cutting-edge Technology Capabilities and High-Quality User Experience

 

We have developed the professional media player in China specifically designed for holographic AR contents. It has built in a comprehensive set of setting parameters and editing tools used for holographic AR content playback and allows end-users to playback complex high-fidelity simulations quickly and cost-effectively. End-users are able to adjust the contrast, saturation and vibrancy of the displayed holographic AR content and create their own custom visual effect.

 

Equipped with advanced AR3D scanning capabilities and simulation solutions, we are able to scan objects from more angles and capture more details of image than most peer companies. As a result, we are capable of identifying and capturing up to 550 blocks of images data per unit, significantly outstripping the average market level of 40 to 50 blocks, according to Frost & Sullivan. Meanwhile, powered by our sophisticated big data and AI analytics, our superior image processing technique and distribution algorithm enable us to efficiently and intelligently synthesize, calibrate and optimize the best possible 3D models based on raw images captured by us.

 

 

 

Source: Frost & Sullivan

 

Our technology platform is built on highly scalable and flexible cloud-based infrastructure, enabling us to store and harness large quantities of real-time data collected from our products and third party sources and ensures high-speed performance to accommodate more business partners. We utilize our sophisticated data mining and user behavioral data analytics to create an interest profile for end-user based on user’s actions. Currently, we have derived over 2,000 user tags by analyzing user data we collected through our holographic AR advertising services from a solid end-user base of approximately 350 million.

 

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Experienced Management Team

 

We benefit significantly from the experience of our founder and senior management team, who have been successfully riding the growth wave of China’s booming holographic AR industry. Our management team has both the technical expertise and the management experience that we believe are needed to continue to guide our growth. Our chairman, Mr. Jie Zhao, has been with our company since our inception and possesses deep entrepreneurship and extensive expertise in the internet industry. Prior to establishing our company, Mr. Zhao founded Weixun Yitong, a mobile internet platform in China. Mr. Fanhua Meng, our Chief Executive Officer, has over ten years of senior management experience in internet companies. Mr. Shuo Shi, our Chief Operations Officer, is experienced in sales marketing, internet management and culture media. Mr. Yanghua Yang, the Chief Financial Officer of our company, has over ten years of experience in audit and finance. Mr. Chengwei Yi, our Chief Technology Officer, has over 15 years of experience focusing on video processing technology, AI and signal processing technology. We believe that our management team’s collective experience and insights have paved and will continue to pave the way for our success. Our management team is supported by a research and development team with strong academic background and industry expertise in audio/video processing, 3D modeling and cloud computing.

 

Development Strategies

 

Bring Holographic AR Experience to Broader Mass Market

 

While holography continues to proliferate, we believe the holographic AR market remains underpenetrated in China and globally. We plan to bring holographic AR experience to the broader mass market and expand into additional use cases and industry verticals on our own or in collaboration with our business partners. For example, we have formed a pool of holographic AR educational course materials, and many holographic AR contents we previously developed for science popularization could also be applied for future education purposes. In the long run, we believe that holographic AR technologies will be applied to wider application scenarios and become compatible to more devices, such as IoT household facilities, in-vehicle entertainment systems and wearable devices. The abundance and variety of compatible devices make more application scenarios possible. For example, we plan to develop a full suite of educational solutions powered by our holographic AR technologies, including course materials, in-class AR display and live remote teaching. In addition, we may increase use cases in filmmaking, entertainment and scientific experiments.

 

Continue to Invest in Technology and Innovations

 

We plan to continue to make substantial investments in enhancing our AR and hologram technologies, such as multi-dimensional modeling and projection, simulation, cloud computing, distributed computing, and our holographic AR content delivery and projection capabilities. Our technology strategies also include developing our big data capabilities and AI technologies. For instance, we are continuing to make substantial additional investments in strengthening our analytics capability, with an aim to gain insights into our customers and end-users in order to provide them with more personalized AR experience.

 

Strengthen Holographic Facial Recognition Application

 

The market for facial recognition industry applications has expanded during recent years. The trend for facial recognition applications is to transition from 2D technology to 3D technology for better accuracy and quality. The impetus for this change is that 2D facial recognition technology tends to be easily affected by posture, light, appearance, and other factors, resulting in a compromised recognition rate. As a result, we believe 3D technology will gradually replace 2D facial recognition technology. Our plan is to provide 3D facial recognition holographic clouding application services through AI-based algorithms. Our future plan for our 3D facial recognition holographic clouding technology is to cater to potential customers in various industries, such as household, retail, travel, telecommunications, finance, national security, robot, education, social media, terminal equipment, business, transportation, intelligence business, or other potential applications.

 

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5G Network

 

Due to the change of bandwidth in 5G communication networks, high-end holographic applications have gradually developed into social media, communication, navigation, home application and other applications. Our plan is to provide holographic clouding platform services through 5G communication networks based on two core technologies: holographic AI facial recognition technology and holographic AI facial change technology.

 

 

Holographic Ecological System

 

We plan to continue to improve and enhance our existing technology to maintain industry leadership by creating an ecological business model. At present, our holographic facial recognition technology and holographic facial change technology are being applied to our existing holographic advertising and entertainment businesses, and we are continuing to upgrade our technology in order to attempt to make breakthroughs in more industry areas. Our goal is to establish a business ecosystem based on holographic technology applications.

 

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Develop the application of holographic AR technologies in the semiconductor industry and invest in seminiconductor sector through setting up a joint venture

 

We believe that the application demand of holographic 3D vision in the semiconductor industry is growing rapidly, representing promising market potentials. In order to develop the application of holographic AR technologies in the semiconductor industry, we, through our Hong Kong subsidiary WiMi Hologram Cloud Limited, or WiMi HK, entered into an agreement on May 24, 2020 to set up a joint venture to develop our business and the relevant applications of holographic 3D vision in the semiconductor industry. We believe that the establishment of the joint venture is conducive to the expansion of the semiconductor industry and the rapid integration of market resources. Furthermore, it could facilitate our strategies of extending the holographic 3D vision software from the application layer to the chip field and combining software and hardware through the holographic 3D vision software solution, namely, the strategic derivative upgrade to the semiconductor industry. We plan to invest in the semiconductor industry, acquire semiconductor-related assets and cooperate with chip factory in the future, so as to enhance the our technical service capability and retain current customers.

 

Strengthen Our AR Content Development Capabilities and Enrich Our Content Library

 

We intend to continue to devote substantial resources to strengthening our own holographic AR content development capability. We are committed to enriching our holographic content portfolio and providing the high-quality holographic experience to our customers and end-users. It is our plan to continue to expand our holographic content library through various avenues.

 

Explore Acquisition or Investment Opportunities

 

While we are focused on organic business growth, we may evaluate and selectively pursue strategic alliance, investment and acquisition opportunities, as we have in the past in China, to supplement and complement our existing business and operations. We are continuing to pursue selected acquisitions of complementary businesses that extend our holographic content production capabilities. Potential acquisition targets may also include companies with strong software engineering and middleware development capabilities and leading patent-protected hologram technologies.

 

Our Technology

 

We have developed powerful, cutting-edge holographic AR technologies.

 

Holographic Image Processing and Recognition Intelligence Technology

 

We insert holographic AR advertisements into online videos based on our imaging detection and recognition technology, template matching and detection technology, video processing and recognition technology, holographic 3D layer replacement technology in imaging recognition and dynamic fusion processing technology in imaging tracking. We expect that these technologies will be applied to our future strategic blueprint, such as the development and application of holographic 3D facial recognition technology and holographic facial change technology.

 

Development and Application in Holographic 3D Facial Recognition Technology

 

The development of holographic 3D facial recognition software is based on our holographic imaging featured imaging detection and recognition technology, template matching holographic imaging detection technology, and deep learning and training based video processing and recognition technology. Traditional 2D facial recognition technology is a biographic recognition technology based on facial features, which captures the information from the facial images or facial video streaming, and automatically detects and tracks the targeted face. By contrast, we believe our holographic 3D facial recognition technology is a biographic recognition technology consisting of a combination of holographic imaging capture and 3D portrait. We focus on the development and application of our software technology, and have technologies in AI, machine recognition, machine learning, model theory, and video imaging processing. Holographic 3D facial recognition technology is a technology using the collection of structured light and infrared light, and the collected featured points can exceed 30,000 points. By contrast, the collected featured points for traditional 2D facial recognition technology is less than 1,000 points. Our 3D technology is also expected to be less affected by the surrounding environment and is expected to overcome many of the issues found in traditional 2D facial recognition technology, such as light, posture, occlusion, dynamic recognition and facial expression, etc.

 

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Development and Application of Holographic Facial Change Technology

 

Holographic facial change technology is based on our holographic 3D layer replacement technology involving image recognition and dynamic fusion processing technology based on AI, tracking images in real time and replacing faces with other faces. This technology replaces faces in video frames, synthesizing the video and adding the original audio. We have validated these technology modules in holographic AR plug-in advertisement applications and continue to develop and upgrade these technology modules. We believe this technology will bring new business growth to applications such as celebrity advertising, film distribution, and live video streaming.

 

Software Engineering

 

Since our inception, we have devoted the majority of our research and development resources to software development. Our software engineering team is responsible for building the company-wide software platform, supporting the integration of our products and applications within our cloud infrastructure, as well as developing the holographic AR-related and MR-related software and solutions we license to our entertainment industry customers.

 

Our holographic AR software development services provide customers with the following benefits:

 

Convenience. We design our software for simplicity, ease of use and user-friendly experience. Through our software’s intuitive, visual interface, users can rapidly and easily manage, distribute and implement holographic AR contents.

 

Adaptability. Our integrated holographic AR software is built with broad compatibility and can run on various computer operating systems, including Windows, Mac OS and Linux. Customers can install our software in the cloud, on-premises or using a hybrid approach.

 

Functionality and Intelligence. We continue to leverage our software engineering capabilities to improve our offerings, which allows for richer software functionality. As our customer base continues to grow, we believe we will be able to further enhance our software intelligence with the increased volume of data processed.

 

Reliability. We value the long-term relationship with our customers and provide our customers continuous ancillary technical support and services. We perform security and code quality reviews before releasing the software to our customers and we also embed mature security practices throughout the whole life span of our holographic AR software to protect our customers’ data and proprietary information.

 

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Content Production

 

Our leading holographic AR content production capabilities are built around image acquisition, object recognition, automated image process, and computer vision technologies. Our software engineering team and visualization design team work closely to consistently advance such visualization-related technologies, and harness them to design and produce innovative holographic AR contents. Through real-time computer vision algorithms which provide an accurate pose estimation, we are able to perform scene recognition and tracking within seconds. Such cutting-edge algorithms also allow us to perform visualization of photorealistic high-resolution renderings of products on a pixel basis. According to Frost & Sullivan, while most peer companies may identify and capture 40 to 50 blocks of image data within a specific space unit, the number of data blocks we can collect reaches 500 to 550. According to Frost & Sullivan, our speed of image processing rises to 80% faster than the industry average, leading to improved operation efficiency. In the course of scene reconstruction, our automated image processing tools can perform noise cleaning and feature enhancement on the image we initially captured, enabling us to create best-in-class holographic AR designs with an industry-leading simulation degree.

 

We have built a comprehensive holographic AR content library as compared to our peers in China, according to Frost & Sullivan. The formats of our holographic AR contents range from 3D models to holographic short videos. As of December 31, 2019, we owned over 4,600 ready-to-use AR holographic contents that were available to be adapted to our holographic AR products and solutions, including animals, cartoon characters, vehicles and foods. Our AR holographic contents can be applied in various scenarios, such as education, tourism, arts and entertainment, and popular science. In addition, our content library is also enriched by copyrighted content that we have licensed from third parties. We cooperate with various content owners, including brands, film producers and talent agencies, to adapt high-quality, popular IPs into holographic AR formats.

 

Cloud

 

We believe that the next-generation cloud delivery technology provides the flexibility and scalability necessary for holographic AR experience. Cloud technology is of high importance to build our comprehensive holographic AR ecosystem. We have developed our cloud architecture to work effectively in a flexible cloud environment that has a high degree of elasticity. Meanwhile, benefiting from our cloud storage and connecting capabilities, users of our integrated holographic AR software are able to access our large-size holographic AR content library on their own devices.

 

Big Data

 

We have developed advanced data analytics capabilities to derive actionable insights from the large amounts of data we collected from our products and third party sources. Currently, we have infiltrated a solid end-user base of approximately 350 million from which we are able to collect raw data. Our processing capabilities enable us to manage extremely large volumes of data and deliver real-time analysis at scale, making it possible for us to continue to improve and innovate our products and services. Our data mining and user behavioral data analytics technologies allow us to build and segment context-rich user profiles and apply such analysis in numerous applications. For instance, we have created over 2,000 user tags by analyzing user data we collected through our holographic AR advertising services. We are also in the process of developing ads performance tracking and evaluation tools.

 

Artificial Intelligence

 

Our holographic image processing capabilities are regularly optimized and improved, including two core technologies: holographic AI facial recognition technology and holographic AI facial change technology. As a result of the development of our video processing and recognition technology, our holographic AR advertising and holographic imaging services, which are based on image detection, recognition, template matching, image dynamic fusion and replacement, are currently in a leading position in the industry.

 

5G+

 

We believe that our holographic services will adapt to 5G technology. Due to the high speed and low latency of 5G technology, the transmission delay of the long-distance communication and data transmission from the system terminal to the service server is lower than the 4G network transmission delay. Such improvement ensures less stagnation, low delay, high efficiency, and diversity of the interaction of multiple terminals in holographic AR remote communication and data transmission. We expect our holographic AR advertising business to develop accordingly.

 

Our Customers

 

We have a broad and diverse customer base. Currently, our customers mainly consist of advertisers, distribution channels, app developers and entertainment companies. Our customer base covers a wide range of industries, including manufacturing, real estate, entertainment, technology, media and telecommunications, travel, education and retails. Our customers typically enter into a master agreement with us for a term of one year, although they do not necessarily purchase products or services from us during each quarter of such year. A separate request is submitted by a customer for each order of products or services.

 

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Generally, we enter into service agreements with customers relating to our holograph AR ad services and our AR SDK payment customers relating to our AR SDK services. We provide customized holographic MR software and middleware software to distributors under software development agreements, who subsequently sub-license the customized software to enterprises and individual end users. The software development agreements entered into between us and the distributors include customization of our integrated holographic AR and MR entertainment software, ancillary technical training, as well as professional service and support. We charge distributors on a fixed-price basis. For our AR ad services, we charge service fees based on the number of views. For our AR SDK payment services, we charge a percentage of the total fees paid by the end users. We generally maintain annual agreements with our customers.

 

Sales and Marketing

 

We promote our products and services directly through our experienced and creative sales and marketing team by making direct office visits, attending conferences and industry exhibitions. Customers unfamiliar with our services and products may also consult with our support team to achieve best solutions. We believe that our sales and marketing team is well respected and helps attracting more customers.

 

We also grow our customer base through word-of-mouth referrals. We focus on continuously improving the quality of our products and services as we believe satisfied customers are more likely to continue using our products and recommend our products and services to others.

 

Research and Development

 

We have a dedicated research and development team responsible for the design and development of our products. They are experienced in hologram, algorithm, AI and image synthesis. Each member of our research and development team has many years of industry experience and is tasked with research and development to achieve innovation and advancement. We have focused on and will continue to focus on investment in our technology system. Our research and development expenses were approximately RMB9.7 million, RMB8.0 million, and RMB18.4 million (USD2.6 million) for the years ended December 31, 2017, 2018, and 2019, respectively.

 

 

Intellectual Property

 

We regard our patents, copyrights, trademarks, trade secrets and other intellectual properties as critical to our success. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. Details of our intellectual properties portfolio as of December 31, 2019 are set out as follows:

 

  Patent: We had 145 registered patents in China, which covers technologies for image processing and display, model input/output and 3D modeling, 68 pending patent applications with the PRC China National Intellectual Property Administration, and no patent under the patent cooperation treaty. Three of our 145 registered patents in China are currently registered under the name of individuals who have signed Intellectual Property Ownership Agreement with us, providing that the ownership of such intellectual properties invented during their employment in the Company should belong to us, and these patents are also undergoing the transfer process from the individuals to us. 144 of our 145 registered patents were granted as patent for utility model;
     
Software copyrights. We maintain a large portfolio of copyright-protected software. We had 237 registered software copyrights in China;

 

Trademarks. We had 23 registered trademark in China, and no pending trademark application with the PRC State Administration for Industry and Commerce; and

 

Domain names. We had 15 registered domain names in China.

 

In addition to the foregoing protections, we generally control access to and use of our proprietary and other confidential information through the use of internal and external controls. For example, for external controls, we enter into confidentiality agreements or agree to confidentiality clauses with our customers and, for internal controls, we adopt and maintain relevant policies governing the operation and maintenance of our systems and the management of user-generated data.

 

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Competition

 

There are many other companies addressing various aspects/verticals of the holographic AR market. The competitive landscape we are faced with is fragmented and evolving. With respect to our holographic AR advertising products, we compete against both holographic AR advertisement producers and traditional advertisement producers.

 

We believe the principal competitive factors in our market are:

 

breadth of use cases supported;

 

product features and functionality;

 

capability for customization, configurability, integration, security, scalability and reliability;

 

quality of technologies and research and development capabilities;

 

ability to innovate and rapidly respond to customer needs;

 

availability of holographic compatible, high-quality content;

 

diversified customer base;

 

relationships with key participants in holographic AR value chain;

 

sufficient capital support;

 

platform extensibility and ability to integrate with other holographic AR infrastructures; and

 

brand awareness and reputation.

 

We believe we compete favorably on the basis of the above factors; however, we expect competition to intensify in the future. Our ability to remain competitive will largely depend on the quality of our applications, the effectiveness of our sales and marketing efforts, the quality of our customer service and our ability to acquire complementary technologies, products and businesses to enhance the features and functionality of our applications.

 

Employees

 

We had 115, 122 and 147 full-time employees, respectively, as of December 31, 2017, 2018, and 2019. As of the date of this prospectus, all of our employees are based in China.

 

The following table sets forth the number of our employees as of December 31, 2019:

 

Function  Number of
full-time
employees
 
Research and Development   81 
Business and Marketing   42 
Administrative, Human Resources and Finance   24 
Total   147 

 

Under PRC law, we participate in various employee social security plans that are organized by municipal and provincial governments for our PRC-based full-time employees, including pension, unemployment insurance, childbirth insurance, work-related injury insurance, medical insurance and housing fund. We are required under PRC law to make contributions monthly to employee benefit plans for our PRC-based full-time employees at specified percentages of the salaries, bonuses and certain allowances of such employees, up to a maximum amount specified by the local governments in China.

 

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We enter into labor contracts and standard confidentiality and intellectual property agreements with our key employees. We believe that we maintain a good working relationship with our employees, and we have not experienced any labor disputes. None of our employees are represented by labor unions.

 

Facilities

 

Our headquarters is located in Beijing, China and we maintain offices in Shenzhen, China, where we currently lease approximately 1,600 square meter of office space in the aggregate. We believe our existing facilities are adequate for our current requirements and that additional space can be obtained on commercially reasonable terms to meet our future requirements.

 

Insurance

 

We do not maintain insurance policies covering damages to our Information Technology systems. We also do not maintain business interruption insurance or general third-party liability insurance, nor do we maintain product liability insurance or key-man insurance. We consider our insurance coverage to be in line with that of other companies in the same industry of similar size in China.

 

Legal Proceedings

 

We may be subject to legal proceedings, investigations and claims incidental to the conduct of our business from time to time. We are not currently a party to, nor are we aware of, any legal proceedings, investigations or claims which, in the opinion of our management, are likely to have a material adverse effect on our business, financial condition or results of operations.

 

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PRC REGULATION

 

Regulation on Foreign Investment Restrictions

 

The Guidance Catalogue of Industries for Foreign Investment (2017 Revision), or the Catalogue, which is promulgated by the Ministry of Commerce and the National Development and Reform Commission and governs investment activities in the PRC by foreign investors. The Catalogue divides industries into three categories—“encouraged,” “restricted,” and “prohibited” for foreign investment. Industries not listed in the Catalogue are generally deemed as falling into a fourth category, “permitted.” Industries such as value-added telecommunication services, including Internet information services, are restricted to foreign investment.

 

The Special Administrative Measures for Entrance of Foreign Investment (Negative List) (2018 Version), or the Negative List, which was promulgated jointly by the Ministry of Commerce and the National Development and Reform Commission on June 28, 2018 and became effective on July 28, 2018, replaced and partly abolished the Guidance Catalogue of Industries for Foreign Investment (2017 Revision) regulating the access of foreign investors to China. Pursuant to the Negative List, foreign investors should refrain from making investing in any of prohibited sectors specified in the Negative List, and foreign investors are required to obtain the permit for access to other sectors that are listed in the Negative List but not classified as “prohibited”.

 

On March 15, 2019, the Foreign Investment Law was formally issued, and become effective on January 1, 2020, on which Regulation for the Implementation of Foreign Investment Law of the People’s Republic of China and Measures for Reporting of Information on Foreign Investment become effective. The Foreign Investment Law and its implementation regulation mainly focuses on the foreign investment promotion, foreign investment protection and foreign investment management. Comparing with the draft Foreign Investment Law (2015), the Foreign Investment Law does not mention concepts such as “De facto control” and “controlling PRC companies by contracts or trusts”, nor did it specify the regulation requirements on controlling through contractual arrangements. Pursuant to Measures for Reporting of Information on Foreign Investment, a foreign investor or foreign-invested enterprise shall, through the enterprise registration system and the enterprise credit information disclosure system, report investment information to the competent departments in charge of commerce. The foreign investment information reports include the initial report, report of changes, report of deregistration, and annual report.

 

Pursuant to the Announcement 2016 No. 22 of the National Development and Reform Commission and the Ministry of Commerce dated October 8, 2016, the special entry administration measures for foreign investment apply to restricted and prohibited categories specified in the Catalogue, and the encouraged categories that are subject to certain requirements relating to equity ownership and senior management under the special entry administration measures.

 

Regulations on AR Industry

 

On December 21, 2018, Ministry of Industry and Information Technology issues the Guidance on Accelerating the Development of AR Industry, which requires that the AR Industry in China shall be promoted and application innovation in AR technology shall be promoted.

 

Regulations on Value-added Telecommunication Services

 

On September 25, 2000, the State Council promulgated the Telecommunications Regulations of the People’s Republic of China, or the Telecom Regulations, which was amended on July 29, 2014 and February 6, 2016. The Telecom Regulations is the primary PRC law governing telecommunication services and sets out the general regulatory framework for telecommunication services provided by PRC companies. The Telecom Regulations distinguishes between “basic telecommunication services” and “value-added telecommunication services.” The Telecom Regulations defines value-added telecommunications services as telecommunications and information services provided through public networks. Pursuant to the Telecom Regulations, commercial operators of value-added telecommunications services must first obtain an operating license from the MIIT, or its provincial level counterparts.

 

The Catalog of Telecommunications Business, or the Catalog, which was issued as an attachment to the Telecom Regulations and updated in February 21, 2003 and December 28, 2015, further categorizes value-added telecommunication services into two classes: Class 1 value-added telecommunication services and Class 2 value-added telecommunication services. Information services provided via cable networks, mobile networks or internet fall within Class 2 value-added telecommunications services.

 

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On July 3, 2017, the MIIT issued the Measures on the Administration of Telecommunications Business Operating Permits, or the Telecom License Measures, which became effective on September 1, 2017, to supplement the Telecom Regulations. The Telecom License Measures sets forth the types of licenses required to operate value-added telecommunications services and the qualifications and procedures for obtaining such licenses. The Telecom License Measures also provides that an operator providing value-added services in multiple provinces is required to obtain an inter-regional license, whereas an operator providing value-added services in one province is required to obtain an intra-provincial license. Any telecommunication services operator must conduct its business in accordance with the specifications in its license.

 

Regulations on Internet Content Providers

 

The Administrative Measures on Internet Information Services, or the Internet Content Measures, which was promulgated by the State Council on September 25, 2000 and amended on January 8, 2011, set out guidelines on the provision of internet information services. The Internet Content Measures classifies internet information services into commercial internet information services and non-commercial internet information services. Commercial internet information services refer to services that provide information or services to internet users with charge. A provider of commercial internet information services must obtain an ICP License.

 

Regulations on Foreign Direct Investment in Value-Added Telecommunications Companies

 

Foreign direct investment in telecommunications companies in China is governed by the Provisions on the Administration of Foreign-Invested Telecommunications Enterprises, which was promulgated by the State Council on December 11, 2001 and amended on September 10, 2008 and February 6, 2016. These regulations require that foreign-invested value-added telecommunications enterprises in China must be established as Sino-foreign equity joint ventures and that the foreign investors may acquire up to 50% equity interests in such joint ventures. In addition, a major foreign investor in a value-added telecommunications business in China must demonstrate a good track record and experience in operating value-added telecommunications business. Moreover, foreign investors that meet these requirements must obtain approvals from the MIIT and the MOFCOM, to provide value-added telecommunication services in China.

 

On July 13, 2006, the Ministry of Information Industry, or the MII, released the Notice on Strengthening the Administration of Foreign Investment in the Operation of Value-added Telecommunications Business, or the MII Notice, pursuant to which, for any foreign investor to invest in telecommunications business in China, a foreign-invested telecommunications enterprise must be established and such enterprise must apply for the relevant telecommunications business operation licenses. Furthermore, under the MII Notice, domestic telecommunications enterprises may not rent, transfer or sell a telecommunications business operation license to foreign investors in any form, and they may not provide any resources, premises, facilities and other assistance in any form to foreign investors for their illegal operation of any telecommunications business in China. In addition, under the MII Notice, the internet domain names and registered trademarks used by a value-added telecommunication service operator shall be legally owned by such operator or its shareholders.

 

Regulations on Infringement upon Intellectual Property Rights via Internet

 

The Tort Liability Law of the PRC, which was adopted by the Standing Committee of the National People’s Congress on December 26, 2009 and became effective on July 1, 2010, provides that (i) an online service provider should be held liable for its own tortious acts in providing online services; (ii) where an online user conducts tortious acts by utilizing online services provided by the online service provider, the infringed party has the right to request such online service provider to take necessary measures, including deleting, blocking and disconnecting the access to the infringing content promptly. If the online service provider fails to take necessary measures in a timely manner upon receipt of notice of such infringement, such online service provider will be held jointly liable with the relevant online users for the additional damages that should have not been incurred if the online service provider took proper actions; and (iii) where the online service provider is aware that online users are infringing upon the civil right or interest of third party and fail to take necessary measures, the online service provider should be jointly liable for such infringement with the online users.

 

Regulation on Intellectual Property Rights

 

The PRC has adopted comprehensive legislation governing intellectual property rights, including patents, trademarks, copyrights and domain names.

 

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Patents

 

Pursuant to the PRC Patent Law, most recently amended on December 27, 2008, and its implementation rules, most recently amended on January 9, 2010, patents in China fall into three categories: invention, utility model and design. An invention patent is granted to a new technical solution proposed in respect of a product or method or an improvement of a product or method. A utility model is granted to a new technical solution that is practicable for application and proposed in respect of the shape, structure or a combination of both of a product. A design patent is granted to the new design of a certain product in shape, pattern or a combination of both and in color, shape and pattern combinations aesthetically suitable for industrial application. Under the PRC Patent Law, the term of patent protection starts from the date of application. Patents relating to invention are effective for twenty years, and utility models and designs are effective for ten years from the date of application. The PRC Patent Law adopts the principle of “first-to-file” system, which provides that where more than one person files a patent application for the same invention, a patent will be granted to the person who files the application first. Existing patents can become narrowed, invalid or unenforceable due to a variety of grounds, including lack of novelty, creativity, and deficiencies in patent application. In China, a patent must have novelty, creativity and practical applicability. Under the PRC Patent Law, novelty means that before a patent application is filed, no identical invention or utility model has been publicly disclosed in any publication in China or overseas or has been publicly used or made known to the public by any other means, whether in or outside of China, nor has any other person filed with the patent authority an application that describes an identical invention or utility model and is recorded in patent application documents or patent documents published after the filing date. Creativity means that, compared with existing technology, an invention has prominent substantial features and represents notable progress, and a utility model has substantial features and represents any progress. Practical applicability means an invention or utility model can be manufactured or used and may produce positive results. Patents in China are filed with the State Intellectual Property Office, or SIPO. Normally, the SIPO publishes an application for an invention patent within 18 months after the filing date, which may be shortened at the request of applicant. The applicant must apply to the SIPO for a substantive examination within three years from the date of application. Article 20 of the PRC Patent Law provides that, for an invention or utility model completed in China, any applicant (not just Chinese companies and individuals), before filing a patent application outside of China, must first submit it to the SIPO for a confidential examination. Failure to comply with this requirement will result in the denial of any Chinese patent for the relevant invention. This added requirement of confidential examination by the SIPO has raised concerns by foreign companies who conduct research and development activities in China or outsource research and development activities to service providers in China.

 

Patent Enforcement

 

Unauthorized use of patents without consent from owners of patents, forgery of the patents belonging to other persons, or engagement in other patent infringement acts, will subject the infringers to infringement liability. Serious offences such as forgery of patents may be subject to criminal penalties. When a dispute arises out of infringement of the patent owner’s patent right, Chinese law requires that the parties first attempt to settle the dispute through mutual consultation. However, if the dispute cannot be settled through mutual consultation, the patent owner, or an interested party who believes the patent is being infringed, may either file a civil legal suit or file an administrative complaint with the relevant patent administration authority. A Chinese court may issue a preliminary injunction upon the patent owner’s or an interested party’s request before instituting any legal proceedings or