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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 20-F

 


 

o

REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

OR

 

 

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2019

 

 

OR

 

 

o

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

 

 

OR

 

 

o

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

 

Commission file number: 001-37871

 

Gridsum Holding Inc.

(Exact name of Registrant as specified in its charter)

 

N/A

(Translation of Registrant’s name into English)

 

Cayman Islands

(Jurisdiction of incorporation or organization)

 

South Wing, High Technology Building

No. 229 North 4th Ring Road

Haidian District, Beijing 100083

People’s Republic of China

(Address of principal executive offices)

 

Ravi Sarathy, Chief Financial Officer

South Wing, High Technology Building

No. 229 North 4th Ring Road

Haidian District, Beijing 100083

People’s Republic of China

Telephone: (86-10) 8261-9988

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

 

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

 

Title of each class

 

Trading Symbol(s)

 

Name of each exchange on which registered

American Depositary Shares, each representing one

Class B Ordinary Share, par value US$0.001 per share

Class B Ordinary Shares, par value US$0.001 per share*

 

GSUM

 

The Nasdaq Stock Market LLC

The Nasdaq Stock Market LLC

 


*  Not for trading, but only in connection with the listing of the American Depositary Shares on The Nasdaq Stock Market.

 

Securities registered or to be registered pursuant to Section 12(g) of the Act. None

 


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Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act. None

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

 

As of December 31, 2019, there were 34,576,351 ordinary shares outstanding, par value $0.001 per share, being the sum of 4,543,461 Class A ordinary shares and 30,032,890 Class B ordinary shares.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

o Yes   x No

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

o Yes   x No

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

x Yes   o No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

x Yes   o No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer x

 

Non-accelerated filer o

 

Emerging growth company x

 

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act. x

 

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. o

 

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

 

U.S. GAAP x

 

International Financial Reporting Standards as issued
by the International Accounting Standards Board
o

 

Other o

 

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

o Item 17   o Item 18

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

o Yes   x No

 

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

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

 

o Yes   o No

 

 


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

 


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TABLE OF CONTENTS

 

DEFINED TERMS

3

FORWARD-LOOKING STATEMENTS

4

PART I

5

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

5

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

5

ITEM 3. KEY INFORMATION

5

ITEM 4. INFORMATION ON THE COMPANY

34

ITEM 4A. UNRESOLVED STAFF COMMENTS

59

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

59

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

79

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

89

ITEM 8. FINANCIAL INFORMATION

90

ITEM 9. THE OFFER AND LISTING

92

ITEM 10. ADDITIONAL INFORMATION

92

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

104

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

105

 

 

PART II

107

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

107

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

107

ITEM 15. CONTROLS AND PROCEDURES

107

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

109

ITEM 16B. CODE OF ETHICS

109

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

109

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

110

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

110

ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

110

ITEM 16G. CORPORATE GOVERNANCE

110

ITEM 16H. MINE SAFETY DISCLOSURE

110

 

 

PART III

110

ITEM 17. FINANCIAL STATEMENTS

110

ITEM 18. FINANCIAL STATEMENTS

110

ITEM 19. EXHIBITS

110

 


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EXPLANATORY NOTE

 

Gridsum Holding Inc. (the “Company”) relied on the Securities and Exchange Commission (the “SEC”) Order under Section 36 of the Securities Exchange Act of 1934 Modifying Exemptions from the Reporting and Proxy Delivery Requirements for Public Companies, dated March 25, 2020 (SEC Release No. 34-88465), to delay its filing of this annual report on Form 20-F for the fiscal year ended December 31, 2019 (this “Annual Report”).

 

As set forth in the Company’s current report on Form 6-K as furnished with the SEC on April 28, 2020, the filing of this Annual Report was delayed due to circumstances related to the outbreak of the novel coronavirus, or COVID-19. Following the outbreak of COVID-19 and the ensuing pandemic, many cities in China were under severe travel restrictions, quarantines and business closures. From January 2020 to February 2020, the Company temporarily closed all of its corporate offices and requested all employees to work remotely. Although the pandemic has been contained to a certain extent in China since March 2020, the Chinese government continued to enforce travel restrictions and quarantines in certain major cities from time to time. The Municipal Government of Beijing, where the Company is headquartered, imposed a 14-day quarantine requirement on any person traveling to Beijing from other areas in China other than several neighboring provinces. Due to business closures and restrictions on access to the Company’s corporate facilities, the Company’s finance team experienced significant delays in completing the financial statements and collecting materials necessary for audit. The travel restrictions and quarantines further impeded the Company’s auditor from performing required field work as originally scheduled. These, in turn, have prevented the Company from timely filing this Annual Report by the original due date of April 30, 2020.

 

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DEFINED TERMS

 

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

 

·                    “ADSs” refers to our American depositary shares, and each ADS represents one Class B ordinary share;

 

·                    “China” and “PRC” refer to the People’s Republic of China, excluding Taiwan, Hong Kong and Macau;

 

·                    “RMB” and “Renminbi” refer to the legal currency of the People’s Republic of China;

 

·                    “shares” and “ordinary shares” refer to our Class A and Class B ordinary shares, US$0.001 par value per share;

 

·                    “US$” and “U.S. Dollar” refer to the legal currency of the United States of America; and

 

·                    “we,” “us,” and “our company” refer to Gridsum Holding Inc., a Cayman Islands company, and its predecessor Cayman Islands entity, subsidiaries and consolidated affiliated entities.

 

We use RMB as our reporting currency in our financial statements and in this annual report. This annual report contains translations of RMB amounts into U.S. Dollars at specific rates solely for the convenience of the readers. Unless otherwise noted, any RMB amounts are translated into U.S. Dollars at the exchange rate set forth in the H.10 statistical release of the Federal Reserve Board on December 31, 2019, which was RMB6.9618 to US$1.00. We make no representation that any RMB or U.S. Dollar amounts could have been, or could be, converted into U.S. Dollars or RMB, as the case may be, at any particular rate, at the rate stated above, or at all. The exchange rate set forth in the H.10 statistical release of the Federal Reserve Board on May 22, 2020 was RMB7.1269 to US$1.00.

 

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FORWARD-LOOKING STATEMENTS

 

Certain statements contained in this annual report on Form 20-F, including those statements contained under the captions “Item 4. Information on the Company” and “Item 5. Operating and Financial Review and Prospects” that are not statements of historical fact, are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or Securities Act, Section 21E of the Securities Exchange Act of 1934, as amended, or Exchange Act, and within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements can be generally identified by the use of terms such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “likely to” or other similar expressions. In addition to the statements contained in this annual report, we (or our directors or executive officers authorized to speak on our behalf) from time to time may make forward-looking statements, orally or in writing, regarding us (including our subsidiaries and consolidated affiliated entities) and our business, including in press releases, oral presentations, filings under the Securities Act, the Exchange Act or securities laws of other countries, and filings with The Nasdaq Stock Market, or other stock exchanges. These forward-looking statements include, but are not limited to, statements about:

 

·                    the duration and impact of the COVID-19 pandemic;

 

·                    our goals and strategies;

 

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

 

·                    expected changes in our revenues, costs or expenditures;

 

·                    our ongoing restructuring of our revenue mix and product offering;

 

·                    the growth of social media, internet and mobile users and internet and mobile advertising in China;

 

·                    competition in our industry;

 

·                    our liquidity, including our ability to continue as a going concern;

 

·                    fluctuations in general economic and business conditions in China; and

 

·                    PRC governmental regulations and policies relating to media, software, big data, the internet and online advertising.

 

You should not rely upon our forward-looking statements as predictors of future events. Such forward-looking statements represent our judgment or expectations regarding the future, and are subject to risks and uncertainties that may cause actual events and our future results to be materially different than is indicated by such statements. See the information under “Item 3. Key Information—D. Risk Factors” and elsewhere in this annual report for a discussion of these risks, assumptions and uncertainties. These risks, assumptions and uncertainties are not necessarily all of the important factors that could cause actual results to differ materially from those expressed in any of our forward-looking statements. We operate in an evolving environment and new risk factors and uncertainties emerge from time to time and it is not possible for us 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 undertake no obligation, and specifically decline any obligation, to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this annual report might not occur. We qualify all of our forward-looking statements by these cautionary statements.

 

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PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not applicable.

 

ITEM 3. KEY INFORMATION

 

A.    Selected Financial Data

 

The following selected consolidated statement of operations data for the years ended December 31, 2017, 2018 and 2019, and selected consolidated balance sheet data as of December 31, 2018 and 2019, have been derived from our audited consolidated financial statements included elsewhere in this annual report. The following selected consolidated statement of operations data for the years ended December 31, 2015 and 2016, and selected consolidated balance sheet data as of December 31, 2015, 2016 and 2017, have been derived from our audited consolidated financial statements not included in this annual report. The selected consolidated financial data should be read together with our consolidated financial statements and the related notes and “Item 5. Operating and Financial Review and Prospects” included elsewhere in this annual report. Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). Our historical results are not necessarily indicative of results for future periods.

 

 

 

For the Year Ended December 31,

 

 

 

2015

 

2016

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

(in thousands, except for share, per share and per ADS data)

 

Consolidated Statements of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Enterprise

 

208,385

 

311,106

 

377,013

 

387,574

 

258,903

 

37,189

 

e-Government and other

 

26,904

 

60,772

 

102,216

 

53,117

 

71,796

 

10,313

 

Less: Business tax and surcharges

 

(3,092

)

(8,055

)

(9,696

)

(9,444

)

(4,147

)

(596

)

Net revenues

 

232,197

 

363,823

 

469,533

 

431,247

 

326,552

 

46,906

 

Cost of revenues(1)

 

(33,392

)

(55,707

)

(94,640

)

(100,867

)

(77,361

)

(11,112

)

Gross profit

 

198,805

 

308,116

 

374,893

 

330,380

 

249,191

 

35,794

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing expenses (1)

 

(88,364

)

(139,781

)

(192,413

)

(166,176

)

(144,401

)

(20,742

)

Research and development expenses (1)

 

(97,553

)

(160,387

)

(257,921

)

(533,586

)

(320,402

)

(46,022

)

General and administrative expenses (1)

 

(60,820

)

(88,108

)

(143,743

)

(182,289

)

(319,653

)

(45,915

)

Total operating expenses

 

(246,737

)

(388,276

)

(594,077

)

(882,051

)

(784,456

)

(112,679

)

Loss from operations

 

(47,932

)

(80,160

)

(219,184

)

(551,671

)

(535,265

)

(76,885

)

Other income/(expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency exchange gain/(loss)

 

1,339

 

(1,600

)

(8,552

)

(9,719

)

(729

)

(105

)

Interest income/(expense), net

 

80

 

(614

)

(5,430

)

(9,878

)

(14,028

)

(2,015

)

Other income/(expense), net

 

111

 

(1,452

)

(1,683

)

1,005

 

(788

)

(113

)

Amortization of debt discount

 

 

 

 

(25,337

)

(40,918

)

(5,878

)

Gain on change in fair value of derivative liabilities

 

 

 

 

57,890

 

27,829

 

3,997

 

Loss before income tax

 

(46,402

)

(83,826

)

(234,849

)

(537,710

)

(563,899

)

(80,999

)

Income tax (expense)/benefit

 

(15,371

)

(14,801

)

(4,275

)

15,165

 

27,010

 

3,880

 

Net loss

 

(61,773

)

(98,627

)

(239,124

)

(522,545

)

(536,889

)

(77,119

)

Less: Net (loss)/income attributable to non-controlling interests

 

(16

)

(53

)

(128

)

(1,220

)

1,040

 

150

 

 

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For the Year Ended December 31,

 

 

 

2015

 

2016

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

(in thousands, except for share, per share and per ADS data)

 

Consolidated Statements of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss attributable to Gridsum Holding Inc.

 

(61,757

)

(98,574

)

(238,996

)

(521,325

)

(537,929

)

(77,269

)

Accretion to preferred shares redemption value

 

(19,707

)

(16,725

)

 

 

 

 

Cumulative dividend to preferred shareholders

 

(16,642

)

(12,990

)

 

 

 

 

Net loss attributable to Gridsum’s ordinary shareholders

 

(98,106

)

(128,289

)

(238,996

)

(521,325

)

(537,929

)

(77,269

)

Net loss

 

(61,773

)

(98,627

)

(239,124

)

(522,545

)

(536,889

)

(77,119

)

Foreign currency translation adjustment, net of tax

 

(19,330

)

8,923

 

(20,452

)

(4,957

)

(2,362

)

(340

)

Comprehensive loss

 

(81,103

)

(89,704

)

(259,576

)

(527,502

)

(539,251

)

(77,459

)

Less: Comprehensive (loss)/income attributable to non-controlling interests

 

(16

)

(53

)

(128

)

(1,220

)

1,040

 

150

 

Comprehensive loss attributable to Gridsum Holding Inc.

 

(81,087

)

(89,651

)

(259,448

)

(526,282

)

(540,291

)

(77,609

)

Net loss per ordinary share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

(9.81

)

(8.52

)

(7.90

)

(16.91

)

(15.91

)

(2.29

)

Net loss per ADS:(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

(9.81

)

(8.52

)

(7.90

)

(16.91

)

(15.91

)

(2.29

)

Weighted average number of ordinary shares used in per share calculations:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

10,000,000

 

15,054,865

 

30,243,250

 

30,827,600

 

33,810,862

 

33,810,862

 

Non-GAAP Financial Data:(3)

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP net loss attributable to Gridsum’s ordinary shareholders

 

(89,300

)

(117,659

)

(216,069

)

(482,299

)

(485,479

)

(69,735

)

Non-GAAP net loss per ordinary share attributable to Gridsum’s ordinary shareholders:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

(8.93

)

(7.82

)

(7.14

)

(15.65

)

(14.36

)

(2.06

)

Non-GAAP net loss per ADS attributable to Gridsum’s ordinary shareholders:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

(8.93

)

(7.82

)

(7.14

)

(15.65

)

(14.36

)

(2.06

)

EBITDA

 

(33,382

)

(59,319

)

(197,945

)

(493,131

)

(514,609

)

(73,919

)

Adjusted EBITDA

 

(24,576

)

(48,689

)

(175,018

)

(454,105

)

(462,159

)

(66,385

)

 


(1)        Share-based compensation expenses were allocated in cost of revenues and operating expenses as follows:

 

 

 

For the Year Ended December 31,

 

 

 

2015

 

2016

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

(in thousands)

 

Cost of revenues

 

335

 

319

 

501

 

801

 

548

 

79

 

Sales and marketing expenses

 

1,651

 

2,252

 

4,739

 

6,810

 

8,537

 

1,226

 

Research and development expenses

 

3,347

 

3,955

 

8,641

 

16,310

 

16,001

 

2,298

 

General and administrative expenses

 

3,473

 

4,104

 

9,046

 

15,105

 

27,364

 

3,931

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

8,806

 

10,630

 

22,927

 

39,026

 

52,450

 

7,534

 

 


(2)        Each ADS represents one Class B ordinary share.

(3)        See “—Non-GAAP Financial Measures.”

 

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As of December 31,

 

 

 

2015

 

2016

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

(in thousands)

 

Consolidated Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

198,523

 

520,452

 

166,690

 

92,684

 

25,206

 

3,621

 

Total assets

 

618,246

 

1,208,500

 

1,403,097

 

915,390

 

596,972

 

85,749

 

Total liabilities

 

357,652

 

431,251

 

859,406

 

860,580

 

954,682

 

137,131

 

Total mezzanine equity

 

476,018

 

 

 

 

 

 

Ordinary shares

 

 

 

 

 

 

 

Class A ordinary shares

 

31

 

31

 

31

 

31

 

31

 

4

 

Class B ordinary shares

 

37

 

168

 

176

 

177

 

202

 

30

 

Additional paid-in capital

 

 

1,090,991

 

1,107,201

 

1,146,253

 

1,272,959

 

182,848

 

Statutory reserve

 

 

6,662

 

6,730

 

12,903

 

12,903

 

1,853

 

Accumulated deficit

 

(196,866

)

(310,847

)

(549,911

)

(1,077,409

)

(1,615,338

)

(232,029

)

Total Gridsum’s shareholders’ (deficiency)/equity

 

(215,808

)

776,918

 

533,688

 

46,459

 

(367,101

)

(52,731

)

Non-controlling interests

 

384

 

331

 

10,003

 

8,351

 

9,391

 

1,349

 

Total shareholders’ (deficiency)/equity

 

(215,424

)

777,249

 

543,691

 

54,810

 

(357,710

)

(51,382

)

Number of outstanding ordinary shares

 

10,000,000

 

15,054,865

 

30,243,250

 

30,827,600

 

33,810,862

 

33,810,862

 

 

Non-GAAP Financial Measures

 

In evaluating our business, we consider and use the following non-GAAP financial measures as supplemental measures to review and assess our operating performance: non-GAAP net loss attributable to Gridsum’s ordinary shareholders, non-GAAP net loss per share attributable to Gridsum’s ordinary shareholders, non-GAAP net loss per ADS attributable to Gridsum’s ordinary shareholders, EBITDA and adjusted EBITDA. The presentation of these non-GAAP financial measures is not intended to be considered in isolation or as a substitute for the financial information prepared in accordance with U.S. GAAP. We define (i) non-GAAP net loss attributable to Gridsum’s ordinary shareholders as net loss attributable to Gridsum’s ordinary shareholders before share-based compensation, (ii) non-GAAP net loss per share attributable to Gridsum’s ordinary shareholders as its per share equivalent and (iii) non-GAAP net loss per ADS attributable to Gridsum’s ordinary shareholders as its per ADS equivalent. We define EBITDA as net loss before interest income and expenses, income tax expenses and depreciation expenses, and adjusted EBITDA as EBITDA before share-based compensation.

 

We present these non-GAAP financial measures because they are used by our management to evaluate our operating performance and formulate our business plans. These non-GAAP financial measures enable our management to assess our operating results without considering the impact of non-cash charges, including depreciation expenses and share-based compensation, and without considering the impact of non-operating items such as interest income and expenses and income tax expenses. We also believe that the use of these non-GAAP measures facilitates investors’ assessment of our operating performance.

 

These non-GAAP financial measures are not defined under U.S. GAAP and are not presented in accordance with U.S. GAAP. These non-GAAP financial measures have limitations as analytical tools. One of the key limitations of using these non-GAAP financial measures is that they do not reflect all items of income and expense that affect our operations. Interest income and expenses, income tax expenses, depreciation expenses and share-based compensation have been and may continue to be incurred in our business and are not reflected in the presentation of adjusted EBITDA. Further, these non-GAAP financial measures may differ from the non-GAAP financial measures used by other companies, including our peer companies, so their utility for comparison purposes may be limited.

 

We compensate for these limitations by reconciling our non-GAAP financial measures to the most directly comparable U.S. GAAP financial measures, which should be considered when evaluating our performance. We encourage you to review our financial information in its entirety and not rely on a single financial measure.

 

The following tables reconcile our non-GAAP net loss attributable to Gridsum’s ordinary shareholders, EBITDA and adjusted EBITDA in 2015, 2016, 2017, 2018 and 2019 to the most directly comparable financial measures calculated in accordance with U.S. GAAP, which are net loss attributable to Gridsum’s ordinary shareholders and net loss, respectively:

 

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For the Year Ended December 31,

 

 

 

2015

 

2016

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

(in thousands, except for share, per share and per ADS data)

 

Reconciliation of Net Loss Attributable to Gridsum’s Ordinary Shareholders to Non-GAAP Net Loss Attributable to Gridsum’s Ordinary Shareholders:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss attributable to Gridsum’s ordinary shareholders

 

(98,106

)

(128,289

)

(238,996

)

(521,325

)

(537,929

)

(77,269

)

Share-based compensation

 

8,806

 

10,630

 

22,927

 

39,026

 

52,450

 

7,534

 

Non-GAAP net loss attributable to Gridsum’s ordinary shareholders

 

(89,300

)

(117,659

)

(216,069

)

(482,299

)

(485,479

)

(69,735

)

Weighted average number of ordinary shares used in net loss per share attributable to Gridsum’s ordinary shareholders and non-GAAP net loss per share attributable to Gridsum’s ordinary shareholders calculations: Basic and diluted

 

10,000,000

 

15,054,865

 

30,243,250

 

30,827,600

 

33,810,862

 

33,810,862

 

Net loss per ordinary share attributable to Gridsum’s ordinary shareholders: Basic and diluted

 

(9.81

)

(8.52

)

(7.90

)

(16.91

)

(15.91

)

(2.29

)

Net loss per ADS attributable to Gridsum’s ordinary shareholders: Basic and diluted (1)

 

(9.81

)

(8.52

)

(7.90

)

(16.91

)

(15.91

)

(2.29

)

Non-GAAP net loss per ordinary share attributable to Gridsum’s ordinary shareholders: Basic and diluted

 

(8.93

)

(7.82

)

(7.14

)

(15.65

)

(14.36

)

(2.06

)

Non-GAAP net loss per ADS attributable to Gridsum’s ordinary shareholders: Basic and diluted

 

(8.93

)

(7.82

)

(7.14

)

(15.65

)

(14.36

)

(2.06

)

 


(1)                       Each ADS represents one Class B ordinary share.

 

 

 

For the Year Ended December 31,

 

 

 

2015

 

2016

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

(in thousands)

 

Reconciliation of Net Loss to EBITDA and Adjusted EBITDA :

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

(61,773

)

(98,627

)

(239,124

)

(522,545

)

(536,889

)

(77,119

)

Interest expense/(income), net

 

(80

)

614

 

5,430

 

9,878

 

14,028

 

2,015

 

Income tax expenses/(benefit)

 

15,371

 

14,801

 

4,275

 

(15,165

)

(27,010

)

(3,880

)

Depreciation and amortization expenses

 

13,100

 

23,893

 

31,474

 

34,701

 

35,262

 

5,065

 

EBITDA

 

(33,382

)

(59,319

)

(197,945

)

(493,131

)

(514,609

)

(73,919

)

Share-based compensation

 

8,806

 

10,630

 

22,927

 

39,026

 

52,450

 

7,534

 

Adjusted EBITDA

 

(24,576

)

(48,689

)

(175,018

)

(454,105

)

(462,159

)

(66,385

)

 

B.    Capitalization and Indebtedness

 

Not applicable.

 

C.    Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

D.    Risk Factors

 

The following risk factors, and other risks that may be described in other reports we submit to or file with the SEC, could affect our actual results and cause those results to differ materially from what is expressed in forward-looking statements we make from time to time. If any of these risks actually occurs, our business, financial condition and results of operations could be materially adversely affected, the trading price of our ADSs could decline, and you could lose all or part of your investment.

 

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Risks Relating to Our Business

 

There is substantial doubt about our ability to continue as a going concern.

 

Our independent registered public accounting firm has issued an opinion on our consolidated financial statements, which states that the consolidated financial statements have been prepared assuming we will continue as a going concern. The opinion also states that we have suffered substantial losses from operations in previous years, have a working capital deficiency, and that substantial doubt exists about our ability to continue as a going concern.

 

We have incurred net losses in each year since our inception in 2005, including net losses of RMB239.1 million, RMB522.5 million and RMB536.9 million (US$77.1 million) in 2017, 2018 and 2019, respectively. As of December 31, 2019, we had an accumulated deficit of RMB1.6 billion (US$232.0 million). Our net cash used in operating activities was RMB306.7 million, RMB233.1 million and RMB289.5 million (US$41.6 million) in 2017, 2018 and 2019, respectively. As of December 31, 2019, we had total current assets of RMB338.9 million (US$48.7 million) and total current liabilities of RMB749.2 million (US$107.6 million), and our balance of cash and cash equivalents was RMB25.2 million (US$3.6 million).

 

On May 31, 2020, we became overdue on our payment obligations of approximately US$48 million under a convertible note. For more details on such overdue amount, see “—We are overdue on a significant amount of debt, and we may not be able to work out a viable debt restructuring plan or otherwise maintain our liquidity and financial position.”

 

Our liquidity is based on our ability to generate cash from operating activities, obtain financing from equity interest investors and borrow funds on favorable economic terms to fund our general operations and capital expansion needs. Our ability to continue as a going concern is dependent on our management’s ability to successfully execute its business plan, which includes increasing revenue while controlling operating cost and expenses to generate positive operating cash flows and obtaining funds from outside sources of financing to generate positive financing cash flows. Based on cash flow projections from operating and financing activities and existing balance of cash and cash equivalents, our management believes that there is substantial doubt as to whether existing cash and cash equivalents will be sufficient to fund our operations within one year from the date of this annual report.

 

Our consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. If we become unable to continue as a going concern, we may have to liquidate our assets, and the value we receive for our assets in liquidation or dissolution could be significantly lower than the values reflected in our consolidated financial statements. Our lack of cash resources and our potential inability to continue as a going concern may materially and adversely affect the price of our ADSs and our ability to continue our operations.

 

The COVID-19 outbreak could significantly disrupt our operations and adversely affect our results of operations.

 

Since December 2019, China has experienced an outbreak of COVID-19, a disease caused by a novel and highly contagious form of coronavirus. The severity of the outbreak in certain provinces resulted in travel restrictions, quarantines and business closures imposed by local governments across China and materially affected general commercial activities in China. In response to this outbreak, from January 2020 to February 2020, we temporarily closed all of our corporate offices and requested all employees to work remotely. The travel restrictions and quarantines also prevented our sales, customer service and other personnel from visiting customers and business partners, making it more difficult for us to carry out marketing and other business activities and promote our products and solutions. The outbreak of COVID-19 has caused and may continue to cause significant slowdown of economic growth in China and globally, which may lead to reduced demand for our products and solutions. Furthermore, the slowdown of economic growth adversely affects the stability of, and investors’ confidence in, the financial market, making it more difficult for us to raise additional capital necessary for our continued operation. Any of the foregoing could have a material adverse impact on our business, results of operations, financial condition, cash flows and liquidity.

 

Following the outbreak of COVID-19, we have seen particular and immediate impacts in our operations, including a significant slowdown in the customer sales origination and renewal cycle, increased timeframes to accomplish key tasks and incremental challenges in collecting accounts receivable in a timely manner. It has hence caused material negative impacts to our net revenues and liquidity position. We expect these and other negative impacts as a result of COVID-19 to continue to adversely affect our business operations, results of operation and financial position through 2020 and potentially in future periods. For example, the outbreak of COVID-19 has caused a significant number of our marketing automation customers to reduce their marketing budgets, which has negatively affected our marketing-related solutions revenues and financial performance generally.

 

We are unable to predict the duration and severity of the spread of COVID-19, as they depend on rapidly evolving developments, which are highly uncertain and involve factors beyond our control, such as the continued spread or recurrence of contagion, the implementation and effectiveness of preventative and containment measures, the development of medical solutions, and public and market reactions to the foregoing. Any similar future outbreak of a contagious disease, other adverse public health developments in China or in other countries, or the measures taken by the governments of China or other countries in response to a future outbreak of a contagious disease may restrict economic activities in affected regions, resulting in traveling restrictions, quarantines, temporary business closures and reduced demand, or otherwise disrupt our business operations and adversely affect results of operations.

 

We are overdue on a significant amount of debt, and we may not be able to work out a viable debt restructuring plan or otherwise maintain our liquidity and financial position.

 

In May 2018, we issued and sold to FutureX Innovation SPC a convertible note in the principal amount of US$40 million, or the FutureX Convertible Note, which is convertible in whole or in part at the holder’s option into our Class B ordinary shares at an initial conversion price of US$6.50, subject to customary adjustments in the case of share splits, share combinations, dividends, spin-offs, recapitalizations and certain other events. The note bears interest at 2.80% per annum. The principal amount of the note and all accrued and unpaid interest became due on November 5, 2019, and we failed to repay the note on such date. On December 9, 2019, FutureX Innovation SPC served a statutory demand on us, under which it (i) claimed that we owed, as of December 9, 2019, a total amount of US$41,913,498 under the note, (ii) demanded that we pay such amount or secure or compound for it to FutureX Innovation SPC’s satisfaction, and (iii) stated that if payment of such amount is not made within 21 days of the date when the statutory demand was served on us, we will be deemed to be insolvent and a winding up petition may be presented against us in accordance with applicable Cayman laws. On March 3, 2020, we entered into an extension agreement with FutureX Innovation SPC, pursuant to which the parties agreed to extend the maturity date of the FutureX Convertible Note to May 31, 2020. In consideration of the extension, we agreed to pay an extension fee and increase the interest rate of the note to 24% per year effective from January 1, 2020. Pursuant to the terms of the extension agreement, FutureX Innovation SPC waived our prior payment default and withdrew the statutory demand served on us on December 9, 2019.

 

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Under the extension agreement, on May 31, 2020, we were required to make a total repayment of approximately US$48 million of principal, interest and extension fee. As of the date of this annual report, we are overdue on our payment obligations under the note. It is unlikely that we will generate sufficient cash flow from our business operations to make such repayment in the near future, and we may need to seek new financing, further extend the maturity date of the note or otherwise restructure our debt to resolve the payment default. After the execution of the extension agreement, we have been working on strategies and structures to restructure or pay our existing debt and finally resolve our payment obligations. However, there can be no assurance that any such debt restructuring or repayment can be executed on a timely basis, or at all. As of the date of this annual report, we have not received any binding proposal or entered into any binding agreement regarding such debt restructuring or repayment. If we cannot work out a viable debt restructuring plan, we may not be able to maintain our liquidity and continue our normal business operation. Even if we successfully enter into arrangements to restructure or resolve our debt, it is possible that our existing creditors and potential financing providers may impose additional conditions, increase interest rates and demand payment of extension fees or penalties in connection with such arrangements, leaving little or no value for our shareholders.

 

We have a history of losses and we may not achieve or sustain profitability.

 

We have incurred net losses in each year since our inception in 2005, including net losses of RMB239.1 million, RMB522.5 million and RMB536.9 million (US$77.1 million) in 2017, 2018 and 2019, respectively. As of December 31, 2019, we had an accumulated deficit of RMB1.6 billion (US$232.0 million). We expect to continue to expend substantial financial and other resources on, among other things:

 

·                    investments in our research and development team and in the development of new solutions and enhancements of our existing solutions;

 

·                    sales and marketing, including retaining our sales force, increasing our customer base, increasing market awareness of our solutions and enhancing our brand;

 

·                    expanding and restructuring our operations and infrastructure;

 

·                    hiring and retaining employees; and

 

·                    hiring and retaining general and administrative employees and executives, including administrative, legal, human resources, information technology, finance and accounting employees and executives.

 

These efforts may prove more expensive than we currently anticipate and may not result in increased revenues or profitability of our business. Further, some or all of the foregoing efforts may be temporarily delayed or re-evaluated as part of our efforts to mitigate the effects of the COVID-19 pandemic on our business, which may negatively affect our ability to improve our business and financial performance. In 2018 and 2019, we experienced a decline in the level of our business activity and related revenues. We may not be able to generate sufficient revenues to offset higher costs and achieve or sustain profitability. If we fail to achieve or sustain profitability, our business and operating results, and the price of our ADSs, will be adversely affected.

 

Our limited operating history makes it difficult to evaluate our current business and future prospects, and increases the risk of your investment.

 

We launched our first data analytics solution in 2009, and introduced our other solutions to the market more recently. This limited operating history and the dynamic nature of the market in which we operate limit our ability to forecast future operating results and subject us to many uncertainties, including our ability to plan for and anticipate future growth. Our revenue growth in earlier periods did not continue in 2018 and 2019, and should not be considered indicative of our future performance. We encounter risks and uncertainties frequently experienced by growing companies in rapidly changing industries, such as determining appropriate investments of our limited resources, market reception of our existing and future solutions, competition from other companies, attracting and retaining customers, hiring, integrating, training and retaining skilled personnel, developing new solutions, determining prices for our solutions and unforeseen expenses. If our assumptions regarding these risks and uncertainties, which we use to plan our business, are incorrect or change, or if we do not address these risks successfully, our operating and financial results and our business could be adversely affected.

 

We identified material weaknesses in our internal controls as of December 31, 2017, 2018 and 2019, and if we fail to address them and to establish and maintain effective internal controls in the future, our ability to report our financial results accurately or to prevent fraud may be adversely affected, along with investor confidence in us and the market price of the ADSs.

 

A material weakness is a deficiency, or combination of deficiencies, in internal controls, 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. In the course of auditing our consolidated financial statements, we and our then independent registered public accounting firm identified two material weaknesses in our internal control over financial reporting as of December 31, 2017, 2018 and 2019. As of December 31, 2019, the material weaknesses related to: (1) our lack of sufficient financial reporting and accounting personnel with appropriate knowledge of U.S. GAAP and the SEC reporting requirements to properly address complex accounting issues and prepare and review our financial statements and related disclosures in accordance with U.S. GAAP and SEC financial reporting requirements; and (2) the lack of written policies and procedures sufficient to timely record revenues and expenses in our financial statements.

 

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Following the identification of these material weaknesses, we have taken measures to remedy them and to remedy other control deficiencies. These measures may not fully address the material weaknesses and other control deficiencies. Any such failure to correct control deficiencies, or any failure to discover and address any other control deficiencies could result in inaccurate financial statements and impair our ability to comply with applicable financial reporting requirements. As a result, our business, and the trading price of our ADSs, may be materially adversely affected.

 

Our net revenues declined in 2018 and 2019, and there can be no assurance that we can avoid further decline in the future.

 

In 2018 and 2019, we experienced a decline in the level of our business activity and related revenue. Our net revenues decreased from RMB469.5 million in 2017 to RMB431.2 million in 2018, and to RMB326.6 million (US$46.9 million) in 2019, representing a decline of 8% and 24%, respectively. The decline was due to China’s general economic conditions, customer attrition, and our ongoing strategic evolution to achieve a more optimal revenue mix by optimizing our search engine marketing business toward higher return opportunities, among other factors. Many of these factors are beyond our control, and they may continue to have negative impact on our financial and operating performance in future periods. We cannot assure you that we will be able to avoid further revenue decline in the future, and we cannot assure you what level of customer demand and revenue may be associated with new solutions that we have developed recently. Even if revenue growth resumes, we are unlikely to experience the same rate of growth as we did in earlier periods. Therefore, investors should not rely on our results of operations in any earlier periods as an indication of our future performance.

 

We expect to need additional financing, and if we are not able to secure it on favorable terms, or at all, we may have to delay, reduce or cease operations, and we may not be able to meet existing payment obligations.

 

We do not know when or if our business will generate sufficient cash to fund our ongoing operations, and we expect to need additional financing from time to time. In the future, we may require additional capital to conduct our business, including the need to develop new solutions or enhance existing solutions, improve our infrastructure or to acquire complementary businesses and technologies. We do not have any specific acquisition plans or targets at this time. We may require additional capital to respond to declines in demand for our products or other unforeseen circumstances. We may be unable to timely secure additional debt or equity financing on favorable terms, or at all. Any debt financing we obtain could involve restrictive covenants relating to financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. If we raise additional funds through issuances of equity, convertible debt or other securities convertible into equity, our existing shareholders could suffer significant dilution in their percentage ownership of our company, and any new equity securities we issue could have rights, preferences and privileges senior to those of holders of the Class B ordinary shares and ADSs.

 

In May 2018, we issued and sold the FutureX Convertible Note to FutureX Innovation SPC, which is convertible in whole or in part at the holder’s option into our Class B ordinary shares at an initial conversion price of US$6.50, subject to certain adjustments. The note was originally due on November 5, 2019. After we failed to repay the note when due, we extended the maturity date of the note to May 31, 2020 on the conditions that we pay an extension fee and increase the interest rate of the note to 24% per year effective from January 1, 2020, among other things. As of the date of this annual report, we are overdue on our payment obligations under the note.

 

In March 2019, we issued and sold 3,461,902 Class B Ordinary Shares for an aggregate price of approximately US$11.1 million, or a per share price of US$3.20, in a private placement transaction to Hammer Capital Private Investments Limited and certain other equity investment firms.

 

In May 2019, one of our consolidated affiliated entities borrowed a working capital loan in the amount of RMB120 million from an entity affiliated with Hammer Capital Private Investments Limited. The loan bears interest at 4% per annum and has a term of 24 months, and may be prepaid by us before the maturity date. The loan agreement includes other customary terms and covenants, including certain events of default after which the RMB Loan may be due and payable immediately. The RMB Loan is guaranteed by certain of our consolidated affiliated entities and subsidiaries, and is secured by the pledge of intellectual properties held by the borrower and the guarantors. In connection with and as part of the consideration for the extension of the loan, we issued to an affiliate of the lender a warrant to purchase our Class B ordinary shares. Under the warrant, the warrant holder may purchase our Class B ordinary shares at the exercise price of US$4.0261 per share, for up to a total number of Class B ordinary shares representing the aggregate exercise price of US$14.45 million. Such aggregate exercise price will be increased to US$17.34 million if the loan is not repaid in full by May 30, 2020, and further increased to US$21.68 million if the loan is not repaid in full by November 30, 2020. Exercise of the warrant would cause significant dilution to the interest of existing holders of our Class B ordinary shares and ADSs.

 

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If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to support our business and to respond to business opportunities and challenges could be significantly limited, our business, operating results, financial condition and prospects could be adversely affected, and we may not be able to meet our payment obligations under our indebtedness.

 

The expansion of our customer base in recent periods has placed demands on our management and operational and financial infrastructure.

 

The number of our customers grew in recent years, from 505 customers in 2017 to 539 customers in 2018, and to 547 customers in 2019. The majority of our revenues in recent years were generated by sales to existing customers. That expansion has placed, and any further expansion will place, significant demands on our management and our operational and financial infrastructure. To manage any future expansion effectively, we must improve our operational, financial and management systems and processes by, among other things:

 

·                    attracting, training and integrating new employees, particularly for our sales and research and development teams;

 

·                    improving our operational infrastructure to support our business;

 

·                    developing our internal financial controls and disclosure controls to ensure timely and accurate reporting of our operational and financial results; and

 

·                    complying with applicable laws and regulations.

 

If we fail to manage our business, or if we fail to implement and maintain effective internal controls, our costs and expenses may increase more than we plan and our abilities to expand our customer base, enhance our existing solutions, develop new solutions, satisfy existing customers, attract new customers, respond to competitive pressures or otherwise execute our business plan may be diminished, and our operating results would be adversely affected.

 

For example, the filing of our 2017 Form 20-F was delayed in part due to inadequate internal control over financial reporting and changes of auditor. As a result, putative class action lawsuits were filed against us, the market price of our ADSs declined significantly, and our ability to secure new financing was adversely affected. Some customers reduced their level of business with us or did not renew their contracts, and our inability to obtain financing at favorable rates impacted our working capital and required us to cease doing business with some customers, which had an adverse effect on our financial results.

 

Our efforts to further develop our technology through increased research and development activities and investment in our platform may not yield satisfactory results.

 

The software industry in China is rapidly evolving and highly competitive, requiring us to invest significant financial resources in research and development and our platform to keep pace with technological advances in the industry. We have expended and may continue to expend significant financial resources in research and development activities and investment in our platform and commercialization of new technologies and platforms to effectively compete in the future. Our research and development expenses were RMB257.9 million, RMB533.6 million and RMB320.4 million (US$46.0 million) in 2017, 2018 and 2019, respectively. Our net losses were RMB239.1 million, RMB522.5million and RMB536.9 million (US$77.1 million) in 2017, 2018 and 2019, respectively. Research and development activities are inherently uncertain and may not generate revenues in a timely manner, or at all, and we may encounter practical difficulties in commercializing our research results and platform and technologies. Competitors’ technologies could prove to be more cost-effective than ours, and our investment in platform and technologies may be rendered obsolete by the technological advances of others.

 

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We have been named as a defendant in shareholder class action lawsuits that could have a material adverse impact on our business, financial condition, results of operation and cash flows, and our reputation.

 

We have been named as a defendant in shareholder class action lawsuits, which are described in “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings,” and will have to defend against such suits, including any appeals of such suits should our initial defense be unsuccessful. We are currently unable to estimate the possible loss or possible range of loss, if any, associated with the resolution of these suits. If our initial defense of these suits is unsuccessful, there can be no assurance that we will prevail in any appeal.

 

We cannot predict the outcome of these lawsuits. The matters that led to our Audit Committee investigation and our financial restatement have exposed us to increased risks of litigation, regulatory proceedings and government enforcement actions. We and our current and former directors and officers may, in the future, be subject to additional litigation relating to such matters. Subject to certain limitations, we are obligated to indemnify our current and former directors and officers in connection with such lawsuits and any related litigation or settlements amounts. Regardless of the outcome, these lawsuits, and any other litigation that may be brought against us or our current or former directors and officers, could be time-consuming, result in significant expense and divert the attention and resources of our management and other key employees. An unfavorable outcome in any of these matters could exceed coverage provided under potentially applicable insurance policies, which is limited. There could also be potential liability to third parties such as underwriters, accountants or others under contribution, indemnification or other claims. Any such unfavorable outcome could have a material effect on our business, financial condition, results of operations and cash flows. Further, we could be required to pay damages or additional penalties or have other remedies imposed against us, or our current or former directors or officers, which could harm our reputation, business, financial condition, results of operations or cash flows.

 

Our solutions may become less useful, and our business may be harmed, if we fail to adapt and respond effectively to rapidly developing technology, evolving industry standards and practices, and changing customer needs, requirements or preferences.

 

The software industry in China is subject to rapid technological development, evolving industry standards and practices and changing customer needs, requirements and preferences. The success of our business will depend, in part, on our ability to adapt and respond effectively to these changes on a timely basis. If we are unable to develop and sell new solutions that satisfy our customers and provide enhancements and new features for our existing solutions that keep pace with rapid technological change and industry developments, our revenues and operating results could be adversely affected. If new technologies emerge that are able to deliver competitive solutions and applications at lower prices, more efficiently, more conveniently or more securely than our solutions, those technologies could adversely impact our ability to compete and adversely affect our operating results.

 

To grow our business, we must achieve a high level of customer satisfaction and contract renewals, extend our relationships with existing customers over time and sell our solutions to new customers.

 

We have no long-term customer contracts, and most of our customer contracts may be renewed on an annual basis. Our top 20 customers accounted for 44%, 39% and 45% of our total revenues during the years ended December 31, 2017, 2018 and 2019, respectively. For our business to succeed we must achieve a high level of customer satisfaction so that our customers will renew their contracts with us and increase their utilization of the solutions they purchase from us. This requires that our solutions perform up to customer expectations and customers achieve the return on investment that they expect. Even if our products perform to specifications, customers may choose not to renew or to cancel early. Our success also depends on our ability to extend our relationships with existing customers, both by growing their utilization of solutions they have purchased and by selling additional products in our solution suites. Finally, our ability to achieve significant revenue growth also depends on our ability to attract new customers.

 

Our ability to generate customer renewal, customer expansion and new customer sales depends on many factors, including customer satisfaction with the performance of our solutions, the prices of our solutions and competing solutions, mergers and acquisitions affecting our customer base, the effects of global economic conditions and reductions in customer spending levels generally, including as a result of the COVID-19 pandemic. Our success with customers also depends on our ability to maintain a consistently high level of customer service and technical support to retain existing customers and attract new customers. If we are unable to hire and train sufficient support resources to provide adequate and timely support to our customers, our customers’ satisfaction with our solutions will be adversely affected. To the extent that our customers do not renew their contracts, terminate early or renew on less favorable terms or if our efforts to sell additional solutions to existing customers or new customers are not successful, our revenues may decline and our operating results could be adversely affected. The success of new solutions and enhancements of existing solutions depends on many factors, including timing, quality and market acceptance. Any new solutions that we develop may contain errors or defects or may not achieve the broad market acceptance necessary to generate sufficient revenues. If we are unable to successfully enhance our existing solutions to meet customer requirements, increase adoption and usage of our solutions or develop new solutions, our business and operating results will be adversely affected.

 

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A significant portion of our revenues is generated from enterprise customers based on the volume of their keyword placements with a small number of premium search engines in China, using our marketing automation solutions. The loss of any of these customers or search engines, or the reduction in their activities, could materially adversely affect our business, results of operations and financial condition.

 

Our marketing automation solutions allow our enterprise customers to automate the bidding for and purchase of keywords on search engines. A small number of premium search engines, such as Baidu, Sogou and Qihoo 360, have historically accounted for a significant portion of the keyword inventory that these customers purchased through our solutions. A majority of the impressions placed by customers using our marketing automation solutions were placed on Baidu websites in 2017, 2018 and 2019. We expect that we will continue for the foreseeable future to depend upon a small number of premium search engines for our customers’ purchases of search keywords. Because we have no long-term commitments from these search engines, they may reduce the inventory they sell to our customers. For example, if Baidu were to change its incentive programs for keyword placements by our marketing automation customers, or to cease doing business with us for any reason, our revenues and our financial results could be materially adversely affected.

 

Strategic relationships are an important part of our ability to grow our e-Government revenues, and if we do not maintain and strengthen those relationships, our results of operations and financial condition could be adversely affected.

 

In 2016, we entered into a strategic cooperation agreement with the PRC Supreme People’s Court Press, or People’s Court Press, which established a framework for the application of our technology to legal information services. We have collaborated with the People’s Court Press to develop new offerings such as the Chinese Legal Information Platform (or “Faxin” in Chinese), and, in cooperation with Tencent, a litigation service on WeChat’s micro application platform (Faxin Wei Su). There can be no assurance that these new offerings will be successful.

 

Selling to public sector customers in China involves special risks. These sales often require significant upfront time and expense without any assurance that these efforts will generate any revenues. Governmental agencies may require us to comply with various regulations that are not applicable to sales to commercial enterprises, and may require us to put in place controls and procedures that may be costly to administer. Failure to comply with any such regulations could adversely affect our business, operating results and financial condition, and sales to public sector customers may prove to be unprofitable.

 

Our quarterly operating results may fluctuate significantly due to a wide range of factors, which makes future results difficult to predict.

 

Our revenues and operating results could vary significantly from quarter to quarter, due to many factors that are outside of our control, including:

 

·                    the impact of the COVID-19 pandemic;

 

·                    changes in the size or composition of our customer base;

 

·                    timing and size of customer renewals and sales of additional solutions to existing customers;

 

·                    timing and size of sales to new customers, including penetration into the judicial and IIoT sectors;

 

·                    timing of our business expenses, such as unexpected business expenses or significant new employee hiring;

 

·                    changes in pricing, and introduction of solutions and enhancements by competitors;

 

·                    changes in customer budgets;

 

·                    seasonal business fluctuations, as reflected in revenues that have generally been highest in the fourth quarter of a calendar year and lowest in the first quarter;

 

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·                    our ability to control costs and expenses;

 

·                    the timing of satisfaction of revenue recognition criteria, particularly for large transactions;

 

·                    our ability to provide software solutions on-demand, without network outages or security breaches;

 

·                    fluctuations in our effective tax rate; and

 

·                    general economic and political conditions, domestically and internationally, as well as economic conditions affecting the specific industries in which our customers operate.

 

Any of these factors could cause our revenues and operating results to fluctuate, so quarter-to-quarter comparisons of our revenues, operating results and cash flows may not necessarily be indicative of our future performance.

 

We believe that quarter-to-quarter comparisons of our revenues, operating results and cash flows may not be meaningful and should not be relied upon as an indication of future performance. If our revenues or operating results fall below the expectations of investors or securities analysts in a particular quarter, or below any guidance we may provide, the price of the ADSs could decline.

 

If the market for our cloud-based SaaS offerings develops more slowly than we expect, our operating results would be adversely affected.

 

The market for business software that is delivered as cloud-based software-as-a-service, or SaaS, offerings is less mature than traditional on-premises software applications, and the adoption rate of SaaS business software may be slower among customers in industries with heightened data security concerns or business practices requiring highly customizable application software. Our success will depend to a substantial extent on the widespread adoption of SaaS business software in general, but we cannot be certain that the trend of adoption of SaaS solutions will continue in the future. In particular, many organizations have invested substantial personnel and financial resources in integrating legacy software into their businesses over time, and some have been reluctant or unwilling to migrate to SaaS. It is difficult to predict customer adoption rates and demand for our solutions, the future growth rate and size of the SaaS business software market or the entry of competitive applications. The expansion of the SaaS business software market depends on a number of factors, including the cost, performance and perceived value associated with SaaS, as well as the ability of SaaS providers to address data security and privacy concerns. If SaaS business software does not continue to achieve market acceptance, or there is a reduction in demand for SaaS business software caused by a lack of customer acceptance, technological challenges, weakening economic conditions, data security or privacy concerns, governmental regulation, competing technologies and solutions or decreases in information technology spending, it would result in decreased revenues and our business would be adversely affected.

 

We may continue to conduct acquisitions and enter into joint ventures, investments or other strategic alliances that may be unsuccessful.

 

We may continue to invest in or acquire other companies, or enter into joint ventures and other strategic alliances when appropriate opportunities arise. Such acquisitions, joint ventures and strategic alliances may expose us to operational, regulatory and market risks as well as risks associated with additional capital requirements and diversion of management attention. In particular, strategic alliances may expose us to unforeseen risks relating to our business partner’s business that we did not discover prior to our investment, or failure to generate anticipated revenue or other benefits from the acquisition, joint venture or alliance. Any of these risks could have a material adverse effect on our business, financial condition and results of operations.

 

Our success depends on being able to attract and retain our sales, service, research and development employees successfully.

 

Our ability to sell more of our solutions and achieve broad market acceptance of our solutions depends, to a significant extent, on our ability to attract and retain our sales, service and research and development employees. We believe there is significant competition for personnel with the skills and technical knowledge that we require, and from time to time we have experienced and expect to continue to experience significant turnover of employees. To the extent we experience unusual levels of turnover of employees or lose particularly valuable contributors, it may limit our ability to grow revenues and may harm our productivity, which could lead to revenue declines. Our ability to achieve revenue growth will depend, in large part, on our success in recruiting, training and retaining sufficient numbers of sales, service and research and development personnel. New hires require significant training and may take significant time before they achieve full productivity. Newly hired personnel may not become productive as quickly as we expect, and we may be unable to hire or retain sufficient numbers of qualified individuals in the markets where we do business or plan to do business. In addition, as we continue to hire new sales employees and develop new solutions, a large percentage of our employees will be new to our company and our solutions, which may make it more difficult to train our employees effectively and may adversely affect our sales, customer service and product development. The recent outbreak of COVID-19 and the related quarantines and travel restrictions have made it more difficult for us to interview, hire and provide on-site training to new employees. If we are unable to hire and train sufficient numbers of sales, service and research and development employees or if our employees are not successful in obtaining new customers, increasing or maintaining sales to our existing customer base or developing new products and solutions, our business will be adversely affected.

 

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We have a large amount of accounts receivable and have seen significant increase in our allowance for doubtful accounts, and our business and results of operations may be adversely affected if we fail to collect amounts owed to us.

 

Our business depends on our ability to collect our accounts receivable from our customers. Failure to collect these accounts receivable in a timely manner may adversely affect our cash flows and results of operations. Our accounts receivable (net of allowance for doubtful accounts) were RMB398.0 million and 191.3 million (US$27.5 million) as of December 31, 2018 and 2019, respectively, representing 43.5% and 32.0% of our total assets. Our allowance for doubtful accounts was RMB62.0 million, or 13.5% of total accounts receivable before allowance for doubtful accounts, as of December 31, 2018. In 2019, due to the uncertainty of collecting a significant amount of accounts receivable that became overdue, we had to make full allowance of such overdue receivable even though we may still be able to collect a portion of such receivable in the future. This has significantly increased our allowance for doubtful accounts to RMB146.5 million (US$21.0 million), or 43.4% of total accounts receivable before allowance for doubtful accounts, as of December 31, 2019. Increases in our allowance for doubtful accounts suggest that our collection of accounts receivable may be less likely than we anticipated. Additionally, the recent outbreak of COVID-19 has adversely affected our customers’ business operations, financial conditions, cash flows and liquidity positions. As a result, they may attempt to ask for longer payment terms or obtain concessions from us, or may fail to make payments to us when due. All of these may adversely affect our business and results of operations.

 

Failure to protect our customers’ proprietary data could expose us to risks of liability, loss of business and reputational damage.

 

Our business depends upon the proper storage, transmission and processing of our customers’ proprietary data, including some personally identifiable information. Security breaches, computer malware and computer hacking attacks could expose us to risks of loss of important customer information, which could result in loss of business, reputational damage, regulatory investigations and orders, litigation, indemnity obligations, damages for contract breach, penalties for violation of applicable laws or regulations and significant costs for remediation and incentives to customers or other business partners in an effort to maintain business relationships after a breach.

 

Cyberattacks and other malicious internet-based activity continue to increase generally. If our security measures are perceived as weak or are compromised as a result of third-party action, employee or customer error, malfeasance, stolen or fraudulently obtained log-in credentials or otherwise, our customers may curtail or stop using our solutions, our reputation could be damaged, our business could be adversely affected, and we could incur significant liability. We may be unable to anticipate or prevent techniques used to obtain unauthorized access or to sabotage systems because they change frequently and generally are not detected until after an incident has occurred. As we increase our customer base and our brand becomes more widely known and recognized, we may become more of a target for third parties seeking to compromise our security systems or gain unauthorized access to our customers’ data.

 

Many of our contracts do not have limitation of liability provisions for a security lapse or breach, and we cannot assure you that any contractual limitations of liability provisions would be enforceable or would otherwise protect us from any liabilities or damages with respect to any particular claim. We do not have insurance to cover such liabilities and damages, and cannot be sure that insurance coverage will be available on acceptable terms, will be available in sufficient amounts to cover one or more large claims related to a security breach, or that the insurer will not deny coverage as to any future claim. The successful assertion of one or more large claims against us that exceed available insurance coverage or the occurrence of changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could have a material adverse effect on our business, including expansion rates, financial condition, operating results and reputation.

 

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Our business collects and processes a large amount of data, and the improper use or disclosure of such data could harm our reputation as well as have a material adverse effect on our business and prospects.

 

In the course of performing data analysis for our customers, we collect and process a large quantity of personal, transactional, demographic and behavioral data. Although we do not store any personally identifiable information, we nevertheless face risks inherent in handling large volumes of data and in protecting the security of such data. In particular, we face a number of challenges relating to data about internet users who visit our customers’ websites:

 

·                    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, disclosure or security of personal information, including any requests from regulatory and government authorities relating to such data.

 

Any systems failure or security breach or lapse on our part that results in the release of user data could harm our reputation and brand and, consequently, our business, in addition to exposing us to potential legal liability.

 

Substantial uncertainties exist with respect to China’s Cyber Security Law as well as any impact it may have on our business operations.

 

China’s Cyber Security Law aims to establish stringent requirements for network operators in China, and applies to the construction, operation, maintenance and use of networks as well as the supervision and administration of cyber security. Under the Cyber Security Law, network operators, who are broadly defined as “owners and administrators of networks and network service providers,” are required to take necessary actions to prevent security attacks and data loss, including data classification, backup and encryption. Furthermore, the Cyber Security Law specifies requirements on user information protection applicable to network operators, who are prohibited from disclosing without permission or selling individual information with limited exceptions. When network operators become aware of any information that is prohibited by laws and administrative regulations, they are required to immediately cease transmission of such information, and take measures such as deletion of relevant information to prevent its dissemination. Network operators are also required to maintain a record of these incidents when they occur and report them to the relevant authorities. Where any information that comes from outside the territory of China is prohibited by law or regulation, the authorities may request relevant institutions to take measures to stop the flow of such prohibited information. The Cyber Security Law also emphasizes the protection of key information infrastructure in important industries and fields, such as e-Government, and operators of such key information infrastructure will be subject to stricter security obligations. For example, an operator of key information infrastructures is generally required to store in the PRC personal information and important business data collected and generated during its business operations within the PRC, and to assess its network security and identify potential risks at least once a year.

 

We may be deemed a “network operator” and thus subject to the various requirements applicable to network operators under the Cyber Security Law. Furthermore, as a provider of e-Government solutions, we may be deemed an operator of key information infrastructure and subject to stricter security obligations. Compliance with the Cyber Security Law, as well as additional laws and regulations that PRC regulatory agencies may enact from time to time, may result in additional expenses to us, subject us to negative publicity which could harm our reputation with users and negatively affect the trading price of our ADSs. There are also uncertainties with respect to how the Cyber Security Law 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. For example, in response to the heightened data security requirements from our e-Government customers, particularly in the judicial system, we have outsourced some of our software optimization and data security enhancement work to two China-based specialist companies. If we are unable to manage these risks, we could become subject to penalties, including fines, suspension of business and revocation of required licenses, and our reputation and results of operations could be materially adversely affected.

 

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If we lose key members of our management team or are unable to attract and retain executives and employees we need to support our operations and growth, our business could be adversely affected.

 

Our success and future growth depend largely upon the continued services of our executive officers and other key employees in the areas of research and development, marketing, sales, services and general administrative functions. From time to time, there may be changes in our executive management team or other key employees resulting from the hiring or departure of these personnel. The loss of one or more of our executive officers, particularly our chief executive officer and chairman, Guosheng Qi, or the failure of our executive team to work with our employees and lead our company effectively, including due to illness, quarantines and travel restrictions resulting from COVID-19, could adversely affect our business.

 

In addition, we must attract and retain highly qualified personnel to execute our growth plan. Competition for these personnel in Beijing, where our headquarters and the majority of our research and development personnel are located, and in other locations where we maintain offices is intense, especially for engineers experienced in designing and developing data analysis and digital intelligence solutions software and experienced sales professionals. We have from time to time experienced, and we expect to continue to experience, difficulty in hiring and retaining employees with appropriate qualifications. Many of the companies with which we compete for experienced personnel are larger and have greater resources than we have. If we hire employees from competitors or other companies, their former employers may attempt to assert that these employees have breached their legal obligations, resulting in a diversion of our time and resources. In addition, prospective and existing employees often consider the value of the equity awards they receive in connection with their employment. If the perceived value of our equity awards declines or experiences significant volatility, it may be more difficult for us to recruit and retain key employees. If we fail to attract new personnel or fail to retain and motivate our current personnel, our business and future growth prospects could be adversely affected.

 

The market in which we participate is intensely competitive, and if we do not compete effectively, our operating results could be adversely affected.

 

The market for digital intelligence solutions is rapidly evolving, fragmented and highly competitive, with relatively low barriers to entry in some segments. Our competitors fall into three primary categories:

 

·                    diversified technology companies such as Google, IBM, Microsoft and Oracle;

 

·                    bid management companies such as adSage, CubeAd, MediaV and Adobe Media Optimizer; and

 

·                    web analytics companies such as Adobe Omniture, WebTrends, Miaozhen Systems, AdMaster and Sensordata.

 

Each of IBM, Oracle and Salesforce.com offer “marketing cloud” solutions to customers, and we believe these companies and Adobe are our primary competitors in the market for marketing automation solutions. Still in its infancy, China’s legal technology and IIoT markets are fast growing, highly fragmented and intensely competitive. We face competition from startups and other companies, such as Beijing Thunisoft and Lawyee, in the legal market, and General Electric and Siemens have developed their respective IIoT solutions.

 

Many of our competitors and potential competitors are larger and have greater name recognition, longer operating histories, more established customer relationships, larger budgets, significantly greater resources and more operating flexibility to bundle competing solutions and services with other software offerings at little or no perceived incremental cost, including offering them at a lower price as part of a larger sale. As a result, our competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or customer requirements. In addition, some competitors may offer solutions or services that address one or a limited number of functions at lower prices or with greater depth than our solutions. Our current and potential competitors may develop and market new technologies with comparable functionality to our solutions, and this could lead to us having to decrease prices in order to remain competitive.

 

With the introduction of new technologies and new market entrants, we expect competition to intensify. As we expand the scope of our solutions, we may face additional competition. Additionally, some existing and potential customers, particularly large enterprises, may elect to develop their own internal solutions. If one or more of our competitors were to merge or partner with another of our competitors, the change in the competitive landscape could also adversely affect our ability to compete effectively. If we are unable to maintain our current pricing due to the competitive pressures, our margins will be reduced and our operating results will be adversely affected. Pricing pressures and increased competition generally could result in reduced sales and margins, losses or the failure of our solutions to achieve or maintain more widespread market acceptance, any of which could adversely affect our business.

 

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Interruptions or performance problems associated with our technology and infrastructure may adversely affect our business and operating results.

 

Our success depends in part on reliable customer access to our solutions and reliably high performance by our solutions. We may experience disruptions, outages and other performance problems due to a variety of factors, including downtime at leased data center facilities, infrastructure changes, introductions of new functionality, human or software errors, capacity constraints due to an overwhelming number of users accessing our solutions simultaneously, denial of service attacks or other security related incidents. In addition, the availability and performance of our solutions are important to our customers, but it may become more difficult over time to maintain and improve our performance levels, especially during peak usage times, and as our solutions become more complex and our usage volume increases. If our solutions are unavailable to customers when needed or our solutions do not perform up to expected levels for any reason, our business will be adversely affected. Addressing these problems will require us to address capacity constraints, continually upgrade our systems and continually develop our technology and network architecture, which will increase our costs and may adversely affect our operating results.

 

Software errors, defects or disruptions in our solutions could diminish demand for our solutions, adversely affect our financial results and subject us to liability.

 

Our customers depend on our solutions for important aspects of their businesses, and any errors, defects or disruptions to our solutions or other performance problems may damage our customers’ businesses and could hurt our brand and reputation. We provide regular updates, which may contain undetected errors when first introduced or released. In the past, we have discovered software errors, failures, vulnerabilities and bugs in our solutions after they have been released, and additional errors in our existing solutions may be detected in the future. Real or perceived errors, failures or bugs in our solutions could result in negative publicity, loss of or delay in market acceptance of our solutions, loss of competitive position, delay of payment to us, lower renewal rates or claims by customers for losses sustained by them. In such an event, we may be required, or may choose for customer relations reasons or otherwise, to expend additional resources in order to help correct the problem. As a result, we could lose future sales and our reputation and our brand could be adversely affected. In addition, we currently do not and may not in the future carry insurance sufficient to compensate us for any losses that may result from claims arising from defects or disruptions in our solutions.

 

Any failure to protect our intellectual property rights could impair our ability to protect our proprietary technology.

 

Our success depends to a significant degree on our ability to protect our proprietary technology. We will not be able to protect our intellectual property if we are unable to enforce our rights or if we do not detect unauthorized use of our intellectual property. If we fail to protect our intellectual property rights adequately, our competitors may gain access to our technology and our business could be adversely affected.

 

We rely on a combination of patents, trademarks, trade secrets, copyrights, service marks, contractual restrictions and other intellectual property laws and confidentiality procedures to establish and protect our proprietary rights. However, the steps we take to protect our intellectual property may be inadequate. We may be unable to obtain any patent protection for our technology subject to the pending patent applications. Any patents, trademarks or other intellectual property rights that we obtain may be challenged by others or invalidated through administrative process or litigation. We enter into confidentiality and invention assignment agreements with our employees and consultants and enter into confidentiality agreements with other parties. There is no assurance that these agreements will be effective in controlling access to and distribution of our proprietary information.

 

Furthermore, legal standards relating to the validity, enforceability and scope of protection of intellectual property rights are uncertain. The laws of the PRC are not as protective of intellectual property rights as those in the United States, and legal procedures for enforcement of intellectual property rights may be inadequate in China. Accordingly, despite our efforts, we may be unable to prevent third parties from infringing upon or misappropriating our intellectual property.

 

We may be required to spend significant resources in monitoring and protecting our intellectual property rights. We may be required to pursue litigation to protect our intellectual property rights and to protect our trade secrets. Litigation brought to protect and enforce our intellectual property rights could be costly, time-consuming and distracting to management, and it could also result in the impairment or loss of portions of our intellectual property. Further, our efforts to enforce our intellectual property rights may be met with defenses, counterclaims and countersuits attacking the validity and enforceability of our intellectual property rights. Our failure to protect our proprietary technology against unauthorized copying or use, as well as any costly litigation or diversion of our management’s attention and resources, could delay further sales or the implementation of our solutions, impair the functionality of our solutions, delay introductions of new solutions, result in our substituting less effective or more costly technologies into our solutions or injure our reputation.

 

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We may be sued by third parties for alleged infringement of their proprietary rights.

 

There are considerable patent, copyright, trademark, trade secret and other intellectual property development activities in our industry. Our success depends in part on not infringing on the intellectual property rights of others. From time to time, our competitors or other third parties may claim that we are infringing upon their intellectual property rights, and we may be found to be infringing upon such rights. Any claims or litigation, regardless of merit, could cause us to incur significant expenses and, if successfully asserted against us, could require that we pay substantial damages or ongoing royalty payments, prevent us from offering our solutions or require that we comply with other unfavorable terms.

 

Even if the claims do not result in litigation or are resolved in our favor, these claims, and the time and resources spent in resolving them, could divert the resources of our management and adversely affect our business and operating results. We expect that the occurrence of infringement claims is likely to grow as the market for digital intelligence solutions grows. Accordingly, our exposure to damages resulting from infringement claims could increase and this could further divert our financial and management resources.

 

Our use of open source software could negatively affect our ability to sell our solutions and subject us to possible litigation.

 

We use open source software in our solutions and expect to continue to use open source software in the future. We may face claims from others claiming ownership of, or seeking to enforce the terms of, an open source license, including by demanding release of the open source software, derivative works or our proprietary source code that was developed using such software. These claims could also result in litigation, require us to purchase a costly license or require us to devote additional research and development resources to change our technologies, any of which would have a negative effect on our business and operating results. In addition, if the license terms for the open source software we utilize change, we may be forced to reengineer or discontinue our solutions or incur additional costs. We cannot be certain that we have incorporated open source software in our solutions in a manner that is consistent with our policies.

 

Natural disasters and other events beyond our control could adversely affect our business.

 

Natural disasters or other catastrophic events may cause damage or disruption to our operations, international commerce and the global economy, and thus could have a strong negative effect on us. Our business operations are subject to interruption by natural disasters, fire, power shortages, pandemics and other events beyond our control. We rely on our network and third-party data center infrastructure, customers’ internal technology systems and our website for our development, marketing, operational support, hosted solutions and sales activities. Although we maintain crisis management and disaster response plans, in the event of a major earthquake, hurricane or other catastrophic event such as fire, power loss, telecommunications failure, cyber-attack, war or terrorism, we may be unable to continue operations without interruption and may suffer lost revenues, delays in developing important software, reputational harm, breaches of data security and loss of critical data, all of which could have an adverse effect on our results of operations.

 

Risks Relating to Our Corporate Structure

 

We conduct our businesses in China by means of contractual arrangements through a variable interest entity and its subsidiaries. If the PRC government determines that such arrangements do not comply with applicable laws and regulations, our business could be materially adversely affected.

 

PRC law restricts foreign ownership of companies that engage in internet, market survey and other related businesses. Foreign ownership in a company engaging in value-added telecommunications business (excluding e-commerce, domestic multi-party communications, store-and-forward and call center businesses) shall not exceed 50% and the primary foreign investor of such company must have a record of good performance and operating experience in conducting value-added telecommunications service.

 

We are a company registered in the Cayman Islands and Dissector (Beijing) Technology Co., Ltd., our wholly-owned PRC subsidiary that we refer to as the WFOE, is considered a foreign-invested enterprise. We conduct our business in China through Gridsum Holding (Beijing) Co., Ltd., or Gridsum PRC Holding, which is our variable interest entity, or VIE, and its subsidiaries, based on a series of contractual arrangements among the WFOE, Gridsum PRC Holding and the shareholders of Gridsum PRC Holding. The shareholders of Gridsum PRC Holding are our founders, Guosheng Qi and Guofa Yu, and a company owned by Guosheng Qi and other key employees. As a result, we control Gridsum PRC Holding and its subsidiaries, and we consolidate their operating results in our financial statements under U.S. GAAP. The subsidiaries of Gridsum PRC Holding hold licenses and key assets that are essential for our business operations

 

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There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations. If the contractual arrangements among the WFOE, Gridsum PRC Holding and the shareholders of Gridsum PRC Holding are determined to be illegal or invalid, the relevant governmental authorities would have broad discretion in dealing with such violation, including revoking our business and operating licenses, requiring us to discontinue or restrict operations, restricting our rights to collect revenues, confiscating our income, requiring us to restructure our ownership structure or operations, imposing additional conditions or requirements with which we may not be able to comply or levying fines. These actions could cause significant disruption to our business operations and may materially adversely affect our business, financial condition and operating results.

 

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

 

We rely on contractual arrangements with Gridsum PRC Holding, in which we have no ownership interest, and the shareholders of Gridsum PRC Holding to conduct our business. These contractual arrangements are intended to provide us with effective control over Gridsum PRC Holding and its subsidiaries and allow us to obtain economic benefits from them, but may not be as effective as direct ownership. If Gridsum PRC Holding or its shareholders fail to perform their respective obligations under the contractual arrangements, we may incur substantial costs and expend substantial resources to enforce our rights.

 

These contractual arrangements are governed by and interpreted in accordance with PRC law, and disputes will be resolved through arbitration in China. There are very few precedents and little official guidance as to how contractual arrangements in the context of a variable interest entity should be interpreted or enforced under PRC law. There remain significant uncertainties regarding the ultimate outcome of arbitration should legal action become necessary. The relevant PRC arbitration panel may conclude that our contractual arrangements violate PRC law or are otherwise unenforceable. In addition, arbitration awards are final and can only be enforced in PRC courts through arbitration award recognition proceedings, which could cause additional expenses and delays. In the event that we are unable to enforce these contractual arrangements or we experience significant delays or other obstacles in the process of enforcing these contractual arrangements, we may not be able to exert effective control over Gridsum PRC Holding, and may lose control over the assets owned by it and its subsidiaries. As a result, we may be unable to consolidate Gridsum PRC Holding and its subsidiaries in our consolidated financial statements, our ability to conduct our business may be adversely affected, and our business operations could be severely disrupted.

 

Some of our executive officers and directors are substantial shareholders of the Company, and they may encounter conflicts of interest in such roles.

 

Substantial shareholders of the Company include some of our executive officers and members of our board of directors, who may encounter conflicts of interest between that beneficial ownership and their roles as executive officers and members of our board of directors. We rely on these individuals to abide by the laws of the Cayman Islands, which provide that directors and officers owe a fiduciary duty to our company to act in good faith and in the best interest of our company and not to use their positions for personal gain. Processes designed to avert or protect against such conflicts may be cumbersome, time-consuming and disruptive to our operations.

 

Contractual arrangements with our consolidated affiliated entities may cause adverse tax consequences for us.

 

Under applicable PRC tax laws and regulations, arrangements and transactions among related parties may be subject to audit or scrutiny by the PRC tax authorities. We could face adverse tax consequences if the PRC tax authorities determine that the contractual arrangements among the WFOE, Gridsum PRC Holding and the shareholders of Gridsum PRC Holding are not on an arm’s length basis and therefore constitute favorable transfer pricing. Such a finding could require Gridsum PRC Holding to adjust its taxable income upward without necessarily reducing the tax expenses of the WFOE, and subject it to fees and penalties for under-payment of taxes. As a result, our consolidated operating results could be adversely affected.

 

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We may lose the ability to use assets held by Gridsum PRC Holding or its subsidiaries that are important to the operation of our business if any of them goes bankrupt or becomes subject to a dissolution or liquidation proceeding.

 

Gridsum PRC Holding and its subsidiaries hold assets and perform functions that are important to the operation of our business. In particular, Gridsum PRC Holding and its subsidiaries hold almost all patents for our proprietary technology, domain names, trademarks, copyrights and other intellectual property rights. If Gridsum PRC Holding or any of its subsidiaries enters into bankruptcy or undergoes a voluntary or involuntary liquidation proceeding, all or part of its assets will become subject to liens or rights of third-party creditors. As a result, we may be unable to continue some or all of our business operations, which could materially adversely affect our business, financial condition and operating results.

 

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

 

On March 15, 2019, the National People’s Congress approved the Foreign Investment Law of the People’s Republic of China, or the Foreign Investment Law, which came into effect on January 1, 2020, and replaced the trio of previously-existing laws regulating foreign investment in China, namely, the Sino-foreign Equity Joint Venture Enterprise Law, the Sino-foreign Cooperative Joint Venture Enterprise Law and the Wholly Foreign-Owned Enterprise Law, together with their implementation rules and ancillary regulations. On December 26, 2019, the Implementing Regulations of the Foreign Investment Law of the People’s Republic of China, or the Implementing Regulations of the Foreign Investment Law, was issued by the State Council, and came into effect on January 1, 2020, which provides further details and guidance on the implementation of the Foreign Investment Law.

 

The Foreign Investment Law and the Implementing Regulations of the Foreign Investment Law seek to rationalize the PRC’s regulation of foreign investment in line with international practice. However, since they are relatively new, uncertainties exist in relation to their interpretation and implementation. For instance, under the Foreign Investment Law, “foreign investment” refers to the investment activities directly or indirectly conducted by foreign individuals, enterprises or other entities in China. Like many PRC-based companies, we have adopted the VIE structure to obtain necessary licenses and permits in the industries that are currently subject to foreign investment restrictions in China. Though the Foreign Investment Law and the Implementing Regulations of the Foreign Investment Law do not explicitly classify contractual arrangements as a form of foreign investment, there is no assurance that foreign investment via contractual arrangement would not be interpreted as a type of indirect foreign investment activities under the definition in the future. In addition, the definition contains a catch-all provision that includes investments made by foreign investors through means stipulated in laws or administrative regulations or other methods prescribed by the State Council. Therefore, it still leaves leeway for future laws, administrative regulations or provisions promulgated by the State Council to provide for contractual arrangements as a form of foreign investment. In any of these cases, it will be uncertain whether our contractual arrangements with our consolidated affiliated entities will be deemed to be in violation of the market access requirements for foreign investment under the PRC laws and regulations. Furthermore, if future laws, administrative regulations or provisions prescribed by the State Council mandate further actions to be taken by companies with respect to existing contractual arrangements, we may face substantial uncertainties as to whether we can complete such actions in a timely manner, or at all.

 

The Foreign Investment Law also specifies that foreign investments shall be conducted in line with the “negative list” to be issued or approved by the State Council, which restricts or prohibits a foreign-invested enterprise’s (such as the WFOE) operations of business in industries to be specified from time to time. On July 30, 2019, the Special Administrative Measures for Access of Foreign Investment (Negative List) (2019 Version), or the Special Administrative Measures, came into effect, pursuant to which the foreign ownership in the business our consolidated affiliated entities operate, such as the Gridsum Big Data Platform and value-added telecommunication services (excluding e-commerce, domestic multi-party communications, store-and-forward and call center businesses), shall not exceed 50%.

 

There is no guarantee that our contractual arrangements with our consolidated affiliated entities, or the business they operate, will be in compliance with the Foreign Investment Law, the Implementing Regulations of the Foreign Investment Law or any future laws, administrative regulations or provisions prescribed by the State Council. If we fail to comply with any such laws, regulations or provisions, our corporate structure and business operations may be materially and adversely affected.

 

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Risks Relating to Doing Business in China

 

A severe or prolonged downturn in the PRC or global economy could materially and adversely affect our business and our financial condition.

 

The global macroeconomic environment is facing challenges. 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 and over the conflicts involving Ukraine, Syria and North Korea. There have also been concerns on the relationship among China and other Asian countries, which may result in or intensify potential conflicts in relation to territorial disputes, and the trade disputes between the United States and China. It is unclear whether these challenges and uncertainties will be contained or resolved, and what effects they may have on the global political and economic conditions in the long term.

 

Economic conditions in China are sensitive to global economic conditions, changes in domestic economic and political policies and the expected or perceived overall economic growth rate in China. While the economy in China has grown significantly over the past decades, growth has been uneven, both geographically and among various sectors of the economy, and the rate of growth has slowed down in recent years. Although the growth of China’s economy remained relatively stable, there is a possibility that China’s economic growth may materially decline in the near future. There have also been concerns about the territorial disputes involving China in Asia and the economic effects, as well as the relationship between China and the U.S., including those resulting from the trade dispute between the two countries.

 

Any severe or prolonged slowdown in the global or PRC economy may lead to a reduction in demand for our products and services, and materially and adversely affect our business, results of operations and financial condition. Our revenues are dependent on the number of our customers and the scope of the solutions used by our customers. Historically, during economic downturns there have been reductions in spending on digital intelligence as well as pressure for extended billing terms and other financial concessions. These conditions affect the level of information technology spending and could adversely affect our customers’ ability or willingness to purchase our solutions, delay prospective customers’ purchasing decisions, and reduce the value or duration of their contracts or affect renewal rates, all of which could adversely affect our operating results. In 2019, the demand for our products and solutions was adversely affected by the slowdown of China’s economic growth, which led to softened consumer demand. Our marketing-oriented solutions were particularly impacted, and we have seen a deterioration of margins and working capital terms with clients in a number of areas as a result. The rapid spread of COVID-19 in 2020 may further impact our customers’ business operations, financial conditions, cash flows and liquidity positions, and cause further decline in our sales and revenue. It is not possible at this time to estimate the impact that COVID-19 could have on our business, as the impact will depend on future developments, which are highly uncertain and cannot be predicted.

 

Adverse changes in economic and political policies of the PRC government could have a material adverse effect on overall economic growth in China, which could materially adversely affect our business.

 

Substantially all of our operations are conducted in China and substantially all of our revenues are generated in China. Accordingly, our operating results, financial condition and prospects are influenced by the economic, political and legal conditions and developments in China. China’s economy differs from the economies of most developed countries in many respects, including the amount of government involvement in the economy, the general level of economic development, growth rates, foreign exchange control and allocation of resources. The PRC government exercises significant control over China’s economic growth through strategically allocating resources, controlling the payment of foreign currency-denominated obligations, setting monetary policies and providing preferential treatment to particular industries or enterprises. Any adverse changes in the policies of the Chinese government or in PRC laws and regulations could have a material adverse effect on the overall economic growth of China, result in decreased demand for our solutions and adversely affect our business and operating results.

 

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

 

The PRC legal system is a civil law system based on written statutes. Unlike the common law system, prior court decisions may be cited for reference but have limited precedential value. In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters. Since then, the legislation has enhanced the protections of foreign investments in China. However, China has not developed a fully integrated legal system, and recently enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. The interpretation and enforcement of these laws and regulations involve uncertainties. Since the PRC administrative authorities and courts have significant discretion in interpreting and implementing statutory and contractual terms, it may be difficult to evaluate the outcome of administrative and court proceedings and the level of legal protection available to our shareholders and us.

 

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Furthermore, the PRC legal system is partly based on government policies and internal rules, some of which are not published in a timely manner or at all, and some of which may have retroactive effects. As a result, we may not be aware of our violation of any of these policies or rules until sometime after the violation. Such uncertainties, including the uncertainty over the scope and effect of our contractual, property (including intellectual property) and procedural rights could materially adversely affect our business and impede our ability to continue our operations.

 

The PRC regulations on offshore holding companies providing loans to and making direct investments in PRC entities may delay or prevent us from making capital contributions or loans to our PRC subsidiary.

 

From time to time, we may need to finance and transfer funds to the WFOE by means of shareholder loans or capital contributions to fund our business operations in the PRC. According to a notice issued by the People’s Bank of China regarding foreign debt on January 12, 2017, the maximum amount of foreign debt that the WFOE is allowed to borrow is two times of its net assets. Any loans we make to the WFOE cannot exceed statutory limit, and must be registered with the State Administration of Foreign Exchange, or SAFE, or its local counterparts. Any capital contributions we make to the WFOE must be filed with appropriate governmental agencies. We may not be able to complete these fillings on a timely basis, if at all. If we fail to complete such fillings or registrations, our ability to provide capital contributions or loans to the WFOE in a timely manner may be adversely affected, which could materially adversely affect our liquidity and our ability to fund and expand our business.

 

Moreover, the registered capital of the WFOE settled in RMB converted from foreign currencies may only be used within the business scope registered with the applicable governmental authority and may not be used to grant loans to persons other than affiliates unless expressly permitted by its business scope. This may significantly limit our ability to fund our business operations in China.

 

The failure of our PRC-resident beneficial owners to comply with PRC foreign exchange regulations may subject the WFOE to liability or penalties, limit our ability to inject capital into the WFOE or limit the WFOE’s ability to distribute profits.

 

On July 4, 2014, SAFE promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Outbound Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37. SAFE Circular 37 requires a PRC resident to make SAFE registration prior to contributing assets or interests to an overseas special purpose vehicle, or SPV, that is directly established or indirectly controlled by such PRC resident for the purpose of conducting investment or financing. SAFE Circular 37 further requires the PRC resident to make amendment registrations in the event of any major changes or events with respect to the SPV, such as increase or decrease of capital contributed by PRC individuals, share transfer or exchange, merger or division. In the event that a PRC-resident shareholder holding interests in a SPV fails to complete the required SAFE Circular 37 registration, the PRC subsidiary of the SPV may be prohibited from making profit distributions to its offshore parent and from carrying out subsequent cross-border foreign exchange activities, and the SPV may be restricted in its ability to contribute additional capital into its PRC subsidiary. Moreover, failure to comply with the various SAFE registration requirements could result in liability under the PRC law for evading foreign exchange controls.

 

The beneficial owners of Generation Gospel Limited, Garden Enterprises Ltd. and Fairy Spirit Limited who are PRC residents have completed initial registrations under SAFE Circular 37 with the local counterparts of SAFE relating to their investments in us. However, we may not be aware of the identities of all of our beneficial owners who are PRC residents. We do not have control over our beneficial owners and cannot assure you that all of our PRC-resident beneficial owners have complied and will comply with SAFE Circular 37 and subsequent implementation rules. The failure of our existing or future beneficial owners who are PRC residents to comply with the registration requirements and procedures set forth in SAFE Circular 37 and subsequent implementation rules may subject the WFOE to fines and legal sanctions, limit our ability to contribute additional capital to the WFOE and limit the WFOE’s ability to distribute dividends or make other distributions to our company, which could adversely affect our business and prospects.

 

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

 

The PRC Enterprise Income Tax Law, or the EIT Law, as most recently amended on December 29, 2018, provides that an enterprise established outside China whose “de facto management body” is located in China is considered a “PRC resident enterprise” and will generally be subject to the uniform 25% PRC enterprise income tax on its global income. Under the implementation rules of the EIT Law, as most recently amended on April 23, 2019, “de facto management body” is defined as the organizational body which effectively manages and controls the production and business operation, personnel, accounting, properties and other aspects of operations of an enterprise.

 

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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 Enterprises on the Basis of De Facto Management Bodies, or Circular 82, as most recently amended on December 29, 2017, which further interprets the application of the EIT Law and its implementation on non-PRC enterprise or group controlled by a PRC enterprise or a PRC enterprise group. According to Circular 82, an overseas incorporated enterprise controlled by PRC enterprises or PRC enterprise groups is considered a PRC resident enterprise if all of the following conditions are met: (i) the senior management and core management departments in charge of daily operations are located mainly in the PRC; (ii) financial and human resources decisions are subject to determination or approval by persons or bodies in the PRC; (iii) major assets, accounting books, company seals and minutes and files of board and shareholders’ meetings are located or kept in the PRC; and (iv) at least half of the enterprise’s directors or senior management with voting rights habitually reside in the PRC. Although these standards only apply to offshore enterprises that are controlled by PRC enterprises or PRC enterprise groups, such standards may reflect the general view of the SAT in determining the tax residence of overseas incorporated enterprises.

 

If the PRC tax authorities determine that our company or any of our non-PRC subsidiaries is a PRC resident enterprise for PRC enterprise income tax purposes, we or any such non-PRC subsidiary could be subject to PRC enterprise income tax at a rate of 25% on our or its global income, which could materially reduce our net income. In addition, we will also be subject to PRC enterprise income tax reporting obligations. Furthermore, if the PRC tax authorities determine that our company is a PRC resident enterprise, dividends paid by us and gains realized on the sale or other disposition of the ADSs or our ordinary shares may be subject to PRC tax, at a rate of 10% if the shareholder is a non-PRC resident enterprise or 20% in the case of a non-PRC individual shareholder (in each case, subject to the provisions of any applicable tax treaty). Such tax may materially reduce the value of the ADSs.

 

Any limitation on the ability of the WFOE to make distributions to us, or the tax implications thereof, could have a material adverse effect on our business or financial condition.

 

We are a holding company, and we rely principally on dividends and other distributions from the WFOE for our cash needs, including the funds necessary to pay dividends to our shareholders or to service any debt we may incur. Current PRC regulations permit the WFOE to pay dividends only out of its accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, the WFOE is required to set aside at least 10% of its after tax profits each year, if any, to fund statutory reserve funds until the aggregate amount of such reserve funds reaches 50% of its registered capital. Apart from these reserves, the WFOE may allocate a portion of its after-tax profits to discretionary reserves at its discretion. These reserves and funds are not distributable as cash dividends. We cannot assure you that the WFOE will generate sufficient earnings and cash flows in the near future to pay dividends or otherwise distribute sufficient funds to enable us to meet our obligations, pay interest and expenses or declare dividends.

 

Since 2016, PRC governmental authorities began imposing more stringent restrictions on outbound capital flows, including through regulations that tightened the authentication and compliance verification of cross-border transactions and cross-border capital flow, such as by requiring banks to verify board resolutions, tax filing forms and audited financial statements before wiring foreign invested company’s foreign exchange dividend distribution of over US$50,000. See “Item 4. Information on the Company—B. Business Overview—Regulation—Regulations on Foreign Exchange.” Any restrictions on outbound capital flows may limit our ability to utilize revenue generated in the PRC to pay dividends in foreign currencies to our shareholders, including holders of our ADSs, or to fund our business activities or service any debt we may incur outside of the PRC.

 

Distributions made by a PRC company to its offshore parent are generally subject to a 10% withholding tax under the EIT Law. Pursuant to the EIT Law and the Arrangement Between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion With Respect to Taxes on Income, the withholding tax rate on dividends paid by the WFOE to Gridsum HK would generally be reduced to 5%, provided that Gridsum HK is the beneficial owner of the income sourced from China. However, on February 3, 2018, SAT promulgated the Announcement Regarding the Beneficial Owners in Tax Treaties, which provides that a comprehensive analysis should be carried out in the determination of a beneficial owner, and certain factors would put Gridsum HK in an unfavorable position in such determination, including but not limited to its non-engagement in substantive business activities. If Gridsum HK is not regarded as a beneficial owner, it will not be entitled to the 5% withholding tax rate with respect to any dividends or distributions made by the WFOE, which would be subject to 10% withholding tax and would reduce our ability to make distributions or dividends to holders of ADSs.

 

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Governmental control of currency conversion may limit our ability to pay dividends and other obligations and affect the value of your investment.

 

The PRC government imposes controls on the convertibility of the RMB into foreign currencies and the remittance of currency out of China. We receive substantially all of our revenues in RMB, and substantially all of our cash inflows and outflows are denominated in RMB. We primarily rely on dividend payments from the WFOE to fund any cash and financing requirements we may have.

 

Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments, and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior SAFE approval as long as routine procedural requirements are fulfilled. Therefore, the WFOE is allowed to pay dividends in foreign currency to us without pre-approval from SAFE. However, approval from or registration with competent government authorities is required where the RMB is to be converted into foreign currency and remitted out of China to pay capital account items such as the repayment of loans denominated in foreign currencies. Also, the PRC government may at its discretion restrict access to foreign currencies for current account items in the future. If the foreign exchange control system in China prevents us from obtaining sufficient foreign currencies to satisfy our foreign currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of the ADSs.

 

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

 

Our employees and directors who are PRC residents and who participate in our equity incentive plans are required to register with SAFE and complete other procedures through a domestic qualified agent, and to retain an overseas entrusted institution to handle matters in connection with their exercise or sale of share options. In addition, the PRC agent is required to make amendment registrations with respect to the share incentive plan if there is any material change to the share incentive plan, the PRC agent or the overseas entrusted institution or other material changes. Failure to comply with such requirements will subject us or our PRC resident option holders to fines and other legal or administrative sanctions. To date, we have completed the SAFE foreign exchange registration with respect to our share incentive plans, but there can be no assurance that we will be able to continue to do so in the future, which would make it more difficult for us to incentivize our employees.

 

Furthermore, our employees working in the PRC who exercise share options, or whose restricted shares or restricted share units, or RSUs, vest, will be subject to PRC individual income tax. Our PRC subsidiary and controlled affiliated entities are required to file documents related to employee share options, restricted shares or RSUs with the relevant tax authorities and to withhold individual income taxes of those employees related to their share options, restricted shares or RSUs. If the employees fail to pay, and our PRC subsidiary and controlled affiliated entities fail to withhold, such PRC individual income taxes, our PRC subsidiary and controlled affiliated entities may face sanctions imposed by the PRC tax authorities.

 

Fluctuation in the value of the RMB may have a material adverse effect on the value of your investment.

 

The value of the RMB against the U.S. Dollar and other currencies is affected by changes in China’s political and economic conditions and China’s foreign exchange policies. While appreciating approximately by 7% against the U.S. Dollar in 2017, the RMB depreciated approximately by 5% and 1% against the U.S. Dollar in 2018 and 2019, respectively. There is no guarantee that the value of the RMB against the U.S. Dollar will not fluctuate significantly in the future, including as a result of the volatile market conditions arising from the COVID-19 pandemic.

 

Substantially all of our revenues and costs are denominated in RMB, and substantially all of our financial assets are also denominated in RMB. Any significant depreciation of the RMB may materially adversely affect the value of, and any dividends payable on, our ADSs in U.S. Dollars. To the extent that we need to convert U.S. Dollars into RMB, appreciation of the RMB against the U.S. Dollar would reduce the RMB amount we would receive from the conversion. Conversely, if we decide to convert RMB into U.S. Dollars, appreciation of the U.S. Dollar against the RMB would reduce the U.S. Dollar amount available to us.

 

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

 

Some of our consolidated affiliated entities have been granted the status of “high and new technology enterprise” by PRC government agencies. As a result, the income tax rate of these entities is reduced to a preferential rate of 15% for three-year terms that expire starting in 2020, although such terms could be extended for another three years if these entities renew their “high and new technology enterprises.” The government agencies may decide not to renew the “high and new technology enterprise” status of these entities after the term expires, and therefore we cannot assure you that the preferential tax treatment will continue. The discontinuation of such preferential tax treatment could increase our tax expenses and adversely affect our net income.

 

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We may have to register our encryption software with Chinese regulatory authorities, and if they request that we change our encryption software, our business operations could be disrupted as we develop or license replacement software.

 

Companies operating in China are allowed to use only commercial cipher code products approved by the National Commission on Encryption Code Regulations or its local counterparts, and are prohibited from using self-developed or imported cipher code products without approval. In addition, all cipher code products shall be produced by those producers appointed and approved by the PRC authority. Moreover, according to the Cryptography Law of the People’s Republic of China which came into effect on January 1, 2020, or the Cryptography Law, commercial cypher code products concerning national security, national economy, people’s livelihood and public interests shall be included in the catalog of network key equipment and special cyber security products developed by the PRC authorities, and shall not be sold without certification from qualified institutions. Since the Cryptography Law is relatively new, uncertainties still exist in relation to its interpretation and implementation. We are unsure as to whether or how the Cryptography Law, along with any implementing regulations, will apply to us and the encryption software we use. The encryption software that we use now or may use in the future may require approval by the authorities or certification from qualified institutions. If the producer of such encryption software fails to obtain the any required approval or certification, we may need to change our current encryption software to an approved or certified cipher code product, which could disrupt our business operations.

 

Risks Relating to Our Ordinary Shares and ADSs

 

The market price for our ADSs has declined significantly and remains volatile, which could result in substantial losses to our shareholders.

 

Since we completed our initial public offering on the Nasdaq Global Select Market in September 2016, the trading price of our ADSs has dropped significantly. The initial public offering price of our ADSs in September 2016 was US$13.00 per ADS, and the closing bid price of our ADSs on June 1, 2020 was US$0.848 per ADS. The trading price of our ADSs may continue to be highly volatile, fluctuating widely due to factors beyond our control. This may happen because of broad market and industry factors, like the performance and fluctuation in the market prices or the underperformance or deteriorating financial results of other companies with business operations located mainly in China that have listed their securities in the United States. The securities of some of these companies have experienced significant volatility since their initial public offerings, including, in some cases, substantial price declines in the trading prices of their securities. The trading performances of other Chinese companies’ securities after their initial public offerings may affect the attitudes of investors toward Chinese companies listed in the United States, which consequently may impact the trading performance of the ADSs, regardless of our actual operating performance. In addition, any negative news or perceptions about inadequate corporate governance practices or fraudulent accounting, corporate structure or matters of other Chinese companies may also negatively affect the attitudes of investors towards Chinese companies in general, including us, regardless of whether we have conducted any inappropriate activities. In addition, securities markets may from time to time experience significant price and volume fluctuations that are not related to our operating performance, which may have a material adverse effect on the market price of our ADSs.

 

In addition to market and industry factors, the trading price of our ADSs may be highly volatile due to factors specific to our own operations, such as:

 

·                    variations in our revenues, earnings and cash flow;

 

·                    fluctuations in our quarterly results of operations;

 

·                    our liquidity position and our ability to repay or restructure existing debts;

 

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

 

·                    announcements of new product offerings and solutions by us or our competitors;

 

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·                    addition or departure of key personnel;

 

·                    litigation, government investigation or other legal or regulatory proceeding; and

 

·                    the status and development of the proposed going private transaction.

 

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

 

The decline and volatility of our ADS price has adversely affected our ability to raise additional capital to support our continued operation, forcing us to seek equity financing at prices that would cause significant dilution to our existing shareholders. The declined ADS price also greatly impairs the stability of our management and key employee teams, many of whom have been granted stock options in prior years with an exercise price significantly higher than the price our ADSs currently trade. In order to be able to retain our management and key employees, we have sought and may continue to seek to reprice our existing stock options or convert our existing stock options into other forms of equity incentives. Such repricing or conversion may increase our share-based compensation expenses and negatively affect our results of operations.

 

If we fail to regain compliance with Nasdaq’s minimum bid price or minimum market value of publicly held shares requirement, our ADSs could be subject to delisting.

 

Our ADSs are currently listed on the Nasdaq Global Select Market. The Nasdaq Listing Rules has minimum requirements that a company must meet for continued listing on the Nasdaq Global Select Market. These requirements include maintaining a minimum closing bid price of US$1.00 per ADS and a minimum market value of publicly held shares of US$15 million for a period of 30 consecutive trading days. On April 17, 2020, we received a notice from Nasdaq that we have failed to comply with the minimum closing bid price requirement. On May 1, 2020, we received a further notice from Nasdaq regarding our failure to comply the minimum market value of publicly held shares requirement. To regain compliance with these requirements, the closing bid price of our ADSs must be at least US$1.00 per ADS, and the market value of our publicly held shares must be at least US$15 million, each for ten consecutive trading days at any time before December 28, 2020.

 

We have not regained compliance with these two requirements as of the date of annual report. We are closely monitoring the bid price of our ADSs and the market value of our publicly held shares, and may consider available options, such as a reserve stock split to increase the per ADS price of our ADSs, if our ADSs do not trade at a level likely to result in our company regaining compliance with these requirements by December 28, 2020. However, there can be no assurance that we will be able to regain compliance with any of these requirements in a timely manner. If we fail to regain compliance by December 28, 2020, we may be subject to delisting, or, subject to certain conditions, transfer the listing of our ADSs to the Nasdaq Capital Market. Even if we transfer the listing of our ADSs to the Nasdaq Capital Market, we may still face delisting if the closing bid price of our ADSs continues to be below US$1.00, or if we fail to meet the other continued listing requirements of the Nasdaq Capital Market. The delisting of our ADSs or transfer of listing may significantly reduce the liquidity of our ADSs, cause further declines to the market price of our ADSs, and make it more difficult for us to obtain adequate financing to support our continued operation.

 

Uncertainty concerning the proposed going private transaction may adversely affect our business and the market price of the ADSs.

 

In July 2019, our board of directors received a preliminary non-binding proposal letter from Guosheng Qi, Guofa Yu, their respective affiliated entities, and Beta Dynamic Limited, an affiliate of Hammer Capital Private Investments Limited, to acquire our company in a going private transaction for US$3.80 in cash per ADS or ordinary share. Our board of directors formed a special committee consisting of independent directors to evaluate the proposal and any other alternative transactions. On May 1, 2020, our board of directors received a revised non-binding proposal letter, from Guosheng Qi, Guofa Yu, their respective affiliated entities, Beta Dynamic Limited, Shenzhen Qianhai Banyan Capital Investment & Management Co., Ltd and Hangzhou Yutao Capital Co., Ltd, to acquire our company in a going private transaction for US$2.00 in cash per ADS or ordinary share.

 

In order for the proposed going private transaction to be consummated, we must first enter into a definitive merger agreement that is approved by our board of directors and later by our shareholders. If the going private transaction is consummated, it would cause us to be delisted from The Nasdaq Stock Market and become a private company, in which event our shareholders and holders of the ADSs, other than those in the approved buyer group, would no longer have an equity interest in our company. If the proposed going private transaction is withdrawn, is not approved by either our board of directors or our shareholders, or is for any other reason not consummated, it could adversely affect the market price of our ADSs. There can be no assurance that the proposed going private transaction will continue to be pursued, approved or consummated.

 

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Whether consummated or not, the proposed going private transaction risks diverting management focus, employee attention and other resources from strategic opportunities and from operational matters. Also, as the going private transaction develops, certain events such as the execution of any merger agreement, completion of the merger or an amendment to or termination of any merger agreement, may increase the volatility of the trading price of the ADSs. Furthermore, we could be subject to potential lawsuits in connection with the proposed going private transaction.

 

Provisions of the FutureX Convertible Note could discourage an acquisition of us by a third party and prevent the completion of the proposed going private transaction.

 

Provisions of the FutureX Convertible Note could make it more difficult, or more expensive, for us to be acquired by a third party. For example, holders of the FutureX Convertible Note have the right to require us to repurchase for cash the entire FutureX Convertible Note at a repurchase price equal to 100% of the principal amount plus accrued and unpaid interest upon the occurrence of certain fundamental changes of our company, including an acquisition. Such “fundamental changes” include, among other things, (1) any person or group gaining control of our company, (2) our company merging with or into another company or disposing of substantially all of our assets, (3) any recapitalization, reclassification or change of our ordinary shares or the ADSs as a result of which these securities would be converted into, or exchanged for, stock, other securities, property or assets, or (4) adoption of a plan to dissolve or liquidate our company or any of our significant subsidiaries.

 

Moreover, it is likely that the proposed going private transaction will be deemed a “fundamental change,” and we will have to repay the FutureX Convertible Note in full upon the consummation of such transaction. The terms of the note also prohibit us from merging with other companies or disposing of all or substantially all of our properties and assets upon the occurrence of any event of default, including our payment default as a result of our failure to repay the note by May 31, 2020. If we are not able to obtain new financing in a sufficient amount to repay the note in full, we will be prevented from completing any proposed going private transaction.

 

If securities or industry analysts do not publish research or reports about our business, or if they publish inaccurate or unfavorable research about us, the market price and trading volume of our ADSs could decline.

 

The trading market for our ADSs depends in part on the research and reports that securities analysts publish about our business. If analysts do not establish and maintain adequate research coverage, or if analysts downgrade our ADSs or publish inaccurate or unfavorable research about our business, the market price for our ADSs would likely decline. In recent years, a number of securities analysts have terminated or suspended coverage of our company, causing us to lose visibility among investors in the financial markets.

 

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

 

As of March 31, 2020, we had 4,543,461 Class A ordinary shares and 30,076,443 Class B ordinary shares outstanding, including 18,770,894 ADSs that were freely transferable. The remaining 15,849,010 ordinary shares outstanding are available for re-sale subject to applicable restrictions under Rule 144 under the Securities Act.

 

Substantial future issuances and sales of our ordinary shares by us or re-sales of our ordinary shares and ADSs, or the perception that these sales could occur, could cause the market price of our ADSs to decline. Certain holders of our Class B ordinary shares, including certain investors in our March 2019 private placement and the holder of our May 2019 warrant, have the right to require us to register under the Securities Act the re-sale of their shares. Additionally, in connection with our offer and sale of the FutureX Convertible Note, we agreed to register under the Securities Act the offer and sale of the Class B ordinary shares issuable upon conversion of the FutureX Convertible Note and granted customary piggyback registration rights. As of March 31, 2020, 6,766,975 Class B ordinary shares were issuable upon conversion of the FutureX Convertible Note. Registration of any of these ordinary shares under the Securities Act would result in ADSs representing these shares being freely tradable, which could cause the price of our ADSs to decline.

 

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Our dual-class ordinary shares structure limits the ability of holders of our Class B ordinary shares and ADSs to influence corporate matters and could discourage others from pursuing change of control transactions that such holders may view as beneficial.

 

Our ordinary shares are divided into Class A and Class B ordinary shares. Holders of Class A ordinary shares are entitled to ten votes per share, and holders of Class B ordinary shares are entitled to one vote per share. Generation Gospel Limited, which is owned and controlled by our chief executive officer, held all 4,543,461 Class A ordinary shares issued and outstanding as of March 31, 2020.

 

Due to these disparate voting powers, our chief executive officer beneficially owned an aggregate of 66.3% of the voting power of our outstanding ordinary shares as of March 31, 2020, and effectively controls or has considerable influence over matters requiring shareholder approval, including election of directors and significant corporate transactions, such as a merger or sale of our company or our assets. This concentrated control limits the ability of holders of our Class B ordinary shares and ADSs to influence corporate matters and could discourage other parties from pursuing any potential merger, takeover or other change of control transactions that such holders may view as beneficial.

 

Because we do not expect to pay dividends in the foreseeable future, investors are dependent on price appreciation of our ADSs for return on their investment.

 

We currently intend to retain most, if not all, of our available funds and any future earnings to fund the development and growth of our business. As a result, we do not expect to pay any cash dividends in the foreseeable future. Therefore, investors should not rely on an investment in our ADSs as a source for any future dividend income. Our Board of Directors has complete discretion as to whether to distribute dividends. Even if our Board decides to declare and pay dividends, the timing, amount and form of future dividends, if any, will depend on, among other things, our future operating results 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. Accordingly, the return on investment in our ADSs, if any, will likely depend entirely upon any future price appreciation of the ADSs. There is no guarantee that our ADSs will appreciate in value or even maintain the price at which the holders of our ADSs purchased the ADSs. The holders of our ADSs may not realize a return on their investment in our ADSs and the holders of our ADSs may even lose their entire investment in the ADSs.

 

Holders of our ADSs may not receive dividends or other distributions on our ADSs and the holders of our ADSs may not receive any value for them, if it is illegal or impractical to make them available to the holders of our ADSs.

 

The depositary of our ADSs has agreed to pay to holders of our ADSs the cash dividends or other distributions it or the custodian receives on Class B ordinary shares or other deposited securities underlying the ADSs, after deducting its fees and expenses. The holders of our ADSs will receive these distributions in proportion to the number of Class B ordinary shares our 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 the holders of our ADSs 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 the holders of our ADSs. These restrictions may cause a material decline in the value of the ADSs.

 

Holders of our ADSs may experience dilution of their holdings due to inability to participate in rights offerings.

 

We may, from time to time, distribute rights to our shareholders, including rights to acquire securities. Under the deposit agreement, the depositary will not distribute rights to holders of our 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 our 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 our ADSs may be unable to participate in our rights offerings and may experience dilution of their holdings as a result.

 

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Holders of our ADSs may be subject to limitations on transfer of the ADSs.

 

Our 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, on weekends and on 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, at any time if we or the depositary thinks it is advisable to do so because of any requirement of law or of any government or governmental body or under any provision of the deposit agreement, or for any other reason.

 

Holders of our ADSs may have fewer rights than holders of our ordinary shares and must act through the depositary to exercise those rights.

 

Holders of our ADSs do not have the same rights of our shareholders and may only exercise the voting rights with respect to the underlying Class B ordinary shares in accordance with the provisions of the deposit agreement. Under our current memorandum and articles of association, the minimum notice period required to convene a general meeting is 14 days. When a general meeting is convened, the holders of our ADSs may not receive sufficient notice of a shareholders’ meeting to permit them to withdraw their Class B ordinary shares to allow them to cast their vote with respect to any specific matter. In addition, the depositary and its agents may not be able to send voting instructions to them or carry out their voting instructions in a timely manner. We will make all reasonable efforts to cause the depositary to extend voting rights to them in a timely manner, but we cannot assure the holders of our ADSs that they will receive the voting materials in time to ensure that they can instruct the depositary to vote the ADSs. Furthermore, the depositary and its agents will not be responsible for any failure to carry out any instructions to vote, for the manner in which any vote is cast or for the effect of any such vote. As a result, the holders of our ADSs may not be able to exercise their right to vote and they may lack recourse if our ADSs are not voted as they requested. In addition, in their capacity as an ADS holder, they will not be able to call a shareholders’ meeting.

 

The depositary for our ADSs will give us a discretionary proxy to vote the Class B ordinary shares underlying their ADSs if the holders of our ADSs do not vote at shareholders’ meetings, except in limited circumstances, which could adversely affect their interests.

 

Under the deposit agreement for the ADSs, if the holders of our ADSs do not vote, the depositary will give us a discretionary proxy to vote the Class B ordinary shares underlying their ADSs at shareholders’ meetings unless:

 

·                    we have failed to timely provide the depositary with notice of meeting and related voting materials;

 

·                    we have instructed the depositary that we do not wish a discretionary proxy to be given;

 

·                    we have informed the depositary that there is substantial opposition as to a matter to be voted on at the meeting;

 

·                    a matter to be voted on at the meeting would have a material adverse impact on shareholders; or

 

·                    the voting at the meeting is to be made on a show of hands.

 

The effect of this discretionary proxy is that if the holders of our ADSs do not vote at shareholders’ meetings, they cannot prevent the Class B ordinary shares underlying their ADSs from being voted, except under the circumstances described above. This may make it more difficult for shareholders to influence the management of our company. Holders of our ordinary shares are not subject to this discretionary proxy.

 

Holders of our ADSs may face difficulties in protecting their interests, and their ability to protect their rights through the U.S. federal courts may be limited because we are incorporated under Cayman Islands law, we conduct substantially all of our operations in China and substantially all of our directors and officers reside outside the United States.

 

We are incorporated in the Cayman Islands and conduct substantially all of our operations in China through our PRC subsidiary and consolidated affiliated entities. Substantially all of our directors and officers reside outside the United States and a substantial portion of their assets are located outside of the United States. As a result, it may be difficult or impossible for the holders of our ADSs to bring an action against us or against these individuals in the United States in the event that they believe that their rights have been infringed under the U.S. securities laws or otherwise. Even if they are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render them unable to enforce a judgment against our assets or the assets of our directors and officers.

 

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There are uncertainties as to whether Cayman Islands courts would:

 

·                    recognize or enforce against us judgments of courts of the United States based on certain civil liability provisions of U.S. securities laws; and

 

·                    impose liabilities against us, in original actions brought in the Cayman Islands, based on certain civil liability provisions of U.S. securities laws that are penal in nature.

 

There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of the Cayman Islands will in certain circumstances recognize and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits.

 

Our corporate affairs are governed by our memorandum and articles of association, as amended and restated from time to time, and by the Companies Law (2020 Revision) and common law of the Cayman Islands. The rights of shareholders to take legal action against us and our directors, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which provides persuasive, but not binding, authority in a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands has a less developed body of securities laws than the United States and provides significantly less protection to investors. In addition, shareholders in Cayman Islands companies may not have standing to initiate a shareholder derivative action in U.S. federal courts.

 

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

 

We may be classified as a passive foreign investment company, or PFIC, under U.S. federal income tax law, which could result in material adverse U.S. federal income tax consequences to U.S. holders of the ADSs.

 

Depending upon the value of our assets, which is generally determined based on the market value of the ADSs, and the nature of our assets and income over time, we could be classified as a PFIC for U.S. federal income tax purposes. Based on our current income and assets and the value of the ADSs, we do not believe we were a PFIC for the 2019 taxable year or for prior years, and we do not expect to be classified as a PFIC for the current taxable year or in the foreseeable future. While we do not anticipate becoming a PFIC for the current taxable year, fluctuations in the market price of our ADSs or changes in the composition of our income or assets may cause us to become a PFIC for the current or any subsequent taxable year.

 

We will be classified as a PFIC for any taxable year if either (i) 75% or more of our gross income for the taxable year is passive income or (ii) 50% or more of the value of our assets (determined on the basis of a quarterly average) is attributable to assets that produce or are held for the production of passive income. Although the law in this regard is unclear, we intend to treat Gridsum PRC Holding as being owned by us for U.S. federal income tax purposes, not only because we exercise effective control over the operation of this entity but also because we are entitled to substantially all of its economic benefits and burdens, and, as a result, we consolidate its operating results in our consolidated U.S. GAAP financial statements. If it were determined, however, that we are not the owner of Gridsum PRC Holding for U.S. federal income tax purposes, the PFIC tests would apply differently and we could be treated as a PFIC for our current taxable year and any subsequent taxable year. Because of the uncertainties in the application of the relevant rules in respect of our VIE structure and because PFIC status is a factual determination made annually after the close of each taxable year on the basis of the composition of our income and the value of our active versus passive assets, there can be no assurance that we will not be a PFIC for the current taxable year or any future taxable year.

 

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If we were to be or become classified as a PFIC, a U.S. holder of our ADSs or Class B ordinary shares generally would be taxed at ordinary income rates on any sale of our ADSs or Class B ordinary shares and on any dividends treated as an “excess distribution” under the U.S. federal income tax rules. An interest charge also generally would apply if U.S. tax were deferred during the U.S. holder’s holding period. Further, if we were a PFIC for any year during which a U.S. holder held our ADSs or ordinary shares, we generally would continue to be treated as a PFIC for all succeeding years during which such U.S. holder held our ADSs or ordinary shares. You are urged to consult your tax advisor concerning the U.S. federal income tax consequences of acquiring, holding and disposing of ADSs or ordinary shares if we are or become classified as a PFIC. For more information see “Item 10. Additional Information—E. Taxation—Material United States Federal Income Tax Considerations—Passive Foreign Investment Company Rules.”

 

Changes in our United States federal income tax classification, or that of our subsidiaries, could result in adverse tax consequences to our 10% or greater U.S. shareholders.

 

The U.S. tax reform act of December 2017 (the “2017 Act”) may have changed the consequences to U.S. shareholders that own, or are considered to own as a result of certain stock ownership attribution rules, 10% or more of the voting power or value of the stock of a non-U.S. corporation (a “10% U.S. Shareholder”) under the U.S. Federal income tax law applicable to owners of U.S. controlled foreign corporations (“CFCs”). Prior to the 2017 Act, we did not believe we, or any of our non-U.S. subsidiaries, were CFCs, based on our 10% U.S. Shareholders (if any) together owning less than 50% of our ordinary shares. The 2017 Act repealed Internal Revenue Code Section 958(b)(4), which, unless clarified in future regulations or other guidance, may result in our classification (or the classification of certain of our non-U.S. subsidiaries) as CFCs. This classification could cause significant and adverse U.S. tax consequences for our existing 10% U.S. Shareholders (if any) or any person who becomes a 10% U.S. Shareholder. Therefore, 10% U.S. Shareholders (if any) and persons considering becoming 10% U.S. Shareholders are strongly urged to consult with their tax advisors regarding the 2017 Act revisions to the U.S. Federal income tax law applicable to owners of CFCs.

 

As a foreign private issuer, we are exempt from some disclosures that apply to U.S. domestic public companies.

 

Because we are a foreign private issuer, 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 requiring filing quarterly reports on Form 10-Q and current reports on Form 8-K with the SEC;

 

·                    provisions regulating the solicitation of proxies, consents or authorizations;

 

·                    provisions 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

 

·                    selective disclosure rules under Regulation FD governing issuer disclosure of material nonpublic information.

 

As a result, our shareholders may not be afforded the same protections or information that would be made available to them were they investing in a U.S. domestic issuer.

 

As a company incorporated in the Cayman Islands, we are permitted to adopt home country practices in relation to corporate governance matters that differ significantly from the Nasdaq corporate governance listing standards; these practices may afford less protection to shareholders than they would enjoy if we complied fully with the Nasdaq corporate governance listing standards.

 

As a Cayman Islands company listed on The Nasdaq Stock Market, we are subject to the Nasdaq corporate governance listing standards. Nasdaq rules permit us to follow the corporate governance practices of our home country, the Cayman Islands, which differ significantly from the Nasdaq corporate governance listing standards. For example, neither the Companies Law of the Cayman Islands nor our memorandum and articles of association requires a majority of our directors to be independent, and we could include non-independent directors as members of our nominating and corporate governance committee. In addition, neither the Companies Law of the Cayman Islands nor our memorandum and articles of association requires us to solicit proxy and hold meetings of our shareholders every year. Furthermore, our independent directors would not necessarily hold regularly scheduled meetings at which only independent directors are present. If we choose to follow home country practice, our shareholders may be afforded less protection than they otherwise would receive under the Nasdaq corporate governance listing standards applicable to U.S. domestic issuers. As of the date of this annual report, we are relying on the home country practices stated above. As a result, we may have less independent oversight over the management of our company.

 

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Any requirement to obtain prior approval for our initial public offering could have a material adverse effect on our business, operating results, reputation and trading price of the ADSs.

 

PRC regulatory agencies have promulgated Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rules, which became effective in September 2006 and was amended on June 22, 2009. The M&A Rules purport to require offshore special purpose vehicles, or SPVs, that are formed for overseas listing purposes through acquisition of PRC domestic companies and controlled by PRC companies or individuals, to obtain regulatory approval prior to publicly listing their securities on an overseas stock exchange. While the application of the M&A Rules remains unclear, we believe that no prior approval was required for our initial public offering. However, uncertainties exist as to how the M&A Rules will be interpreted and implemented. If PRC regulatory agencies determine that we needed to obtain regulatory approval for our initial public offering, we may face sanctions by the regulatory agencies, including fines and penalties or limits on our operations in the PRC, delays or restrictions on the repatriation of the proceeds from our initial public offering into the PRC or other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, any of which would harm the trading price of the ADSs.

 

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

 

We are an “emerging growth company,” as defined in the federal securities laws, and we may take advantage of exemptions from various reporting requirements that are applicable to other public companies, including not being required to provide auditor attestation of our internal control over financial reporting, reduced disclosure obligations regarding executive compensation, and exemption from the requirement to hold a nonbinding shareholder advisory vote on executive compensation. If some investors find our ADSs less attractive as a result, there may be a less active trading market for our ADSs and our stock price may be more volatile.

 

We incur significant costs and devote substantial management time in order to operate as a Nasdaq-listed public company.

 

As a public company, we incur significant legal, accounting and other expenses that are not incurred by a private company. For example, we are subject to reporting requirements of the Exchange Act, and to other securities laws, rules and regulations implemented by the SEC and The Nasdaq Stock Market, are required to establish and maintain effective internal controls, disclosure controls and corporate governance practices. Compliance with these requirements increases our legal and financial compliance costs and makes some activities more time consuming and costly. In addition, these public company requirements may divert management attention from operational and other business matters. We need to prepare and maintain an effective contract tracking database, hire additional accounting and finance staff with sufficient U.S. GAAP accounting and SEC reporting experience. As a public company, it may be difficult for us to attract and retain qualified people to serve on our Board of Directors, or as executive officers.

 

Shareholders of a public company often bring securities class action lawsuits against the company following periods of instability in the market price of that company’s securities. We have been, and may continue to be, involved in class action lawsuits, which could divert a significant amount of our management’s attention and other resources from our business and operations, and harm our results of operations and require us to incur significant expenses to defend the suits. Any such class action lawsuit could harm our reputation and restrict our ability to raise capital in the future, and, if successfully made against us, could have a material adverse effect on our business, financial condition and results of operations. See “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings.”

 

ITEM 4. INFORMATION ON THE COMPANY

 

A.    History and Development of the Company

 

Gridsum Holding Inc. is an exempted company incorporated under the laws of the Cayman Islands on July 21, 2014.

 

Our principal executive offices are located at South Wing, High Technology Building, No. 229 North 4th Ring Road, Haidian District, Beijing 100083, People’s Republic of China. Our telephone number at this address is (86-10) 8261-9988. Our registered office in the Cayman Islands is located at the offices of International Corporation Services Ltd., Harbour Place 2nd Floor, 103 South Church Street, P.O. Box 472, George Town, Grand Cayman KY1-1106. Our agent for service of process in the United States is Law Debenture Corporate Services Inc., located at 801 2nd Avenue, Suite 403, New York, NY 10017 and Cogency Global Inc., located at 122 East 42nd Street, 18th Floor New York, NY 10168.

 

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Our Internet address is www.gridsum.com. The information on our website is not a part of this document. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at the website of http://www.sec.gov.

 

We commenced operations in December 2005 with the establishment of Beijing Gridsum Technology Co., Ltd., or Beijing Gridsum, in China. We have established or acquired some additional operating companies: Beijing Moment Everlasting Ad Co., Ltd., in January 2011, and its wholly-owned subsidiary, Beijing Yunyang Ad Co., Ltd., in March 2013, and Guoxinjunhe (Beijing) Technology Co., Ltd., in April 2012, Beijing Guoxinwangyan Technology Co., Ltd., in August 2015, Beijing Gridsum Yizhun Technology Co., Ltd., in February 2016, Beijing Zhixunyilong Software Co., Ltd., which was acquired by Beijing Gridsum in May 2017, and Beijing Gridsum Wang’an Technology Co., Ltd., in June 2017. We refer to these operating companies as Beijing Moment, Beijing Yunyang, Guoxinjunhe, Beijing Guoxinwangyan, Beijing Yizhun, Beijing Zhixunyilong and Beijing Gridsum Wang’an, respectively.

 

From July to December 2014, we undertook a reorganization of our group of companies in preparation for our proposed initial public offering in the United States. We incorporated Gridsum Holding Inc., or Gridsum Cayman, under the laws of the Cayman Islands on July 21, 2014, as the parent holding company of our group of related companies. Gridsum Cayman established a wholly-owned subsidiary in Hong Kong, Gridsum Holding (China) Limited, or Gridsum HK, which in turn established a wholly-owned subsidiary in the PRC, Dissector (Beijing) Technology Co., Ltd., or the WFOE. Also as part of this reorganization, we established Gridsum PRC Holding in China, which acquired full ownership of Beijing Gridsum, Beijing Moment and Guoxinjunhe. The shareholders of Gridsum PRC Holding are Guosheng Qi, Guofa Yu, and Gridsum (Beijing) Management Consulting Co., Ltd., a company incorporated in the PRC and owned by Guosheng Qi and other key employees.

 

To comply with applicable PRC laws and regulations, we conduct our operations in China principally through Beijing Gridsum, Guoxinjunhe, Beijing Moment, Beijing Yunyang, Beijing Guoxinwangyan, Beijing Zhixunyilong, Beijing Gridsum Wang’an and Beijing Yizhun. The WFOE entered into a series of contractual arrangements on December 22, 2014 with Gridsum PRC Holding, the parent of our PRC operating companies, and the shareholders of Gridsum PRC Holding. These contractual arrangements allow us to exercise effective control over Gridsum PRC Holding and receive substantially all of the economic benefits of Gridsum PRC Holding. As a result, we are the primary beneficiary of Gridsum PRC Holding and treat it as our variable interest entity, or VIE, under U.S. GAAP. We have consolidated the financial results of Gridsum PRC Holding and its subsidiaries in our consolidated financial statements.

 

Prior to the reorganization in 2014, our group of companies was controlled by a predecessor Cayman Islands entity, whose wholly-owned subsidiary in the PRC controlled our operating companies in China pursuant to a set of contractual arrangements, which contained substantially the same terms as, and were replaced by, the contractual arrangements entered into among the WFOE, Gridsum PRC Holding and the shareholders of Gridsum PRC Holding in 2014.

 

In June 2015, in connection with our collaboration projects with a third party in the e-Government field, we established a joint venture company, Beijing Guoxinwangyan. Beijing Gridsum and Guoxinjunhe each owns 40% of the equity interest in Beijing Guoxinwangyan. The remaining 20% equity interest in Beijing Guoxinwangyan, which was initially owned by the third party, has been transferred to Beijing Gridsum Wang’an following the termination of the collaboration projects.

 

On September 23, 2016, our ADSs commenced trading on The Nasdaq Stock Market under the symbol “GSUM.”

 

On April 30, 2018, we entered into a convertible note purchase agreement with FutureX Innovation SPC. On May 5, 2018, we completed the transactions contemplated by the convertible note purchase agreement and issued an US$40 million convertible note to FutureX Innovation SPC for a total consideration of US$40 million. In accordance with the convertible note purchase agreement, we also entered into a registration rights agreement with FutureX Innovation SPC. The principal amount of the note and all accrued and unpaid interest became due on November 5, 2019, and we failed to repay the note on such date. On December 9, 2019, FutureX Innovation SPC served a statutory demand on us, under which it (i) claimed that we owed, as of December 9, 2019, a total amount of US$41,913,498 under the note, (ii) demanded that we pay such amount or secure or compound for it to FutureX Innovation SPC’s satisfaction, and (iii) stated that if payment of such amount is not made within 21 days of the date when the statutory demand was served on us, we will be deemed to be insolvent and a winding up petition may be presented against us in accordance with applicable Cayman laws. On March 3, 2020, we entered into an extension agreement with FutureX Innovation SPC, pursuant to which the parties agreed to extend the maturity date of the FutureX Convertible Note to May 31, 2020. In consideration of the extension, we agreed to pay an extension fee and increase the interest rate of the note to 24% per year effective from January 1, 2020. Pursuant to the terms of the extension agreement, FutureX Innovation SPC waived our prior payment default and withdrew the statutory demand served on us on December 9, 2019.

 

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On May 8, 2018, our board of directors received a preliminary non-binding proposal letter, from FutureX Capital Limited, an affiliate of FutureX Innovation SPC, to acquire all of our outstanding ordinary shares not already owned by it in a going private transaction. The proposal was withdrawn by FutureX Capital Limited on January 3, 2020.

 

On February 28, 2019, we entered into a share subscription agreement with Hammer Capital Private Investments Limited and certain other equity investment firms. Pursuant to the share subscription agreement, we agreed to issue and sell an aggregate of 3,461,902 newly issued Class B ordinary shares to the investors in a private placement transaction for an aggregate price of approximately US$11.1 million, or a per share price of US$3.20. The transaction was closed on March 4, 2019. In connection with the transaction, we also entered into a registration rights agreement with the investors.

 

On May 30, 2019, one of our consolidated affiliated entities borrowed a 24-month working capital loan in the amount of RMB120 million from an entity affiliated with Hammer Capital Private Investments Limited. In connection with and as part of the consideration for the extension of the loan, we issued to an affiliate of the lender a warrant to purchase our Class B ordinary shares. Under the warrant, the warrant holder may purchase our Class B ordinary shares at the exercise price of US$4.0261 per share, for up to a total number of Class B ordinary shares representing the aggregate exercise price of US$14.45 million. Such aggregate exercise price will be increased to US$17.34 million if the loan is not repaid in full by May 30, 2020, and further increased to US$21.68 million if the loan is not repaid in full by November 30, 2020. We also entered into a registration rights agreement with Hammer Capital Private Investments Limited with respect to the ordinary shares issuable under the warrant.

 

On July 15, 2019, our board of directors received a preliminary non-binding proposal letter from Guosheng Qi, Guofa Yu, their respective affiliated entities, and Beta Dynamic Limited, an affiliate of Hammer Capital Private Investments Limited, to acquire our company in a going private transaction for US$3.80 in cash per ADS or ordinary share. Our board of directors formed a special committee consisting of independent directors to evaluate the proposal and any other alternative transactions. On May 1, 2020, our board of directors received a revised non-binding proposal letter, from Guosheng Qi, Guofa Yu, their respective affiliated entities, Beta Dynamic Limited, Shenzhen Qianhai Banyan Capital Investment & Management Co., Ltd and Hangzhou Yutao Capital Co., Ltd, to acquire our company in a going private transaction for US$2.00 in cash per ADS or ordinary share. As of the date of this annual report, the special committee is in the process of considering, with the assistance of the special committee’s legal and financial advisors, the proposal and possible responses. If completed, the going private transaction will result in us becoming a privately-held company and the ADSs will no longer be listed on The Nasdaq Stock Market. There can be no assurance that the proposal will be pursued further, approved or consummated. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Ordinary Shares and ADSs—Uncertainty concerning the proposed going private transaction may adversely affect our business and the market price of the ADSs.”

 

B.    Business Overview

 

Gridsum is a leading provider of sophisticated data analysis software for multinational and domestic enterprises and government agencies in China. Our proprietary distributed data architecture allows our customers to efficiently collect and analyze vast amounts of information that is collected, indexed and stored in an organized manner, or structured data, and information that is not organized, or unstructured data. Our core technology, the Gridsum Big Data Platform and the Gridsum Prophet: Enterprise Artificial Intelligence, or AI, Engine, with its machine learning and AI capability, performs multi-dimensional correlation analysis and analyzes complex real-time events. With the support of our Big Data Platform and the Gridsum Prophet, our customers use our data visualization and data-mining technologies to identify complex relationships within their data and gain new insights that help them make better business decisions.

 

Our leading position is based on our solutions and our core technologies. Our software products are designed for a variety of commercial and governmental applications. To help our enterprise customers reach China’s large and growing online and mobile population, our initial products have focused on digital marketing analytics and automation solutions. We were among the first companies to offer web analytics solutions based on data warehouse technology, and we were among the first digital intelligence companies in China to build solutions entirely on a distributed data warehouse architecture using the open-source Hadoop framework. By leveraging the analytic capabilities of our Big Data Platform and the Gridsum Prophet, we have developed additional software solutions, including new media analytics and information discovery solutions, to address a broad range of customer needs. In 2019, our customers included Fortune 500 and China 500 enterprises, comprising 547 customers across diverse industries.

 

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Key Advantages of our Solutions

 

We deliver our solutions as cloud-based software-as-a-service, or SaaS, offerings that are easy to deploy, easy to access, automatically updated without disruption, and enable our customers to reduce IT support costs by outsourcing hardware and software maintenance and support. The key advantages of our solutions include:

 

Fast and Efficient Multi-dimensional Drill-down—Our software is designed to enable customers to derive valuable intelligence from both structured and unstructured data quickly and easily. Our proprietary technology leverages our high performance correlation analysis engine to provide real-time response to customer data queries. Customers perform multi-dimensional data drill-down and correlation analysis with simple point-and-click and fingertip gestures, thereby identifying issues and isolating causes.

 

Simple and Customizable Visualization—We design our visualization to be simple, intuitive and user-friendly. Users learn and begin using our products with little to no training required. Our dashboards are optimized for multiple industry verticals, and within each industry the visualization can easily be customized based on specific customer needs. This ease of use allows users with little technical training or IT support to leverage our products and achieve desired results for their work.

 

Fully Integrated Solution Suites—All of the individual solutions in our solution suites share a common user interface, through which customers access the solutions they have purchased. Our solutions are accessible across all screen formats, from large multi-screen control centers to desktops and mobile devices.

 

Easy and Rapid Deployment—Our solutions can typically be deployed and configured by our customers within a day, without specialized training, and readily integrate with customers’ management and operating systems. Easy implementation and reduced start-up time allow customers to gain proficiency in our software quickly and to see results immediately. Updates such as software enhancements and new features can be delivered from the cloud without disruption to customers’ daily operation. Our highly flexible and extensible architecture delivers scalable and adjustable solutions for customers and allows us to offer specific solutions for specific customer needs. Customer dashboards are readily customizable based on customer needs, with no special coding or reconfiguration required.

 

Lower Total Cost of Ownership—Our cloud-based solutions enable our customers to access our software solutions anywhere, anytime and in real time, and reduce upfront investment and total cost of ownership because our customers do not need to invest in additional hardware or IT infrastructure to utilize our products.

 

Made in China, for China—Our solutions are designed with the China market in mind and are readily customizable or adaptable to address specific needs of domestic enterprise customers. Our natural language processing capabilities are designed to handle unstructured data in the Chinese language.

 

Our Core Technology

 

We offer suites of solutions that are built on our core technology. These end-to-end solution suites address customer needs in marketing automation, e-Government, new media, information discovery, data visualization and intelligent Industrial Internet of Things, or IIoT, solutions. Our solutions and core technologies are built on our distributed data warehouse architecture using the open-source Hadoop framework. Our data architecture offers high scalability and high performance characteristics. Our core technology consists of our data visualization and interactive data mining technologies, the Gridsum Big Data Platform, Gridsum Prophet, and our data acquisition and data pre-processing technologies.

 

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GRAPHIC

 

Gridsum Big Data Platform

 

Our software solutions are built on the Gridsum Big Data Platform, our proprietary technology designed to acquire, store, process and analyze large and rapidly growing volumes of both structured and unstructured data, leveraging our highly scalable correlation analysis engine and complex event processing capability. A distributed computing architecture is required in order to analyze in real time the rapidly growing volume and complexity of digital data. We were among the first digital intelligence companies in China to build solutions entirely on a distributed data warehouse architecture using the open-source Hadoop framework, allowing us to perform multi-dimensional correlation analysis in real time, on data sets regardless of size, and to implement real-time interactive data mining at large scale.

 

The core capabilities of the Gridsum Big Data Platform include:

 

·                    Multi-dimensional correlation analysis—Our correlation analysis engine enables us to dynamically correlate large quantities of structured and unstructured data on an unlimited number of dimensions. This high performance capability, enabled by our large-scale distributed data warehouse architecture, allows us to run multi-dimensional data drill down and data correlation analysis in real time, on datasets regardless of size. We perform this analysis on all of the data in the dataset, without resorting to sampling. Our correlation analysis capability is further enhanced by the size and quality of our datasets, including data acquired from consenting customers and third parties, public information that we have collected from web crawling and data derived from these datasets. Our data includes the correlations that we have retained from our past projects. Because we have been accumulating our datasets since 2009, with a focus on data closely related to our customers’ business operations and customer interactions, we believe that our data assets are among China’s largest and highest quality.

 

·                    Real-time complex event processing—Our complex event processing technology tracks all available data about events as they occur and applies sophisticated rules to identify patterns that signify problems, threats and opportunities for our customers. This technology is well suited for analysis of large-scale concurrent streaming data in real time.

 

All of these capabilities of the Gridsum Big Data Platform are easily extensible and are highly scalable, allowing us to enter into new industries and serve new customers.

 

Gridsum Prophet: Enterprise AI Engine

 

In May 2017, we launched Gridsum Prophet which is our enterprise AI engine. Gridsum Prophet is built on top of the Gridsum Big Data Platform and delivers the AI capabilities that powers Gridsum’s current and future products and solutions across industry verticals and applications. These AI capabilities include machine learning, predictive modeling, natural language processing, speech and image recognition, and knowledge graph which enable Gridsum’s solutions to deliver data driven insights, predictions, recommendations, and automations.

 

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·                    Machine learning capability powered by highly relevant large-scale historical data assets and industry experience —Our machine-learning algorithms learn from experience, identify patterns of interest and make data-driven predictions within their defined parameters. We leverage our data assets and industry expertise to design machine-learning algorithms that solve specific industry problems for our customers. In conjunction with our natural language processing technology, machine learning is particularly suitable for processing unstructured data by recognizing patterns and connections through which the raw data can be structured and analyzed.

 

·                    Natural language processing technologies—Natural language processing, or NLP, for the Chinese market is extremely complex due to fundamental characteristics of the Chinese language, including multiple meanings of the same Chinese characters, contextual association of characters into words and lack of punctuation. We have solved these long-standing problems by developing proprietary NLP technologies based on algorithms and machine learning techniques that are designed to understand and analyze the complexity of the Chinese language and its usage in various contexts. Our NLP technologies enable the extraction of information about entities, correlations, sentiments and emotions from vast amounts and variety of digitized documents, text converted from audio and video streams and other digital content in targeted industries such as legal and media. With our NLP technologies, we are able to extract structure from unstructured data, so that it can be processed and analyzed effectively.

 

·                    Knowledge Graph is fundamental in delivering human-like intelligent enterprise solutions. We developed China’s first knowledge graph for the legal domain and it has been successfully used to provide intelligent recommendations in the Smart Push product and automatic verdict generation for the civil courts. The technology and methodology used in developing knowledge graphs is a key capability in Gridsum Prophet.

 

Visualization Technologies

 

We offer intuitive interactive visualization platform that allows customers to display vital performance metrics in a highly flexible and customizable way and allow users to interact directly with data by using simple fingertip and point-and-click gestures to perform analyses and answer questions. Our visualization capabilities support a full range of formats, from live data displays on large multi-screen control centers, to reports optimized for mobile devices. Our visualization platform is designed to be a rich interface that supports interactive data mining and integrates across device formats. Visualization is an important component of our technology used in all of our solutions and is highly adaptable to the requirements of different industries and individual customers.

 

Data Acquisition Technologies

 

Time-stamping is a universal characteristic of all machine generated and reported data. Our technology gives us the ability to apply an analytical framework to any raw data that is time stamped, whether the data is sourced from a single click on a website or from complex natural language documents. This capability allows us to organize data and cross correlate it and to perform sequence analysis to determine causality of events. We collect and process massive volumes of time-stamped data at high speed using our proprietary Extract, Transform and Load, or ETL, technologies. Our ETL technologies enable us to apply relevant analytical frameworks to raw data in various forms and give us the high performance required to analyze rapidly growing volumes of structured and unstructured data in real time, extracting intelligence critical to our customers.

 

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Our Solutions

 

GRAPHIC

 

We offer suites of solutions for marketing automation, e-Government, new media, information discovery, data visualization and IIoT. Customers using our solutions are able to:

 

·                    analyze user behavior online on the web and on mobile devices;

 

·                    assess web design and conduct A/B testing of web and mobile web design;

 

·                    manage massive scale search engine marketing campaigns;

 

·                    measure the contribution of different marketing channels to user conversion;

 

·                    monitor and analyze streaming media and optimize user experience;

 

·                    correlate information in unstructured datasets using natural language processing;

 

·                    gather and integrate data from diverse data sources online and offline, from the Web and IIoT;

 

·                    visualize and interact with graphical information across multiple display sizes and formats; and

 

·                    make data driven predictions, recommendations, and decisions.

 

We deliver our solutions as cloud-based SaaS offerings designed for ease of use and rapid adoption within the customer’s organization.

 

Intelligent CRM Solution

 

Gridsum’s Intelligent CRM Solution is a cloud-based, marketing-centric CRM solution tailor-made for both multinational and local companies operating in China which allows our clients to leverage both online and offline data derived from their digital marketing and sales divisions and customers’ digital footprints, to drive sales and close orders in a more efficient and KPI-enhancing manner. The solution leverages Gridsum’s AI Engine, Gridsum Prophet, and our marketing automation suite, as well as Gridsum’s deep experience in seamlessly interfacing our marketing automation suite with our clients’ sales infrastructure and systems, to create a ground breaking and tailor-made marketing-centric CRM solution for the China market.

 

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Gridsum’s Intelligent CRM solution allows clients to automate and increase sales efficiency across their entire businesses by marketing to individual customers rather than broader demographics. The solution is designed and optimized as a powerful and complete standalone CRM solution. It also has advanced “plug and play” capability allowing it to seamlessly integrate with a client’s legacy systems where necessary.

 

With machine learning, Gridsum’s clients will be able to automate the identification, prioritization and “valuation” of promising leads and relationships and sort through massive amounts of data related to multiple areas of their business—from marketing and sales, to loyalty programs, e-commerce, promotions, and more—to easily track customers throughout the different stages of the customer lifecycle.

 

By seamlessly integrating multiple social platforms, Gridsum clients will also be able to create a “social map” of their customers’ professional and social networks, matching this to their own organizations, to further drive the sales process.

 

Marketing Automation Suite

 

All of our marketing automation solutions are available as an integrated suite of solutions, which we call ADSUITE. The capabilities of each solution are described below.

 

Web Dissector is used to analyze customer websites by monitoring and analyzing key performance indicators such as clicks, page views, sessions, conversion rates and sales. Web Dissector precisely measures the effectiveness of online promotional activities and detects click fraud. The capabilities and features of Web Dissector include:

 

·                    online operational data analysis;

 

·                    pixel-level interactive click and touch “heat maps”;

 

·                    multi-dimension drill-down analysis;

 

·                    click fraud detection;

 

·                    online asset assessment;

 

·                    user behavior analysis;

 

·                    online performance optimization; and

 

·                    online advertisement delivery and performance analysis.

 

Mobile Dissector is used to understand mobile app user activity, gain insight into users’ interactive behavior, and improve user experience with the application and retention rate. Mobile Dissector also helps advertisers monitor characteristics of mobile audiences on mobile web sites and apps, user behavior and the value of different mobile channels. The capabilities and features of Mobile Dissector include:

 

·                    mobile application promotion and distribution analysis;

 

·                    mobile apps data analysis;

 

·                    error and exception tracking;

 

·                    custom event analysis;

 

·                    multi-dimensional drill-down analysis;

 

·                    app life-cycle analysis; and

 

·                    cross platform analysis.

 

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SEM Dissector automates search engine marketing processes for advertisers, advertising agencies and advertising account managers, and provides comprehensive, objective and transparent performance reports. SEM Dissector supports simultaneous management of multiple accounts and grouping of customized keywords with major Chinese search engines, including Baidu, Sogou and Qihoo 360. Built-in analytical models guide customers to optimize keyword advertising, and automatic bidding algorithms monitor competitors’ advertising activities and make appropriate bids automatically. The capabilities and features of SEM Dissector include:

 

·                    customer data integration and key performance indicator customization;

 

·                    keyword advertising management;

 

·                    report customization;

 

·                    automatic advertising placement and bid management; and

 

·                    attribution model.

 

SEO Dissector is our search engine optimization tool. It analyzes website quality and the website’s level of accessibility to various search engines. Customers use SEO Dissector to evaluate website performance, identify defects and make improvements. Customers also evaluate reports of keyword search results on different search engines, enabling them to optimize their websites to improve their organic rankings on search engine results pages. The capabilities and features of SEO Dissector include:

 

·                    website indexability analysis;

 

·                    multi-dimensional analysis of keywords ranking;

 

·                    rich and intuitive presentation of analysis results;

 

·                    practical webmaster tools; and

 

·                    flexible customization.

 

Ad Dissector is our advertisement performance monitoring and optimization product. It monitors and analyzes banner, rich media and text link and other advertising formats and leverages our core technology to provide optimization solutions. Advertisers and advertising agencies use Ad Dissector to measure performance of online advertising and allocate media resources to improve returns. The capabilities and features of Ad Dissector include:

 

·                    user-friendly placement management;

 

·                    convenient landing page and scheduling management;

 

·                    real-time data tracking;

 

·                    powerful multi-source data correlation analysis; and

 

·                    Gantt chart performance visualization.

 

Contribution Dissector tracks and analyzes user behavior over the entire user life cycle from original access to ultimate conversion, tracing that behavior over years and various conversion data points and applying various attribution model algorithms to the data. Customers assess advertisement results across media outlets, connect off-line conversion, analyze contribution from each channel to the ultimate conversion process and optimize online businesses. Website operators use Contribution Dissector to evaluate the performance of their advertising campaigns across media outlets, connect offline conversion, analyze historical channel contributions to the ultimate conversion or sale and allocate their advertising resources efficiently based on the results. The capabilities and features of Contribution Dissector include:

 

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·                    conversion path identification;

 

·                    integration of online and offline data;

 

·                    multiple attribution models;

 

·                    multi-dimensional analysis;

 

·                    marketing channel analysis; and

 

·                    user behavior playback.

 

Audience Dissector is our audience analysis product. It combines customer offline user data from customer relationship management systems with our online user behavior data and digital intelligence capabilities to identify high value and high loyalty users and improve customer returns on their marketing investments. The capabilities and features of Audience Dissector include:

 

·                    intelligent customer relationship maintenance system;

 

·                    decision-making support and optimization;

 

·                    flexible user behavior tagging management;

 

·                    flexible application programming interface; and

 

·                    data security and privacy.

 

Recommendation Engine is our data driven content recommendation solution for customers delivering adaptive video, news and e-commerce content on websites, mobile apps and Internet protocol television terminals. By accumulating user behavior data, Recommendation Engine continuously captures user preferences and improves the accuracy of its recommendations. The capabilities and features of Recommendation Engine include:

 

·                    mainstream mobile operating system data collection and analysis;

 

·                    optimization for industry verticals;

 

·                    personalized recommendations for mobile application content; and

 

·                    powerful content management platform.

 

E-Government Suite

 

Government Web Dissector is our digital intelligence solution for public sector websites, providing government website operators at local, municipal, provincial and national levels with real-time website operating data and digital intelligence that is similar to what is provided to commercial customers by our Web Dissector solution. Our public sector customers use Government Web Dissector to optimize the quality and efficiency of online public services, such as driver’s license applications and marriage certificate applications. In addition to the features available from the standard Web Dissector, the capabilities and features of Government Web Dissector include:

 

·                    public service performance metrics; and

 

·                    intelligent diagnostics across websites.

 

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Government Website Group Integrated Management Platform, which we refer to as the Integrated Management Platform, is our integrated big data visualization system used by government website operators that are responsible for managing groups of websites. It provides a visualized integrated display of website group operating status and data. The capabilities and features of the Integrated Management Platform include:

 

·                    comprehensive overview of website groups;

 

·                    performance overview;

 

·                    visual comparison;

 

·                    website correlation display; and

 

·                    geographic distribution visualization.

 

New Media Suite

 

Streaming Dissector is our real-time viewership analysis and operational efficiency monitor for digital online video. Unlike traditional methods of measuring viewership, Streaming Dissector does not rely on viewer sampling, but continually monitors all viewers of the streaming video. The capabilities and features of Streaming Dissector include:

 

·                    real-time streaming monitoring;

 

·                    content delivery network monitoring;

 

·                    reporting and alerting;

 

·                    real-time rating analysis; and

 

·                    multi-platform support.

 

Video Dissector is our online video content analytics tool for discovering the most valuable or attractive parts in video content. It provides analysis of viewer behavior and solutions for optimizing online video content. The capabilities and features of Video Dissector include:

 

·                    online video operation analysis;

 

·                    video content evaluation;

 

·                    viewer analysis; and

 

·                    online video performance analysis.

 

TV Dissector is our analytics tool for internet protocol television, internet television, cable television, satellite television and digital television. It monitors and analyzes viewer behavior and provides solutions to optimize the business and operations of TV station operators. TV station operators use TV Dissector to analyze the development and activity of users and viewership of live broadcast, play on-demand and playbacks, generate accurate statistics about the conversion of their electronic program guide pages and advertising activities and optimize product packages and pay-per-view businesses. The capabilities and features of TV Dissector include:

 

·                    user development and activeness analysis;

 

·                    viewership analysis;

 

·                    play on-demand and playback analysis;

 

·                    product package analysis;

 

·                    electronic program guide analysis; and

 

·                    user experience analysis.

 

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Rating Plus is our television viewing data analytics tool for traditional TV stations. Rating Plus automatically combines traditional viewership log data with the channels and programs of the TV stations and generates viewership analysis. The management and operation personnel of the TV stations easily access the analysis via computers and mobile phones. Rating Plus provides search functionality that supports complex multi-dimension data searches and alerting feature that provides monitoring and malfunction alerting related to program broadcasts. The capabilities and features of Rating Plus include:

 

·                    automatic generation of viewership data;

 

·                    viewership analysis; and

 

·                    program analysis.

 

Information Discovery Suite

 

Media Dissector is our mass media, social media and user-generated content media monitoring and analytics tool. Media Dissector applies distributed cloud computing crawler technology to capture media information on the internet. It uses natural language processing technology such as word segmentation, named-entity recognition and Chinese information processing technology to process information and provides correlation analysis to enable drill downs for information discovery. The capabilities and features of Media Dissector include:

 

·                    information overview;

 

·                    item mentions and context analysis;

 

·                    media event and public opinion analysis; and

 

·                    sentiment analysis.

 

Information Dissector is an insightful analytical system developed to provide stock price predictions based on market sentiment in Chinese equity markets. Information Dissector gathers information from many sources, such as news, blogs, forums and analyst reports, maps each piece of information to particular industries and companies and processes the information into specific metrics used as input for complex time-series models and algorithms. The capabilities and features of Information Dissector include:

 

·                    market sentiment analysis;

 

·                    multiple metric measurement; and

 

·                    intuitive visualization interface.

 

Social Listening is our could-based social listening solution, which enables our enterprise clients to monitor and analyze web and social media posts regarding the brand, products, customer service of the client and its competitors. The Social Listening solution utilizes our advanced natural language processing and machine learning technologies to analyze textual and image content and delivers the most relevant and actionable insight. The capabilities and features of Social Listening include:

 

·                    broad coverage of search, vertical sites and social media data;

 

·                    powerful data analytics and visualization;

 

·                    sentiment and topic analysis with easy access to data sources;

 

·                    alerts of noteworthy topics or posts; and

 

·                    delivered via mobile app as well as web browser on personal computers.

 

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Legal Service Product Suite

 

Law Dissector and Smart Push. Law Dissector is our search and statistical analysis tool for legal research. It utilizes our natural language processing technology and applies data science methodology in the legal industry. Law Dissector summarizes the key attributes of legal cases and aggregates them for statistical analysis, which enables judges, lawyers and researchers to find implied patterns or rules that would be valuable for their respective professional objectives.  Smart Push is our legal research tool that recommends relevant cases and legal information by keyword search or natural language search. The capabilities and features of Law Dissector and Smart Push include:

 

·                    information retrieval;

 

·                    powerful aggregation and statistical research;

 

·                    intelligent case analysis; and

 

·                    recommendation of relevant judicial precedents and legal information.

 

Intelligent Voice Recognition and Transcription System. The advanced AI-enabled Intelligent Voice Recognition and Transcription System converts voice into text in real time during court proceedings. The system leverages both Gridsum’s vertically-focused enterprise-AI engine, optimized for the legal space, and Tencent’s world-leading consumer-focused Chinese-language speech recognition engine. Gridsum adapted Tencent’s speech recognition technology to create a high-accuracy and high-reliability speech-to-text and text-to-speech application for the highly specialized legal space. Key dynamics of the product include the following:

 

·                    A highly focused AI optimized for the legal sector: it adopts industry-leading voice recognition modeling methods and acoustic modeling technologies. With an ultra-large-scale language model — and through the application of machine learning to the huge amount of content codified in laws and regulations, court verdicts and other corpus — a customized engine was created to effectively identify and recognize legal terms and context.

 

·                    Outstanding performance: with real-time speech-to-text transcription in courts, text is generated in milliseconds with accuracy of approximately 95%, significantly improving the efficiency of the trial process. It supports custom “hot” words recognition, allowing the accuracy for names of people and organizations, and special words to reach approximately 90%.

 

·                    Highly secured and reliable data: deployed on the private network of the PRC courts, its data packets adopt unique encryption formats and algorithms from Tencent Cloud, which ensure highly secured audio data packet transmission. In addition, it has an improved access authorization mechanism on the client end to manage and control the security of services and business, and it supports multiple backup storage of audio files, which enhances data security and reliability.

 

Faxin Wei Su, a litigation service on WeChat’s micro application platform and powered by Gridsum’s Chinese legal information platform and knowledge base Faxin, delivers China’s first integrated online litigation and remote trial handling service and offers the following capabilities:

 

·                    Our Faxin Wei Su platform provides both the courts and litigants with a fast and secure channel to match similar cases, make case status inquiries, submit files, and set appointments during the litigation process.

 

·                    All parties can join a trial remotely through our Faxin Wei Su platform and produce and question evidence throughout the process.

 

·                    All documents, including trial records, settlement agreements and other related files can also be accessed online after the trial is over.

 

·                    Our Faxin Wei Su platform’s diversified dispute resolution system provides efficient and flexible tools for remote trials and should help ease congestion in a highly crowded court system.

 

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Industrial Internet of Things (IIoT) Solutions

 

In August 2017, Gridsum began to assemble a team of industrial experts and experienced data scientists and engineers to develop our Industrial AI and IIoT platform and applications on top of the Gridsum Big Data Platform and Gridsum Prophet and in 2018, Gridsum increased investment in research and development relating to Industrial Internet of Things (IIoT) solutions. These effort brings Gridsum’s AI and data science capabilities to the industrial verticals and helps our industrial clients optimize processes, reduce cost, and improve quality throughout the product design, manufacturing, and operations cycle. In 2019, we launched our IIoT platform COMPaaS, which builds on the foundation of our big data and enterprise AI capabilities to enable clients to design, develop, and deploy data and knowledge driven IIoT solutions in industrial settings. Some of the initial applications include:

 

·                    Smart fuel/power consumption prediction for new energy automobiles;

 

·                    Airport aviation fuel supply optimization;

 

·                    Oil drilling equipment failure prediction and preventive maintenance solutions;

 

·                    Energy consumption optimization solutions for building facilities such as data centers, hospitals and expo halls; and

 

·                    Automatic product defect detection.

 

Visualization Suite

 

Gridsum Visualization Platform is our agile business intelligence platform that provides visual data analytics and data visualization capabilities to rapidly build and deploy modern business intelligence solutions for enterprise. Powered by our high performance multi-dimensional correlation analysis and AI engine, it supports interactive data mining and visual data analytics. Gridsum Visualization Platform integrates charts, graphics and tables from various data sources and displays them on a single multi-screen interface. It offers pre-configured data visualization templates and provides customers with options to customize their data displays. Gridsum Visualization Platform improves visualization of customer digital intelligence data to help customers understand their business operations in a timely and intuitive manner, and provides business intelligence support for decision-makers. The capabilities and features of Gridsum Visualization Platform include:

 

·                    real-time connection to multiple data sources;

 

·                    integration with our big data and AI platforms;

 

·                    built-in data visualization templates and interactive data mining and modeling tools;

 

·                    data security and fine-grained access control; and

 

·                    user-friendly interface.

 

Gridsum Dashboard is our data visualization tool for our digital intelligence solutions. It is used for interactive data mining and visualized data analysis. Gridsum Dashboard integrates charts, graphics and tables from various data sources and displays them on a single multi-screen interface. It offers pre-configured data visualization templates and provides customers with options to customize their data displays. Gridsum Dashboard improves visualization of customer digital intelligence data, so that customers understand the business operations in a timely and intuitive manner and provides business intelligence support for decision-makers. The capabilities and features of Gridsum Dashboard include:

 

·                    real-time connection to data;

 

·                    visualization templates;

 

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·                    access control; and

 

·                    user-friendly interface.

 

Gridsum Report Center is our automated report generation and distribution tool, which supports data reporting for all of our solutions, aggregates data from multiple dimensions, customizes and creates report templates and configures report distribution. The data integrity verification capability makes report preparation convenient and improves the visual quality and accuracy of reports. The capabilities and features of Gridsum Report Center include:

 

·                    seamless integration;

 

·                    data integrity verification;

 

·                    multiple methods for report distribution;

 

·                    reusable report templates; and

 

·                    customizable and data combination from multiple dimensions.

 

Intellectual Property

 

We rely on a combination of trademark, fair trade practice, copyright and trade secret protection laws and patent protection in China and other jurisdictions, as well as contractual restrictions, to protect our intellectual property. We control access to our proprietary technology and algorithms by entering into confidentiality and invention assignment agreements with our employees and contractors and confidentiality agreements with third parties. As of March 5, 2020, we had 805 issued patents in China, which will expire between 2025 and 2040, 2,317 patent applications pending in China and 55 patent applications pending in various other countries and jurisdictions.

 

In order to assess the effectiveness of Gridsum’s innovative research and development activities, in March 2019 we engaged an independent third-party asset appraisal firm to evaluate a portion of our intellectual property assets as of February 28, 2019. The appraisal firm examined 64 of our software copyrights and 1,250 of our issued patents and patent applications, and concluded that these assets had a total value of RMB2.5 billion (US$364.8 million) under PRC asset appraisal principles. We believe these results demonstrate the success of our research and development activities and our technology leadership, and the long-term value of our investments in research and development.

 

Despite our efforts to protect our proprietary technology and our intellectual property rights, unauthorized parties may attempt to copy or obtain and use our technology to develop applications with the same functionality as our products. Policing unauthorized use of our technology and intellectual property rights is difficult.

 

We expect that software in our industry may be subject to third-party infringement claims as the number of competitors grows and the functionality of applications in different industry segments overlaps. Any of these third parties might make a claim of infringement against us at any time.

 

Legal Proceedings

 

From time to time we may become involved in legal proceedings or be subject to claims arising in the ordinary course of our business.

 

We are involved with shareholder class action lawsuits described in “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings.” Otherwise, we are not presently a party to any legal proceedings that in the opinion of our management, if determined adversely to us, would have a material adverse effect on our business, financial condition, operating results or cash flows. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.

 

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Regulation

 

Our business operations are primarily in the PRC and are primarily subject to PRC laws and regulations. The following is a summary of the most significant PRC laws and regulations affecting our business or our shareholders’ rights to receive dividends and other distributions from us.

 

Regulations on Internet Information Service

 

There are several principal laws and regulations on internet information service business with respect to foreign investment restriction and qualification requirement, including (i) the Telecommunications Regulations of the People’s Republic of China, promulgated by the State Council on September 25, 2000, as most recently amended on February 6, 2016, (ii) the Administrative Measures on Internet Information Services, promulgated by the State Council on September 25, 2000, as most recently amended on January 8, 2011, or the Internet Measures, (iii) the Administrative Rules for Foreign Investment in Telecommunications Enterprises issued by the State Council effective on January 1, 2002, as most recently amended on February 6, 2016, (iv) the Special Administrative Measures, (v) the Foreign Investment Law and (vi) the Implementing Regulations of the Foreign Investment Law.

 

These laws and regulations prescribe line between different types of telecommunications business activities, including basic telecommunications services and value-added telecommunications services, and internet information service is categorized as value-added telecommunications service which shall be subject to the special administrative measures. Under these laws and regulations, the proportion of foreign investment in companies conducting value-added telecommunications services (excluding e-commerce, domestic multi-party communication, store-and-forward and call center businesses) shall not exceed 50%, and the primary foreign investor must have a record of good performance and operating experience in conducting value-added telecommunications services. Due to these restrictions on foreign investment, we operate our internet information service business through Gridsum PRC Holding, our VIE, and its subsidiaries through contractual arrangements

 

The Internet Measures divide internet information services into two categories: services of an operative nature and services of a non-operative nature. Our business conducted through our website (under domain name www.gridsumdissector.com) involves operative internet information services, which requires us to obtain an ICP license. Our affiliated PRC entity and a subsidiary of our VIE, Beijing Gridsum, obtained an ICP license issued by Beijing Communications Administration, a local branch of the Ministry of Industry and Information Technology, or the MIIT, in July 2015.

 

Regulations on Market Survey Business

 

There are several principal regulations on market survey business in terms of foreign investment restriction and qualification requirement, including (i) the Special Administrative Measures and (ii) the Measures on the Administration of Foreign-related Surveys, promulgated by the PRC National Bureau of Statistics on October 13, 2004.

 

The Special Administrative Measures classifies market surveys as subjecting to the special administrative measures, stating that market surveys shall be limited to Sino-foreign equity or cooperative joint venture operations, and specifically, Chinese parties shall be controlling shareholders for survey of television and radio program ratings. We conduct our market survey business in the PRC through contractual arrangements with our VIE in compliance with the Special Administrative Measures.

 

The Measures on the Administration of Foreign-related Surveys define foreign-related market surveys as those including (i) market and social surveys conducted under the entrustment or with the financial aid of, or in cooperation with, any overseas organization, individual or any overseas organization’s agency in the PRC, (ii) market surveys conducted by any overseas organization’s agency in the PRC in accordance with applicable laws and (iii) market and social surveys wherein survey materials and results are to be provided to any overseas organization, individual or overseas organization’s agency in the PRC. Such surveys must be conducted through a survey institution possessing a foreign-related survey permit in accordance with applicable laws. We used to conduct foreign-related market surveys primarily through Beijing Moment, a subsidiary of our VIE, which held a foreign-related survey permit that has expired in November 2018.

 

Regulations on Advertising Business

 

The Advertising Law of the People’s Republic of China, promulgated by the Standing Committee of the National People’s Congress on October 27, 1994, as most recently amended on October 26, 2018, and the Interim Measures on the Administration of Internet Advertising, promulgated by the State Administration for Industry and Commerce (currently known as the State Administration for Market Regulation) on July 4, 2016, are the principal law and regulation regulating our advertising business. These laws require the media platform operators to (i) verify the identity documents, name, address, contact details and other related information of a counterparty when entering an advertising contract, establish information files and update such files on a regular basis, and (ii) delete, block, broken links of any advertisement or take other similar technical measures and management measures to prevent such advertisement from spreading if they know or should know such advertisement is illegal. Our advertising business is required to comply with these rules and requirements.

 

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Regulations on Government Procurement

 

On June 29, 2002, the Standing Committee of the National People’s Congress promulgated the Government Procurement Law of the People’s Republic of China, which came into effect on January 1, 2003 and was amended on August 31, 2014. This law was enacted for purposes of regulating government procurement activities and applies to government procurement activities conducted within the PRC. It prohibits suppliers from (i) providing false materials in an attempt to win a bid, (ii) defaming or excluding other suppliers by illegitimate means, (iii) colluding with the procuring entity or agency, or other suppliers, (iv) bribing or providing illegitimate benefits to the procuring entity or agency, (v) in the course of procurement through bid invitation, engaging in consultation or negotiation with the procuring entity or (vi) refusing to subject themselves to supervision by the relevant department or providing false information. Our business with the government is required to comply with these rules and requirements.

 

Regulations on Intellectual Property Rights

 

China has adopted legislation governing intellectual property rights, including copyrights, trademarks and patents. China is a signatory to major international conventions on intellectual property rights and is subject to the Agreement on Trade Related Aspects of Intellectual Property Rights as a result of its accession to the World Trade Organization in December 2001.

 

Computer Software Copyright

 

On March 1, 2013, the amended Regulations for the Protection of Computer Software promulgated by the State Council came into effect. These regulations are formulated for protecting the rights and interests of computer software copyright owners, encouraging the development and application of computer software and promoting the development of software business. As of March 5, 2020, we had 242 registered copyrights, including 230 registered computer software copyrights in the PRC.

 

Patent

 

Patents in the PRC are principally protected under the Patent Law of the People’s Republic of China, which was amended by the Standing Committee of the National People’s Congress as of December 27, 2008. This law is formulated for protecting the rights and interests of patentees, encouraging invention, promoting the application of inventions, enhancing innovation capacity, and facilitating the advancement of science and technology and the economic and social development. Under this law, the duration of a patent right is either 10 years or 20 years from the date of application, depending on the type of patent right. As of March 5, 2020, we had 805 patents granted in the PRC, 2,317 patent applications pending in the PRC and 55 patent applications pending in various other countries and jurisdictions.

 

Trademark

 

The PRC Trademark Law, effective in 1983 and most recently amended in 2019, protects the proprietary rights with respect to registered trademarks. The National Intellectual Property Administration under the State Administration for Market Regulation handles trademark registrations and may grant a term of 10 years for registered trademarks, which may be extended for another 10 years of each renewal upon request. Trademark license agreements shall be filed with the National Intellectual Property Administration for record. In addition, if a registered trademark is recognized as a well-known trademark, the protection of the proprietary right of the trademark holder may reach beyond the specific class of the relevant products or services. As of March 5, 2020, we had 722 registered trademarks in different trademark categories and 11 trademark applications in the PRC.

 

Domain Name

 

On November 1, 2017, the Administrative Measures for Internet Domain Names promulgated by the Ministry of Information came into effect, replacing the Measures for the Administration of Internet Domain Names of the PRC promulgated by the Ministry of Information effective on December 20, 2004. These measures are formulated with reference to the norms on administration of internet domain names worldwide, for the purposes of regulating services regarding internet domain, safeguarding users’ legitimate rights and interests, guaranteeing the safe and reliable operation of the system of internet domain names, promoting the development and application of Chinese domain names and top-level domains of the state, and promoting the healthy development of the PRC Internet network. As of March 5, 2020, we had 92 registered domain names.

 

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Regulations on Network Security

 

Operation Security

 

On November 7, 2016, the Standing Committee of the National People’s Congress promulgated the Cyber Security Law, which came into effect on June 1, 2017. The Cyber Security Law aims to establish more stringent requirements for network operators in China, and applies to the construction, operation, maintenance and use of networks as well as the supervision and administration of cyber security. Under the Cyber Security Law, network operators, who are broadly defined as “owners and administrators of networks and network service providers,” are required to take necessary actions to prevent security attacks and data loss, such as:

 

·                       formulating internal security management systems and operation manual, to specify the person in charge of cyber security and to define responsibilities in cyber security protection;

 

·                       taking technical measures to prevent computer virus, network attacks, network intrusions and other activities that endanger cyber security;

 

·                       taking technical measures to monitor and record network operation and cyber security status, and maintaining relevant logs for no less than six months as required;

 

·                       taking measures such as data classification, and backup and encryption of important data, etc.; and

 

·                       performing other obligations required by relevant laws and administrative regulations.

 

In addition, the Cyber Security Law specifies that network products and services shall satisfy the mandatory requirements set forth in applicable national standards. Any provider of network products or services shall not install malwares. In case of identifying any cyber security risk such as security defect or bug, relevant product/service provider is required to take immediate remedial actions, timely inform users of the risk, and report the event to the competent authority.

 

Furthermore, the Cybersecurity Law specifies requirements on user information protection applicable to network operators, and requires that a network operator should establish and improve its user information protection system. Network operators shall collect, store, and use individual information with consent from such individuals by lawful and proper means on a necessary basis. Network operators cannot collect individual user information that is not relevant to the services it provides, or distort or destroy individual information collected by it. Network operators are prohibited from disclosing without permission or selling individual information unless individual specifics are unidentifiable or irretrievable. In addition, a network operator shall strengthen its management of information released by its users. Where any information that comes from outside the territory of China is prohibited by law or regulation, the authorities may request relevant institutions to take measures to stop the flow of such prohibited information. Also, a network operator is required to establish network information security complaint and reporting mechanisms, and to release the complaint and reporting channels to promptly accept and settle complaints and reports concerning network information security.

 

The Cyber Security Law also emphasizes the protection of key information infrastructure in important industries and fields, such as e-Government, and operators of such key information infrastructure will be subject to stricter security obligations. For example, an operator of key information infrastructures is generally required to store in the PRC personal information and important business data collected and generated during its business operations within the PRC, and to assess its network security and identify potential risks at least once a year. Failure to comply with this requirement may lead to the confiscation of illegal gains, fines, revocation of the business permit or even the business license.

 

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Information Security

 

As an internet content provider and a network operator, we are subject to regulations relating to the protection of privacy. Under the Internet Measures, internet content providers are prohibited from producing, copying, publishing or distributing information that is humiliating or defamatory to others or that infringes on the lawful rights and interests of others. Internet content providers that violate the prohibition could face criminal charges or administrative sanctions by the PRC security authorities. In addition, relevant authorities may suspend their services, revoke their licenses or temporarily suspend or close down their websites. Under the Several Provisions on Regulating the Market Order of Internet Information Services, issued by the MIIT in December 2011, internet content providers are prohibited from collecting any user-related information that can reveal the identity of the user whether by itself or when used in combination with other information, or providing any such information to third parties without the consent of a user. Internet content providers must expressly inform the users of the method, content and purpose of the collection and processing of such user personal information and may only collect such information necessary for their services. Internet content providers are also required to properly maintain the user personal information and, in case of any leakage or likely leakage of user personal information, must take remedial measures immediately and report any material leakage to the telecommunications regulatory authority. In addition, the Decision on Strengthening Network Information Protection promulgated by the Standing Committee of the National People’s Congress in December 2012 emphasizes the need to protect electronic information that contains personal identification information and other private data. The decision requires internet content providers to establish and publish policies regarding the collection and use of personal electronic information and to take necessary measures to ensure the security of the information and to prevent leakage, damage or loss. Furthermore, the MIIT’s Rules on Protection of Personal Information of Telecommunications and Internet Users issued in July 2013 contain detailed requirements on the use and collection of personal information as well as the security measures to be taken by internet content providers. The PRC government retains the power and authority to order internet content providers to provide an internet user’s personal information if such user posts any prohibited content or engages in any illegal activities through the internet. The Cyber Security Law reiterates the abovementioned regulations and specifies the administrative penalties.

 

On November 29, 2017, the State Administration for Market Regulation issued the Information Security Technology—Personal Information Security Specification, which came into effect on May 1, 2018. The specification includes a recommendation for the nationwide standards for protection and processing of private personal information, and provides and clarifies the definitions and data processing, disclosure and protection requirements regarding personal information. Furthermore, the Ministry of Public Safety published the Guidance to the Protection of Internet Personal Information Safety on April 10, 2019, providing for the management mechanisms, security technical measures and business processes for the protection of personal information. On May 28, 2019 and June 13, 2019, respectively, the Cyberspace Administration of China issued the Administrative Measures for Data Security (Draft for Comment), or the Draft Data Security Measures, and the Measures for Security Assessment for Cross-border Transfer of Personal Information (Draft for Comment), or the Draft Cross-Border PI Transfer Measures, seeking public opinions on these draft measures. The aforementioned measures further the protection on data and personal information as currently provided in the Cyber Security Law. Under the Draft Data Security Measures, those who make use of cyberspace within the PRC for data collection, storage, transmission, processing, use and other activities, as well as data security protection, supervision and management, other than for pure family and personal affairs, shall comply with the detailed requirements specified in the Data Security Measures. The Draft Cross-Border PI Transfer Measures require a mandatory security assessment be done before the cross-border transfer of personal information collected during the business operations within the PRC by a network operator. We may be required to comply with these draft measures once they come into effect.

 

Regulations on Employment

 

There are several principal rules and regulations in the PRC with respect to rights and obligations of employers and labors, including (i) the Labor Law of the People’s Republic of China, promulgated by the Standing Committee of the National People’s Congress effective on January 1, 1995, as most recently amended on December 29, 2018, or the Labor Law, (ii) the Labor Contract Law of the People’s Republic of China, promulgated by the Standing Committee of the National People’s Congress effective on January 1, 2008, as most recently amended on December 28, 2012 or the Labor Contract Law, (iii) the Social Insurance Law of the People’s Republic of China, promulgated by the Standing Committee of the National People’s Congress effective on July 1, 2011, as most recently amended on December 29, 2018, or the Social Insurance Law, and (iv) the Regulations on the Management of Housing Provident Fund, promulgated by the State Council on April 3, 1999, as most recently amended on March 24, 2019, or the Housing Fund Regulations.

 

According to the Labor Law and the Labor Contract Law, employers must execute written labor contracts with full-time employees. All employers must compensate their employees with wages equal to at least the local minimum wage standards. All employers are required, among other things, to establish a system for labor safety and workplace sanitation and provide employees with workplace safety training. Violations of the Labor Law and the Labor Contract Law may result in the imposition of fines and other administrative penalties. For serious violations, criminal liability may arise. In addition, pursuant to the Social Insurance Law and the Housing Fund Regulations, employers in the PRC are required to provide employees with welfare schemes covering pension insurance, unemployment insurance, maternity insurance, work-related injury insurance, medical insurance and housing funds.

 

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Regulations on Taxation

 

PRC Enterprise Income Tax

 

PRC enterprise income tax is calculated based on taxable income, which is determined under (i) the PRC Enterprise Income Tax Law, promulgated by the National People’s Congress of China effective on January 1, 2008, as most recently amended on December 29, 2018, or the EIT Law, and (ii) the implementation rules to the EIT Law promulgated by the State Council effective on January 1, 2008, as most recently amended on April 23, 2019. The EIT Law imposes a uniform enterprise income tax rate of 25% on all resident enterprises in the PRC, including foreign-invested enterprises and domestic enterprises, unless they qualify for certain exceptions. According to the EIT Law and its implementation rules, the income tax rate of an enterprise that has been determined to be a high and new technology enterprise may be reduced to 15% with the approval of relevant tax authorities.

 

In addition, according to the EIT Law, enterprises registered in countries or regions outside the PRC but have their “de facto management bodies” located within China may be considered as PRC resident enterprises and are therefore subject to PRC enterprise income tax at the rate of 25% on their worldwide income. Though the implementation rules of the EIT Law define “de facto management bodies” as “establishments that carry out substantial and overall management and control over the manufacturing and business operations, personnel, accounting, properties, etc. of an enterprise,” the only detailed guidance currently available for the definition of “de facto management body” as well as the determination and administration of tax residency status of offshore-incorporated enterprises are set forth in Circular 82, and the Administrative Measures for Enterprise Income Tax of Chinese-Controlled Overseas Incorporated Resident Enterprises (Trial Version), or Bulletin No. 45, which was most recently amended on June 15, 2018, both issued by the SAT, which provide guidance on the administration as well as determination of the tax residency status of a Chinese-controlled offshore-incorporated enterprise, defined as an enterprise that is incorporated under the law of a foreign country or territory and that has a PRC company or PRC corporate group as its primary controlling shareholder.

 

According to Circular 82, a Chinese-controlled offshore-incorporated enterprise will be regarded as a PRC tax resident by virtue of having its “de facto management body” in China and will be subject to PRC enterprise income tax on its global income only if all of the following conditions are met:

 

·                    the primary location of the day-to-day operational management and the places where they perform their duties are in the PRC;

 

·                    decisions relating to the enterprise’s financial and human resource matters are made or are subject to approval of organizations or personnel in the PRC;

 

·                    the enterprise’s primary assets, accounting books and records, company seals and board and shareholder resolutions are located or maintained in the PRC; and

 

·                    50% or more of voting board members or senior executives habitually reside in the PRC.

 

Bulletin No. 45 further clarifies certain issues related to the determination of tax resident status and competent tax authorities. It also specifies that when provided with a copy of Recognition of Residential Status from a resident Chinese-controlled offshore-incorporated enterprise, a payer does not need to withhold a 10% income tax when paying certain PRC-sourced income such as dividends, interest, royalties and income from the transfer of assets to such Chinese-controlled offshore-incorporated enterprise. In the event that we are considered a PRC resident enterprise, we would be subject to the PRC enterprise income tax at the rate of 25% on our worldwide income.

 

The Arrangement Between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion With Respect to Taxes on Income was promulgated by the SAT and implemented on December 8, 2006, and was most recently amended on July 19, 2019. This arrangement reduces withholding tax rate in respect of the payment of dividends by a PRC enterprise to a Hong Kong enterprise from a standard rate of 10% to 5% if the Hong Kong enterprise directly holds at least 25% of the PRC enterprise. Pursuant to the Notice of the State Administration of Taxation on the Issues concerning the Application of the Dividend Clauses of Tax Agreements, or Circular 81 a Hong Kong resident enterprise must meet the following conditions, among others, in order to enjoy the reduced withholding tax rate: (i) it must be a company; (ii) it must directly own the required percentage of equity interests and voting rights in the PRC resident enterprise; and (iii) it must have directly owned such required percentage in the PRC resident enterprise throughout the 12 months prior to receiving the dividends. Furthermore, the Administrative Measures for Entitlement to Treaty Benefits for Non-Resident Taxpayers, which became effective on January 1, 2020, require that non-resident taxpayers must report and submit the relevant statements and materials specified in this measure and be administrated and supervised subsequently by the relevant tax authority in order to enjoy the reduced withholding tax rate. There are also other conditions for enjoying the reduced withholding tax rate pursuant to other applicable tax rules and regulations.

 

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Income Tax for Share Transfers

 

According to the Announcement of the State Administration of Taxation on Matters Concerning Withholding of Enterprise Income Tax of Non-Resident Enterprises at Source, or SAT Circular 37, promulgated by the SAT on October 17, 2017, as most recently amended on June 15, 2018, and the Announcement of the State Administration of Taxation on Several Issues Concerning the Enterprise Income Tax on Indirect Property Transfer by Non-Resident Enterprises, or Circular 7, promulgated by the SAT on February 3, 2015, as most recently amended on December 29, 2017, if a non-resident enterprise transfers the equity interests of a PRC resident enterprise indirectly by transfer of the equity interests of an offshore holding company (other than a purchase and sale of shares issued by a PRC resident enterprise in public securities market) without a reasonable commercial purpose, the PRC tax authorities have the power to reassess the nature of the transaction and the indirect equity transfer will be treated as a direct transfer. As a result, the gain derived from such transfer, which means the equity transfer price less the net value of equity, will be subject to PRC withholding tax at a rate of up to 10%. Under the terms of Circular 7, the transfer which meets all of the following circumstances shall be directly deemed as having no reasonable commercial purposes: (i) over 75% of the value of the equity interests of the offshore holding company are directly or indirectly derived from PRC taxable properties; (ii) at any time during the year before the indirect transfer, over 90% of the total properties of the offshore holding company are investments within PRC territory, or in the year before the indirect transfer, over 90% of the offshore holding company’s revenue is directly or indirectly derived from PRC territory; (iii) the function performed and risks assumed by the offshore holding company are insufficient to substantiate its corporate existence; and (iv) the foreign income tax imposed on the indirect transfer is lower than the PRC tax imposed on the direct transfer of the PRC taxable properties.

 

There is uncertainty as to the application of SAT Circular 37 and Circular 7. SAT Circular 37 and Circular 7 may be determined by the PRC tax authorities to be applicable to our prior private equity financing transactions that involved non-resident investors, if any of such transactions were determined by the tax authorities to lack reasonable commercial purpose. As a result, we and our non-resident investors in such transactions may become at risk of being taxed under SAT Circular 37 and Circular 7, and we may be required to expend valuable resources to comply with SAT Circular 37 and Circular 7 or to establish that we should not be taxed under the general anti-avoidance rule of the EIT Law, which may have a material adverse effect on our financial condition and results of operations.

 

Value Added Tax and Business Tax

 

Pursuant to the Provisional Regulations on Value-Added Tax of the PRC (Revision 2017), and its implementation regulations, unless otherwise specified by relevant laws and regulations, any entity or individual engaged in the sales of goods or processing, repairs and replacement services, sale of services, intangible assets, immovables, and importation of goods into China is generally required to pay a value-added tax, or VAT, for revenues generated from sales of products, while qualified input VAT paid on taxable purchase can be offset against such output VAT.

 

In November 2011, the Ministry of Finance and the State Administration of Taxation promulgated the Pilot Plan for Imposition of Value-Added Tax to Replace Business Tax, or the Pilot Plan. In March 2016, the Ministry of Finance and the State Administration of Taxation further promulgated the Notice on Fully Promoting the Pilot Plan for Replacing Business Tax by Value-Added Tax, which became effective on May 1, 2016. In November 2017, the State Council promulgated the Decision of State Council on Abolition of the Provisional Regulations of the People’s Republic of China on Business Tax and Revision of the Provisional Regulations of the People’s Republic of China on Value-added Tax, or the Decision. Pursuant to the Pilot Plan and relevant notices and the Decision, VAT is generally imposed in the modern service industries on a nationwide basis and the Provisional Regulations of the People’s Republic of China on Business Tax has been abolished. VAT of a rate of 6% applies to revenue derived from the provision of some modern services. If the services provided are related to technology development and transfer, such VAT may also be exempted subject to the approval of relevant tax authorities. Unlike business tax, a taxpayer is allowed to offset the qualified input VAT paid on taxable purchases against the output VAT chargeable on the modern services provided.

 

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Pursuant to the Pilot Plan and relevant notices and the Decision, the VAT rates generally applicable are 6%, 11% and 17%. The Notice of the Ministry of Finance and the State Administration of Taxation on Adjusting VAT Rates, which became effective on May 1, 2018, revised the VAT rates to 6%, 10% and 16%. The Public Notice regarding certain Policies for Deepening the VAT Reform, which became effective on April 1, 2019, further reduced the VAT rates to 6%, 9% and 13%. As of the date of this annual report, our PRC subsidiaries and consolidated affiliated entities are generally subject to VAT rates of 6%, 9% or 13%.

 

Dividends Withholding Tax

 

We are a Cayman Islands holding company and substantially all of our income may come from dividends we receive from our PRC subsidiary. Pursuant to the EIT Law and its implementation rules, dividends generated after January 1, 2008 and distributed to us by our PRC subsidiary are subject to withholding tax at a rate of 10%.

 

As uncertainties remain regarding the interpretation and implementation of the EIT Law and its implementation rules, we cannot assure you that, if we are deemed a PRC resident enterprise, any dividends to be distributed by us to our non-PRC shareholders and ADS holders would not be subject to any PRC withholding tax.

 

Regulations on Foreign Exchange

 

The Regulations of the People’s Republic of China on Foreign Exchange Control, promulgated by the State Council on January 29, 1996 and as most recently amended on August 5, 2008, are principal regulations on foreign currency exchange in the PRC. Under these regulations, the RMB is freely convertible for current account items after due process, including distribution of dividends, trade-related foreign exchange transactions and service-related foreign exchange transactions, whereas foreign exchange for capital account items, such as direct investments or loans, requires prior approval of and registration with the SAFE.

 

Capital Settlement and Overseas Remittance of Foreign-Invested Enterprises

 

On June 1, 2015, the Notice of the State Administration of Foreign Exchange on Reforming the Administrative Approach Regarding the Settlement of the Foreign Exchange Capitals of Foreign-invested Enterprises came into effect and then was specified by the Notice of the State Administration of Foreign Exchange on Reforming and Standardizing the Administrative Provisions on Capital Account Foreign Exchange Settlement promulgated on June 9, 2016, which helps further deepen the reform of the foreign exchange administration system and better satisfy and facilitate the needs of foreign-invested enterprises for business and fund operations. This notice allows foreign-invested enterprises to settle their foreign exchange capitals on a discretionary basis. Moreover, the Provisions on Foreign Exchange Administration Over Direct Investment Made by Foreign Investors in the PRC were promulgated by the SAFE on May 10, 2013 in order to promote and facilitate foreign investors to make direct investment in the PRC, which allow a foreign-invested enterprise that needs to remit funds abroad to purchase and remit foreign exchange with the relevant bank due to capital reduction, liquidation, advance recovery of investment, profit distribution, etc. after due registration.

 

SAFE promulgated the Circular on Further Improving Reform of Foreign Exchange Administration and Optimizing Authenticity and Compliance Verification, or SAFE Circular 3, effective on January 26, 2017. SAFE Circular 3 relaxes the policy restriction on foreign exchange inflow to further enhance trade and investment facilitation, including expanding the scope of foreign exchange settlement for domestic foreign exchange loans, allowing the capital repatriation for offshore financing backed by domestic guarantee, facilitating the centralized management of foreign exchange funds of multinational companies, and allowing the offshore institutions within pilot free trade zones to settle foreign exchange in domestic foreign exchange accounts. SAFE Circular 3 also tightens the authenticity and compliance verification process of cross-border transactions and cross-border capital flow, such as requiring banks to verify board resolutions, tax filing form, and audited financial statements before wiring foreign invested companies’ foreign exchange distribution above US$50,000.

 

SAFE promulgated the Circular of the State Administration of Foreign Exchange on Further Promoting the Facilitation of Cross-border Trade and Investment, or SAFE Circular 28, effective on October 23, 2019. Among others, SAFE Circular 28 relaxes prior restrictions and allows a foreign-invested enterprise that does not have equity investment in its approved business scope to use its capital funds to make domestic equity investment as long as such investment is real and in compliance with the foreign investment-related laws and regulations. However, since it is relatively new, uncertainties still exist in relation to its interpretation and implementation.

 

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Outbound Investment, Financing and Roundtrip Investment

 

On July 4, 2014, the Circular on the Relevant Issues Concerning Foreign Exchange Control on Domestic Residents Outbound Investment and Financing and Roundtrip Investment though Special Purpose Vehicles came into effect, which was promulgated by the SAFE to make full use of domestic and international resources and markets. This circular prescribes operational procedures and registration requirements for roundtrip investment though special purpose companies and others. In particular, it states that a domestic resident shall apply to the relevant local branch of the SAFE for foreign exchange registration of overseas investment, prior to making contribution to a special purpose company with legitimate domestic or overseas assets or interests.

 

Equity Incentive Plans

 

On February 15, 2012, the Circular of SAFE on Relevant Issues Concerning the Foreign Exchange Administration for Domestic Individuals’ Participation in Equity Incentive Plans of Overseas-Listed Companies came into effect. This notice prescribes foreign exchange procedural requirements for domestic individuals such as directors, supervisors, officials and other employees in relation to equity incentive plans of companies listed abroad, including employee stock ownership plans, employee stock option plans and other equity incentive programs permitted by applicable laws and regulations. Under the notice, individuals who participate in equity incentive plans of the same overseas listed company shall, through the domestic companies they serve, collectively entrust a domestic agency to handle matters such as foreign exchange registration with the SAFE, account opening, and funds transfer and remittance, and entrust an overseas institution to handle matters such as exercise of options, purchasing and sale of related equity and funds transfer. Besides, an individual may use his/her own foreign currency funds in his/her personal foreign currency deposit account, RMB funds or other legitimate domestic funds to participate in an equity incentive plan.

 

Regulations on Dividend Distribution

 

The principal legislation with respect to payment or distribution of dividends by wholly foreign-owned enterprises includes (i) the Company Law of the People’s Republic of China, most recently amended by the Standing Committee of the National People’s Congress as of October 26, 2018, and (ii) the Foreign Investment Law and its implantation rules. Under these laws, wholly foreign-owned enterprises in the PRC may pay dividends only out of accumulated profits, after setting aside annually at least 10% of accumulated after-tax profits to its statutory reserves, until such time as the accumulative amount of such reserves reaches 50% of the enterprise’s registered capital. A wholly foreign-owned enterprise may allocate a portion of its after-tax profits to discretionary reserves at its discretion. These reserve funds may not be distributed as cash dividends.

 

Seasonality

 

We experience seasonality in the sale of our solutions, with generally higher sales in the fourth quarter typically followed by a decline or low sequential growth of net revenues in the first quarter. Sales and marketing expenses typically increase towards the end of the year as a result of commissions. Overall, the historical seasonality of our business has been relatively mild but may increase further in the future. Due to our limited operating history, the seasonal trends that we have experienced in the past may not be indicative of our future operating results.

 

C.    Organizational Structure

 

The following diagram illustrates our corporate structure, including our significant subsidiaries and consolidated affiliated entities:

 

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Contractual Arrangements with Gridsum PRC Holding and its Shareholders

 

The following is a summary of the currently effective contractual arrangements among the WFOE, Gridsum PRC Holding and the shareholders of Gridsum PRC Holding:

 

Exclusive Business Cooperation Agreement

 

Under the Exclusive Business Cooperation Agreement dated December 22, 2014 between the WFOE and Gridsum PRC Holding, Gridsum PRC Holding has appointed the WFOE as its exclusive provider of complete technical support, business support and related consulting services, and, without prior written consent of the WFOE, may not accept the same or similar services provided by, or establish similar cooperation relationship with, any other party. In consideration of the services provided by the WFOE, Gridsum PRC Holding shall pay the WFOE, on a quarterly basis, service fees equal to 90% of Gridsum PRC Holding’s net income (which equals gross income less mutually agreed costs). The parties can reasonably adjust the calculation ratio of such service fees. The WFOE shall have exclusive and proprietary rights and interests in all rights, ownership, interests and intellectual properties owned and used by WFOE during the performance of the agreement. The term of the agreement is 10 years and may be extended if confirmed in writing by the WFOE prior to expiration (and Gridsum PRC Holding shall unconditionally accept such extension). Gridsum PRC Holding shall not terminate the agreement prior to its expiration, unless the WFOE commits gross negligence or fraudulent act against Gridsum PRC Holding, whereas the WFOE may terminate the agreement upon giving 30 days’ prior written notice to Gridsum PRC Holding at any time.

 

Exclusive Option Agreements

 

Under the Exclusive Option Agreements, each dated December 22, 2014, among the WFOE, Gridsum PRC Holding and the shareholders of Gridsum PRC Holding, the shareholders of Gridsum PRC Holding granted to the WFOE an irrevocable and exclusive right to purchase, or designate other person(s) to purchase, to the extent permitted by PRC laws, at any time all or part of such shareholders’ equity interests in Gridsum PRC Holding. The purchase price shall be equal to RMB10.00 multiplied by the ratio of the equity interests to be purchased to the total registered capital of Gridsum PRC Holding, or, if there is any mandatory provision regarding the purchase price under PRC laws, then at the election of the WFOE or its designated person, the lowest price permitted by PRC laws. Without the WFOE’s prior written consent, Gridsum PRC Holding shall not: (i) supplement, change or amend its articles of association, increase or decrease its registered capital or change its capital structure in any manner, (ii) sell, transfer, mortgage or dispose of, or create security interest on, any of its assets, business or legal right to collect interests, (iii) create, succeed to, guarantee or permit any debt, except for debts arising in the course of ordinary or daily business operation, (iv) enter into any material contract (i.e., any contract with a value exceeding RMB1,000,000), (v) provide loan or credit to any person, (vi) merge or combine with, buy or invest in, any other person or (vii) distribute dividends to its shareholders; and the shareholders of Gridsum PRC Holding shall not sell, transfer, mortgage or dispose of, or create security interest on, such shareholders’ legal or beneficial interest in the equity interests in Gridsum PRC Holding without the prior written consent of the WFOE, except in accordance with the terms of the Equity Pledge Agreements described below. The term of each of the agreements is 10 years and may be renewed at the WFOE’s election.

 

Shareholders’ Voting Rights Proxy Agreements

 

Under the Shareholders’ Voting Rights Proxy Agreements, each dated December 22, 2014, among the WFOE, Gridsum PRC Holding and the shareholders of Gridsum PRC Holding, the shareholders of Gridsum PRC Holding irrevocably authorized the WFOE or its designee to act on their behalf as their exclusive agent and attorney with respect to all matters concerning their shareholder rights, as shareholders of Gridsum PRC Holding, including without limitation to propose, convene and attend shareholder meetings as proxy of such shareholders, and to exercise all of such shareholder’s voting rights provided under PRC laws or the articles of association of Gridsum PRC Holding. Each agreement will remain effective until all equity interests of the respective shareholder in Gridsum PRC Holding have been transferred to the WFOE and the related regulatory process has been completed.

 

Equity Pledge Agreements

 

Under the Equity Pledge Agreements, each dated December 22, 2014, among the WFOE, Gridsum PRC Holding and the shareholders of Gridsum PRC Holding, the shareholders of Gridsum PRC Holding pledged all of their equity interests in Gridsum PRC Holding to the WFOE as security for, among other things, the performance of the obligations of Gridsum PRC Holding and its shareholders under the Exclusive Business Cooperation Agreement, the Exclusive Option Agreements and the Shareholders’ Voting Rights Proxy Agreements. In the event of any breach of any secured obligations by Gridsum PRC Holding or the respective shareholder, the WFOE is entitled to all remedial rights and powers afforded under PRC laws, including to be repaid in priority with proceeds from auctions or sale-offs of the pledged equity. Dividends may only be paid to the shareholders of Gridsum PRC Holdings in respect of the pledged equity with the prior consent of the WFOE, and the dividends received by the shareholders shall first be applied to satisfy the secured obligations. The pledges will be released upon the full and complete performance of the secured obligations and the full payment of losses and fees resulting from a breach of those agreements by Gridsum PRC Holding or its shareholders. The equity pledges have been registered with local registration authority in accordance with PRC laws.

 

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In the opinion of Merits & Tree Law Offices, our PRC counsel, (a) the ownership structures of the WFOE, Gridsum PRC Holding and the subsidiaries of Gridsum PRC Holding do not violate applicable PRC laws; and (b) each agreement pertaining to the contractual arrangements among the WFOE, Gridsum PRC Holding and its shareholders is valid, binding and enforceable in accordance with its terms under applicable PRC laws, and does not violate applicable PRC laws. However, there are substantial uncertainties regarding the interpretation and application of current and future PRC laws and regulations, and there can be no assurance that the PRC government will take a view that is not contrary to or otherwise different from the opinion of our PRC counsel. If the PRC government finds that the agreements that establish the structure for operating our business do not comply with PRC government restrictions on foreign investment in the business we engage in, we could be subject to severe penalties, including being prohibited from continuing operations. See “Item. 3 Key Information—D. Risk Factors—Risks Relating to Our Corporate Structure—We conduct our businesses in China by means of contractual arrangements through a variable interest entity and its subsidiaries. If the PRC government determines that such arrangements do not comply with applicable laws and regulations, our business could be materially adversely affected,” “Item. 3 Key Information—D. Risk Factors—Risks Relating to Doing Business in China—Uncertainties in the interpretation and enforcement of PRC laws and regulations could limit the legal protections available to our shareholders and us.” and “Item. 3 Key Information—D. Risk Factors—Risks Relating to Our Corporate Structure—Substantial uncertainty exists with respect to the interpretation and implementation of the PRC Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations.”

 

D.    Property, Plants and Equipment

 

Facilities

 

Our corporate headquarters, which includes sales, marketing, business operations and executive offices, is located in Beijing, China and consists of approximately 9,800 square meters of office space under 22 leases that will expire beginning in 2020. In addition to our headquarters, we lease space in Shanghai, Guangzhou, Shenzhen, Chengdu and Xi’an. In addition, we maintain data centers in Beijing and Shanghai.

 

We lease all of our facilities and do not own any real property. We intend to procure additional space as we add employees and expand geographically. We believe our facilities are adequate and suitable for our current needs and that, should it be needed, suitable additional or alternative space will be available to accommodate any such expansion of our operations.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

The following discussion and analysis of our financial condition and results of operations is based upon and should be read in conjunction with our audited consolidated financial statements included elsewhere in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of many factors, including those set forth under “Item 3. Key Information—D. Risk Factors” and elsewhere in this annual report.

 

A.    Operating Results

 

Overview

 

Gridsum is a leading provider of sophisticated data analysis software for multinational and domestic enterprises and government agencies in China. Our proprietary distributed data architecture allows our customers to efficiently collect and analyze vast amounts of information that is collected, indexed and stored in an organized manner, or structured data, and information that is not organized, or unstructured data. Our core technology, the Gridsum Big Data Platform and the Gridsum Prophet: Enterprise AI Engine, with its machine learning and AI capability, performs multi-dimensional correlation analysis and analyzes complex real-time events. With the support of our Big Data Platform and the Gridsum Prophet, our customers use our data visualization and data-mining technologies to identify complex relationships within their data and gain new insights that help them make better business decisions.

 

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Our leading position is based on our solutions and our core technologies. Our software products are designed for a variety of commercial and governmental applications. To help our enterprise customers reach China’s large and growing online and mobile population, our initial products have focused on digital marketing analytics and automation solutions. We were among the first companies to offer web analytics solutions based on data warehouse technology, and we were among the first digital intelligence companies in China to build solutions entirely on a distributed data warehouse architecture using the open-source Hadoop framework. By leveraging the analytic capabilities of our Big Data Platform and the Gridsum Prophet, we have developed additional software solutions, including new media analytics and information discovery solutions, to address a broad range of customer needs. In 2019, our customers included Fortune 500 and China 500 enterprises, comprising 547 customers across diverse industries.

 

We are exclusively dedicated to developing proprietary technologies and solutions in digital intelligence. In 2009, we launched Web Dissector, our first digital intelligence solution, and our first Web Dissector customer remains a customer today. Since 2009, we have released a series of solutions based on our Big Data Platform, including SEM Dissector, SEO Dissector, Mobile Dissector, Contribution Dissector, Streaming Dissector, Video Dissector, Government Web Dissector, Media Dissector and Law Dissector. In 2014, we launched ADSUITE, a fully integrated package through which customers can access all our marketing automation solutions. In October 2016, we launched our social listening solution. It is a cloud-based service that enables an enterprise customer to monitor and analyze web and social media posts regarding the brand, products, customer service of the customer and its competitors. It also provides sentiment analysis and generates alerts from those posts. In November 2017, we, in cooperation with Tencent and the PRC People’s Court Press, launched our Faxin Wei Su Platform, a litigation service on WeChat’s micro application platform. It provides integrated online litigation and remote trial handling services in China, enabling both the courts and litigants to join a trial remotely through our Faxin Wei Su platform. In December 2017, we launched our Intelligent CRM Solution. The Intelligent CRM Solution is a cloud-based, marketing-centric CRM solution tailor-made for both multinational and local companies operating in China, enabling our clients to leverage both online and offline data derived from their digital marketing and sales divisions and customers’ digital footprints, to drive sales and close orders in a more efficient and KPI-enhancing manner. In 2019, we launched our IIoT platform COMPaaS, which builds on the foundation of our big data and enterprise AI capabilities to enable clients to design, develop, and deploy data and knowledge-driven IIoT solutions in industrial settings.

 

Despite our growth in earlier periods, our business activity and related revenues have declined from 2017 to 2019. Our net revenues were RMB469.5 million, RMB431.2 million and RMB326.6 million (US$46.9 million) in 2017, 2018 and 2019, respectively, representing a year-over-year decline of 8% and 24%, respectively. We continued to make expenditures and investments, including in our technologies, personnel, sales and marketing, infrastructure and operations, incurring net losses of RMB239.1 million, RMB522.5million and RMB536.9 million (US$77.1 million) in 2017, 2018 and 2019, respectively. Our employee headcount decreased from 1,078 employees as of December 31, 2017 to 929 employees as of December 31, 2019. We had 505, 539 and 547 customers in 2017, 2018 and 2019, respectively

 

We deliver our solutions as cloud-based software-as-a-service, or SaaS, offerings that are easy to deploy, easy to access, automatically updated without disruption, and enable our customers to reduce IT support costs by outsourcing hardware and software maintenance and support. We account for our revenues on a net basis, based on the fees our customers pay us without including any amounts they pay third parties for advertising or other services. We charge most customers based on percentage of their spending on our system in the bid management application or the volume of data being processed (e.g., page views or viewer views). When we provide our data analytics solutions with bid management functionality, we charge customers based on a percentage of their ad spending with search engine providers. For example, a customer utilizing our bid management software to optimize performance of its search engine marketing campaign would pay us a service fee calculated as a negotiated percentage of its ad spending through our software. When we offer our data analytics solutions to customers without reference to ad spending, we typically charge them negotiated variable amounts based on the monthly volume of data processed. We arrive at an annual data volume estimate before the engagement commences, and charge a fee for a predetermined base number of page views or viewer views. If the volume of the data processed exceeds the base, we charge progressively for the additional usage. To satisfy some of our customers’ needs, we set a fee cap based on negotiation, subject to annual adjustment, or negotiate fixed-fee based contracts with them. In 2019, 68% of our revenues were recognized based on capped or fixed-fee arrangements. For our marketing automation solutions, we earn and record service fee revenues over the contractual period, in proportion to ad spending or the completion of milestones that are stipulated in the contracts. In addition, we receive revenues from the incentive programs of search engine providers based on factors determined by them, such as yearly growth in the amount of advertising on the provider’s search engine platform that our customers purchase through our solutions and other factors selected at the discretion of these providers. Revenues from these programs are received on both a quarterly and an annual basis. A majority of our customer contracts have terms of one year and may be renewed. Our gross margin in 2017, 2018 and 2019 was 80%, 77% and 76%, respectively.

 

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Factors Affecting Our Results of Operations

 

Investment in Expansion and Penetration of Our Customer Base

 

Our performance depends on our ability to continue to attract new customers and expand usage of our products by existing customers. We had 505, 539 and 547 customers in 2017, 2018 and 2019, respectively. For the foreseeable future, we expect that our revenue growth, if any, will be primarily driven by the pace of adoption of our products and we will incur expenses associated with educating the market about the benefits of our products. We had grown our sales and marketing team, which consists of our sales personnel and customer service consultants, from a total of 410 employees as of December 31, 2017 to 571 employees as of December 31, 2018. As part of our efforts to reorganize the sales and marketing functions and optimize the composition of our employees across difference divisions, we reduced the number of our sales and marketing employees to 287 as of December 31, 2019. We intend to continue our marketing efforts to increase our awareness of our solutions and our brand.

 

Investment in Innovation

 

Our performance is significantly dependent on the investments we make in research and development to innovate, improve functionality, develop new technologies, and adapt to new technologies or changes to existing technologies. Our product innovation and development allows our customers to analyze growing volumes and variety of data in new ways. Our research and development team included 546 employees as of December 31, 2017, 491 employees as of December 31, 2018 and 518 employees as of December 31, 2019. We intend to continue to invest in product innovation and leadership, including hiring top technical talent, focusing on core technology innovation and product development and new industry verticals. One area of focus in the nearer term is development of solutions in the legal and financial services verticals and IIoT based on our Gridsum Big Data Platform and Gridsum Prophet. Another area of focus is the development of integrated solutions in data analytics, information discovery, and data visualization. We do not expect to realize significant revenues from these development initiatives in the near term.

 

Investment in Infrastructure

 

We have made substantial investments in our infrastructure, and expect to continue to make such investments. For example, we expect to make investments in infrastructure such as data centers, network bandwidth and technical operations personnel. Additionally, and in response to the heightened data security requirements for our e-Government customers, particularly in the judicial system, we from time to time outsource some of our software optimization and data security enhancement work to specialist companies in this field, and incur expenses relating to such outsourced services. We also expect to make additional investments in our infrastructure as we continue to develop our capabilities across our product range.

 

Development of the SaaS Enterprise Software Industry in China

 

Our revenues are significantly affected by the growth in demand for enterprise SaaS software in China. Such demand is dependent on many factors, including the economic growth in the industries in which our customers operate and the overall adoption of SaaS solutions among enterprises and government agencies in China. Our performance will also depend on the emergence of future competition from multinational and domestic software providers in China. In addition, government policy and regulation of China’s software industry may affect our results of operations.

 

Trends in Key Performance Indicators

 

We review the following key metrics to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans and make strategic decisions:

 

Average Customer Contribution

 

We calculate average customer contribution by dividing total net revenues in a period by the total number of customers for the same period. We monitor average customer contribution as a measure of our cross selling and upselling of our new solutions. Our average customer contribution was RMB0.9 million, RMB0.8 million and RMB0.6 million (US$0.1 million) in 2017, 2018 and 2019, respectively, representing a decrease of 14% from 2017 to 2018 and a decrease of 25% from 2018 to 2019.

 

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Customers

 

We define a customer in a period as a single organization that purchases our products and solutions and with respect to which we recognize revenue during such period. A single customer may have multiple paid business accounts for separate divisions, segments or subsidiaries, but all entities that are part of the same corporate structure are counted as a single customer. We periodically review and optimize our customer portfolio. In 2017, 2018 and 2019, we had 505, 539 and 547 customers, respectively. No single customer represented 10% or more of our total net revenues in 2017, 2018 or 2019. The majority of our revenues were generated by sales to existing customers.

 

Company Strategic Restructuring and Operating Environment

 

During 2019, we conducted a substantial restructuring of the company, which remains ongoing, for purposes of evolving our solution and product mix toward areas that we believe would ultimately generate higher margins, higher return and higher growth, increasing efficiencies and productivity, and ultimately improving our results of operation and financial condition.

 

Key components of this process include the restructuring of the development, sales and service functions, the evolution of organizational and departmental KPIs, and the restructuring and evolution of our sales teams and their product and client focus.

 

In addition, during 2019, the demand for our products and solutions was adversely affected by the slowdown of China’s economic growth, which led to softened consumer demand. Our marketing-oriented solutions were particularly impacted, and we have seen a deterioration of margins and working capital terms with clients in a number of areas as a result. These challenges were most acute for our search-related businesses including our SEM Dissector and SEO Dissector solutions.

 

The combination of these factors has resulted in a relatively tight financial environment for our company. The availability of cash and other financial resources have reduced, requiring us to carefully manage our working capital and adjust our cost and revenue mix, among others, to maintain liquidity and continue our business operations. As a result, through 2019, we accelerated our move to reduce our business in search-related areas. These areas are typically characterized by having heavy working capital requirements and sub-optimal receivable terms, resulting in a lower return on capital profile. These dynamics have deteriorated further through 2019 to the extent that we have continued to reduce our business in these areas into 2020. Depending on market conditions and our financial position, we may continue to deprioritize our search-heavy businesses during 2020, and we may consider a full exit from such business.

 

Our financial performance in 2019 reflected the impact of our efforts and challenges around our strategic restructuring to achieve a more optimal revenue and cost structure, as well as the tightening operating conditions as a result of our cash flow and liquidity pressures. The slowdown in the Chinese economy and softened consumer demand also adversely affected our results of operations. Under the impact of these factors, we experienced a relatively low growth in our overall customer numbers from 539 in 2018 to 547 in 2019, and a reduction in average customer contribution from RMB0.8 million in 2018 to RMB0.6 million (US$0.1 million) in 2019. These in turn resulted in the significant 24.3% decline in our net revenues from RMB431.2 million in 2018 to RMB326.6 million (US$46.9 million) in 2019). Additionally, the size of our employee team reduced from 1,192 employees as of December 31, 2018 to 929 employees as of December 31, 2020, partly due to our reduction of employee headcount to increase efficiency and also as a result of employee departures under a challenging environment with regard to hiring and retaining key employees.

 

These challenging operating conditions have continued into 2020, and we expect additional and increasingly negative impacts to our business, financial condition and results of operation, as a result of these factors as well as the outbreak of COVID-19. For details of the impact of the outbreak of COVID-19, see “—COVID-19.”

 

COVID-19

 

Since December 2019, China has experienced an outbreak of COVID-19, a disease caused by a novel and highly contagious form of coronavirus, which then spread throughout China and other parts of the world, including the United States. On January 30, 2020, the World Health Organization declared the outbreak of COVID-19 a “Public Health Emergency of International Concern,” and on March 11, 2020, the World Health Organization characterized the outbreak as a “pandemic.”

 

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Government efforts to contain the spread of the coronavirus through lockdowns of cities, business closures, travel restrictions and emergency quarantines, among others, and responses by businesses and individuals to reduce the risk of exposure to infection, including reduced travel, cancellation of meetings and events, and implementation of work-at-home policies, among others, have caused significant disruptions to the global economy and normal business operations across a substantial list of sectors and countries. The foregoing are likely to adversely affect business confidence, consumer sentiment and economic activity, and have been, and may continue to be, accompanied by significant volatility in financial and commodity markets. The spread of the coronavirus is also likely to have broader macroeconomic implications, including reduced levels of economic growth and possibly a global recession, the effects of which will likely be felt well beyond the time the spread of infection is contained.

 

Substantially all of our operations are conducted in China and substantially all of our revenues are generated in China. In response to the intensifying efforts to contain the spread of COVID-19, the Chinese government took certain emergency measures, including extension of the Lunar New Year holidays, implementation of travel bans, blockade of certain roads and closure of factories and businesses, and may continue to take further measures to keep this epidemic outbreak in check. From January 2020 to February 2020, we temporarily closed all of our corporate offices and requested all employees to work remotely. This outbreak of communicable diseases has caused, and may continue to cause companies, including us and certain of our customers, and other stakeholders, to implement temporary adjustment of work schemes allowing employees to work from home and adopt remote collaboration.

 

In particular, the recent outbreak of COVID-19 has caused a significant number of our marketing automation customers to reduce their marketing budgets, which has negatively affected our marketing-related solutions revenues and financial performance generally. Consequently, the COVID-19 outbreak and any measures to combat the spread of the virus, and their aftermath, will likely adversely affect our business operations, financial condition, operating results and cash flow.

 

Following the outbreak of COVID-19, we have seen particular and immediate impacts in our operations, including a significant slowdown in the customer sales origination and renewal cycle, increased timeframes to accomplish key tasks and incremental challenges in collecting accounts receivable in a timely manner. It has hence caused material negative impacts to our net revenues and liquidity position. We expect these and other negative impacts as a result of COVID-19 to continue to adversely affect our business operations, results of operation and financial position through 2020 and potentially in future periods. It is not possible at this time to estimate the impact that COVID-19 could have on our business, as the impact will depend on future developments, which are highly uncertain and cannot be predicted.

 

Key Components of Results of Operations

 

Net Revenues

 

Net revenues consist of revenues recognized from customers that used our software solutions during the period, including net revenues that we receive from the incentive programs of search engine providers, less business taxes and surcharges. In the near term, we may experience slower growth in net revenue in some periods. We expect our net revenues to increase over the long term as more customers adopt our solutions and demand more business intelligence to improve their operational efficiency, and as we continue to bring more innovative solutions to market and serve our customers.

 

Cost of Revenues

 

Cost of revenues consists primarily of personnel and personnel-related expenses for our customer service consultants, who work closely with our customer sales, marketing, IT and other operating professionals to help customers optimize the performance of their accounts, and periodically provide in-depth analyses for customers. Personnel costs consist of salaries, benefits, bonuses and share-based compensation. Cost of revenues also includes data center expenses, office and overhead costs, outsourcing cost, bandwidth costs, and depreciation expenses related directly to providing services to customers. We plan to continue increasing the capacity, capability and reliability of our infrastructure to support the growth of our customer base and the number of products we offer. We expect that, for the foreseeable future, our cost of revenues will fluctuate as a percentage of our net revenues.

 

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Gross Profit and Gross Margin

 

Gross profit is net revenues less cost of revenues; gross margin is gross profit as a percentage of net revenues. Our gross margin has been, and will continue to be, affected by many factors, including the timing and extent of our investments in our operations and personnel, outsourcing costs, hosting-related costs and other depreciation expense allocations. The increased utilization of outsourcing is likely to reduce our gross margin. We expect that our gross margin will fluctuate from period to period.

 

Operating Expenses

 

Our operating expenses consist of sales and marketing, research and development, and general and administrative expenses. For each category, the most significant component of our operating expenses are personnel costs, which consist of salaries, benefits, bonuses, share-based compensation, and for sales and marketing expenses, sales commissions. We also incur other non-personnel costs such as an allocation of our general overhead expenses, and collaboration with third parties to develop and launch new solutions.

 

Sales and Marketing Expenses

 

Sales and marketing expenses consist primarily of personnel costs for our sales, marketing and business development employees and executives. Commissions are expensed in the period when a customer contract is executed. Sales and marketing expenses also include the costs of our marketing and brand awareness programs. We plan to continue investing in sales and marketing by continuing to attract and hire talented sales and marketing professionals, expanding our marketing activities, building brand awareness and sponsoring additional marketing events. We expect our sales and marketing expenses to decrease as a percentage of net revenues over the long term, although our sales and marketing expenses may fluctuate from period to period depending on fluctuations in net revenues and the timing of our sales and marketing expenses.

 

Research and Development Expenses

 

Research and development expenses consist primarily of personnel costs, allocation of general overhead expenses and outsourcing expenses, and collaboration with third-party vertical specialists. We continue to focus our research and development efforts on adding new features and products and on improving the functionality and ease of use of our existing products. In addition, we invest aggressively in the research and development of the infrastructure layer of software technologies, which will benefit us in the long run. We expense all our software development costs as they are incurred. We plan to continue to hire employees for our engineering, product management and consulting teams to support our research and development efforts, particularly in our legal services, intelligent CRM and IIoT solutions, addressing three verticals where we intend to introduce advanced solutions. Our research and development expenses declined in absolute amount in 2019 as we invested significant amounts in research and development in 2018, and we expect our research and development expenses to decline modestly in absolute amount in the near term. We also expect our research and development expenses to decrease modestly as a percentage of net revenues over the long term, with variation from period to period depending on fluctuations in net revenues and the timing and extent of our research and development expenses.

 

General and Administrative Expenses

 

General and administrative expenses consist primarily of personnel costs for our administrative, legal, human resources, information technology, finance and accounting employees and executives, along with legal and other professional fees. We plan to continue to expand our business in China, and we expect to increase the size of our general and administrative function to support the growth of our business and the complexities of being a public company. As a result, we expect our general and administrative expenses to increase in absolute amount for the foreseeable future. We expect our general and administrative expenses as a percentage of net revenues to decrease modestly over the long term, although it may fluctuate from period to period depending on fluctuations in our net revenues and the timing and extent of our general and administrative expenses.

 

Other Income/(Expense), Net

 

Other income/(expense), net consists primarily of interest income, net, and foreign exchange gain or loss.

 

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Results of Operations

 

The following table sets forth a summary of our consolidated results of operations for the periods indicated. This information should be read together with our consolidated financial statements and related notes included elsewhere in this annual report. Due to our limited operating history, period-to-period comparisons discussed below may not be meaningful or indicative of our future trends.

 

 

 

For the Year Ended December 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

(in thousands)

 

Consolidated Statements of Operations Data:

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Enterprise

 

377,013

 

387,574

 

258,903

 

37,189

 

e-Government and other

 

102,216

 

53,117

 

71,796

 

10,313

 

Less: Business tax and surcharges

 

(9,696

)

(9,444

)

(4,147

)

(596

)

Net revenues

 

469,533

 

431,247

 

326,552

 

46,906

 

Cost of revenues(1)

 

(94,640

)

(100,867

)

(77,361

)

(11,112

)

Gross profit

 

374,893

 

330,380

 

249,191

 

35,794

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing expenses(1)

 

(192,413

)

(166,176

)

(144,401

)

(20,742

)

Research and development expenses (1)

 

(257,921

)

(533,586

)

(320,402

)

(46,022

)

General and administrative expenses (1)

 

(143,743

)

(182,289

)

(319,653

)

(45,915

)

Total operating expenses

 

(594,077

)

(882,051

)

(784,456

)

(112,679

)

Loss from operations

 

(219,184

)

(551,671

)

(535,265

)

(76,885

)

Other income/(expense):

 

 

 

 

 

 

 

 

 

Foreign currency exchange gain/(loss)

 

(8,552

)

(9,719

)

(729

)

(105

)

Interest income/(expense), net

 

(5,430

)

(9,878

)

(14,028

)

(2,015

)

Other income/(expense), net

 

(1,683

)

1,005

 

(788

)

(113

)

Amortization of debt discount

 

 

(25,337

)

(40,918

)

(5,878

)

Gain on change in fair value of derivative liabilities

 

 

57,890

 

27,829

 

3,997

 

Loss before income tax

 

(234,849

)

(537,710

)

(563,899

)

(80,999

)

Income tax (expense)/benefit

 

(4,275

)

15,165

 

27,010

 

3,880

 

Net loss

 

(239,124

)

(522,545

)

(536,889

)

(77,119

)

 


(1)             Share-based compensation was allocated in costs and operating expenses as follows:

 

 

 

For the Year Ended December 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

(in thousands)

 

Cost of revenues

 

501

 

801

 

548

 

79

 

Sales and marketing expenses

 

4,739

 

6,810

 

8,537

 

1,226

 

Research and development expenses

 

8,641

 

16,310

 

16,001

 

2,298

 

General and administrative expenses

 

9,046

 

15,105

 

27,364

 

3,931

 

Total

 

22,927

 

39,026

 

52,450

 

7,534

 

 

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

 

Net Revenues

 

 

 

For the Year Ended December 31,

 

Change

 

 

 

2018

 

2019

 

Amount

 

%

 

 

 

RMB

 

RMB

 

US$

 

RMB

 

 

 

 

 

(in thousands, except for percentages)

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

Enterprise

 

387,574

 

258,903

 

37,189

 

(128,671

)

(33

)%

e-Government and other

 

53,117

 

71,796

 

10,313

 

18,679

 

35

%

Less: Business tax and surcharges

 

(9,444

)

(4,147

)

(596

)

(5,297

)

(56

)%

 

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

431,247

 

326,552

 

46,906

 

(104,695

)

(24

)%

 

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Net revenues decreased by RMB104.7 million, or 24%, from 2018 to 2019, including a 33% decrease in enterprise revenues and a 35% increase in e-Government and other revenues. Total customers increased 1%, to 547 customers in 2019 from 539 customers in 2018.

 

Enterprise revenues decreased by RMB128.7 million, or 33%, to RMB258.9 million (US$37.2 million) from RMB387.6 million in 2018, as we are shifting focus from search engine marketing to products and solution-based services. Enterprise customers increased 2%, from 496 to 508, and average enterprise customer contribution decreased from RMB0.8 million in 2018 to RMB0.5 million (US$0.1 million) in 2019.

 

E-Government and other revenues increased by RMB 18.7million, or 35%, reflecting improved sales of IIoT solutions, and average e-Government and other customer contribution increased from RMB1.2 million in 2018 to RMB1.8 million (US$0.3 million) in 2019.

 

Cost of Revenues

 

 

 

For the Year Ended December 31,

 

Change

 

 

 

2018

 

2019

 

Amount

 

%

 

 

 

RMB

 

RMB

 

US$

 

RMB

 

 

 

 

 

(in thousands, except for percentages)

 

Cost of revenues

 

(100,867

)

(77,361

)

(11,112

)

(23,506

)

(23

)%

 

Cost of revenues decreased by RMB23.5 million, or 23%, from 2018 to 2019. The decrease was primarily as a result of a RMB17.5 million decrease in technical service fees, a RMB3.3 million decrease in personnel and related costs, a RMB1.2 million decrease in depreciation and amortization and share-based compensation, a RMB0.8 million decrease in other miscellaneous cost and a RMB0.7 million decrease in outsourcing fee. The decrease in technical service fees was mainly attributable to the decrease of system-related maintenance services for system optimization and data security after heavier investment in prior periods. The decrease in cost of revenues was also attributable to a decrease of our personnel costs which is a direct result of our decrease of revenue and related business activity, which reduced the amount of in-depth analyses we perform for our customers and the number of employees required to help customers optimize the performance of our solutions.

 

Gross Profit

 

Gross profit decreased by RMB81.2 million, or 25%, from 2018 to 2019, and gross margin decreased from 77% in 2018 to 76% in 2019.

 

Operating Expenses

 

 

 

For the Year Ended December 31,

 

Change

 

 

 

2018

 

2019

 

Amount

 

%

 

 

 

RMB

 

RMB

 

US$

 

RMB

 

 

 

 

 

(in thousands, except for percentages)

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing expenses

 

(166,176

)

(144,401

)

(20,742

)

(21,775

)

(13

)%

Research and development expenses

 

(533,586

)

(320,402

)

(46,022

)

(213,184

)

(40

)%

General and administrative expenses

 

(182,289

)

(319,653

)

(45,915

)

137,364

 

75

%

Total operating expenses

 

(882,051

)

(784,456

)

(112,679

)

(97,595

)

(11

)%

 

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Table of Contents

 

Sales and Marketing Expenses

 

Sales and marketing expenses decreased by RMB21.8 million, or 13%, from 2018 to 2019, primarily due to a RMB12.5 million decrease in marketing and promotion expenses, a RMB3.6 million decrease in office lease fees and office utilities expenses, a RMB3.6 million decrease in meeting-related and travel expenses, a RMB3.3 million decrease in personnel and related costs, and a RMB1.6 million decrease in depreciation and amortization expenses, which were partially offset by a RMB1.7million increase in share-based compensation and a RMB1.1 million increase in meal, entertainment and decorating expenses.

 

Research and Development Expenses

 

Research and development expenses decreased by RMB213.2 million, or 40%, from 2018 to 2019, primarily due to a RMB134.4 million decrease in outsourcing costs, a RMB72.1 million decrease in technical service fee, a RMB4.5 million decrease in office lease fees and office utilities expenses, a RMB3.4 million decrease in depreciation and amortization expenses, a RMB2.0 million decrease in other miscellaneous cost, a RMB0.8 million decrease in personnel and related costs, a RMB0.5 million decrease in meeting-related and travel expenses and a RMB0.3 million decrease in share-based compensation, which were partially offset by a RMB4.6 million increase in decorating expenses and a RMB0.2 million increase in meal and entertainment expenses.

 

Prior to 2019, we spent a substantial amount of investment in the development of our IIoT platform as well as the continued development of our CRM and other solutions, in particular in developing and “training” our sense and cognition layer AI platform tailored for certain specific IIoT industry verticals and in developing and maintaining our data warehouse product with contracting specialized UI (user interface), security and other module development. In 2019, we passed the peak investment period and our outsourcing costs and technical service fee declined in absolute amount accordingly.

 

General and Administrative Expenses

 

General and administrative expenses increased by RMB137.4 million, or 75%, from 2018 to 2019, primarily due to a RMB121.3 million increase in allowance for doubtful accounts. The recent outbreak of COVID-19 has adversely affected our customers’ business operations, financial conditions, cash flows and liquidity positions, which in turn adversely affected our ability to collect accounts receivable from our customers. In light of the uncertainties of collection, we made allowance of all overdue accounts receivable in 2019. The increase also included a RMB19.7 million increase in personnel and related costs, a RMB12.3 million increase in share-based compensation, a RMB5.0 million increase in office lease fees and office utilities expenses, a RMB4.9 million increase in meeting related and travel expenses, a RMB1.2 million increase in depreciation and amortization expenses, and a RMB 0.3 million increase in other miscellaneous general and administrative expenses, which were partially offset by a RMB26.8 million decrease in profession fees and a RMB0.5 million decrease in bank charges.

 

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

 

Net Revenues

 

 

 

For the Year Ended December 31,

 

Change

 

 

 

2017

 

2018

 

Amount

 

%

 

 

 

RMB

 

RMB

 

US$

 

RMB

 

 

 

 

 

(in thousands, except for percentages)

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

Enterprise

 

377,013

 

387,574

 

56,370

 

10,561

 

3

%

e-Government and other

 

102,216

 

53,117

 

7,726

 

(49,099

)

(48

)%

Less: Business tax and surcharges

 

(9,696

)

(9,444

)

(1,374

)

252

 

(3

)%

Net revenues

 

469,533

 

431,247

 

62,722

 

(38,286

)

(8

)%

 

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Net revenues decreased by RMB38.3million, or 8%, from 2017 to 2018, including a 3% increase in enterprise revenues and a 48% decrease in e-Government and other revenues. Total customers increased 7%, to 539 customers in 2018 from 505 customers in 2017.

 

Enterprise revenues increased by RMB10.6 million, or 3%, to RMB387.6 million from RMB377.0 million in 2017, reflecting improved sales of Social Listening solutions in the first half of the year and a general decline in enterprise revenues in the second half of the year that was mainly due to customer attrition and prolonged contract renewal processes associated with delayed filing of our periodic reports with the SEC and general economic conditions in China. Enterprise customers increased 11%, from 447 to 496, and average enterprise customer contribution decreased from RMB843 thousand in 2017 to RMB781 thousand in 2018.

 

E-Government and other revenues decreased by RMB49.1 million, or 48%, due to a decrease in average e-Government and other customer contribution from approximately RMB1.8 million to RMB1.2 million, and a decrease in the number of e-Government and other customers from 58 to 43 primarily as a result of government reorganization activities in 2018.

 

Cost of Revenues

 

 

 

For the Year Ended December 31,

 

Change

 

 

 

2017

 

2018

 

Amount

 

%

 

 

 

RMB

 

RMB

 

US$

 

RMB

 

 

 

 

 

(in thousands, except for percentages)

 

Cost of revenues

 

(94,640

)

(100,867

)

(14,670

)

(6,227

)

7

%

 

Cost of revenues increased by RMB6.2 million, or 7%, from 2017 to 2018. The increase was primarily as a result of a RMB5.8 million increase in product and solution-related outsource service fees and a RMB5.4 million increase in personnel and related costs, partially offset by a RMB5.0 million decrease in technical service fees. The increase in the cost of product and solution-related outsource service fees was mainly related to the outsourcing of some of our search engine optimization and social media optimization services, so that we could reassign internal resources to research and development activities. The increase in cost of revenues was also attributable to an increase of our personnel costs associated with helping customers optimize the performance of our solutions, and provide periodic in-depth analyses for customers. The decrease in technical service fees was mainly attributable to the decrease of system-related maintenance services for system optimization and data security after heavier investment in prior periods.

 

Gross Profit

 

Gross profit decreased by RMB44.5 million, or 12%, from 2017 to 2018, and gross margin decreased from 80% in 2017 to 77% in 2018.

 

Operating Expenses

 

 

 

For the Year Ended December 31,

 

Change

 

 

 

2017

 

2018

 

Amount

 

%

 

 

 

RMB

 

RMB

 

US$

 

RMB

 

 

 

 

 

(in thousands, except for percentages)

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing expenses

 

(192,413

)

(166,176

)

(24,169

)

26,237

 

(14

)%

Research and development expenses

 

(257,921

)

(533,586

)

(77,607

)

(275,665

)

107

%

General and administrative expenses

 

(143,743

)

(182,289

)

(26,513

)

(38,546

)

27

%

Total operating expenses

 

(594,077

)

(882,051

)

(128,289

)

(287,974

)

48

%

 

Sales and Marketing Expenses

 

Sales and marketing expenses decreased by RMB26.2 million, or 14%, from 2017 to 2018, primarily due to a RMB27.3 million decrease in industry research expenses, a RMB14.9 million decrease in advertising expense, a RMB5.4 million decrease in meal and entertainment expenses, and a RMB2.1 million decrease in meeting related expenses, which were partially offset by a RMB14.9 million increase in personnel and related costs, a RMB3.1million increase in office lease fees and office utilities expenses, a RMB2.8 million increase in travel expenses, a RMB2.1 million increase in share-based compensation, and a RMB0.6 million increase in other miscellaneous sales and marketing expenses.

 

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Research and Development Expenses

 

Research and development expenses increased by RMB275.7 million, or 107%, from 2017 to 2018, primarily due to substantial front-end load investment in the development of our IIoT platform as well as continued development of our CRM and other solutions. In particular, we invested RMB140.4 million to develop and train our sense and cognition layer AI platform tailored for certain specific IIoT industry verticals. In addition, a RMB77.9 million increase in technical service fees was associated with the development and maintenance of our data warehouse product and with contracting specialized UI (user interface), security and other module development. The increases also included a RMB41.1 million increase in personnel and related costs, a RMB12.4 million increase in office lease fees, office utilities fees and decorating expenses, a RMB7.7 million increase in share-based compensation, which were partially offset by a RMB3.8 million decrease in other miscellaneous research and development expenses.

 

General and Administrative Expenses

 

General and administrative expenses increased by RMB38.5 million, or 27%, from 2017 to 2018, including a RMB22.3 million increase in professional fees incurred for accounting and legal matters, including a RMB11.6 million increase in profession fees in connection with our internal investigations, changes of auditor and class action litigations, a RMB16.9 million increase in office leasing fees, a RMB9.3 million increase in consulting and intellectual property related expenses, a RMB6.1 million increase in share-based compensation and a RMB4.4 million increase in office expenses, which were partially offset by a RMB10.4 million decrease in allowance for doubtful accounts, a RMB4.5 million decrease in travel expenses, a RMB4.2 million decrease in meeting related expenses and a RMB1.2 million decrease in other miscellaneous general and administrative expenses.

 

Taxation

 

We generate the majority of our operating loss from our PRC operations and have recorded income tax provisions for the periods presented. On a consolidated basis, we have not been profitable yet and have an operating loss carried forward. However, some of our operating entities have taxable income in the past, due to the profit before tax or permanent difference incurred by non-deductible expenses, which resulted in the income tax payment and liability. Income tax liability is calculated based on a separate return basis as if we had filed separate tax returns for all the periods presented.

 

Cayman Islands

 

We are not subject to income or capital gains tax under the current laws of the Cayman Islands. There are no other taxes likely to be material to us levied by the government of the Cayman Islands.

 

Hong Kong

 

Our subsidiary incorporated in Hong Kong, Gridsum Holding (China) Limited, is subject to Hong Kong profit tax at a rate of 16.5%. Hong Kong does not impose a withholding tax on dividends.

 

China

 

Our subsidiaries, VIEs and VIE subsidiaries in the PRC are subject to enterprise income tax on their taxable income in China at a standard rate of 25% if they are not eligible for any preferential tax treatment. Taxable income is based on the entity’s global income as determined under PRC tax laws and accounting standards. According to the PRC Enterprise Income Tax Law and relevant regulations, with approval of relevant tax authorities, the income of Beijing Gridsum, Beijing Moment, Beijing Yunyang, Guoxinjunhe and the WFOE, which is determined to be generated from a high and new technology enterprise, is taxed at a preferential rate of 15%.

 

Our subsidiaries, VIEs and VIE subsidiaries in the PRC are also subject to Value Added Tax (“VAT”) at rate of 6% and related surcharges.

 

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Table of Contents

 

Dividends that the WFOE, our wholly-owned subsidiary in China, pays to Gridsum HK, our intermediary holding company in Hong Kong, will be subject to PRC withholding tax at a rate of 10%, unless they qualify for a special exemption. If Gridsum HK satisfies all the requirements under the Arrangement Between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to Taxes on Income and receives approval from the relevant tax authority, then dividends paid by the WFOE to Gridsum HK will be subject to a withholding tax rate of 5% instead. See “Item. 3 Key Information—D. Risk Factors—Risks Relating to Doing Business in China—Any limitation on the ability of the WFOE to make distributions to us, or the tax implications thereof, could have a material adverse effect on our business or financial condition.”

 

If our holding company in the Cayman Islands, Gridsum Cayman, were deemed to be a “PRC resident enterprise” under the Enterprise Income Tax Law, it would be subject to enterprise income tax on its global income at a rate of 25%. See “Item. 3 Key Information—D. Risk Factors—Risks Relating to Doing Business in China—We and our Hong Kong subsidiary may be classified as a ‘PRC resident enterprise’ for PRC enterprise income tax purposes, which would likely result in unfavorable tax consequences to us and our non-PRC shareholders.”

 

Critical Accounting Policies and Estimates

 

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP, appearing elsewhere in this annual report. The preparation of these consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. We evaluate these estimates, judgments and assumptions on an on-going basis for taxes.

 

Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. These estimates form the basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from such estimates under different assumptions or conditions.

 

We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements:

 

Consolidation of Variable Interest Entities

 

To comply with applicable PRC laws and regulations, we conduct operations in China principally through our PRC-based variable interest entity and its operating subsidiaries. One of our wholly-owned subsidiaries has entered into a series of contractual arrangements with our PRC-based variable interest entity and its shareholders. These contractual arrangements allow us to exercise effective control over, and receive substantially all of the economic benefits, of our PRC-based variable interest entity and its operating subsidiaries, and we treat it and its operating subsidiaries as variable interest entities under U.S. GAAP, the financial results of which are included in our consolidated financial statements. See “Item. 4 Information on the Company—C. Organizational Structure.”

 

Revenue Recognition

 

Revenues are generated from sales of our marketing automation and e-Government and other solutions. The targeted customers for marketing automation solutions are enterprise customers and the targeted customers for e-Government and other solutions are governmental agencies and state-owned entities.

 

Prior to January 1, 2018, revenues are recognized when (1) persuasive evidence of an arrangement exists, (2) our platform is made available and services have been delivered to the customer, (3) the fee is fixed or determinable and (4) collection is reasonably assured.

 

Revenues received from incentive programs of search engine providers are based on factors determined by these providers, such as yearly growth in the amount of advertising on the provider’s search engine platform that our customers purchase through our solutions, and other factors selected at the discretion of these providers. Revenues are recorded net of value-added taxes and surcharges.

 

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In accordance with ASC 605-45, Revenue Recognition: Principal Agent Considerations, we consider several factors in determining whether we act as the principal or as an agent in the arrangement of merchandise sales and provision of various related services and thus whether it is appropriate to record our revenues and the related cost of sales on a gross basis or record the net amount earned as service fees.

 

Where customers purchase multiple solutions in a single contract, we allocate the total consideration to the various elements based on the relative selling price method and recognize revenues as services are rendered. In accordance with ASC 605-25, Revenue Recognition—Multiple-Element Arrangements, the following hierarchy are followed when determining the appropriate selling price for each element: (1) vendor specific objective evidence, or VSOE, (2) third party evidence, or TPE and (3) best estimate of selling price, or BESP. We recognize revenues based on the elements delivered and defer the recognition of revenues for the fair value of the undelivered elements until the remaining obligations have been satisfied. Where all of the elements within an arrangement are delivered uniformly over the agreement period, revenues are recognized on a straight line basis over the contract period.

 

On January 1, 2018 we adopted Accounting Standards Update (“ASU”) 2014-09 Revenue from Contracts with Customers (FASB ASC Topic 606) using the modified retrospective method for contracts that were not completed as of January 1, 2018. We did not result in an adjustment to the retained earnings upon adoption of this new guidance as our revenue was recognized based on the amount of consideration we expect to receive in exchange for satisfying the performance obligations.

 

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 the performance obligation. 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 and using the five-step model under the new guidance and confirmed that there were no differences in the pattern of revenue recognition.

 

We account for a contract with a customer when the contract is committed in writing, the rights of the parties, including payment terms, are identified, the contract has commercial substance and consideration to collect is substantially probable.

 

We continue to derive our revenues from sales contracts where customers purchase multiple solutions in a single contract with we allocate the total consideration to the various elements based on the relative selling price method and recognizes revenues as services are rendered over the period of time. We continue to recognize revenues on the elements delivered and defer the recognition of revenues for the fair value of the undelivered elements until the remaining obligations have been satisfied. Where all of the elements within an arrangement are delivered uniformly over the agreement period, revenues are recognized on a straight-line basis over the contract period.

 

Enterprise

 

We generate enterprise revenue primarily by providing our marketing automation solutions, including bid management and data analysis solutions, to enterprise customers. We earn and record service fee revenues over the contractual period, in proportion to ad spending or the completion of milestones that are stipulated in the contracts. Sometimes, we receive revenues from the incentive programs of search engine providers based on factors determined by them, such as yearly growth in the amount of advertising on the provider’s search engine platform that our customers purchase through our solutions and other factors selected at the discretion of these providers. Revenues from these programs are received on both a quarterly and an annual basis and are calculated in accordance with our customers’ usage of the search engine providers.

 

In addition, we sell distribution rights of public sentiment tracking service provided by certain third-party search engine to sub-distributor, due to uncertainty of collection, the revenue is recognized when fees are collected.

 

With respect to the bid management services, we determined that: (i) the search engines are responsible for providing the advertisements service to the customers; (ii) we lack the latitude to determine the prices charged by the search engine providers and earns only a fixed service fee from the customers; (iii) the hosting and maintenance of the advertisements are the responsibilities of the search engine providers; (iv) the customers have the discretion in choosing the search engines; and (v) we receive revenues from incentive programs based on the search engines providers’ policies. It is our responsibility to manage the customer’s advertising campaign on the search engines providers, according to the terms of the customer contract, so we view ourselves as an agent and record revenues related to these services on a net basis.

 

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e-Government and Other

 

We generate e-Government and other revenue by entering into service contracts with governmental agencies for our e-Government solutions. We also generate e-Government and other revenue by entering into contracts with state-owned television stations for our new media solutions, including TV Dissector, Streaming Dissector and Video Dissector.

 

Share-based Compensation

 

All share-based awards to employees and directors, including stock option awards, are measured at the grant date based on the fair value of the awards. Share-based compensation, net of forfeitures, is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period. We used the binominal option pricing model to determine the fair value of stock options and account for share-based compensation expenses using an estimated forfeiture rate at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates. Share-based compensation expenses were recorded net of estimated forfeitures such that expenses were recorded only for those share-based awards that are expected to vest. Historically, our share-based compensation expenses were relatively low.

 

The following table sets forth information regarding the stock options we granted during the years ended December 31, 2017, 2018 and 2019.

 

Date of Tranche

 

Number of Options
Granted

 

Exercise Price

 

Fair Value of
the Options as of the
Grant Date

 

Fair Value of
the Underlying
Ordinary Shares
as of the Grant Date

 

Intrinsic Value
as of the Grant Date

 

January 17, 2017

 

1,320,000

 

US$

10.11

 

US$

4.93

 

US$

11.35

 

US$

1.24

 

June 25, 2018

 

320,000

 

US$

6.34

 

US$

4.31

 

US$

6.30

 

 

 

February 1,2019

 

1,425,000

 

US$

2.23

 

US$

1.52

 

US$

2.23

 

 

 

 

The fair value of each option grant is estimated on the date of grant. The following table summarizes assumptions used in the fair value estimates on the dates indicated.

 

Date of Tranche

 

Expected Volatility
 (1)

 

Risk-Free
Interest Rate
(Per Annum)
 (2)

 

Expected Dividend
Yield
 (3)

 

Expected Term
(in Years)
 (4)

 

Expected Forfeiture
Rate
 (5)

 

January 17, 2017

 

46

%

3.14

%

 

2.2

 

3

%

June 25, 2018

 

56

%

3.02

%

 

2.2

 

3

%

February 1,2019

 

56

%

3.03

%

 

2.2

 

3

%

 


(1)    We estimated expected volatility based on the annualized standard deviation of the daily return embedded in historical share prices of comparable companies with a time horizon close to the expected expiration of the term.

(2)    We estimated the risk-free interest rate based on the yield of U.S. Treasury bills with maturity terms similar to the expected terms on the share-based awards.

(3)    We have never declared or paid any cash dividends on our capital stock, and we do not anticipate any dividend payments on our ordinary shares in the foreseeable future.

(4)    Expected term (in years) represents the weighted average period of time that share-based awards granted are expected to be outstanding giving consideration to historical exercise patterns. We used the simplified method to calculate the expected term.

(5)    Expected forfeiture rate is estimated based on historical employee turnover rate after each option grant.

 

For the purpose of determining the estimated fair value of our stock options, we believe the expected volatility and the estimated fair value of our ordinary shares are the most critical assumptions. Changes in these assumptions could significantly affect the fair value of stock options and hence the amount of share-based compensation we recognize in our combined and consolidated financial statements. Since we did not have a trading history for our shares sufficient to calculate our own historical volatility, the expected volatility of our future ordinary share price was estimated based on the price volatility of the shares of comparable public companies that operate in the same or similar business.

 

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The following table sets forth information regarding the RSUs we granted during the years ended December 31, 2017, 2018 and 2019.

 

Date of Tranche

 

Number of RSUs
Granted

 

Fair Value of the RSUs
as of the Grant Date

 

Intrinsic Value as of the
Grant Date

 

 

 

 

 

 

 

 

 

January 3, 2017

 

19,782

 

US$

10.11

 

US$

10.11

 

January 11, 2017

 

300

 

US$

11.24

 

US$

11.24

 

August 28, 2017

 

3,217

 

US$

9.37

 

US$

9.37

 

October 1, 2017

 

862,900

 

US$

9.80

 

US$

9.80

 

October 10, 2017

 

20,000

 

US$

9.40

 

US$

9.40

 

October 26, 2017

 

3,000

 

US$

8.87

 

US$

8.87

 

October 23, 2017

 

10,000

 

US$

8.20

 

US$

8.20

 

November 1, 2017

 

8,500

 

US$

8.40

 

US$

8.40

 

November 7, 2017

 

3,000

 

US$

8.64

 

US$

8.64

 

November 15, 2017

 

3,000

 

US$

8.69

 

US$

8.69

 

December 1, 2017

 

3.000

 

US$

8.57

 

US$

8.57

 

January 2, 2018

 

35,718

 

US$

9.33

 

US$

9.33

 

January 4, 2018

 

3,223

 

US$

9.54

 

US$

9.54

 

February 28, 2018

 

25,000

 

US$

10.89

 

US$

10.89

 

March 1, 2018

 

269,425

 

US$

10.26

 

US$

10.26

 

March 2, 2018

 

36,733

 

US$

10.23

 

US$

10.23

 

March 5, 2018

 

12,000

 

US$

10.22

 

US$

10.22

 

April 2, 2018

 

14,312

 

US$

8.46

 

US$

8.46

 

April 16, 2018

 

4,750

 

US$

7.70

 

US$

7.70

 

April 23, 2018

 

2,592

 

US$

6.12

 

US$

6.12

 

May 6, 2018

 

9,157

 

US$

5.66

 

US$

5.66

 

May 16, 2018

 

3,000

 

US$

6.20

 

US$

6.20

 

May 29, 2018

 

200,000

 

US$

6.27

 

US$

6.27

 

June 1, 2018

 

2,275

 

US$

6.86

 

US$

6.86

 

June 19, 2018

 

2,436

 

US$

6.39

 

US$

6.39

 

July 2, 2018

 

1,075

 

US$

6.96

 

US$

6.96

 

August 16, 2018

 

7,133

 

US$

6.10

 

US$

6.10

 

August 28, 2018

 

4,957

 

US$

5.93

 

US$

5.93

 

September 3, 2018

 

17,331

 

US$

5.91

 

US$

5.91

 

April2,2019

 

9,246

 

US$

3.22

 

US$

3.22

 

April 16,2019

 

10,849

 

US$

3.16

 

US$

3.16

 

May 1, 2019

 

6,444

 

US$

3.69

 

US$

3.69

 

May 4, 2019

 

2,357

 

US$

3.71

 

US$

3.71

 

May 29, 2019

 

200,000

 

US$

3.50

 

US$

3.50

 

June 1, 2019

 

4,301

 

US$

3.37

 

US$

3.37

 

July 2, 2019

 

6,549

 

US$

2.85

 

US$

2.85

 

August 26, 2019

 

5,000

 

US$

2.10

 

US$

2.10

 

October 1, 2019

 

20,000

 

US$

1.60

 

US$

1.60

 

October 8, 2019

 

20,000

 

US$

1.56

 

US$

1.56

 

November 1, 2019

 

20,000

 

US$

1.88

 

US$

1.88

 

 

The grant date fair value of the RSUs is equal to the closing price of our ADSs on the grant date with the cost of US$0.001 per RSU.

 

Income Taxes

 

Current income taxes are provided on the basis of net income/(loss) for financial reporting purposes, and adjusted for income and expense items which are not assessable or deductible for income tax purposes, in accordance with the regulations of the relevant tax jurisdictions. Deferred income taxes are provided using the liability method. Under this method, deferred tax assets and liabilities are recognized for the tax effects of temporary differences and are determined by applying enacted statutory tax rates that will be in effect in the period in which the temporary differences are expected to reverse to the temporary differences between the financial statements’ carrying amounts and the tax bases of assets and liabilities. A valuation allowance is provided to reduce the amount of deferred tax assets if, based on the weight of available evidence, it is more likely than not that some portion, or all, of the deferred tax assets will not be realized.

 

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We apply a “more likely than not” recognition threshold in the evaluation of uncertain tax positions. We recognize the benefit of a tax position in our consolidated financial statements if the tax position is “more likely than not” to prevail based on the facts and technical merits of the position. Tax positions that meet the “more likely than not” recognition threshold are measured at the largest amount of tax benefit that has a greater than fifty percent likelihood of being realized upon settlement. Unrecognized tax benefits may be affected by changes in interpretation of laws, rulings of tax authorities, tax audits and expiry of statutory limitations. In addition, changes in facts, circumstances and new information may require us to adjust the recognition and measurement estimates with regard to individual tax positions. Accordingly, unrecognized tax benefits are periodically reviewed and re-assessed. Adjustments, if required, are recorded in our consolidated financial statements in the period in which the change that necessities the adjustments occur. The ultimate outcome for a particular tax position may not be determined with certainty prior to the conclusion of a tax audit and, in certain circumstances, a tax appeal or litigation process.

 

Recently Issued Accounting Pronouncements

 

See Item 18 of Part III, “Financial Statements—Note 2—Principal Accounting Policies—(dd) Recent Accounting Pronouncements.”

 

B.    Liquidity and Capital Resources

 

Going Concern

 

We have incurred net losses in each year since our inception in 2005, including net losses of RMB239.1 million, RMB522.5 million and RMB536.9 million (US$77.1 million) in 2017, 2018 and 2019, respectively. As of December 31, 2019, we had an accumulated deficit of RMB1.6 billion (US$232.0 million). Our net cash used in operating activities was RMB306.7 million, RMB233.1 million and RMB289.5 million (US$41.6 million) in 2017, 2018 and 2019, respectively. As of December 31, 2019, we had total current assets of RMB338.9 million (US$48.7 million) and total current liabilities of RMB749.2 million (US$107.6 million), and our balance of cash and cash equivalents was RMB25.2 million (US$3.6 million).

 

On May 31, 2020, we became overdue on our payment obligations of approximately US$48 million under a convertible note. For more details on such overdue amount, see “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Business—We are overdue on a significant amount of debt, and we may not be able to work out a viable debt restructuring plan or otherwise maintain our liquidity and financial position.”

 

Our liquidity is based on our ability to generate cash from operating activities, obtain financing from equity interest investors and borrow funds on favorable economic terms to fund our general operations and capital expansion needs. Our ability to continue as a going concern is dependent on our management’s ability to successfully execute its business plan, which includes increasing revenue while controlling operating cost and expenses to generate positive operating cash flows and obtaining funds from outside sources of financing to generate positive financing cash flows. Based on cash flow projections from operating and financing activities and existing balance of cash and cash equivalents, our management believes that there is substantial doubt as to whether existing cash and cash equivalents will be sufficient to fund our operations within one year from the date of this annual report.

 

In order to meet our cash flow needs and continue as a going concern, we may need to reduce operating expenses through restructuring, or increase our working capital through additional sales of equity or debt securities or other financing arrangements. Any such restructuring activities may adversely affect our revenues, and any issuance and sale of additional equity would result in further dilution to our shareholders and holders of our ADSs. The incurrence of additional indebtedness would result in increased fixed obligations and could result in operating covenants that would restrict our operations. Failure to increase our working capital would have a material adverse effect on our business.

 

There can be no assurance that the above measures will be successfully implemented on terms acceptable to us, or when implemented, it will mitigate the relevant conditions or events that raise substantial doubt about our ability to continue as a going concern. Our plans for maintaining our continuing operations, even if successful, may not result in sufficient cash flow to finance and maintain our business. Various facts and circumstances, including our recurring losses, working capital deficiency as well as the uncertainties relating to the restructuring or repayment of our existing debts, raise substantial doubt about our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

Cash Flows and Working Capital

 

The following table sets forth the movements of our cash and cash equivalents for the periods presented:

 

 

 

For the Year Ended December 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

(in thousands)

 

Net cash used in operating activities

 

(306,704

)

(233,130

)

(289,546

)

(41,591

)

Net cash provided by/(used in) investing activities

 

42,797

 

(57,231

)

(23,315

)

(3,349

)

Net cash provided by/(used in) financing activities

 

190,948

 

(26,953

)

245,402

 

35,250

 

Effect of exchange rate changes on cash, cash equivalents and restricted cash

 

(39,485

)

(678

)

36

 

6

 

Net decrease in cash, cash equivalents and restricted cash

 

(112,444

)

(317,992

)

(67,423

)

(9,684

)

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

 

524,454

 

412,010

 

94,018

 

13,505

 

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

 

412,010

 

94,018

 

26,595

 

3,821

 

 

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Cash, Cash Equivalents and Restricted Cash

 

As of December 31, 2018 and 2019, our total cash, cash equivalents and restricted cash were RMB94.0 million and RMB26.6 million (US$3.8 million), respectively. Our cash, cash equivalents and restricted cash decreased by RMB67.4 million from December 31, 2018 to December 31, 2019, primarily due to our cash used in operating, investing and financing activities described below.

 

In 2018 and 2019, we entered into several short-term guaranteed loan agreements. Each of the loan agreements provides for a RMB revolving credit facility with a maturity term within three months or twelve months. These loans were guaranteed by Guosheng Qi, our chief executive officer and chairman, Gridsum PRC Holding or the accounts receivable under Beijing Moment.

 

Short-term bank loans as of December 31, 2019 amounted to RMB38.0 million (US$5.5 million), which consisted of several bank borrowings denominated in RMB. All of these bank borrowings were repayable within one year. During 2019, we repaid RMB27.0 million (US$3.9 million) of our short-term bank loans.

 

On May 5, 2018, we completed the transactions contemplated by our April 30, 2018 convertible note purchase agreement with FutureX Innovation SPC, an affiliate of FutureX. In accordance with the convertible note purchase agreement, we received US$40 million and issued the FutureX Convertible Note that is convertible, in whole or in part, into our Class B ordinary shares at a conversion price of US$6.50 per share, subject to customary adjustments. The FutureX Convertible Note has a term of 18 months and bears interest at 2.80% per annum. The principal amount of the note and all accrued and unpaid interest became due on November 5, 2019, and we failed to repay the note on such date. On December 9, 2019, FutureX Innovation SPC served a statutory demand on us, under which it (i) claimed that we owed, as of December 9, 2019, a total amount of US$41,913,498 under the note, (ii) demanded that we pay such amount or secure or compound for it to FutureX Innovation SPC’s satisfaction, and (iii) stated that if payment of such amount is not made within 21 days of the date when the statutory demand was served on us, we will be deemed to be insolvent and a winding up petition may be presented against us in accordance with applicable Cayman laws. On March 3, 2020, we entered into an extension agreement with FutureX Innovation SPC, pursuant to which the parties agreed to extend the maturity date of the FutureX Convertible Note to May 31, 2020. In consideration of the extension, we agreed to pay an extension fee and increase the interest rate of the note to 24% per year effective from January 1, 2020. Pursuant to the terms of the extension agreement, FutureX Innovation SPC waived our prior payment default and withdrew the statutory demand served on us on December 9, 2019.

 

On July 16, 2019, we entered into a financing agreement with the Beijing Zhongguancun Technology Finance Guarantee Co., Ltd., or Beijing Zhongguancun Technology, pursuant to we issued a RMB20 million corporate bond bearing interest at 6.5% per annum and having a term of 36 months. The corporate bond is guaranteed by Beijing Zhongguancun Technology. In consideration for the guarantee, Beijing Gridsum, Guosheng Qi, our chief executive officer and chairman, Guofa Yu, our chief operating officer and director, and Michael Yang Xu, our senior vice president, jointly provided counter-guarantees to Beijing Zhongguancun Technology. Beijing Gridsum and Guosheng Qi also counter-pledged certain of their respective assets to Beijing Zhongguancun Technology.

 

As of December 31, 2019, our total cash, cash equivalents and restricted cash were approximately RMB26.6 million (US$3.8 million). Our cash and cash equivalents decreased substantially from December 31, 2018 primarily due to our use of cash in operating, investment and financing activities and funding our net loss. To raise additional working capital and improve our liquidity position, we intend to obtain additional debt or equity financing from investors and financial institutions.

 

Our future capital requirements will depend on many factors, including our growth rate, the timing and extent of spending to support research and development efforts, the continued expansion of sales and marketing activities, the introduction of new and enhanced products, and the continued market acceptance of our products. In the event that additional external financing is required, we may not be able to raise such financing on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition would be adversely affected.

 

In utilizing the cash that we hold offshore, we may (i) make additional capital contributions to our PRC subsidiary, (ii) establish new PRC subsidiaries and make capital contributions to these new PRC subsidiaries, (iii) make loans to our PRC subsidiary or consolidated affiliated entities or (iv) acquire offshore entities with business operations in China in offshore transactions. However, most of these uses are subject to PRC regulations and approvals. For example, loans by us to finance the activities of our PRC subsidiary, which is a foreign-invested enterprise, cannot exceed statutory limits and must be registered with SAFE or its local branches.

 

See “Item 4. Information on the Company—B. Business Overview—Regulation—Regulations on Foreign Exchange.”

 

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Substantially all of our future revenues are likely to continue to be in the form of RMB. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior SAFE approval as long as certain routine procedural requirements are fulfilled. Therefore, our PRC subsidiary is allowed to pay dividends in foreign currencies to us without prior SAFE approval by following certain routine procedural requirements. However, approval from or registration with competent government authorities is required where the RMB is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of loans denominated in foreign currencies. The PRC government may at its discretion restrict access to foreign currencies for current account transactions in the future. See “Item. 3 Key Information—D. Risk Factors—Risks Relating to Doing Business in China—Governmental control of currency conversion may limit our ability to pay dividends and other obligations and affect the value of your investment.”

 

Operating Activities

 

Net cash used in operating activities in 2019 was RMB289.5 million (US$41.6 million), reflecting a net loss of RMB536.9 million (US$77.1 million), a decrease of RMB138.6 million (US$19.9 million) in advances from customers, and a payment of RMB30.8 million (US$4.4 million) in operating lease liabilities, a decrease of RMB24.8 million (US$3.6 million) in deferred revenues, a decrease of RMB47.8 million (US$6.9 million) in accrued expenses and other current liabilities, a decrease of RMB18.5 million (US$2.7 million) in accounts payable, and an increase of RMB3.8 million (US$0.5 million) in notes receivable, partially offset by a decrease of RMB178.6 million (US$25.7 million) in prepayments and other current assets, a decrease of RMB68.8 million (US$9.9 million) in accounts receivable, an increase of RMB 8.9 million (US$1.3 million) in salaries and welfare payables, an increase of RMB 5.5 million (US$0.8 million) in tax payable, and an increase of RMB 1.2 million (US$0.2 million) in other non-current liabilities. The principal non-cash items accounting for the difference between the net loss and the cash used in operating activities in 2019 were RMB137.9 million (US$19.8 million) in provision for allowance for doubtful accounts, RMB52.5 million (US$7.5 million) in share-based compensation expense, RMB35.3 million (US$5.1 million) in depreciation and amortization expense, RMB34.0 million (US$4.9 million) in amortization of operating lease right-of-use assets, RMB 27.8 million (US$4.0 million) change in fair value of derivative liabilities, and RMB 27.6 million (US$4.0 million) in deferred tax expense. Net cash used in operating activities increased from RMB233.1 million in 2018 to RMB289.5 million (US$41.6 million) in 2019.

 

The amount of payments to search engine service providers on behalf of customers included in accounts receivable was RMB283.7 million and RMB166.1 million (US$23.9 million) as of December 31, 2018 and December 31, 2019, respectively. When we provide the bid management services to our customers, customer spending on search engine service providers will pass through our accounts. The flow of the funds impacts on several accounts, including accounts receivable, accounts payable, deferred revenues and advance from customers.

 

Net cash used in operating activities in 2018 was RMB233.1 million, reflecting a net loss of RMB522.5 million, a decrease of RMB110.9 million in accounts payable, partially offset by a decrease of RMB184.8 million in accounts receivable, a decrease of RMB12.9 million in prepayment and other current asset, an increase of RMB52.5 million in accrued expenses and other liabilities, an increase of RMB22.7 million in deferred revenue, and an increase of RMB37.9 million in advance from customers. The principal non-cash items accounting for the difference between the net loss and the cash used in operating activities in 2018 were RMB34.7 million in depreciation and amortization expenses, RMB39.0 million in share-based compensation expense, and RMB16.5 million in provision for allowance for doubtful accounts. Net cash used in operating activities decreased from RMB306.7 million in 2017 to RMB233.1 million in 2018.

 

Net cash used in operating activities in 2017 was RMB306.7 million, reflecting a net loss of RMB239.1 million, an increase of RMB267.6 million in accounts receivable, and an increase of RMB102.4 million in prepayments and other current assets, partially offset by an increase of RMB158.6 million in accounts payable, an increase of RMB36.5 million in tax payable, and an increase of RMB18.6 million in salary and welfare payable. The principal non-cash items accounting for the difference between the net loss and the cash used in operating activities in 2017 were RMB24.5 million in provision for allowance for doubtful accounts, RMB31.5 million in depreciation and amortization expenses, RMB22.9 million in share-based compensation expense, and RMB20.5 million in foreign currency exchange loss. Net cash used in operating activities increased from RMB235.2 million in 2016 to RMB306.7 million in 2017. The increased cash outflow was primarily attributable to investment in working capital for certain low risk customers, to which a longer credit period was granted.

 

Investing Activities

 

Net cash used in investing activities in 2019 was RMB23.3 million (US$3.3 million), primarily due to purchases of property, equipment and software of RMB23.4 million (US$3.4 million).

 

Net cash used in investing activities in 2018 was RMB57.2 million (US$8.3 million), primarily due to purchases of property and equipment of RMB52.3 million (US$7.6 million).

 

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Net cash provided by investing activities in 2017 was RMB42.8 million, primarily due to maturity of time deposit of RMB67.6 million, and partially offset by purchases of property and equipment of RMB23.0 million.

 

Financing Activities

 

Net cash provided by financing activities in 2019 was RMB245.4 million (US$35.3 million), primarily due to RMB120.0 million (US$17.2 million) proceeds from long-term borrowing, RMB74.3 million (US$10.7 million) proceeds from issuance of ordinary shares, RMB60.0 million (US$8.6 million) in proceeds from bank loans, and RMB 18.1 million (US$ 2.6 million) proceeds from issuance of corporate bond, partially offset by RMB27.0 million (US$3.9 million) in repayment of our bank loans.

 

Net cash used in financing activities in 2018 was RMB27.0 million (US$3.9 million), primarily due to RMB266.0 million (US$38.7 million) in repayment of our bank loans, partly offset by RMB234.0 million (US$34.0 million) from convertible note, and RMB5.0 million (US$0.7 million) proceeds from bank loans.

 

Net cash provided by financing activities in 2017 was RMB190.9 million, primarily due to RMB266.0 million proceeds from bank loans and net proceeds of RMB3.1 million from issuance of ordinary shares for options exercised, partly offset by RMB65.0 million in repayment of our bank loans.

 

Capital Expenditures

 

Our capital expenditures were RMB23.0 million, RMB52.3 million and RMB23.4 million (US$3.4 million) in 2017, 2018 and 2019, respectively, primarily related to purchase of servers, computers and other equipment for our business. We intend to continue to incur capital expenditures as our business continues to grow, and we may make acquisitions of businesses and properties that complement our operations when suitable opportunities arise. We expect to fund our future capital expenditures with our current cash, cash equivalents and time deposits and anticipated cash flow from operations.

 

Holding Company Structure

 

We are a holding company with no material operations of our own. We conduct our operations primarily through our wholly-owned subsidiary and consolidated affiliated entities established in the PRC. As a result, our ability to pay dividends depends upon dividends paid to us by the WFOE, our PRC subsidiary. If the WFOE, or any other newly formed subsidiary of ours, incurs debt on its own behalf in the future, the instruments governing its debt may restrict its ability to pay dividends to us. In addition, the WFOE 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, the WFOE 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, the WFOE may allocate a portion of its after-tax profits to staff welfare and bonus funds, a discretionary surplus fund and an enterprise expansion fund at its discretion or in accordance with its articles of association.

 

These reserve funds and staff welfare and bonus funds are not distributable as cash dividends. In addition, registered capital and capital reserve accounts are restricted from withdrawal in the PRC, up to the amount of net assets held in such entity. As of December 31, 2019, the total restricted net assets was RMB70.1 million (US$10.1 million). The WFOE has never paid dividends and will not be able to pay dividends until it generates accumulated profits and has satisfied the requirements for statutory reserve funds.

 

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

 

Our research and development organization is responsible for the design, development and testing of all aspects of our dashboard and suite of solutions. We invest heavily in these efforts to continuously improve, innovate and add new features to our solutions.

 

We deploy new features, functionality and technologies through periodic software releases or updates in order to minimize disruption and provide for constant improvement. Our product managers regularly engage with customers, partners and industry analysts, as well as other stakeholders, in functions such as sales, customer success, marketing and business development to understand customer needs as well as general trends in our industry. Once product improvements are identified, the development organization works closely together to design, develop, test and launch a solution.

 

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The majority of our research and development team is based in our Beijing office and to a lesser degree in Shanghai, Shenzhen, Chengdu and Xi’an. To foster rapid innovation, our team is further apportioned into small agile development teams.

 

Our research and development expenses were RMB257.9 million, RMB533.6 million and RMB320.4 million (US$46.0 million) for the years ended December 31, 2017, 2018 and 2019, respectively.

 

D.    Trend Information

 

Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events for the period from January 1, 2019 to December 31, 2019 that are reasonably likely to have a material effect on our net revenues, income, profitability, liquidity or capital resources, or that would cause the disclosed financial information to be not necessarily indicative of future operating results or financial conditions.

 

E.    Off-Balance Sheet Arrangements

 

As of December 31, 2019, we have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. In addition, we have not entered into any derivative contracts that are indexed to our own shares and classified as shareholder’s equity, or that are not reflected in our consolidated combined financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. Moreover, we do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

 

F.    Tabular Disclosure of Contractual Obligations

 

The following sets forth information regarding our aggregate payment obligations under our contracts and commercial commitments as of December 31, 2019:

 

 

 

Payments Due by Period

 

 

 

Total

 

Less than 1 year

 

1-3 years

 

3-5 years

 

More than 5 years

 

 

 

RMB

 

US$

 

RMB

 

US$

 

RMB

 

US$

 

RMB

 

US$

 

RMB

 

US$

 

 

 

(in thousands)

 

Operating lease obligations

 

131,698

 

18,917

 

43,491

 

6,247

 

72,392

 

10,398

 

15,815

 

2,272

 

 

 

FutureX Convertible Note*

 

335,230

 

48,153

 

335,230

 

48,153

 

 

 

 

 

 

 

Other commitments

 

21,956

 

3,154

 

16,557

 

2,378

 

5,289

 

760

 

110

 

16

 

 

 

Total

 

488,884

 

70,224

 

395,278

 

56,778

 

77,681

 

11,158

 

15,925

 

2,288

 

 

 

 


*                   Includes accrual interest and extension fee.

 

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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

 

A.    Directors and Senior Management

 

The following table sets forth information regarding our directors and executive officers as of the date of this annual report. The business address of each of our directors and executive officers is Beijing Gridsum Technology Co., Ltd., South Wing, High Technology Building, No. 229 North 4th Ring Road, Haidian District, Beijing 100083, People’s Republic of China.

 

Directors and Executive Officers

 

Age

 

Position/Title

Guosheng Qi

 

36

 

Chairman of the Board, Chief Executive Officer

Guofa Yu

 

46

 

Director, Chief Operating Officer

Herman Fong

 

47

 

Director, President

Yanchun Bai

 

53

 

Director

Xudong Gao

 

54

 

Director

Feng Lu

 

64

 

Director

Dannis Cheuk Yin Lee

 

49

 

Director

Ravi Sarathy

 

49

 

Chief Financial Officer

John Jiyang Liu

 

55

 

Chief Technology Officer

Aaron Feng Li

 

46

 

Senior Vice President

Michael Yang Xu

 

49

 

Senior Vice President

Xijian Liu

 

63

 

Chief Strategy Officer

 

Guosheng Qi is one of our co-founders and has served as our chief executive officer and chairman of our Board of Directors since our inception. Mr. Qi founded Beijing Gridsum in 2005 when he was a student at Tsinghua University. Mr. Qi holds a bachelor’s degree in computer software from Tsinghua University.

 

Guofa Yu is one of our co-founders and has served as our chief operating officer and a member of our Board of Directors since 2005. Mr. Yu served as the operation director of Dyne Junhui, an information technology company, in 2005. Prior to that, Mr. Yu served as a project director of Founder Group, an information technology company, from 2002 to 2005. From 2000 to 2002, Mr. Yu served in technology and management roles in several small technology companies. From 1998 to 2000, Mr. Yu served as a software engineer at Neusoft Group, a software company. Mr. Yu holds a bachelor’s degree in management information systems from Central South University.

 

Herman Fong has served as our president and a member of our Board of Directors since February 2019. From 2011 to October 2018, he was a partner and Chief Investment Officer of Public Markets Strategy at Pacific Alliance Group, or PAG, an investment management firm in Hong Kong. He was Managing Director and CIO of Asia Pacific liquid trading strategies from 2005 to 2008, and has held a variety of senior roles in trading across Asia, including at ABN AMRO Bank, Credit Agricole Indosuez, Lehman Brothers, and Salomon Brothers. Mr. Fong received a Master of Science in operations research from Stanford University and a Bachelor of Science in mechanical engineering from University of California, Berkeley.

 

Yanchun Bai has served as a member of our Board of Directors since 2012. Mr. Bai has been a partner at the Commerce & Finance Law Offices, a law firm, since May 2013. Prior to that, Mr. Bai was a partner at King & Wood Mallesons, a law firm, from 1993 to May 2013. Mr. Bai currently serves as a member of the board of directors of Baoshan Iron & Steel Co. Ltd., a company listed on Shanghai Stock Exchange, NETAC Technology Co., Ltd., a company listed on Shenzhen Stock Exchange, Shijiazhuang Changshan Beiming Technology Co., Ltd., a company listed on Shenzhen Stock Exchange, and certain other private company. Mr. Bai holds a bachelor’s degree in law from China University of Political Science and Law and an LLM degree from Stanford Law School.

 

Xudong Gao has served as a member of our Board of Directors since 2006. Mr. Gao has served as the vice director of Tsinghua University Research Center for Technological Innovation since 2011. Mr. Gao has been a member of the Ministry of Industry and Information Technology’s Expert Committee of Telecom Economy since January 2010. Mr. Gao also served as a director of the Tsinghua MBA program from 2008 to 2011. Mr. Gao is currently a professor at the School of Economics and Management and the Schwarzman College of Tsinghua University. Mr. Gao also serves as a member of the board of directors of Changhong Jiahua Holdings Limited, a company listed on the Hong Kong Stock Exchange. Mr. Gao holds a bachelor’s degree in industrial engineering from Harbin Institute of Technology, a master’s degree in economics from Renmin University of China and a Ph.D. degree in management from Massachusetts Institute of Technology.

 

Feng Lu has served as a member of our Board of Directors since April 2019. Mr. Lu has been a professor of the School of Government at Peking University since 2003. Prior to that, Mr. Lu had been an associate professor of the School of Public Policy and Management at Tsinghua University from 1999 to 2003. Mr. Lu also served as an officer at the Research Center of the Finance and Commerce Office of Beijing Municipal Government from 1984 to 1986, as an officer at the Finance and Commerce Bureau of the PRC State Economic Commission from 1986 to 1988, and as an officer at the Consumer Market Department and Comprehensive Planning Department of the PRC State Planning Commission from 1988 to 1991. Since 2008, Mr. Lu has served on the board of directors of Chery Automobile Co., Ltd., a China-based automobile manufacturer. Mr. Lu holds a bachelor’s degree in philosophy from the Central Institute of Nationalities of the PRC, and a Ph.D. degree in political science from Columbia University.

 

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Dannis Cheuk Yin Lee has served as a member of our Board of Directors since April 2019. Mr. Lee is a managing director of DLK Advisory Limited, a company engaged in company positioning, investor communications and related advisory services, which he joined in 2010. Mr. Lee held various management positions at AMVIG Holdings Limited, a tobacco packaging business, from 2001 to 2010. Previously, Mr. Lee served senior accounting or audit roles at Arthur Andersen LLP and Philip Morris Asia Limited. Mr. Lee is an associate member of the Hong Kong Institute of Certified Public Accountants and a member of the American Institute of Certified Public Accountants. Mr. Lee is an independent director of Geely Automobile Holdings Limited, an automobile manufacturer listed on the Hong Kong Stock Exchange, chairman of its audit committee and member of its remuneration and nomination committees. He is also a member of the boards of directors of several companies listed on the Hong Kong Stock Exchange. Mr. Lee holds a bachelor’s degree in business administration from Texas A&M University.

 

Ravi Sarathy has served as our chief financial officer since September 2019, our co-chief financial officer from April 2017 to September 2019, and our chief strategy officer from October 2016 to April 2017. Prior to joining us, Mr. Sarathy served as a managing director and the head of APAC Internet and software equity research at Citigroup from 2010. Prior to that, Mr. Sarathy was the co-founder and served as president of iRealityGroup, an Asia-focused investment advisory firm since 2000. Mr. Sarathy also served as the head of global internet research and head of Asia internet, media and telecommunications research at Lehman Brothers from 1996 to 2000. Mr. Sarathy holds a bachelor’s degree and a master’s degree, both in economics, from Peterhouse, Cambridge University.

 

John Jiyang Liu has served as our chief technology officer since December 2014. Prior to joining us, Mr. Liu was an engineer, research manager and R&D director of Microsoft Corporation, a software company, from 1998 to December 2014, and an engineer at Hewlett-Packard Company, a computer company, from 1994 to 1998. Mr. Liu served as a researcher at University of Paderborn from 1989 to 1990. Mr. Liu holds a bachelor’s degree in computer science from Tsinghua University and a master’s degree in computer science from University of Pittsburgh.

 

Aaron Feng Li has joined us since 2009 and currently serves as our senior vice president. Prior to joining us, Mr. Li served as the general manager of the key account division and general manager of the East China branch of Baidu, Inc. from 2004 to 2008. Prior to that, Mr. Li was the sales director of China eNet Internet Co., an internet media company, from 2000 to 2004. Mr. Li served as the chief representative of the Beijing region of Xiamen Powerlong Industrial Co., Ltd., a technology company, from 1991 to 1995. Mr. Li holds a bachelor’s degree in industrial analysis from Qiqihar University and a Global Executive MBA degree from China Europe International Business School.

 

Michael Yang Xu has joined us since 2008 and currently serves as our senior vice president. Prior to that, Mr. Xu served as the general manager of multiple divisions of Sinochem Tianjin Co Limited, a subsidiary of Sinochem Group, from 2005 to 2007. Mr. Xu also held various investment and management positions at Sinochem Group, a Chinese state-owned chemical enterprise, from 1994 to 1999, including serving as financial controller of Zhonghuan Jinyuan Real Estate Co Limited, a subsidiary of Sinochem Group. Mr. Xu is currently the International Ambassador of Search Engine Marketing Professional Organization, also known as SEMPO, and the chairman of SEMPO’s Greater China working group. Mr. Xu holds a bachelor’s degree in accounting from Renmin University of China, a master’s degree in telecommunication systems from California State University, East Bay, and an MBA degree from California State University, East Bay.

 

Xijian Liu has served as our chief strategy officer since August 2017. Prior to joining us, Mr. Liu served as the director of the information management department of China National Petroleum Corporation and the general manager of the information management department of PetroChina Company Limited from September 2005 to July 2017. Mr. Liu was the general manager of the technology and information management department of PetroChina Company Limited from October 1999 to August 2005. Mr. Liu holds a bachelor’s degree in engineering from Daqing Petroleum Institute, and a master’s degree in business administration from the School of Management of University at Buffalo.

 

B.    Compensation

 

For 2019, we paid an aggregate of approximately RMB12.6 million (US$1.8 million) in cash to our executive officers and directors as a group. Our PRC subsidiary and consolidated affiliated entities are required by law to make contributions equal to certain percentages of each employee’s salary for his or her pension insurance, medical insurance, housing fund, unemployment and other statutory benefits. Our executive officers and directors also received equity incentive compensation in the form of equity awards. For 2019, we granted options to purchase 925,000 Class B ordinary shares to our executive officers and directors, and exchanged certain options previously granted to our executive officers and directors into RSUs. For details on the share incentive grants to our executive officers and directors and the option to RSU exchange, see “—Share Incentive Plans.”

 

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Share Incentive Plans

 

Gridsum Holding Inc. Stock Option Plan

 

Our stock option plan was originally adopted in 2011 and amended in 2014 and 2017. This plan, which we refer to as our Stock Option Plan, is intended to promote our success and shareholder value by attracting, motivating and retaining selected employees and other eligible participants through awards of stock options.

 

A maximum of 2,500,000 ordinary shares were issuable pursuant to awards under our Stock Option Plan. As of March 31, 2020, 1,161,879 Class B ordinary shares were issuable pursuant to stock options outstanding under our Stock Option Plan. After the completion of our initial public offering, awards were no longer made under the Stock Option Plan, and were made under a successor equity plan known as Gridsum Holding Inc. Equity Incentive Plan, or our Equity Incentive Plan.

 

Eligibility. Our Stock Option Plan provides for the grant of stock options to our employees or employees of related entities, such as a parent or subsidiary corporation.

 

Administration. Subject to the terms of our Stock Option Plan, either our Board of Directors or the Compensation Committee has the discretion to make all decisions implementing our Stock Option Plan.

 

Stock Options. Stock options are granted pursuant to stock option agreements. In general, the Board or Compensation Committee determined the purchase price and the vesting and exercise schedule of each stock option, which are set forth in the stock option agreements with each optionee. Stock options may not be transferred, except by will or by the laws of descent or distribution, unless the Board or Compensation Committee otherwise determines.

 

Changes to Capitalization. In the event that there is a specified type of change in our capital structure not involving the receipt of consideration by us, our Stock Option Plan provides for the proportional adjustment of the number of shares reserved under our Stock Option Plan and the number of shares and exercise or purchase price, if applicable, of all outstanding options.

 

Change in Control Transactions. Unless otherwise provided in the option agreement or provided by the Board of Directors or Compensation Committee, in the event of certain change in control transactions, any or all outstanding stock options under our Stock Option Plan may be assumed or replaced by any surviving entity or will otherwise terminate without vesting acceleration.

 

Additional Provisions. Our Board of Directors has the authority to amend, alter, suspend or terminate our Stock Option Plan. However, no amendment or termination of the plan may adversely affect any rights under awards already granted to a participant without the affected participant’s consent and certain changes may require shareholder approval.

 

Gridsum Holding Inc. Equity Incentive Plan

 

We adopted our Equity Incentive Plan upon the completion of our initial public offering in September 2016, and the Equity Incentive Plan was amended in 2017. The maximum number of shares which may be issued pursuant to all awards under our Equity Incentive Plan was 2,500,000 initially. The number of shares reserved for issuance under our Equity Incentive Plan has increased automatically on January 1 of each of 2017 through 2020, and will increase automatically on January 1 of each of 2021 through 2026 by the number of shares equal to 2.5% of the aggregate number of outstanding Class B ordinary shares as of the immediately preceding December 31. However, our Board of Directors may reduce the amount of the increase in any particular year. In addition, the following Class B ordinary shares will again be available for grant and issuance under our Equity Incentive Plan:

 

·                    ordinary shares subject to options or share appreciation rights granted under our Equity Incentive Plan that cease to be subject to the option or stock appreciation right for any reason other than exercise of the option or share appreciation right;

 

·                    ordinary shares subject to awards granted under our Equity Incentive Plan that are subsequently forfeited or repurchased by us at the original issue price;

 

·                    ordinary shares subject to awards granted under our Equity Incentive Plan that otherwise terminate without ordinary shares being issued; and

 

·                    ordinary shares surrendered, cancelled or exchanged for cash or a different award (or combination thereof).

 

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Shares that otherwise become available for grant and issuance because of the provisions above will not include shares subject to awards that initially became available due to our substitution of outstanding awards granted by another company in an acquisition of that company or otherwise.

 

On July 16, 2019, we entered into contractual arrangements with certain executive officers and key employees, pursuant to which we cancelled a total of 1,170,000 options to purchase our Class B ordinary shares, which were granted to such individuals on January 3, 2017 pursuant to our Equity Incentive Plan. In exchange, we granted to such individuals a total of 866,667 restricted share units under our Equity Incentive Plan.

 

As of March 31, 2020, 1,745,000 Class B ordinary shares may be issued pursuant to outstanding stock options and 2,326,594 Class B ordinary shares may be issued pursuant to outstanding RSUs under our Equity Incentive Plan, and there were 1,123,278 Class B ordinary shares reserved for future issuance.

 

Eligibility. Our Equity Incentive Plan provides for the grant of incentive stock options to our employees and any parent and subsidiary corporations’ employees and for the grant of nonqualified share options, restricted shares, RSUs, share appreciation rights, share bonuses and performance awards to our employees, directors and consultants and our parent and subsidiary corporations’ employees and consultants. No more than 5,000,000 shares may be issued as incentive stock options under our Equity Incentive Plan.

 

Administration. Our Equity Incentive Plan will be administered by the Board of Directors or by our Compensation Committee; in this plan description we refer to the Board of Directors or Compensation Committee as the plan administrator. The plan administrator determines the terms of all awards.

 

Types of Awards. Our Equity Incentive Plan will allow for the grant of options, restricted shares, RSUs, share appreciation rights, share bonuses and performance awards.

 

Award Agreements. All awards under our Equity Incentive Plan will be evidenced by an award agreement which shall set forth the number of ordinary shares subject to the award and terms and conditions of the award, which shall be consistent with our Equity Incentive Plan.

 

Term of Awards. The term of awards granted under our Equity Incentive Plan shall not exceed ten years from the date of grant. Subject to the foregoing, the plan administrator will be authorized to extend the term of any outstanding award.

 

Vesting Schedule and Price. The plan administrator will have sole discretion in setting the vesting period and, if applicable, exercise schedule of an award, determining that an award may not vest for a specified period after it is granted and accelerating the vesting period of an award. The plan administrator determines the exercise or purchase price of each award, to the extent applicable.

 

Transferability. Unless the plan administrator provides otherwise, our Equity Incentive Plan does not allow for the transfer of awards other than by will or the laws of descent and distribution. Unless otherwise permitted by the plan administrator, options may be exercised during the lifetime of the optionee only by the optionee or the optionee’s guardian or legal representative.

 

Changes in Capitalization. In the event there is a specified type of change in our capital structure without our receipt of consideration, such as a share split, or if required by applicable law, appropriate adjustments will be made to the share maximums and exercise prices, as applicable, of outstanding awards under our Equity Incentive Plan.

 

Change in Control Transactions. In the event of specified types of mergers or consolidations, a sale, lease, or other disposition of all or substantially all of our assets or a corporate transaction, outstanding awards under our Equity Incentive Plan may be assumed or replaced by any surviving or acquiring corporation; the surviving or acquiring corporation may substitute similar awards for those outstanding under our Equity Incentive Plan; outstanding awards may be settled for the full value of such outstanding award (whether or not then vested or exercisable) in cash, cash equivalents, or securities (or a combination thereof) of the successor entity with payment deferred until the date or dates the award would have become exercisable or vested; or outstanding awards may be terminated for no consideration. The plan administrator, may, on a discretionary basis, accelerate, in full or in part, the vesting and exercisability of the awards.

 

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Compliance with Law. Ordinary shares will not be issued under an award unless the issuance is permitted by applicable law.

 

Amendment and Termination. Our Equity Incentive Plan will terminate ten years from the date it is adopted by our Board of Directors, unless it is terminated earlier by our Board of Directors. Our Board of Directors may amend or terminate our Equity Incentive Plan at any time. Our Board of Directors generally may amend our Equity Incentive Plan, without shareholder approval unless required by applicable law.

 

The following table summarizes outstanding options held by our executive officers and directors as of March 31, 2020.

 

Name

 

Class B Ordinary
Shares Underlying
Options Awarded

 

Exercise Price
(US$/Share)

 

Date of Grant

 

Date of Expiration

Xudong Gao

 

*

 

0.42

 

January 1, 2011

 

January 1, 2021

 

 

*

 

0.42

 

July 1, 2011

 

July 1, 2021

Yanchun Bai

 

*

 

0.42

 

September 1, 2012

 

September 1, 2022

 

 

*

 

0.42

 

September 1, 2013

 

September 1, 2023

Ravi Sarathy

 

400,000

 

2.23

 

February 1, 2019

 

January 31, 2029

John Jiyang Liu

 

*

 

0.42

 

December 10, 2014

 

December 10, 2024

Herman Fong

 

925,000

 

2.23

 

February 1, 2019

 

January 31, 2029

 


*            Upon exercise of all options granted and vesting of all restricted share units, would beneficially own less than 1% of our outstanding ordinary shares.

 

The following table summarizes outstanding RSUs held by our executive officers and directors under our Equity Incentive Plan as of March 31, 2020.

 

Name

 

Class B Ordinary
Shares Underlying
Options Awarded

 

Date of Grant

 

Date of Expiration

Guosheng Qi

 

370,370

 

January 3, 2017

(1)

January 3, 2027

Ravi Sarathy

 

222,222

 

January 3, 2017

(1)

January 3, 2027

John Jiyang Liu

 

*

 

January 3, 2017

(1)

January 3, 2027

Xijian Liu

 

*

 

August 28, 2017

 

August 28, 2027

 

 

*

 

August 28, 2018

 

August 28, 2028

 


*            Upon exercise of all options granted and vesting of all restricted share units, would beneficially own less than 1% of our outstanding ordinary shares.

 

(1)         Represents the original grant date of the options granted to such individual, which were exchanged to RSUs at a ratio of approximately 1.35 options for 1 RSU on July 16, 2019.

 

As of March 31, 2020, other individuals as a group held options to purchase 1,070,486 Class B ordinary shares, with a weighted average exercise price of US$2.36 per ordinary share; other individuals as a group held RSUs for 1,520,699 Class B ordinary shares upon vesting.

 

C.    Board Practices

 

Board of Directors

 

Our Board of Directors currently consists of seven directors. Under Cayman Islands law, a director is not required to hold any shares in the company to qualify to serve as a director. A director may vote in respect of any contract or transaction in which he or she is interested, provided that the director shall disclose the nature of his or her interest in such contract or transaction at or prior to its consideration and any vote thereon. Our Board of Directors may exercise all the powers of our company to borrow money and to mortgage or charge its undertaking, property and uncalled capital or any part thereof, and to issue debentures whether outright or as security for any debt, liability or obligation of our company or of any third party. We have no service contract with any of our directors providing for benefits upon termination of employment.

 

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Committee of the Board of Directors

 

We have established three standing committees of the Board of Directors. The committees are the Audit Committee, the Compensation Committee and the Nominating and Corporate Governance Committee. We have adopted a charter for each of these committees. We are relying on home country practices whereby our Compensation Committee and Nominating and Corporate Governance Committee need not consist of all independent directors. Each committee’s members and functions are described below:

 

Audit Committee

 

Our Audit Committee consists of Mr. Gao, Mr. Lee and Mr. Lu, and is chaired by Mr. Lee. We have determined that Mr. Gao, Mr. Lee and Mr. Lu each satisfy the independence requirements of The Nasdaq Stock Market and Rule 10A-3 under the Exchange Act. Mr. Lee meets the criteria of an audit committee financial expert as set forth under the applicable rules of the SEC.

 

The Audit Committee oversees our accounting and financial reporting processes and the audits of the financial statements of our company. It is responsible for, among other things:

 

·                    appointing the independent auditor and pre-approving all auditing and non-auditing services permitted to be performed by the independent auditor;

 

·                    reviewing with the independent auditor any audit problems or difficulties and management’s response;

 

·                    reviewing and approving all proposed related party transactions;

 

·                    reviewing and discussing audited annual financial statements with management and the independent auditor;

 

·                    reviewing major issues as to the adequacy of our internal controls and any special audit steps adopted in light of material control deficiencies;

 

·                    annually reviewing and reassessing the adequacy of our Audit Committee charter;

 

·                    meeting separately and periodically with management and the independent auditor; and

 

·                    reporting regularly to the Board of Directors.

 

Compensation Committee

 

Our Compensation Committee consists of Mr. Gao and Mr. Lee, and is chaired by Mr. Gao. We have determined that Mr. Gao and Mr. Lee each satisfy the independence requirements of The Nasdaq Stock Market for compensation committee members set forth in Rule 5605(d)(2)(A).

 

The Compensation Committee assists the Board of Directors in reviewing and approving the compensation structure, including all forms of compensation, relating to our directors and executive officers. The Compensation Committee is responsible for, among other things:

 

·                    reviewing and approving, or recommending to the Board of Directors for its approval, the compensation of our chief executive officer and other executive officers;

 

·                    reviewing and approving, or recommending to the Board of Directors for its approval, the compensation of our directors; and

 

·                    reviewing periodically and making recommendations to the Board of Directors regarding any long-term incentive compensation or equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans; and

 

·                    selecting compensation consultant, legal counsel or other advisers for the committee after taking into consideration all factors relevant to that person’s independence from management.

 

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Nominating and Corporate Governance Committee

 

Our Nominating and Corporate Governance Committee consists of Mr. Gao, Mr. Qi and Mr. Lu, and is chaired by Mr. Lu. We have determined that Mr. Gao and Mr. Lu each satisfy the independence requirements of The Nasdaq Stock Market. The Nominating and Corporate Governance Committee assists the Board of Directors in selecting individuals qualified to serve on the Board of Directors and in determining the composition of the Board of Directors and its committees. The Nominating and Corporate Governance Committee is responsible for, among other things:

 

·                    identifying and recommending to the Board nominees for election by the shareholders or appointment by the Board of Directors;

 

·                    reviewing annually with the Board of Directors the current composition of the Board of Directors with regard to characteristics such as independence, knowledge, skills, experience and diversity;

 

·                    making recommendations on the frequency and structure of Board of Directors meetings and monitoring the functioning of Board of Directors committees; and

 

·                    advising the Board of Directors periodically about significant developments in the law and practice of corporate governance as well as our compliance with applicable laws and regulations and making recommendations to the Board of Directors on all matters of corporate governance.

 

Special Committee

 

In response to the non-binding proposal received by our board of directors on July 15, 2019 from Guosheng Qi, Guofa Yu, their respective affiliated entities, and Beta Dynamic Limited, an affiliate of Hammer Capital Private Investments Limited, our board of directors has formed a special committee comprised of three independent directors, Dannis Cheuk Yin Lee, Xudong Gao and Feng Lu, to evaluate the proposal and any other alternative transactions. Mr. Lee has been appointed chairman of the special committee.

 

Duties of Directors

 

Under Cayman Islands law, our directors have a fiduciary duty to act honestly in good faith with a view to our best interests. Our directors also have a duty to exercise the skill they actually possess and such care and diligence that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our memorandum and articles of association. A shareholder may have the right to seek damages if a duty owed by our directors is breached. See “Item 10. Additional Information—B. Memorandum and Articles of Association—Differences in Corporate Law” for additional information on our standard of corporate governance under Cayman Islands law.

 

Terms of Directors and Officers

 

Our officers are elected by and serve at the discretion of the Board of Directors. Our directors are not subject to a term of office and hold office until such time as they resign or are removed from office by a special resolution of our shareholders. A director will be removed from office automatically if, among other things, the director becomes bankrupt or makes any arrangement or composition with his creditors generally, or dies or is found by our company to be of unsound mind.

 

Employment Agreements and Indemnification Agreements

 

We have entered into employment agreements with each of our executive officers. Under these agreements, we may terminate employment for cause, at any time, without advance notice or remuneration, for certain acts of the executive officer, such as conviction of a criminal offense, fraud or dishonesty, material misconduct or material failure to discharge the officer’s duties to our detriment. An executive officer may terminate his employment at any time with a thirty-day prior written notice.

 

Each executive officer has agreed to hold in strict confidence and not to use or disclose to any person, corporation or other entity any of our proprietary information or trade secrets. Each executive officer has also agreed to assign to our company all inventions and works of authorship which the executive officer develops during the period of his or her employment with us that are either related to the scope of the employment or make use of the resources of our company. In addition, all executive officers have agreed to be bound by non-competition restrictions set forth in their agreements during the term of employment.

 

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We have entered into indemnification agreements with each of our directors and executive officers, under which we agree to indemnify them against certain liabilities and expenses they may incur in connection with claims made by reason of their being our directors or executive officers.

 

D.    Employees

 

We had 1,078, 1,192 and 929 employees as of December 31, 2017, 2018 and 2019, respectively. All of our employees are based in China.

 

The following table sets out the breakdown of our employees by function as of December 31, 2019:

 

Function

 

Number of
employees

 

Sales and marketing

 

287

 

Research and development

 

518

 

General and administrative

 

124

 

Total

 

929

 

 

We enter into standard employment agreements and standard confidentiality agreements with all of our employees. We also entered into non-competition agreement with certain of our key employees upon termination of their employment agreement, which provide with a non-compete restricted period typically expiring one year after the termination of employment, and we agreed to provide reasonable compensation to the employees during the restricted period.

 

In accordance with Chinese regulations, we participate in various employee social security plans that are organized by municipal and provincial governments, including pension insurance, medical insurance, unemployment insurance, maternity insurance, job-related injury insurance and housing fund. We are required by PRC laws to make contributions to employee social security plans at specified percentages of the salaries, bonuses and certain allowances of our employees, up to a maximum amount specified by the local government from time to time.

 

None of our employees are covered by collective bargaining agreements, and we consider our relations with our employees to be good.

 

E.    Share Ownership

 

The following table sets forth information concerning the beneficial ownership of our ordinary shares, as of March 31, 2020, by:

 

·                    each of our directors and executive officers; and

 

·                    each person known to us to beneficially own more than 5% of our ordinary shares.

 

The calculations in the table below are based on 34,619,904 ordinary shares outstanding as of March 31, 2020, comprising (i) 4,543,461 Class A ordinary shares, and (ii) 30,076,443 Class B ordinary shares (excluding 477,164 Class B ordinary shares issued to our depositary bank for bulk issuance of ADSs reserved for future issuances upon the exercise or vesting of awards granted under our share incentive plans).

 

Beneficial ownership is determined in accordance with the rules and regulations of the SEC. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, we have included shares that the person has the right to acquire within 60 days of March 31, 2020, including through the exercise of any option, warrant or other right or the conversion of any other security. These shares, however, are not included in the computation of the percentage ownership of any other person.

 

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Ordinary shares beneficially owned

 

 

 

Class A
ordinary shares

 

Class B
ordinary
shares

 

Total ordinary
shares on as-
converted basis

 

% of total ordinary
shares on as-
converted basis

 

% of aggregate
voting power
 (2)

 

Directors and Executive Officers: (1)

 

 

 

 

 

 

 

 

 

 

 

Guosheng Qi(3)

 

4,543,461

 

4,809,643

 

9,353,104

 

26.8

 

66.3

 

Guofa Yu(4)

 

 

1,393,038

 

1,393,038

 

4.0

 

1.8

 

Herman Fong

 

 

*

 

*

 

*

 

*

 

Yanchun Bai

 

 

*

 

*

 

*

 

*

 

Xudong Gao

 

 

*

 

*

 

*

 

*

 

Dannis Cheuk Yin Lee

 

 

 

 

 

 

Feng Lu

 

 

 

 

 

 

Ravi Sarathy

 

 

310,185

 

310,185

 

0.9

 

0.4

 

John Jiyang Liu

 

 

*

 

*

 

*

 

*

 

Aaron Feng Li(5)

 

 

1,200,000

 

1,200,000

 

3.5

 

1.6

 

Michael Yang Xu(6)

 

 

515,000

 

515,000

 

1.5

 

0.7

 

Xijian Liu

 

 

*

 

*

 

*

 

*

 

All directors and executive officers as a group (12 persons)

 

4,543,461

 

7,336,221

 

11,879,682

 

32.9

 

68.6

 

Principal Shareholders:

 

 

 

 

 

 

 

 

 

 

 

FutureX Innovation SPC (7)

 

 

6,766,975

 

6,766,975

 

16.4

 

8.2

 

Hammer Capital entities(8) (9)

 

 

6,695,802

 

6,695,802

 

17.5

 

8.5

 

Generation Gospel Limited (10)

 

4,543,461

 

1,199,267

 

5,742,728

 

16.4

 

61.5

 

Fairy Spirit Limited(11)

 

 

3,563,501

 

3,563,501

 

10.3

 

4.7

 

Light Street Capital Management, LLC (12)

 

 

2,869,765

 

2,869,765

 

8.3

 

3.8

 

Entities affiliated with Goldman Sachs (13)

 

 

2,652,765

 

2,652,765

 

7.7

 

3.5

 

Moon Capital Management LP (14)

 

 

2,360,375

 

2,360,375

 

6.8

 

3.1

 

Steamboat Ventures Asia, L.P. (15)

 

 

2,167,439

 

2,167,439

 

6.3

 

2.9

 

 


*                     Represents less than 1%.

 

(2)         The business address of our directors and executive officers is South Wing, High Technology Building, No. 229 North 4th Ring Road, Haidian District, Beijing 100083, People’s Republic of China.

 

(3)         For each person or group included in this column, the percentage of total voting power represents voting power based on all ordinary shares beneficially owned by such person or group. Each Class A ordinary share is entitled to ten votes and is convertible at any time into one Class B ordinary share. Each Class B ordinary share is entitled to one vote and is not convertible into Class A ordinary shares under any circumstances.

 

(4)         Represents (i) 4,543,461 Class A ordinary shares held by Generation Gospel Limited, as described in footnote (10) below; (ii) 937,500 Class B ordinary shares directly held by Mr. Qi or held by Generation Gospel Limited, as described in footnote (10) below; (iii) 3,563,501 Class B ordinary shares held by Fairy Spirit Limited, as described in footnote (11) below; and (iii) 308,642 Class B ordinary shares that Generation Gospel Limited is entitled to acquire upon settlement of RSUs held by it under our Equity Incentive Plan, as described in footnote (10) below.

 

(5)         Represents 1,393,038 Class B ordinary shares held by Garden Enterprises Ltd., a British Virgin Islands company wholly owned by Guofa Yu. The registered address of Garden Enterprises Ltd. is Geneva Place, Waterfront Drive, PO Box 3469, Road Town, Tortola, British Virgin Islands.

 

(6)         Represents 1,200,000 Class B ordinary shares beneficially owned by Mr. Li through Fairy Spirit Limited, as described in footnote (11) below.

 

(7)         Represents 515,000 Class B ordinary shares beneficially owned by Mr. Xu through Fairy Spirit Limited, as described in footnote (11) below.

 

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(8)         Represents 6,766,975 Class B ordinary shares issuable upon conversion of the convertible note issued by us to FutureX Innovation SPC (on behalf of and for the account of New Technology Fund II SP as one of its segregated portfolios), as reported in the Schedule 13D/A jointly filed on March 5, 2020 by FutureX Innovation SPC (on behalf of and for the account of New Technology Fund II SP as one of its segregated portfolios), FutureX Capital Limited, FutureX Asset Management Limited and ZHANG Qian. According to the Schedule 13D/A filing, FutureX Capital Limited is the sole management shareholder of FutureX Innovation SPC and the sole shareholder of FutureX Asset Management Limited. FutureX Asset Management Limited acts as the investment manager of FutureX Innovation SPC. ZHANG Qian is a director of FutureX Asset Management Limited, and a director and the sole shareholder of FutureX Capital Limited. The principal business address of FutureX Innovation SPC and FutureX Asset Management Limited is 4th Floor, Harbour Place, 103 South Church Street, P.O. Box 10240, Grand Cayman, KY1-1002, Cayman Islands. The principal business address of FutureX Capital Limited is P.O. Box 31119, Grand Pavilion, Hibiscus Way, 802 West Bay Road, Grand Cayman, KY1-1205, Cayman Islands.

 

(9)         Represents (i) 3,125,000 Class B ordinary shares held by Hammer Capital Private Investments Limited, and (ii) 3,570,802 Class B ordinary shares that Hammer Capital China Limited is entitled to acquire upon exercise of the warrant to purchase ordinary shares issued by us to Hammer Capital China Limited on May 30, 2019. This number does not include 18,279 Class B ordinary shares underlying the warrant that are not issuable due to a “beneficial ownership limitation” included in the warrant, which provides that the warrant is only exercisable to the extent that the holder, together with its affiliates and any other persons acting as a group together with the holder or any of the holder’s affiliates, would not beneficially own more than 19.9% of our outstanding Class B ordinary shares after giving effect to such exercise. The “beneficial ownership limitation” may be waived at the holder’s option upon not less than 61 days’ prior notice. This number also does not include the automatic increases in the number of Class B ordinary shares underlying the warrant in the event that we do not repay the RMB120 million we borrowed from an affiliate of the holder within the time periods specified in the warrant.

 

(10)  According to the Schedule 13D/A jointly filed on July 25, 2019 by Hammer Capital China Limited and Cheung Siu Fai, and the Schedule 13G/A jointly filed on February 14, 2020 by Hammer Capital Private Investments Limited and Tsang Ling Kay Rodney, each of Cheung Siu Fai and Tsang Ling Kay Rodney owns 50% of the outstanding voting shares of Hammer Capital Private Investments Limited, and shares the power to vote and dispose of the Class B ordinary shares held by Hammer Capital Private Investments Limited. Mr. Cheung is the sole director and ultimately the sole controlling shareholder of Hammer Capital China Limited, and is deemed to have sole voting and dispositive power with respect to the Class B ordinary shares that Hammer Capital China Limited is entitled to acquire. The principal business address of Hammer Capital Private Investments Limited is Mandar House, 3rd Floor, Johnson’s Ghut, Tortola, British Virgin Islands. The principal business address of Hammer Capital China Limited is Room 1005, 10/F, Tower Two Lippo Centre, No. 89 Queensway, Hong Kong.

 

(11)  Represents (i) 4,543,461 Class A ordinary shares, (ii) 890,625 Class B ordinary shares, and (ii) 308,642 Class B ordinary shares that Generation Gospel Limited is entitled to acquire upon settlement of RSUs held by it under our Equity Incentive Plan. Generation Gospel Limited, a British Virgin Islands company, is wholly owned by Guosheng Qi, our chief executive officer and chairman. The registered address of Generation Gospel Limited is Geneva Place, Waterfront Drive, P.O. Box 3469, Road Town, Tortola, British Virgin Islands.

 

(12)  Represents 3,563,501 Class B ordinary shares held by Fairy Spirit Limited, a British Virgin Islands company owned by certain key employees of our company, including Aaron Feng Li and Michael Yang Xu, and controlled by Guosheng Qi, our chief executive officer and chairman. The registered address of Fairy Spirit Limited is Geneva Place, Waterfront Drive, P.O. Box 3469, Road Town, Tortola, British Virgin Islands.

 

(13)  Represents (i) 324,201 Class B ordinary shares held for the account of Light Street Mercury Master Fund, L.P., or Mercury, (ii) 2,459,481 Class B ordinary shares held in the form of ADSs for the account of Mercury, (iii) 12,701 Class B ordinary shares held for the account of Light Street Tungsten Master Fund, L.P., or Tungsten; and (iv) 73,382 Class B ordinary shares held in the form of ADSs for the account of Tungsten, as reported in the Schedule 13G/A jointly filed on February 14, 2020 by Light Street Capital Management, LLC, or LSCM, Glen Thomas Kacher and Mercury. LSCM serves as investment adviser and general partner to each of Mercury and Tungsten, and, in such capacity, exercises voting and investment power over the Class B ordinary shares held in the accounts for each of Mercury and Tungsten. Glen Thomas Kacher is the chief investment officer of LSCM. The business address for these entities and persons is 525 University Avenue, Suite 300, Palo Alto, CA 94301.

 

(14)  Includes (i) 1,657,444 Class B ordinary shares held by Broad Street Principal Investments, L.L.C., (ii) 258,332 Class B ordinary shares held by Bridge Street 2015, L.P., (iii) 96,231 Class B ordinary shares held by Bridge Street 2015 Offshore, L.P., (iv) 66,539 Class B ordinary shares held by MBD 2015, L.P., (v) 23,933 Class B ordinary shares held by MBD 2015 Offshore, L.P., (vi) 75,377 Class B ordinary shares held by Stone Street 2015, L.P., (vii) 32,069 Class B ordinary shares held by Stone Street 2015 Offshore L.P., and (viii) 441,986 Class B ordinary shares held by certain other investment entities of which Goldman, Sachs & Co. acts as the investment manager, as reported in the Schedule 13G/A jointly filed on February 12, 2020 by The Goldman Sachs Group, Inc., Goldman, Sachs & Co. LLC and certain other entities. The Goldman Sachs Group, Inc. is the parent holding company of the entities in abovementioned item (i) to (vii). The business address of these entities is 200 West Street, New York, NY 10282.

 

(15)  Represents (i) 2,342,672 Class B ordinary shares directly owned by Moon Capital Partners Master Fund Ltd., or the Partners Fund, and (ii) 17,703 Class B ordinary shares directly owned by Moon Capital Performance Plus Master Fund Ltd., or the Performance Plus Fund, as reported in the Schedule 13G/A jointly filed on February 14, 2019 by Moon Capital Management LP, JWM Capital LLC, John W. Moon, the Partnership Fund and the Performance Plus Fund. According to the Schedule 13G/A filing, Moon Capital Management LP serves as the investment manager of the Partners Fund and the Performance Plus Fund with respect to the Class B ordinary shares directly owned by them. JWM Capital LLC serves as the general partner to Moon Capital Management LP with respect to such Class B ordinary shares. John W. Moon serves as the managing member of JWM Capital LLC with respect to such Class B ordinary shares. The business address for these entities and persons is 499 Park Avenue, 8th Floor, New York, NY 10022.

 

(16)  Represents 2,167,439 Class B ordinary shares held by Steamboat Ventures Asia, L.P., as reported in the Schedule 13G/A jointly filed on February 10, 2020 by Steamboat Ventures Asia, L.P., Steamboat Ventures Asia Manager, L.P., Steamboat Ventures Asia GP, Ltd., John R. Ball and Liping Fan. According to the Schedule 13G/A filing, the general partner of Steamboat Ventures Asia, L.P. is Steamboat Ventures Asia Managers, L.P. The general partner of Steamboat Ventures Asia Managers, L.P. is Steamboat Ventures Asia GP, Ltd. John R. Ball and Liping Fan are directors of Steamboat Ventures Asia GP, Ltd., and may be deemed to have shared power to vote and dispose of these shares. The business address of these entities and persons is Steamboat Ventures Asia, c/o Campbell’s Corporate Services Limited, Floor 4, Willow House, Cricket Square, Grand Cayman KY1-9010, Cayman Islands.

 

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To our knowledge, as of March 31, 2020, three shareholders in the United States held an aggregate of 400,248 Class B ordinary shares, representing approximately 1.2% of our total outstanding ordinary shares on record as of March 31, 2020, and none of our outstanding Class A ordinary shares were held by record holders in the United States. In addition, Citi (Nominees) Limited, the custodian of our depositary bank, held 18,770,894 Class B ordinary shares on record (excluding 477,164 Class B ordinary shares issued to it for bulk issuance of ADSs reserved for future issuances upon the exercise or vesting of awards granted under our share incentive plans), representing approximately 54.2% of our total outstanding shares on record as of March 31, 2020. The number of beneficial owners of our ADSs in the United States is likely to be much larger than the number of record holders of our ordinary shares in the United States. We are not aware of any arrangement that may, at a subsequent date, result in a change of control of our company, other than the previously announced proposed going private transaction described in “Item 4. Information on the Company—A. History and Development of the Company.”

 

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

 

A.    Major Shareholders

 

See “Item 6. Directors, Senior Management and Employees—E. Share Ownership.”

 

B.    Related Party Transactions

 

Contractual Arrangements

 

See “Item 4. Information on the Company—C. Organizational Structure” for a description of the contractual arrangements between the WFOE, Gridsum PRC Holding and the shareholders of Gridsum PRC Holding.

 

Shareholders Agreement

 

On June 30, 2015, we entered into a second amended and restated shareholders agreement with our then existing shareholders. Pursuant to the agreement, we have granted certain registration rights to holders of our registrable securities, which include our ordinary shares issued or issuable upon conversion of preferred shares, ordinary shares owned or acquired by the holders of our preferred shares, and ordinary shares issued as a dividend or distribution of, in exchange for, or in replacement of, the ordinary shares mentioned above. Set forth below is a description of the registration rights granted under the agreement.

 

Demand Registration Rights. Holders of at least 25% of then outstanding registrable securities have the right to demand in writing that we file a registration statement covering the offer and sale of their securities. We, however, are not obligated to effect more than two demand registrations, unless the sale of all registrable securities sought to be included in such registration is not consummated for reasons not attributable to the requesting holders.

 

Form F-3 or Form S-3 Registration Rights. When we are eligible for registration on Form F-3 or Form S-3, any holder of our then outstanding registrable securities has the right to request that we file a registration statement under Form F-3. We, however, are not obligated to effect more than two registrations within any 12-month period pursuant to this registration right, unless the sale of all registrable securities sought to be included in such registration is not consummated for reasons not attributable to the requesting holders.

 

Deferral of Registration. We are not obligated to effect the above demand registration or Form F-3 or Form S-3 registration, (i) if, within ten days of the receipt of any registration request, we give notice to the requesting holders of our intention to effect the filing for our own account of a registration statement of ordinary shares within 60 days of receipt of such request, and we are actively employing in good faith our best efforts to cause such registration statement to become effective within such 60-day period or (ii) during the period starting with the date of filing by us of, and ending six months following the effective date of, any registration statement pertaining to our ordinary shares, provided that in either case, the holders of registrable securities are entitled to join such registration subject to the piggyback registration rights described below. Furthermore, we have the right to defer filing of a registration statement for up to 90 days if we provide the requesting holders a certificate signed by our chief executive officer stating that in the good faith judgment of our Board of Directors that filing of a registration statement in the near future will be materially detrimental to us and our shareholders, but we cannot exercise the deferral right more than once in any 12-month period, nor can we register any other securities during the period the requested registration is deferred.

 

Piggyback Registration Rights. If we propose to file a registration statement for a public offering of our equity securities, either for our own account or for the account of any shareholder other than a holder of registrable securities, other than, among other things, relating to the sale of securities to participates in our share plan or a corporate reorganization, then we must use our best efforts to include in the registration any registrable securities requested by their holder to be registered. The underwriters of any underwritten offering will have the right to limit the number of shares having registration rights to be included in the registration statement.

 

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Expenses of Registration. We will pay all expenses, other than underwriting discounts and commissions, relating to any demand, Form F-3 or Form S-3 or piggyback registration. We are not required to pay for any expenses of any registration proceeding begun in response to holders’ exercise of their registration rights if the registration request is subsequently withdrawn at the request of the holders of a majority of the registrable securities to be registered.

 

Termination of Obligations. The registration rights described above shall terminate on the earlier of (i) the date that is five years after the closing of our initial public offering or (ii) with respect to any holder of registrable securities, the date on which such holder may sell all of such holder’s registrable securities under Rule 144 of the Securities Act in any 90-day period without registration.

 

All of the rights provided to our preferred shareholders under the shareholders agreement, except for registration rights, have automatically terminated upon the completion of our initial public offering in September 2016.

 

Loan Guarantee

 

In 2018 and 2019, we entered into several short-term guaranteed loan agreements. Each of the loan agreements provides for a RMB revolving credit facility with a maturity term within three months or twelve months. Guosheng Qi, our chief executive officer and chairman, provided guarantees for some of these credit facilities.

 

In May 2019, one of our consolidated affiliated entities borrowed a working capital loan in the amount of RMB120 million from an entity affiliated with Hammer Capital Private Investments Limited, our existing shareholder. The loan bears interest at 4% per annum and has a term of 24 months, and may be prepaid by us before the maturity date. The loan agreement includes other customary terms and covenants, including certain events of default after which the RMB Loan may be due and payable immediately. The RMB Loan is guaranteed by certain of our consolidated affiliated entities and subsidiaries, and is secured by the pledge of intellectual properties held by the borrower and the guarantors. In connection with and as part of the consideration for the extension of the loan, we issued to an affiliate of the lender a warrant to purchase our Class B ordinary shares. Under the warrant, the warrant holder may purchase our Class B ordinary shares at the exercise price of US$4.0261 per share, for up to a total number of Class B ordinary shares representing the aggregate exercise price of US$14.45 million. Such aggregate exercise price will be increased to US$17.34 million if the loan is not repaid in full by May 30, 2020, and further increased to US$21.68 million if the loan is not repaid in full by November 30, 2020.

 

Employment Agreements and Indemnification Agreements

 

See “Item 6. Directors, Senior Management and Employees—C. Board Practices—Employment Agreements and Indemnification Agreements.”

 

Share Incentives

 

See “Item 6. Directors, Senior Management and Employees—B. Compensation—Share Incentive Plans.”

 

C.    Interests of Experts and Counsel

 

Not applicable.

 

ITEM 8. FINANCIAL INFORMATION

 

A.    Consolidated Statements and Other Financial Information

 

Financial Statements

 

Please see “Item 18. Financial Statements.”

 

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Legal Proceedings

 

From time to time we may become involved in legal proceedings or be subject to claims arising in the ordinary course of our business.

 

On April 25, 2018 and June 25, 2018, purported securities class action complaints were filed in the United States District Court for the Southern District of New York against us, Guosheng Qi, our chief executive officer and chairman, and Michael Peng Zhang, our then co-chief financial officer, among other defendants. These lawsuits, which are captioned Xu v. Gridsum Holding Inc., et al., Case No. 18-CV-3655, and Li v. Gridsum Holding Inc., et al., Case No. 18-CV-5749, alleged, among other things, that “false and/or misleading statements” were made “and/or” we failed to disclose our lack of effective controls over financial reporting, in connection with our announcement on April 23, 2018 that our financial statements for the year ended December 31, 2016 should no longer be relied upon. On September 17, 2018, the court appointed a lead plaintiff pursuant to the Private Securities Litigation Reform Act of 1995 and ordered the lawsuits consolidated. A consolidated amended complaint was filed on November 30, 2018 that variously alleges violations of Sections 10(b) and 20(a) of the Exchange Act, Rule 10b-5 of the Exchange Act, and Sections 11 and 15 of the Securities Act against us and our current and former officers and directors, among other defendants. On March 1, 2019, the lead plaintiff filed a second amended class action complaint, or the SAC, that alleges a putative class period between September 22, 2016 to January 7, 2019. We and a defendant who is a former director filed a motion to dismiss the SAC. On March 30, 2020, the court granted the motion with respect to certain claims, dismissing the claims under Sections 11 and 15 of the Securities Act in their entirety, and the Section 10(b) claim of the Exchange Act with respect to the director. The court in the same order also denied the lead plaintiffs’ motion for alternative service on the remaining individual defendants who were named in the SAC, but have not yet been served. On May 7, 2020, the lead plaintiff filed a third amended complaint, or TAC. The defendants will file their response to the TAC on or before June 8, 2020.

 

On July 2, 2018, a third purported securities class action complaint was filed in the Supreme Court of the State of New York against us and certain of our current and former directors and executive officers, among other defendants, variously alleging violations of Sections 11, 12(a)(2) and 15 of the Securities Act against them. The lawsuit, captioned, Gordon v. Gridsum Holding Inc., et al., Index No. 18-653342, is brought on behalf of a putative class of shareholders who “purchased or otherwise acquired” ADSs in our initial public offering on September 23, 2016, and are based on substantially the same allegations as the consolidated proceeding described above. On January 22, 2019, an amended complaint was filed. On April 10, 2019, the court granted our motion to stay this action pending the determination of the federal action, and this action remains stayed pending the resolution of the federal action.

 

We believe that the claims against us are without merit and intend to vigorously defend against the litigation.

 

Except for the shareholder class action lawsuits described above, there were no legal or arbitration proceedings that have had in the recent past, or to our knowledge may have, a material adverse effect on our financial position, profitability or cash flows.

 

Dividend Policy

 

We have not previously declared or paid cash dividends and have no plan to declare or pay any dividends on our shares or ADSs for the foreseeable future. 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 “Item 3. Key Information—D. Risk Factors—Risks Relating to Doing Business in China—Any limitation on the ability of the WFOE to make distributions to us, or the tax implications thereof, could have a material adverse effect on our business or financial condition.”

 

Our Board of Directors has discretion as to whether to distribute dividends, subject to applicable laws. 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, we will pay the ADS holders to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Item 12. Description of Securities Other Than Equity Securities —D. American Depositary Shares.” Cash dividends on our ordinary shares, if any, will be paid in U.S. Dollars.

 

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B.    Significant Changes

 

Except as disclosed elsewhere in this annual report, we have not experienced any significant changes since the date of our audited consolidated financial statements included in this annual report.

 

ITEM 9. THE OFFER AND LISTING

 

A.    Offer and Listing Details

 

Our ADSs have been quoted on The Nasdaq Stock Market under the symbol “GSUM” since September 23, 2016. Each ADS represents one Class B ordinary share. On June 1, 2020, the last reported sale price of our ADSs on The Nasdaq Stock Market was US$0.848.

 

B.    Plan of Distribution

 

Not applicable.

 

C.    Markets

 

Our ADSs have been listed on The Nasdaq Stock Market under the symbol “GSUM” since September 23, 2016.

 

D.    Selling Shareholders

 

Not applicable.

 

E.    Dilution

 

Not applicable.

 

F.    Expenses of the Issue

 

Not applicable.

 

ITEM 10. ADDITIONAL INFORMATION

 

A.    Share Capital

 

Not applicable.

 

B.    Memorandum and Articles of Association

 

Company Objects and Purposes

 

We are a Cayman Islands exempted company and our affairs are governed by our memorandum and articles of association, as amended and restated from time to time, the Companies Law (2020 Revision) of the Cayman Islands, which is referred to below as the Companies Law, and the common law of the Cayman Islands. A Cayman Islands exempted company is a company that conducts its business outside of the Cayman Islands, is exempted from certain requirements of the Companies Law, including a filing of an annual return of its shareholders with the Registrar of Companies, does not have to make its register of shareholders open to inspection and may obtain an undertaking against the imposition of any future taxation.

 

According to our fifth amended and restated memorandum and articles of association, the objects for which we are established are unrestricted and we have full power and authority to carry out any object not prohibited by the Companies Law or any other law of the Cayman Islands.

 

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The following are summaries of material terms and provisions of our fifth amended and restated memorandum and articles of association and the Companies Law insofar as they relate to the material terms of our ordinary shares. These summaries are not complete, and you should read our fifth amended and restated memorandum and articles of association, which was filed as exhibits to our registration statement on Form F-1 (file number: 333-213348).

 

The holders of our ADSs will not be treated as our shareholders and will be required to surrender their ADSs for cancellation and withdrawal from the depositary facility in which the ordinary shares are held in order to exercise shareholders’ rights in respect of the ordinary shares. The depositary will agree, so far as it is practical, to vote or cause to be voted the amount of ordinary shares represented by ADSs in accordance with the non-discretionary written instructions of the holder of such ADSs.

 

Registered Office

 

Our registered office in the Cayman Islands is located at the offices of International Corporation Services Ltd., Harbour Place 2nd Floor, 103 South Church Street, P.O. Box 472, George Town, Grand Cayman KY1-1106.

 

Board of Directors

 

See “Item 6. Directors, Senior Management and Employees—C. Board Practices.”

 

Ordinary Shares

 

General

 

As of the date of this annual report, our authorized share capital is US$200,000 divided into 200,000,000 ordinary shares, par value of US$0.001 per share, which is divided into 20,000,000 Class A ordinary shares, par value of US$0.001 per share, and 180,000,000 Class B ordinary shares, par value of US$0.001 per share. Holders of Class A ordinary shares and Class B ordinary shares have the same rights except for voting and conversion rights. All of our outstanding ordinary shares are fully paid up and non-assessable. Certificates representing the ordinary shares are issued in registered form. Our shareholders who are non-residents of the Cayman Islands may freely hold and vote their shares.

 

Dividends

 

The holders of our ordinary shares are entitled to such dividends as may be declared by our Board of Directors. Holders of Class A ordinary shares and Class B ordinary shares are entitled to the same amount of dividends, if declared.

 

Voting Rights

 

In respect of all matters subject to a shareholders’ vote, each Class A ordinary share is entitled to ten votes, and each Class B ordinary share is entitled to one vote, voting together as one class. Voting at any shareholders’ meeting is by show of hands unless a poll is demanded. A poll may be demanded by the chairman or any shareholder(s) present in person or by proxy holding at least 10% of the voting share capital of our company. Actions that may be taken at a general meeting may also be taken by a unanimous resolution of the shareholders in writing.

 

A quorum of shareholders for a general meeting consists of the holders of at least 50% of the aggregate voting power of all outstanding ordinary shares, being entitled to vote, attend and vote at the general meeting. An ordinary resolution to be passed at a general meeting requires the affirmative vote of a simple majority of the votes cast, while a special resolution requires the affirmative vote of at least two-thirds of votes cast at a general meeting. A special resolution will be required for important matters.

 

An annual general meeting may be held each year. Extraordinary general meetings may be held at such times as may be determined by our board of directors, and must be held upon requisition by shareholders holding at least one-third of the aggregate voting power of our issued and outstanding shares. Advance notice of at least 14 calendar days is required for any general meetings.

 

Conversion

 

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 transfer of Class A ordinary shares by the holder or beneficial owner thereof to any person that is not affiliated with such holder or beneficial owner, such Class A ordinary shares will be automatically and immediately converted into an equal number of Class B ordinary shares.

 

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Transfer of Ordinary Shares

 

Subject to the restrictions set out below, any of our shareholders may transfer all or any of his or her ordinary shares by an instrument of transfer in the usual or common form or any other form approved by our Board of Directors.

 

Our Board of Directors may, in its sole discretion, decline to register any transfer of any ordinary share which is not fully paid up or on which we have a lien. Our directors may also decline to register any transfer of any ordinary share unless (a) the instrument of transfer is lodged with us, accompanied by the certificate for the ordinary shares to which it relates and such other evidence as our Board of Directors may reasonably require to show the right of the transferor to make the transfer; (b) the instrument of transfer is in respect of only one class of ordinary shares; (c) the instrument of transfer is properly stamped, if required; (d) in the case of a transfer to joint holders, the number of joint holders to whom the ordinary share is to be transferred does not exceed four; and (e) any fee related to the transfer has been paid to us.

 

If our directors refuse to register a transfer, they shall, within three months after the date on which the instrument of transfer was lodged, send to each of the transferor and the transferee notice of such refusal.

 

The registration of transfers may, with 14 days’ prior notice, be suspended and the register closed at such times and for such periods as our Board of Directors may from time to time determine, provided, however, that the registration of transfers shall not be suspended nor the register closed for more than 30 days in any year.

 

Liquidation

 

On a return of capital on winding up or otherwise (other than on conversion, redemption or purchase of shares), assets available for distribution among the holders of ordinary shares shall be distributed among the holders of the ordinary shares on a pro rata basis. If our assets available for distribution are insufficient to repay all of the paid up capital, the assets will be distributed so that the losses are borne by our shareholders proportionately.

 

Calls on Ordinary Shares and Forfeiture of Ordinary Shares

 

Our Board of Directors may from time to time make calls upon shareholders for any amounts unpaid on their ordinary shares in a notice served to such shareholders at least 14 days prior to the specified time and place of payment. The shares that have been called upon and remain unpaid on the specified time are subject to forfeiture.

 

Redemption of Shares

 

We may issue shares on terms that are subject to redemption, at our option or at the option of the holders, on such terms and in such manner as may be determined by our Board of Directors.

 

Variations of Rights of Shares

 

All or any of the special rights attached to any class of shares may, be varied with the sanction of a special resolution passed at a general meeting of the holders of the shares of that class. Consequently, the rights of any class of shares cannot be altered without a majority of two-thirds of the votes cast at such meeting.

 

Inspection of Books and Records

 

Holders of our ordinary shares will have no general right under Cayman Islands law to inspect or obtain copies of our list of shareholders or our corporate records. However, we will provide our shareholders with annual audited financial statements.

 

Issuance of Additional Shares

 

Our fifth amended and restated memorandum and articles of association authorizes our Board of Directors to issue additional ordinary shares from time to time as our Board of Directors shall determine, to the extent of available authorized but unissued shares.

 

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Our fifth amended and restated memorandum and articles of association also authorizes our Board of Directors to establish from time to time one or more series of preferred shares and to determine, with respect to any series of preferred shares, the terms and rights of that series, including:

 

·                      the designation of the series;

 

·                      the number of shares of the series;

 

·                      the dividend rights, dividend rates, conversion rights, voting rights; and

 

·                      the rights and terms of redemption and liquidation preferences.

 

Our Board of Directors may issue preferred shares without action by our shareholders to the extent authorized but unissued. Issuance of these shares may dilute the voting power of holders of ordinary shares.

 

Differences in Corporate Law

 

The Companies Law is derived, to a large extent, from the older Companies Acts of England but does not follow recent United Kingdom statutory enactments, and accordingly there are significant differences between the Companies Law and the current Companies Act of England. In addition, the Companies Law differs from laws applicable to United States corporations and their shareholders. Set forth below is a summary of the significant differences between the provisions of the Companies Law applicable to us and the laws applicable to companies incorporated in the United States and their shareholders.

 

Mergers and Similar Arrangements

 

The Companies Law permits mergers and consolidations between Cayman Islands companies and between Cayman Islands companies and non-Cayman Islands companies. For these purposes, (a) “merger” means the merging of two or more constituent companies and the vesting of their undertaking, property and liabilities in one of such companies as the surviving company and (b) a “consolidation” means the combination of two or more constituent companies into a combined company and the vesting of the undertaking, property and liabilities of such companies to the consolidated company. In order to effect such a merger or consolidation, the directors of each constituent company must approve a written plan of merger or consolidation, which must then be authorized by (a) a special resolution of the shareholders of each constituent company and (b) such other authorization, if any, as may be specified in such constituent company’s articles of association. The written plan of merger or consolidation must be filed with the Registrar of Companies together with a certificate of good standing, a declaration as to the solvency of the consolidated or surviving company and a further director declaration that the merger or consolidation is bona fide and covering such other matters as required by the Companies Law, including a list of the assets and liabilities of each constituent company and an undertaking that a copy of the certificate of merger or consolidation will be given to the members and creditors of each constituent company and that notification of the merger or consolidation will be published in the Cayman Islands Gazette. Dissenting shareholders have the right to be paid the fair value of their shares (which, if not agreed between the parties, will be determined by the Cayman Islands court) if they follow the required procedures, subject to certain exceptions. Court approval is not required for a merger or consolidation which is effected in compliance with these statutory procedures.

 

In addition, there are statutory provisions that facilitate the reconstruction and amalgamation of companies, provided that the arrangement is approved by a majority in number of each class of shareholders or creditors with whom the arrangement is to be made, and who must in addition represent three-fourths in value of each such class of shareholders or creditors, as the case may be, that are present and voting either in person or by proxy at a meeting, or meetings, convened for that purpose. The convening of the meetings and subsequently the arrangement must be sanctioned by the Grand Court of the Cayman Islands. While a dissenting shareholder has the right to express to the court the view that the transaction ought not to be approved, the court can be expected to approve the arrangement if it determines that:

 

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·                    the statutory provisions as to the required majority vote have been met;

 

·                    the shareholders have been fairly represented at the meeting in question and the statutory majority are acting bona fide without coercion of the minority to promote interests adverse to those of the class;

 

·                    the arrangement is such that may be reasonably approved by an intelligent and honest man of that class acting in respect of his interest; and

 

·                    the arrangement is not one that would more properly be sanctioned under some other provision of the Companies Law.

 

When a takeover offer is made and accepted by holders of 90% of the shares affected within four months, the offeror may, within a two-month period commencing on the expiration of such four-month period, require the holders of the remaining shares to transfer such shares on the terms of the offer. An objection can be made to the Grand Court of the Cayman Islands but this is unlikely to succeed in the case of an offer which has been so approved unless there is evidence of fraud, bad faith or collusion.

 

If an arrangement and reconstruction is thus approved, the dissenting shareholder would have no rights comparable to appraisal rights, which would otherwise ordinarily be available to dissenting shareholders of Delaware corporations, providing rights to receive payment in cash for the judicially determined value of the shares.

 

Shareholders’ Suits

 

Generally legal proceedings can be originated in the Grand Court of the Cayman Islands. In principle, we will normally be the proper plaintiff to sue for a wrong done to us as a company and a derivative action may ordinarily not be brought by a minority shareholder. However, based on English authority, which would in all likelihood be of persuasive authority in the Cayman Islands, the Cayman Islands courts can be expected (and have had occasion) to follow and apply the common law principles (namely the rule in Foss v. Harbottle and the exceptions thereto) so that a non-controlling shareholder may be permitted to commence a class action against, or derivative actions in the name of, our company to challenge:

 

·                    an act which is illegal or ultra vires and is therefore incapable of ratification by the shareholders;

 

·                    an act which requires a resolution with a qualified or special majority which has not been obtained; and

 

·                    an act which constitutes a fraud against the minority where the wrongdoers are themselves in control of the company.

 

Indemnification of Directors and Executive Officers and Limitation of Liability

 

Cayman Islands law does not limit the extent to which a company’s memorandum and articles of association may provide for indemnification of officers and directors, except to the extent any such provision may be held by the Cayman Islands courts to be contrary to public policy, such as to provide indemnification against civil fraud or the consequences of committing a crime. Our fifth amended and restated memorandum and articles of association require us to indemnify our officers and directors for losses, damages, costs and expenses incurred in their capacities as such unless such losses or damages arise from dishonesty, willful default or fraud of such directors or officers. This standard of conduct is generally the same as permitted under the Delaware General Corporation Law for a Delaware corporation.

 

In addition, we have entered into indemnification agreements with our directors and executive officers that provide such persons with additional indemnification beyond that provided in our fifth amended and restated memorandum and articles of association.

 

Insofar as indemnification for liabilities arising under the Securities Act may be permitted to our directors, officers or persons controlling us under the foregoing provisions, we have been informed that, in the opinion of the SEC, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.

 

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Directors’ Fiduciary Duties

 

Under Delaware corporate law, a director of a Delaware corporation has a fiduciary duty to the corporation and its shareholders. This duty has two components: the duty of care and the duty of loyalty. The duty of care requires that a director act in good faith, with the care that an ordinarily prudent person would exercise under similar circumstances. Under this duty, a director must inform himself of, and disclose to shareholders, all material information reasonably available regarding a significant transaction. The duty of loyalty requires that a director acts in a manner he or she reasonably believes to be in the best interests of the corporation. He or she must not use his corporate position for personal gain or advantage. This duty prohibits self-dealing by a director and mandates that the best interest of the corporation and its shareholders take precedence over any interest possessed by a director, officer or controlling shareholder and not shared by the shareholders generally. In general, actions of a director are presumed to have been made on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the corporation. However, this presumption may be rebutted by evidence of a breach of one of the fiduciary duties. Should such evidence be presented concerning a transaction by a director, the director must prove the procedural fairness of the transaction and that the transaction was of fair value to the corporation.

 

As a matter of Cayman Islands law, a director of a Cayman Islands company is in the position of a fiduciary with respect to the company and therefore it is considered that he or she owes the following duties to the company—a duty to act in good faith in the best interests of the company, a duty not to make a personal profit based on his position as director (unless the company permits him to do so), a duty not to put himself in a position where the interests of the company conflict with his personal interest or his duty to a third party and a duty to exercise powers for the purpose for which such powers were intended. A director of a Cayman Islands company owes to the company a duty to act with skill and care. It was previously considered that a director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience. However, English and Commonwealth courts have moved towards an objective standard with regard to the required skill and care and these authorities are likely to be followed in the Cayman Islands.

 

Shareholder Action by Written Consent

 

Under the Delaware General Corporation Law, a corporation may eliminate the right of shareholders to act by written consent by amendment to its certificate of incorporation. Cayman Islands law and our fifth amended and restated articles of association provide that shareholders may approve corporate matters by way of a unanimous written resolution signed by or on behalf of each shareholder who would have been entitled to vote on such matter at a general meeting without a meeting being held.

 

Shareholder Proposals

 

Under the Delaware General Corporation Law, a shareholder has the right to put any proposal before the annual meeting of shareholders, provided it complies with the notice provisions in the governing documents. A special meeting may be called by the Board of Directors or any other person authorized to do so in the governing documents, but shareholders may be precluded from calling special meetings.

 

Cayman Islands law provides shareholders with only limited rights to requisition a general meeting and does not provide shareholders with any right to put any proposal before a general meeting. However, these rights may be provided in a company’s articles of association. Our fifth amended and restated articles of association allow our shareholders holding at least one-third of the aggregate voting power of our issued and outstanding shares to requisition a general meeting. However, our fifth amended and restated articles of association do not provide our shareholders with any right to put proposal before a general meeting.

 

As a Cayman Islands exempted company, we are not obliged by the Companies Law to call shareholders’ annual general meetings. Our fifth amended memorandum and articles of association provide that we may (but are not obliged to) in each year hold a general meeting at such time and place as may be determined by our directors.

 

Cumulative Voting

 

Under the Delaware General Corporation Law, cumulative voting for elections of directors is not permitted unless the corporation’s certificate of incorporation specifically provides for it. Cumulative voting potentially facilitates the representation of minority shareholders on a board of directors since it permits the minority shareholder to cast all the votes to which the shareholder is entitled on a single director, which increases the shareholder’s voting power with respect to electing such director. As permitted under Cayman Islands law, our fifth amended and restated articles of association do not provide for cumulative voting. As a result, our shareholders are not afforded any less protections or rights on this issue than shareholders of a Delaware corporation.

 

Removal of Directors

 

Under the Delaware General Corporation Law, a director of a corporation with a classified board may be removed only for cause with the approval of a majority of the outstanding shares entitled to vote, unless the certificate of incorporation provides otherwise.

 

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Under our fifth amended and restated articles of association, directors may be removed with or without cause, by a special resolution of our shareholders.

 

Transactions with Interested Shareholders

 

The Delaware General Corporation Law contains a business combination statute applicable to Delaware public corporations whereby, unless the corporation has specifically elected not to be governed by such statute by amendment to its certificate of incorporation, it is prohibited from engaging in certain business combinations with an “interested shareholder” for three years following the date that such person becomes an interested shareholder. An interested shareholder generally is a person or a group who or which owns or owned 15% or more of the target’s outstanding voting shares within the past three years. This has the effect of limiting the ability of a potential acquirer to make a two-tiered bid for the target in which all shareholders would not be treated equally. The statute does not apply if, among other things, prior to the date on which such shareholder becomes an interested shareholder, the board of directors approves either the business combination or the transaction which resulted in the person becoming an interested shareholder. This encourages any potential acquirer of a Delaware corporation to negotiate the terms of any acquisition transaction with the target’s board of directors.

 

Cayman Islands law has no comparable statute. As a result, we cannot avail ourselves of the types of protections afforded by the Delaware business combination statute. However, although Cayman Islands law does not regulate transactions between a company and its significant shareholders, it does provide that such transactions must be entered into bona fide in the best interests of the company and for a proper purpose and not with the effect of constituting a fraud on the minority shareholders.

 

Dissolution; Winding Up

 

Under the Delaware General Corporation Law, unless the board of directors approves the proposal to dissolve, dissolution must be approved by shareholders holding 100% of the total voting power of the corporation. Only if the dissolution is initiated by the board of directors may it be approved by a simple majority of the corporation’s outstanding shares. Delaware law allows a Delaware corporation to include in its certificate of incorporation a supermajority voting requirement in connection with dissolutions initiated by the board.

 

Under Cayman Islands law, a company may be wound up by either an order of the courts of the Cayman Islands or by a special resolution of its members or, if the company is unable to pay its debts as they fall due, by an ordinary resolution of its members. The court has authority to order winding up in a number of specified circumstances including where it is, in the opinion of the court, just and equitable to do so. Under the Companies Law, our company may be dissolved, liquidated or wound up by a special resolution of our shareholders or by an ordinary resolution on the basis that our company is unable to pay its debts as they fall due.

 

Variation of Rights of Shares

 

Under the Delaware General Corporation Law, a corporation may vary the rights of a class of shares with the approval of a majority of the outstanding shares of such class, unless the certificate of incorporation provides otherwise. Under Cayman Islands law and our fifth amended and restated articles of association, the rights attached to any class or series of our shares may be varied with a special resolution passed at a general meeting of the holders of the shares of that class or series.

 

Amendment of Governing Documents

 

Under the Delaware General Corporation Law, a corporation’s certificate of incorporation may be amended only if adopted and declared advisable by the board of directors and approved by a majority of the outstanding shares entitled to vote, and the bylaws may be amended with the approval of a majority of the outstanding shares entitled to vote and may, if so provided in the certificate of incorporation, also be amended by the board of directors. Under the Companies Law, our memorandum and articles of association may only be amended by special resolution or the unanimous written resolution of all shareholders.

 

Rights of Non-resident or Foreign Shareholders

 

There are no limitations imposed by our fifth amended and restated memorandum and articles of association on the rights of non-resident or foreign shareholders to hold or exercise voting rights on our shares. In addition, there are no provisions in our fifth amended and restated memorandum and articles of association governing the ownership threshold above which shareholder ownership must be disclosed.

 

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C.    Material Contracts

 

We have not entered into any material contracts other than in the ordinary course of business and other than those described in “Item 4. Information on the Company,” “Item 7. Major Shareholders and Related Party Transactions—B. Related Party Transactions,” or elsewhere in this annual report.

 

D.    Exchange Controls

 

Foreign Currency Exchange

 

See “Item 4. Information on the Company—B. Business Overview—Regulation—Regulations on Foreign Exchange.”

 

Dividend Distribution

 

See “Item 4. Information on the Company—B. Business Overview— Regulation—Regulations on Dividend Distribution.”

 

E.    Taxation

 

The following is a summary of material Cayman Islands, PRC and U.S. federal income tax consequences of an investment in our ADSs or Class B ordinary shares. It is based upon laws and relevant interpretations thereof in effect as of the date of this annual report, all of which are subject to change. This summary does not deal with all possible tax consequences relating to an investment in our ADSs or Class B ordinary shares, such as the tax consequences under state, local and other tax laws.

 

Cayman Islands Taxation

 

The Cayman Islands currently levies 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 brought within, the jurisdiction of the Cayman Islands. The Cayman Islands is not party to any double tax treaties which are applicable to any payments made by or to our company. There are no exchange control regulations or currency restrictions in the Cayman Islands.

 

People’s Republic of China Taxation

 

The PRC Enterprise Income Tax Law, or the EIT Law, which became effective on January 1, 2008 and was most recently amended on December 29, 2018, provides that an enterprise established under the laws of a foreign country or region but whose “de facto management body” is located in the PRC is treated as a PRC resident enterprise for PRC tax purposes and consequently is subject to PRC enterprise income tax at the rate of 25% on its global income. On April 22, 2009, the SAT issued 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 the PRC. Furthermore, the SAT issued Bulletin No. 45, which became effective on September 1, 2011 and was most recently amended on June 15, 2018, to provide more guidance on the implementation of Circular 82. Bulletin No. 45 clarified certain issues in the areas of resident status determination, post-determination administration and competent tax authorities procedures. According to Circular 82, an offshore incorporated enterprise controlled by a PRC enterprise or a PRC enterprise group will be considered as a PRC tax resident enterprise by virtue of having its “de facto management body” in the PRC only if all of the following conditions are met: (a) the senior management and core management departments in charge of its daily operations are located 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) at least half of the enterprise’s directors or senior management with voting rights habitually reside in the PRC. Although Circular 82 and Bulletin No. 45 only apply to offshore incorporated enterprises controlled by PRC enterprises or PRC enterprise groups and not those controlled by PRC individuals or foreigners, the determination criteria set forth therein may reflect the 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.

 

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We believe that neither Gridsum Cayman nor Gridsum HK is a PRC resident enterprise for PRC tax purposes, because neither of them meets all of the criteria described above. Neither is controlled by a PRC enterprise or PRC enterprise group. Their records (including the resolutions of the board of directors and the resolutions of shareholders) are maintained outside the PRC. However, an enterprise’s tax resident status is subject to determination by the PRC tax authorities and uncertainties remain with respect to the interpretation of the term “de facto management body” when applied to our offshore entities.

 

If the PRC tax authorities determine that we are a PRC resident enterprise, we will be subject to PRC enterprise income tax at 25% on our global income. In addition, dividends paid by us to our non-PRC shareholders may be subject to PRC withholding tax, and gains realized on the sale or other disposition of our ADSs or Class B ordinary shares may be subject to PRC tax, at a rate of 0% in the case of non-PRC corporate shareholders that are deemed PRC resident enterprises, 10% in the case of non-PRC corporate shareholders that are deemed non-resident enterprises or 20% in the case of non-PRC individual shareholders (in each case, subject to any applicable tax treaty), if such dividends or gains are deemed to be from sources within the PRC. A holder of our Class B ordinary shares or our ADSs (other than our depositary bank who is a nominee shareholder) may be deemed a “non-resident enterprise” if (a) its “de facto management body” is outside the PRC, and (b) it meets one of the following conditions: (i) it has establishment or place of business within the PRC, or (ii) it does not have establishment or place of business within the PRC but has received income from PRC sources. As a result, you may be subject to PRC withholding tax on dividends distributed by us or gains realized on the disposition of our ADSs or Class B ordinary shares, unless the jurisdiction of your incorporation has a tax treaty with China that provides for a different withholding arrangement. The Cayman Islands does not have such tax treaty with China. Any such tax may reduce the returns on your investment in the ADSs. Furthermore, if we are a PRC resident enterprise and the dividends paid by us to our non-PRC shareholders are subject to PRC withholding tax, we will be obligated to withhold and pay such tax in respect of the dividends actually paid by us to our non-PRC shareholders, and failure to so withhold and pay may subject us to a penalty of not less than 50% of and not more than three times the amount of the unpaid tax imposed by the relevant PRC tax authority.

 

If we are deemed a “non-resident enterprise” by the PRC tax authorities, the dividends paid to us by our PRC subsidiary will be subject to a 10% withholding tax (or a 5% withholding tax in certain circumstances discussed below). The EIT Law imposes a withholding income tax of 10% on dividends distributed by a foreign-invested enterprises to its immediate holding company outside of the PRC, if such immediate holding company is considered as a non-resident enterprise without any establishment or place of business within the PRC or if the received dividends have no connection with the establishment or place of business of such immediate holding company within the PRC, unless such immediate holding company’s jurisdiction of incorporation has a tax treaty with the PRC that provides for a different withholding arrangement. Under the Arrangement Between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion With Respect to Taxes on Income, the dividend withholding tax rate may be reduced to 5%, if a Hong Kong resident enterprise that receives the dividends is considered a “non-resident enterprise” and holds at least 25% of the equity interests in the PRC enterprise distributing the dividends, subject to approval of the PRC local tax authority. However, if the Hong Kong resident enterprise is not considered to be the beneficial owner of such dividends under applicable PRC tax regulations, such dividends may remain subject to withholding tax at a rate of 10%. Accordingly, dividends received by Gridsum HK from our PRC subsidiary will be subject to PRC withholding tax, the rate of which might be reduced from 10% to 5% if Gridsum HK satisfies the relevant conditions under applicable PRC tax regulations and obtains the approvals as required.

 

Material United States Federal Income Tax Considerations

 

The following is a discussion of material U.S. federal income tax considerations relating to the acquisition, ownership and disposition of our ADSs or Class B ordinary shares by U.S. Holders (as defined below) that hold our ADSs or Class B ordinary shares as “capital assets” (generally, property held for investment) as of the date hereof and under the U.S. Internal Revenue Code of 1986, as amended, or the Code. This discussion is based upon applicable provisions of the Code, Treasury regulations promulgated thereunder, pertinent judicial decisions, interpretive rulings of the Internal Revenue Service, or the IRS, and such other authorities as are relevant, all as of the date hereof, and all of which are subject to change, possibly with retroactive effect. In addition, this discussion is based, in part, upon representations made by the depositary to us and assumes that the deposit agreement, and all other related agreements, will be performed in accordance with their terms. This discussion does not address all aspects of U.S. federal income taxation that may be important to particular investors in light of their individual investment circumstances, including investors subject to special tax rules (for example, certain financial institutions, insurance companies, broker-dealers, pension plans, regulated investment companies, real estate investment trusts, cooperatives, tax-exempt organizations (including private foundations), holders who are not U.S. Holders, holders who own (directly, indirectly or constructively) 10% or more of our stock by vote or value, investors that hold our ADSs or Class B ordinary shares as part of a straddle, hedge, conversion, constructive sale or other integrated transaction for U.S. federal income tax purposes, investors that are traders in securities that have elected the mark-to-market method of accounting or investors that have a functional currency other than the U.S. Dollar), all of whom may be subject to tax rules that differ significantly from those discussed below.

 

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In addition, this discussion does not address any non-U.S., state, local or any U.S. federal estate, gift or alternative minimum tax considerations. Each U.S. Holder is urged to consult its tax advisors regarding the U.S. federal, state, local and non-U.S. income and other tax considerations of an investment in ADSs or Class B ordinary shares.

 

General

 

The discussion below of U.S. federal income tax consequences to “U.S. Holders” will apply to you if you are a beneficial owner of our ADSs or Class B ordinary shares and you are, for U.S. federal income tax purposes, (i) an individual who is a citizen or resident of the United States, (ii) a corporation, or other entity treated as a corporation for U.S. federal income tax purposes, created in or organized under the law of the United States or any state thereof or the District of Columbia, (iii) an estate the income of which is includible in gross income for U.S. federal income tax purposes regardless of its source or (iv) a trust (A) the administration of which is subject to the primary supervision of a U.S. court and which has one or more U.S. persons who have the authority to control all substantial decisions of the trust or (B) that has otherwise validly elected to be treated as a U.S. person under the Code.

 

If you are a partner in a partnership or other entity treated as a partnership for U.S. federal income tax purposes that holds our ADSs or Class B ordinary shares, your tax treatment generally will depend on your status (including, for example, whether you are a U.S. Holder) and the activities of the partnership. Partners in a partnership holding our ADSs or Class B ordinary shares should consult their tax advisers regarding the tax consequences of an investment in our ADSs or Class B ordinary shares.

 

If you own (directly, indirectly or constructively) 10% or more of our stock by vote or value, due to changes in U.S. tax laws under the 2017 Act, you could be subject to unexpected and extremely unfavorable U.S. tax consequences. Such holders should consult their tax advisers regarding the tax consequences of an investment in our stock.

 

ADSs

 

If you hold ADSs, for U.S. federal income tax purposes, you generally will be treated as the owner of the underlying Class B ordinary shares that are represented by such ADSs. Accordingly, deposits or withdrawals of Class B ordinary shares for ADSs, or vice versa, will not be subject to U.S. federal income tax.

 

Dividends

 

Subject to the discussion under “—Passive Foreign Investment Company Rules” below, any cash distributions (including the amount of any PRC tax withheld if we are deemed to be a PRC resident enterprise under PRC tax law) paid on our ADSs or Class B ordinary shares out of our current or accumulated earnings and profits, as determined under U.S. federal income tax principles, will generally be includible in your gross income as dividend income on the day actually or constructively received by you, in the case of Class B ordinary shares, or by the depositary, in the case of ADSs. Dividends received on our ADSs or Class B ordinary shares will not be eligible for the dividends received deduction allowed to corporations under the Code.

 

A non-corporate recipient of dividends will be subject to tax at the reduced tax rate applicable to “qualified dividend income,” provided that certain conditions are satisfied, including that (1) our ADSs are readily tradable on an established securities market in the United States, or, in the event that we are deemed to be a PRC resident enterprise under the PRC tax law, we are eligible for the benefit of the United States-PRC income tax treaty, or the Treaty, (2) we are neither a passive foreign investment company nor treated as such with respect to a U.S. Holder (as discussed below) for the taxable year in which the dividend was paid or the preceding taxable year and (3) certain holding period requirements are met.

 

Our ADSs are listed on the Nasdaq Global Select Market. United States Treasury Department guidance indicates that the ADSs, when they are listed on the Nasdaq Global Select Market, are readily tradable on an established securities market in the United States. Thus, provided we are not classified as a PFIC subject to the U.S. federal income tax rules governing PFICs summarized in the discussion below under “—Passive Foreign Investment Company Rules” and certain holding period requirements are met, we believe that dividends we pay on our ADSs will meet the conditions required for the reduced tax rate applicable to “qualified dividend income.” However, since we do not expect that our Class B ordinary shares will be listed on an established securities market, we do not believe that dividends that we pay on our Class B ordinary shares that are not represented by ADSs currently meet the conditions required for these reduced tax rates (unless we are eligible for the benefit of the Treaty as discussed below).

 

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In the event that we are deemed to be a PRC resident enterprise under PRC tax law, you may be subject to PRC withholding taxes on dividends paid on our ADSs or Class B ordinary shares. If we are deemed to be a PRC resident enterprise, we may, however, be eligible for the benefits of the Treaty. If we are eligible for such benefits, dividends we pay on our Class B ordinary shares, regardless of whether such shares are represented by the ADSs, would be eligible for the reduced rates of taxation applicable to qualified dividend income, as discussed above. Determining eligibility for benefits under U.S. income tax treaties is complex. You should consult your tax advisor if you intend to rely on our eligibility for the benefits of the Treaty to claim a reduced rate of tax on dividends.

 

For U.S. foreign tax credit purposes, dividends generally will be treated as income from foreign sources and generally will constitute passive category income. Depending on your particular circumstances, you may be eligible, subject to a number of complex limitations, to claim a foreign tax credit in respect of any foreign withholding taxes imposed on dividends received on our ADSs or Class B ordinary shares. If you do not elect to claim a foreign tax credit for foreign tax withheld, you are permitted instead to claim a deduction, for U.S. federal income tax purposes, for the foreign tax withheld, but only for a year in which you elect to do so for all creditable foreign income taxes. The rules governing the foreign tax credit are complex. You are urged to consult your tax advisor regarding the availability of the foreign tax credit under your particular circumstances.

 

To the extent that the amount of any distribution exceeds our current and accumulated earnings and profits for a taxable year, as determined under U.S. federal income tax principles, the distribution will first be treated as a tax-free return of capital, causing a reduction in the adjusted basis of our ADSs or Class B ordinary shares, and to the extent the amount of the distribution exceeds your tax basis, the excess will be taxed as capital gain recognized on a sale or exchange. Because we do not intend to determine our earnings and profits under U.S. federal income tax principles, any distribution paid will generally be treated as a “dividend” for U.S. federal income tax purposes (as discussed above). Consequently, your taxable dividend income may be greater than it would be if we determined our earnings and profits under U.S. federal income tax purposes.

 

Sale or Other Disposition of ADSs or Class B Ordinary Shares

 

Subject to the discussion under “—Passive Foreign Investment Company Rules” below, you generally will recognize capital gain or loss upon the sale or other disposition of our ADSs or Class B ordinary shares in an amount equal to the difference, if any, between the amount realized upon the disposition and your adjusted basis in such ADSs or Class B ordinary shares. Any capital gain or loss will be long-term capital gain or loss if you have held our ADSs or Class B ordinary shares for more than one year and will generally be U.S.-source gain or loss for U.S. foreign tax credit purposes. In the event that we are deemed to be a PRC resident enterprise under PRC tax law and gain from the disposition of our ADSs or Class B ordinary shares would be subject to tax in the PRC, you generally can elect to treat the gain as PRC-source gain for U.S. foreign tax credit purposes under the Treaty. The deductibility of a capital loss may be subject to limitations. You are urged to consult your tax advisor regarding the tax consequences if a foreign tax is imposed on a disposition of our ADSs or Class B ordinary shares, including any election to treat the gain on disposition as having a PRC source under the Treaty and the availability of the foreign tax credit under your particular circumstances.

 

Passive Foreign Investment Company Rules

 

A non-U.S. corporation, such as our company, will be classified as a “passive foreign investment company,” or PFIC, for U.S. federal income tax purposes for any taxable year, if either (i) 75% or more of its gross income for such year consists of certain types of “passive” income or (ii) 50% or more of the value of its assets (determined on the basis of a quarterly average) during such year produce or are held for the production of passive income. Passive income generally includes dividends, interest, royalties, rents, annuities, net gains from the sale or exchange of property producing such income and net foreign currency gains. For this purpose, cash is categorized as a passive asset and the company’s unbooked intangibles associated with active business activity are taken into account as a non-passive asset. We will be treated as owning our proportionate share of the assets and earning our proportionate share of the income of any other corporation in which we own, directly or indirectly, at least 25% (by value) of the stock.

 

Although the law in this regard is unclear, we intend to treat our VIE as being owned by us for U.S. federal income tax purposes, not only because we exercise effective control over the operation of such entity but also because we are entitled to substantially all of its economic benefits and burdens, and, as a result, we consolidate its results of operation in our consolidated financial statements. If it were determined, however, that we are not the owner of our VIE for U.S. federal income tax purposes, the PFIC rules would apply differently to us, and as a result, we could be treated as a PFIC for our current taxable year and/or future taxable years.

 

Assuming we are the owner of our VIE for U.S. federal income tax purposes, based on our current income and assets and the value of our ADSs and Class B ordinary shares, we do not believe we were a PFIC for the 2019 taxable year or for prior years, and we presently do not expect to be classified as a PFIC for the current taxable year and we do not anticipate becoming a PFIC in future taxable years. While we do not anticipate becoming a PFIC, changes in the nature of our income or assets or the value of our ADSs and Class B ordinary shares may cause us to become a PFIC for the current or any subsequent taxable year. Under circumstances where revenues from activities that produce passive income significantly increase relative to our revenues from activities that produce non-passive income or where we determine not to deploy significant amounts of cash, our risk of becoming classified as a PFIC may substantially increase.

 

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The discussion above under “—Dividends” and “—Sale or Other Disposition of ADSs or Class B Ordinary Shares” assumes that we will not be classified as a PFIC for U.S. federal income tax purposes.

 

If we were classified as a PFIC in any year with respect to which a U.S. Holder holds ADSs or Class B ordinary shares, we would continue to be treated as a PFIC with respect to the U.S. Holder in all succeeding years during which the U.S. Holder owns our ADSs or Class B ordinary shares, regardless of whether we continue to meet the tests described above.

 

If we were treated as a PFIC for any taxable year during which a taxable U.S. Holder held the ADS or Class B ordinary shares, gain recognized by the U.S. Holder on a sale or other disposition (including certain pledges) of our ADSs or Class B ordinary shares would be allocated ratably over the U.S. Holder’s holding period for our ADSs or Class B ordinary shares. The amounts allocated to the taxable year of the sale or other disposition and to any year before we became a PFIC would be taxed as ordinary income. The amount allocated to each other taxable year would be subject to tax at the highest rate in effect for individuals or corporations, as appropriate, for that taxable year, and an interest charge would be imposed on the amount allocated to that taxable year. Further, to the extent that any dividend or other distribution received by a U.S. Holder on its ADSs or Class B ordinary shares exceeded 125% of the average of the annual distributions received by the U.S. Holder on its ADSs or Class B ordinary shares during the preceding three years or the U.S. Holder’s holding period, whichever is shorter, that distribution (referred to as “excess distribution”) would be subject to taxation in the same manner as gain, described immediately above.

 

Thus, if we were treated as a PFIC, gains on disposition of ADSs or Class B ordinary shares, and excess distributions thereon, would be taxed at ordinary income rates and subject to an interest charge, which generally results in a significantly greater amount of U.S. tax than would otherwise be imposed if the PFIC rules did not apply.

 

Certain elections may be available that would result in alternative treatments of our ADSs or Class B ordinary shares. However, we do not expect that we will prepare or provide to U.S. Holders a “PFIC annual information statement,” which would enable a U.S. Holder to make one type of election, a “qualified electing fund” or “QEF” election.

 

If our ADSs were considered “marketable stock” (as defined below), U.S. Holders generally would be eligible to make a different type of election, a “mark-to-market” election, to elect out of the tax treatment discussed in the preceding paragraphs. If you make a valid mark-to-market election for the ADSs, you generally will include in income for each year we are a PFIC, as ordinary income, an amount equal to the excess of the fair market value of our ADSs at the end of the year over your adjusted tax basis, and you will be allowed an ordinary deduction for any excess of your adjusted tax basis over the fair market value of the ADSs at the end of the year. However, deductions will be allowable only to the extent of any net mark-to-market income you reported on our ADSs in prior years. Gain on the sale or other disposition of our ADSs will also be treated as ordinary income. Loss on sale will be treated as ordinary loss to the extent of any net mark-to-market gains you reported on the ADSs. Your basis in our ADSs will be adjusted to reflect any annual mark-to-market income or loss amounts. If you make a mark-to-market election, any distributions we make would generally be subject to the rules discussed above under “—Dividends,” except the lower rate applicable to qualified dividend income would not apply.

 

The mark-to-market election is available only for “marketable stock” which is stock that is traded in other than de minimis quantities on at least 15 days during each calendar quarter (“regularly traded”) on a qualified exchange or other market, as defined in applicable Treasury regulations. Our ADSs are listed on the Nasdaq Global Select Market, which is a qualified exchange for these purposes, and, consequently, assuming that our ADSs are regularly traded, if you are a holder of ADSs, it is expected that the mark-to-market election would be available to you if we were to become a PFIC. It should be noted that only our ADSs and not the Class B ordinary shares are listed on the Nasdaq Global Select Market. Consequently, if you are a U.S. Holder of Class B ordinary shares that are not represented by ADSs, you generally will not be eligible to make a mark-to-market election if we are or were to become a PFIC.

 

Each U.S. Holder of a PFIC is generally required to file an annual report containing such information as the U.S. Department of the Treasury may require.

 

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U.S. Holders are strongly urged to consult their own tax advisors regarding the details of the PFIC rules and any elections that may be available.

 

Medicare Tax

 

U.S. Holders that are individuals, estates or trusts and whose income exceeds certain thresholds will generally be subject to a 3.8% Medicare tax (in addition to the regular income tax) on certain investment income, including dividends and gains from the sale, exchange or other taxable disposition of an ADS or Class B ordinary share. You are urged to consult your tax advisors regarding the applicability of the Medicare tax to your income and gains in respect of an investment in our ADSs or Class B ordinary shares.

 

Information Reporting and Backup Withholding

 

You may be required to submit to the IRS certain information with respect to your beneficial ownership of our ADSs or Class B ordinary shares, if such ADSs or Class B ordinary shares are not held on your behalf by a financial institution. This law also imposes penalties if you are required to submit such information to the IRS and fail to do so.

 

Dividend payments with respect to ADSs or Class B ordinary shares and proceeds from the sale, exchange or redemption of ADSs or Class B ordinary shares may be subject to information reporting to the IRS and possible U.S. backup withholding. Backup withholding will not apply, however, to a U.S. Holder who furnishes a correct taxpayer identification number and makes any other required certification or who is otherwise exempt from backup withholding and in the case of dividend payments, reports the full amount of dividend income. U.S. Holders who are required to establish their exempt status must provide such certification on IRS Form W-9.

 

Backup withholding is not an additional tax. Amounts withheld as backup withholding may be credited against your U.S. federal income tax liability, and you may obtain a refund of any excess amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the IRS and furnishing any required information. You are urged to consult your tax advisors regarding the application of the U.S. information reporting and backup withholding rules.

 

F.    Dividends and Paying Agents

 

Not applicable.

 

G.    Statement by Experts

 

Not applicable.

 

H.    Documents on Display

 

We file annual reports with and furnish other information to the SEC as may be applicable from time to time. You may read and copy any documents filed or furnished by us at the SEC’s public reference room in Washington, D.C. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room.

 

In accordance with Nasdaq Stock Market Rule 5250(d), we will post this annual report on Form 20-F on our website at www.gridsum.com. In addition, we will provide physical copies of our annual report free of charge to shareholders and ADS holders upon request.

 

I.    Subsidiary Information

 

Not applicable.

 

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Foreign Exchange Risk

 

Substantially all of our revenues and costs are denominated in RMB, and substantially all of our financial assets are also denominated in RMB. We do not believe that we currently have any significant direct foreign exchange risk and we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. Although in general our exposure to foreign exchange risks should be limited, the value of your investment in our ADSs will be affected by the exchange rate between the U.S. Dollar and the RMB because the value of our business is effectively denominated in RMB, while our ADSs will be traded in U.S. Dollars.

 

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The value of the RMB against the U.S. Dollar and other currencies is affected by changes in China’s political and economic conditions and China’s foreign exchange policies, among other things. On July 21, 2005, the PRC government changed its decades-old policy of pegging the value of the RMB to the U.S. Dollar, and the RMB appreciated by more than 20% against the U.S. Dollar over the following three years. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the RMB and the U.S. Dollar remained within a narrow band. Since June 2010, the RMB has fluctuated against the U.S. Dollar, at times significantly and unpredictably, and in recent years the RMB has depreciated significantly against the U.S. Dollar. Since October 1, 2016, the RMB has joined the International Monetary Fund’s basket of currencies that make up the Special Drawing Right (SDR), along with the U.S. Dollar, Euro, Japanese yen and British pound. In 2016, the value of the RMB depreciated by approximately 7%. While appreciating approximately by 7% against the U.S. Dollar in 2017, the RMB depreciated approximately by 5% and 1% against the U.S. Dollar in 2018 and 2019, respectively. With the development of the foreign exchange market and progress towards interest rate liberalization and RMB internationalization, the PRC government may in the future announce further changes to the exchange rate system and there is no guarantee that the RMB will not appreciate or depreciate significantly in value against the U.S. Dollar in the future. It is difficult to predict how market forces, including the volatile market conditions arising from the COVID-19 pandemic, or PRC or U.S. government policy may impact the exchange rate between the RMB and the U.S. Dollar in the future.

 

To the extent that we need to convert U.S. Dollars into RMB for our operations, appreciation of the RMB against the U.S. Dollar would have an adverse effect on the RMB amount we receive from the conversion. Conversely, if we decide to convert RMB into U.S. Dollars for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. Dollar against the RMB would have a negative effect on the U.S. Dollar amounts available to us.

 

As of December 31, 2019, we had RMB-denominated cash and cash equivalents of RMB21.2 million, and U.S. Dollar-denominated cash and cash equivalents of US$0.6 million. Assuming we had converted RMB21.2 million into U.S. Dollars at the exchange rate of RMB6.9618 for US$1.00 as of December 31, 2019, our U.S. Dollar cash and cash equivalents would have been US$3.6 million. If the RMB had depreciated by 10% against the U.S. Dollar, our U.S. Dollar cash and cash equivalents would have been US$3.3 million instead. Assuming we had converted US$0.6 million into RMB at the exchange rate of RMB6.9618 for US$1.00 as of December 31, 2019, our RMB cash and cash equivalents would have been RMB25.2 million. If the RMB had appreciated by 10% against the U.S. Dollar, our RMB cash and cash equivalents would have been RMB24.8 million instead.

 

Interest Rate Risk

 

Our exposure to interest rate risk primarily relates to interest expenses incurred by our short-term borrowings and the interest income generated by excess cash, which is mostly held in interest-bearing bank deposits. We have not used derivative financial instruments in our investment portfolio. Interest earning instruments carry a degree of interest rate risk. We have not been exposed to, nor do we anticipate being exposed to, material risks due to changes in market interest rates. However, due to changes in market interest rates, our future interest expense may increase and our future interest income may fall short of expectations.

 

Inflation Risk

 

To date, inflation in China has not materially impacted our results of operations. According to the PRC National Bureau of Statistics, 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 4.5%, respectively. Although we have not been materially affected by inflation in the past, we can provide no assurance that we will not be affected in the future by higher rates of inflation in China.

 

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

 

A.    Debt Securities

 

Not applicable.

 

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B.    Warrants and Rights

 

Not applicable.

 

C.    Other Securities

 

Not applicable.

 

D.    American Depositary Shares

 

Fees and Charges

 

Our ADS holder will be required to pay the following fees under the terms of the deposit agreement:

 

Service

 

Fees

·    Issuance of ADSs (i.e., an issuance of ADS upon a deposit of shares or upon a change in the ADS-to-share ratio), excluding ADS issuances as a result of distributions of shares

 

Up to US$5.00 per 100 ADSs issued

·    Cancellation of ADSs (i.e., a cancellation of ADSs for delivery of deposited property or upon a change in the ADS-to-share ratio)

 

Up to US$5.00 per 100 ADSs cancelled

·    Distribution of cash dividends or other cash distributions (i.e., upon a sale of rights and other entitlements)

 

Up to US$5.00 per 100 ADSs held

·    Distribution of ADSs pursuant to (i) stock dividends or other free stock distributions, or (ii) exercise of rights to purchase additional ADSs

 

Up to US$5.00 per 100 ADSs held

·    Distribution of securities other than ADSs or rights to purchase additional ADSs (i.e., upon a spin-off)

 

Up to US$5.00 per 100 ADSs held

·    ADS Services

 

Up to US$5.00 per 100 ADSs held on the applicable record date(s) established by the depositary bank

 

As an ADS holder you will also be responsible to pay certain charges such as:

 

·                    taxes (including applicable interest and penalties) and other governmental charges;

 

·                    the registration fees as may from time to time be in effect for the registration of shares or other deposited securities on the share register and applicable to transfers of shares or other deposited securities to or from the name of the custodian, the depositary bank or any nominees upon the making of deposits and withdrawals, respectively;

 

·                    certain cable, telex and facsimile transmission and delivery expenses;

 

·                    the expenses and charges incurred by the depositary bank in the conversion of foreign currency;

 

·                    the fees and expenses incurred by the depositary bank in connection with compliance with exchange control regulations and other regulatory requirements applicable to shares, deposited securities, ADSs and ADRs; and

 

·                    the fees and expenses incurred by the depositary bank, the custodian, or any nominee in connection with the servicing or delivery of deposited property.

 

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ADS fees and charges payable upon (i) the issuance of ADSs, and (ii) the cancellation of ADSs are charged to the person to whom the ADSs are issued (in the case of ADS issuances) and to the person whose ADSs are cancelled (in the case of ADS cancellations). In the case of ADSs issued by the depositary bank into DTC, the ADS issuance and cancellation fees and charges may be deducted from distributions made through DTC, and may be charged to the DTC participant(s) receiving the ADSs being issued or the DTC participant(s) holding the ADSs being cancelled, as the case may be, on behalf of the beneficial owner(s) and will be charged by the DTC participant(s) to the account of the applicable beneficial owner(s) in accordance with the procedures and practices of the DTC participants as in effect at the time. ADS fees and charges in respect of distributions and the ADS service fee are charged to the holders as of the applicable ADS record date. In the case of distributions of cash, the amount of the applicable ADS fees and charges is deducted from the funds being distributed. In the case of (i) distributions other than cash and (ii) the ADS service fee, holders as of the ADS record date will be invoiced for the amount of the ADS fees and charges and such ADS fees and charges may be deducted from distributions made to holders of ADSs. For ADSs held through DTC, the ADS fees and charges for distributions other than cash and the ADS service fee may be deducted from distributions made through DTC, and may be charged to the DTC participants in accordance with the procedures and practices prescribed by DTC and the DTC participants in turn charge the amount of such ADS fees and charges to the beneficial owners for whom they hold ADSs.

 

In the event of refusal to pay the depositary bank fees, the depositary bank may, under the terms of the deposit agreement, refuse the requested service until payment is received or may set off the amount of the depositary bank fees from any distribution to be made to the ADS holder. The fees and charges holders of ADSs may be required to pay may vary over time and may be changed by us and the depositary bank. Holders of ADSs will receive prior notice of such changes.

 

The obligations of holders of ADSs to pay ADS fees and charges will survive the termination of the deposit agreement. Upon the resignation or removal of the depositary bank, the depositary bank will retain the right to collect ADS fees and charges incurred prior to such resignation or removal.

 

Fees and Payments from the Depositary to Us

 

The depositary bank may reimburse us for certain expenses incurred by us in respect of the ADR program, by making available a portion of the ADS fees charged in respect of the ADR program or otherwise, upon such terms and conditions as we and the depositary bank agree from time to time. We did not receive any reimbursement from the depositary for the expenses related to the administration and maintenance of the facility for the year ended December 31, 2019.

 

PART II

 

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

 

None.

 

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

 

See “Item 10. Additional Information—B. Memorandum and Articles of Association—Ordinary Shares” for a description of the rights of securities holders, which remain unchanged.

 

ITEM 15. CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including our chief executive officer and our chief financial officer, we carried out an evaluation of the effectiveness of our disclosure controls and procedures, which is defined in Rule 13a-15(e) of the Exchange Act, as of December 31, 2019.

 

Based upon that evaluation, our management has concluded that, due to the outstanding material weaknesses and other control deficiencies described below, as of December 31, 2019, our disclosure controls and procedures were not effective in ensuring that the information required to be disclosed by us in the reports that we file and furnish under the Exchange Act was recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act was accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

 

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Management’s Annual Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f), for our company. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements in accordance with generally accepted accounting principles, and includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with U.S. GAAP and that a company’s receipts and expenditures are being made only in accordance with authorizations of our management and directors, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on our consolidated financial statements.

 

Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable assurance with respect to consolidated financial statements preparation and presentation and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

As required by Section 404 of the Sarbanes-Oxley Act of 2002 and related rules as promulgated by the Securities and Exchange Commission, our management including our chief executive officer and chief financial officer assessed the effectiveness of internal control over financial reporting as of December 31, 2019 using the criteria set forth in the report “Internal Control—Integrated Framework” published by the Committee of Sponsoring Organizations of the Treadway Commission (known as COSO).

 

Based on this evaluation, our management identified two material weaknesses and certain other control deficiencies in our internal controls, as defined in the standards established by U.S. Public Company Accounting Oversight Board, in our internal control over financial reporting as of December 31, 2019. A material weakness is a deficiency, or combination of deficiencies, in internal controls, 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 two material weaknesses relate to: (1) our lack of sufficient financial reporting and accounting personnel with appropriate knowledge of U.S. GAAP and the SEC reporting requirements to properly address complex accounting issues and prepare and review our financial statements and related disclosures in accordance with U.S. GAAP and SEC financial reporting requirements; and (2) the lack of written policies and procedures sufficient to timely record revenues and expenses in our financial statements.

 

Based on this assessment, our management has concluded that our internal control over financial reporting was not effective as of December 31, 2019. These material weaknesses resulted in the restatement of our financial statements as of and for the years ended December 31, 2015 and 2016.

 

Changes in Internal Control over Financial Reporting

 

Since January 1, 2019, we have taken initiatives to improve our internal control over financial reporting to address the material weaknesses and certain other control deficiencies that have been identified, including:

 

·                    In 2019, we implemented a Business Process Management (BPM) system, which allows the company to proactively identify process bottlenecks for continuous business process improvement, integrates compliance into the process life cycle and ensures the company stays in compliance through periodic reviews of documented processes; and improves the transparency of the organizational processes;

 

·                    In 2019, we implemented iWork, an employee timesheet system, which helps tracking and recording the amount of time that an employee spends completing given tasks;

 

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·                    In 2019, we distributed internal policies to optimize our accounts receivable collection management, including a weekly accounts receivable outstanding and aged analysis to assess accounts receivable regularly; and

 

·                    In 2019, we conducted a comprehensive “as is” and gap analysis of our IT systems and approved procurement of a customized ERP system. A committee consisting of all our senior executives was organized to facilitate the assessment and implement any necessary changes.

 

Except for the matters described above to improve our internal control over financial reporting, there were no changes in our internal control over financial reporting that occurred during the period covered by this annual report on Form 20-F that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

 

Our Board of Directors has determined that Mr. Lee, the chairman of our Audit Committee and an independent director, qualifies as an “audit committee financial expert” as defined in Item 16A of Form 20-F.

 

ITEM 16B. CODE OF ETHICS

 

We have adopted a Code of Business Conduct and Ethics that applies to all of our directors, officers and employees. We have never granted a waiver for non-compliance with the policies and procedures set forth in the code of ethics for any director, officer or employee of our company or any of our subsidiaries.

 

A copy of our Code of Business Conduct and Ethics is available on our website at www.gridsum.com.

 

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The following table sets forth the aggregate fees in connection with professional services rendered by Shandong Haoxin Certified Public Accountants Co. Ltd., Marcum Bernstein & Pinchuk LLP and PricewaterhouseCoopers Zhong Tian LLP, each an independent registered public accounting firm, for fiscal year 2018, and rendered by Shandong Haoxin Certified Public Accountants Co. Ltd., an independent registered public accounting firm, for fiscal year 2019.

 

 

 

For the Year Ended December 31,

 

 

 

2018

 

2019

 

 

 

(in thousands)

 

(in thousands)

 

Audit Fees

 

US$

1,357

 

US$

393

 

Audit-Related Fees

 

US$

600

 

 

Tax Fees

 

 

 

All Other Fees

 

US$

28

 

 

Total

 

US$

1,985

 

US$

393

 

 

Audit Fees means the aggregate fees billed in each of the fiscal years listed for professional services rendered by our principal auditors for the audit of our annual financial statements and assistance with and review of documents filed with the SEC.

 

Audit-Related Fees means the aggregate fees billed in each of the fiscal years listed for professional services rendered by our principal auditors for the assurance and related services that are reasonably related to the performance of the audit or review of our financial statements and not reported under “Audit Fees.”

 

Tax Fees means the aggregate fees billed in each of the fiscal years listed for the professional services rendered by our principal auditors for tax compliance, tax advice and tax planning.

 

All Other Fees. There were no other fees billed for the fiscal years ended December 31, 2018 and 2019, respectively.

 

The policy of our Audit Committee is to pre-approve all audit and non-audit services provided by our independent registered public accounting firms, including audit services, audit-related services, tax services and other services as described above, other than those for de minimis services which are approved by the Audit Committee prior to the completion of the audit.

 

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

 

Not applicable.

 

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

 

None.

 

ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

 

Not applicable.

 

ITEM 16G. CORPORATE GOVERNANCE

 

We are incorporated in the Cayman Islands and our corporate governance practices are governed by applicable Cayman Islands law. In addition, because our ADSs are listed on The Nasdaq Stock Market, we are subject to Nasdaq’s corporate governance requirements.

 

Nasdaq Marketplace Rule 5615(a)(3) permits a foreign private issuer like us to follow home country practices in lieu of certain requirements of Rule 5600, provided that such foreign private issuer discloses in its annual report filed with the SEC each requirement of Rule 5600 that it does not follow and describes the home country practice followed in lieu of such requirement.

 

We currently follow our home country practices that does not require a majority of our directors to be independent and that does not require us to solicit proxy and hold meetings of our shareholders every year. In addition, our Chief Executive Officer, who is not an independent director, serves as a member of our nominating and corporate governance committee, and our independent directors do not hold regularly scheduled meetings at which only independent directors are present. As a result, we may have less independent oversight over the management than other companies that are listed on The Nasdaq Stock Market. Other than the practices described above, there are no significant differences between our corporate governance practices and those followed by U.S. domestic companies under the rules of The Nasdaq Stock Market.

 

ITEM 16H. MINE SAFETY DISCLOSURE

 

Not applicable.

 

PART III

 

ITEM 17. FINANCIAL STATEMENTS

 

We have elected to provide financial statements pursuant to Item 18.

 

ITEM 18. FINANCIAL STATEMENTS

 

The consolidated financial statements of Gridsum Holding Inc., its subsidiaries and its consolidated affiliated entities are included at the end of this annual report.

 

ITEM 19. EXHIBITS

 

EXHIBIT INDEX

 

 

 

 

 

 

Incorporated by Reference

Exhibit
Number

 

Exhibit Title

 

Form

 

File No.

 

Exhibit
No.

 

Filing Date

1.1

 

Fifth Amended and Restated Memorandum and Articles of Association of the registrant

 

F-1

 

333-213348

 

3.3

 

August 26, 2016

 

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2.1

 

Specimen Certificate for Class B ordinary shares

 

F-1

 

333-213348

 

4.2

 

August 26, 2016

2.2

 

Deposit Agreement among the registrant, the depositary and all holders and beneficial owners of the American Depositary Shares issued thereunder

 

S-8

 

333-216798

 

4.3

 

March 17, 2017

2.3

 

Specimen American Depositary Receipt (included in Exhibit 2.2)

 

 

 

 

 

 

 

 

2.4

 

Second Amended and Restated Shareholders’ Agreement dated June 30, 2015 among the registrant and certain other parties

 

F-1

 

333-213348

 

4.4

 

August 26, 2016

2.5*

 

Description of registrant’s securities

 

 

 

 

 

 

 

 

4.1

 

Gridsum Holding Inc. Stock Option Plan

 

6-K

 

001-37871

 

99.1

 

March 17, 2017

4.2

 

Gridsum Holding Inc. Equity Incentive Plan

 

6-K

 

001-37871

 

99.2

 

March 17, 2017

4.3

 

Form of Indemnification Agreement between the registrant and members of its board of directors and its executive officers

 

F-1

 

333-213348

 

10.3

 

August 26, 2016

4.4

 

Form of Employment Agreement between the registrant and its executive officers

 

F-1

 

333-213348

 

10.4

 

August 26, 2016

4.5

 

Exclusive Business Cooperation Agreement dated December 22, 2014 between Dissector (Beijing) Technology Co., Ltd. and Gridsum Holding (Beijing) Co., Ltd.

 

F-1

 

333-213348

 

10.5

 

August 26, 2016

4.6

 

Exclusive Option Agreements dated December 22, 2014 among Dissector (Beijing) Technology Co., Ltd., Gridsum Holding (Beijing) Co., Ltd. and the shareholders of Gridsum Holding (Beijing) Co.,  Ltd.

 

F-1

 

333-213348

 

10.6

 

August 26, 2016

4.7

 

Shareholders’ Voting Rights Proxy Agreements dated December 22, 2014 among Dissector (Beijing) Technology Co., Ltd., Gridsum Holding (Beijing) Co., Ltd. and the shareholders of Gridsum Holding (Beijing) Co.,  Ltd.

 

F-1

 

333-213348

 

10.7

 

August 26, 2016

4.8

 

Equity Pledge Agreements dated December 22, 2014 among Dissector (Beijing) Technology Co., Ltd., Gridsum Holding (Beijing) Co., Ltd. and the shareholders of Gridsum Holding (Beijing) Co., Ltd.

 

F-1

 

333-213348

 

10.8

 

August 26, 2016

4.9

 

English Translation of the Cooperation Agreement, dated March 16, 2012, by and between Beijing Gridsum Technology Co., Ltd. and the State Information Center of China

 

F-1

 

333-213348

 

10.9

 

August 26, 2016

4.10

 

US$40 Million Convertible Note issued by the registrant, dated May 5, 2018

 

6-K

 

001-37871

 

99.2

 

May 7, 2018

4.11

 

Registration Rights Agreement dated May 5, 2018 between the registrant and FutureX Innovation SPC (on behalf of and for the account of New Technology Fund II SP as one of its segregated portfolios)

 

6-K

 

001-37871

 

99.3

 

May 7, 2018

 

111


Table of Contents

 

4.12

 

Convertible Note Purchase Agreement dated April 30, 2018 by and between the registrant and FutureX Innovation SPC (on behalf of and for the account of New Technology Fund II SP as one of its segregated portfolios)

 

20-F

 

001-37871

 

4.13

 

January 7, 2019

4.13

 

Registration Rights Agreement dated March 4, 2019 between the registrant and certain other parties

 

6-K

 

001-37871

 

99.1

 

March 4, 2019

4.14

 

Warrant to Purchase Ordinary Shares issued by the registrant to Hammer Capital China Limited, dated May 30, 2019

 

6-K

 

001-37871

 

99.1

 

June 3, 2019

4.15

 

Registration Rights Agreement dated May 30, 2019 between the registrant and Hammer Capital China Limited

 

6-K

 

001-37871

 

99.2

 

June 3, 2019

4.16

 

Extension Agreement relating to the US$40 Million Convertible Note issued by the registrant, dated March 3, 2020

 

6-K

 

001-37871

 

99.1

 

March 3, 2020

8.1*

 

List of significant subsidiaries and consolidated affiliated entities

 

 

 

 

 

 

 

 

12.1*

 

CEO Certification required by Rule 13a-14(a)

 

 

 

 

 

 

 

 

12.2*

 

CFO Certification required by Rule 13a-14(a)

 

 

 

 

 

 

 

 

13.1**

 

CEO Certification required by Rule 13a-14(b)

 

 

 

 

 

 

 

 

13.2**

 

CFO Certification required by Rule 13a-14(b)

 

 

 

 

 

 

 

 

15.1*

 

Consent of Independent Registered Public Accounting Firm

 

 

 

 

 

 

 

 

15.2*

 

Consent of Merits & Tree Law Offices

 

 

 

 

 

 

 

 

101.INS*

 

XBRL Instance Document.

 

 

 

 

 

 

 

 

101.SCH*

 

XBRL Taxonomy Extension Schema Document.

 

 

 

 

 

 

 

 

101.CAL*

 

XBRL Taxonomy Extension Calculation Linkbase Document.

 

 

 

 

 

 

 

 

101.DEF*

 

XBRL Taxonomy Extension Definition Linkbase Document.

 

 

 

 

 

 

 

 

101.LAB*

 

XBRL Taxonomy Extension Label Linkbase Document.

 

 

 

 

 

 

 

 

101.PRE*

 

XBRL Taxonomy Extension Presentation Linkbase Document.

 

 

 

 

 

 

 

 

 


*       Filed herewith

**     Furnished herewith

 

112


Table of Contents

 

SIGNATURES

 

The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.

 

 

Gridsum Holding Inc.

 

 

 

By:

/s/ Guosheng Qi

 

Name:

Guosheng Qi

 

Title:

Chief Executive Officer and Chairman

 

 

Date: June 2, 2020

 


Table of Contents

 

Report of Independent Registered Public Accounting Firm

 

To the shareholders and the board of directors of Gridsum Holding Inc.

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheets of Gridsum Holding Inc. and its subsidiaries (the "Company") as of December 31, 2019 and 2018, the related consolidated statements of comprehensive loss, shareholders’ equity and cash flows, for each of the three years in the period ended December 31, 2019, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

 

The Company’s Ability to Continue as a Going Concern

 

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered substantial losses from operations in previous years, has a working capital deficiency, and has stated that substantial doubt exists about the Company’s ability to continue as a going concern. Management's evaluation of the events and conditions and management’s plans regarding these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

Change in Accounting Principle

 

As discussed in Note 2 to the financial statements, the Company has changed its method of accounting for leases in 2019 due to the adoption of the guidance in Accounting Standards Codification (“ASC”) Topic 842, Leases (“Topic 842”).

 

Basis for Opinion

 

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ Shandong Haoxin Certified Public Accountants Co., Ltd.

Shandong Haoxin Certified Public Accountants Co., Ltd. 

 

We have served as the Company's auditor since 2019.

Weifang, the People’s Republic of China

 

June 2, 2020

 

F-2


Table of Contents

 

Gridsum Holding Inc.

 

CONSOLIDATED BALANCE SHEETS

 

As of December 31, 2018 and 2019

(In thousands, except for share and per share data)

 

 

 

As of December 31,

 

 

 

2018

 

2019

 

2019

 

 

 

RMB

 

RMB

 

US$

 

ASSETS

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

92,684

 

25,206

 

3,621

 

Restricted cash

 

1,334

 

1,389

 

200

 

Notes Receivable

 

 

3,753

 

539

 

Accounts receivable, net

 

397,969

 

191,299

 

27,477

 

Prepayments and other current assets

 

294,904

 

117,269

 

16,845

 

Total current assets

 

786,891

 

338,916

 

48,682

 

 

 

 

 

 

 

 

 

Non-current assets:

 

 

 

 

 

 

 

Investment in associates

 

5,000

 

5,000

 

718

 

Property and equipment, net

 

62,328

 

45,892

 

6,592

 

Intangible assets, net

 

13,840

 

19,735

 

2,835

 

Goodwill

 

537

 

537

 

77

 

Deferred tax assets

 

46,359

 

73,971

 

10,625

 

Other non-current assets

 

435

 

 

 

Operating lease right-of-use assets

 

 

112,921

 

16,220

 

Total non-current assets

 

128,499

 

258,056

 

37,067

 

Total assets

 

915,390

 

596,972

 

85,749

 

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY(DEFICIENCY)

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Short-term bank loans

 

5,000

 

38,000

 

5,458

 

Accounts payable

 

97,293

 

78,776

 

11,315

 

Salary and welfare payables

 

65,451

 

75,630

 

10,864

 

Taxes payable

 

110,529

 

115,990

 

16,661

 

Deferred revenues

 

36,126

 

11,328

 

1,627

 

Advances from customers

 

154,731

 

16,130

 

2,317

 

Accrued expenses and other current liabilities

 

147,940

 

95,701

 

13,747

 

Derivative liabilities

 

596

 

 

 

Convertible note

 

242,702

 

278,472

 

40,000

 

Operating lease liabilities current

 

 

39,219

 

5,633

 

Total current liabilities

 

860,368

 

749,246

 

107,622

 

 

 

 

 

 

 

 

 

Non-current liabilities:

 

 

 

 

 

 

 

Long-term borrowing

 

 

99,274

 

14,260

 

Corporate bond

 

 

18,545

 

2,664

 

Deferred tax liabilities

 

212

 

175

 

25

 

Other non-current liabilities

 

 

1,248

 

179

 

Derivative liabilities non-current

 

 

1,974

 

284

 

Operating lease liabilities non-current

 

 

84,220

 

12,097

 

Total non-current liabilities

 

212

 

205,436

 

29,509

 

Total liabilities

 

860,580

 

954,682

 

137,131

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity (deficiency):

 

 

 

 

 

 

 

Ordinary shares—Class A (US$0.001 par value; 20,000,000 shares authorized, 4,543,461 shares issued and outstanding as of December 31, 2018 and 2019)

 

31

 

31

 

4

 

Ordinary shares—Class B (US$0.001 par value; 180,000,000 shares authorized; 26,289,929 and 30,032,890 shares issued and outstanding as of December 31, 2018 and 2019, respectively)

 

177

 

202

 

30

 

Additional paid-in capital

 

1,146,253

 

1,272,959

 

182,848

 

Statutory reserve

 

12,903

 

12,903

 

1,853

 

Accumulated other comprehensive loss

 

(35,496

)

(37,858

)

(5,437

)

Accumulated deficit

 

(1,077,409

)

(1,615,338

)

(232,029

)

Total Gridsum’s shareholders’ equity (deficiency)

 

46,459

 

(367,101

)

(52,731

)

Non-controlling interests

 

8,351

 

9,391

 

1,349

 

Total shareholders’ equity (deficiency)

 

54,810

 

(357,710

)

(51,382

)

Total liabilities and shareholders’ equity (deficiency)

 

915,390

 

596,972

 

85,749

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-3


Table of Contents

 

Gridsum Holding Inc.

 

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

 

For the Years Ended December 31, 2017, 2018 and 2019

(In thousands, except for share and per share data)

 

 

 

For the Year Ended
December 31,

 

 

 

2017

 

2018

 

2019

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

Revenues:

 

 

 

 

 

 

 

 

 

Enterprise

 

377,013

 

387,574

 

258,903

 

37,189

 

e-Government and other

 

102,216

 

53,117

 

71,796

 

10,313

 

Less: Business tax and surcharges

 

(9,696

)

(9,444

)

(4,147

)

(596

)

Net revenues

 

469,533

 

431,247

 

326,552

 

46,906

 

Cost of revenues(1)

 

(94,640

)

(100,867

)

(77,361

)

(11,112

)

Gross profit

 

374,893

 

330,380

 

249,191

 

35,794

 

Operating expenses(1):

 

 

 

 

 

 

 

 

 

Sales and marketing expenses

 

(192,413

)

(166,176

)

(144,401

)

(20,742

)

Research and development expenses

 

(257,921

)

(533,586

)

(320,402

)

(46,022

)

General and administrative expenses

 

(143,743

)

(182,289

)

(319,653

)

(45,915

)

Total operating expenses

 

(594,077

)

(882,051

)

(784,456

)

(112,679

)

Losses from operations

 

(219,184

)

(551,671

)

(535,265

)

(76,885

)

Other income/(expense):

 

 

 

 

 

 

 

 

 

Foreign currency exchange loss

 

(8,552

)

(9,719

)

(729

)

(105

)

Interest expense, net

 

(5,430

)

(9,878

)

(14,028

)

(2,015

)

Other income/(expense), net

 

(1,683

)

1,005

 

(788

)

(113

)

Amortization of debt discount

 

 

(25,337

)

(40,918

)

(5,878

)

Gain on change in fair value of derivative liabilities

 

 

57,890

 

27,829

 

3,997

 

Loss before income tax

 

(234,849

)

(537,710

)

(563,899

)

(80,999

)

Income tax (expense)/benefit

 

(4,275

)

15,165

 

27,010

 

3,880

 

Net loss

 

(239,124

)

(522,545

)

(536,889

(77,119

Less: Net (loss) income attributable to non-controlling interests

 

(128

)

(1,220

)

1,040

 

150

 

Net loss attributable to Gridsum Holding Inc.

 

(238,996

)

(521,325

)

(537,929

)

(77,269

)

 

 

 

 

 

 

 

 

 

 

Net loss

 

(239,124

)

(522,545

)

(536,889

)

(77,119

)

Foreign currency translation adjustment, net of tax

 

(20,452

)

(4,957

)

(2,362

)

(340

)

Comprehensive loss

 

(259,576

)

(527,502

)

(539,251

)

(77,459

)

Less: Comprehensive (loss) income attributable to non-controlling interests

 

(128

)

(1,220

)

1,040

 

150

 

Comprehensive loss attributable to Gridsum Holding Inc.

 

(259,448

)

(526,282

)

(540,291

)

(77,609

)

Net loss per share attributable to Gridsum’s ordinary shareholders, basic and diluted

 

(7.90

)

(16.91

)

(15.91

)

(2.29

)

Weighted average shares outstanding used in computing net loss per share attributable to Gridsum’s ordinary shareholders

 

30,243,250

 

30,827,600

 

33,810,862

 

33,810,862

 

 


Note:

 

(1) Share-based compensation expenses were allocated in cost of revenues and operating expenses as follows:

 

 

 

For the Year Ended
December 31,

 

 

 

2017

 

2018

 

2019

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

Cost of revenues

 

501

 

801

 

548

 

79

 

Sales and marketing expenses

 

4,739

 

6,810

 

8,537

 

1,226

 

Research and development expenses

 

8,641

 

16,310

 

16,001

 

2,298

 

General and administrative expenses

 

9,046

 

15,105

 

27,364

 

3,931

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-4


Table of Contents

 

Gridsum Holding Inc.

 

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (DEFICIENCY)

 

For the Years Ended December 31, 2017, 2018 and 2019

(In thousands, except for share and per share data)

 

 

 

 

 

 

 

Additional

 

 

 

Accumulated
Other

 

 

 

 

 

Total

 

 

 

Ordinary Shares

 

Paid-in

 

Statutory

 

Comprehensive

 

Accumulated

 

Non-controlling

 

Shareholders’

 

 

 

Shares

 

Amount

 

Capital

 

Reserve

 

Income /(Loss)

 

Deficit

 

Interests

 

Equity/(Deficit)

 

 

 

 

 

RMB

 

RMB

 

RMB

 

RMB

 

RMB

 

RMB

 

RMB

 

Balances as of December 31, 2016

 

29,735,166

 

199

 

1,090,991

 

6,662

 

(10,087

)

(310,847

)

331

 

777,249

 

Share-based compensation expenses

 

 

 

22,927

 

 

 

 

 

22,927

 

Appropriation of statutory reserves

 

 

 

 

68

 

 

(68

)

 

 

Net loss

 

 

 

 

 

 

(238,996

)

(128

)

(239,124

)

Issuance of ordinary shares upon exercise of share options and restricted stock units

 

1,088,662

 

8

 

3,083

 

 

 

 

 

3,091

 

Consolidation of Hainatianchuang

 

 

 

(9,800

)

 

 

 

9,800

 

 

Foreign currency translation adjustments, net of tax

 

 

 

 

 

(20,452

)

 

 

(20,452

)

Balances as of December 31, 2017

 

30,823,828

 

207

 

1,107,201

 

6,730

 

(30,539

)

(549,911

)

10,003

 

543,691

 

Share-based compensation expenses

 

 

 

39,026

 

 

 

 

 

39,026

 

Appropriation of statutory reserves

 

 

 

 

6,173

 

 

(6,173

)

 

 

Net loss

 

 

 

 

 

 

(521,325

)

(1,220

)

(522,545

)

Issuance of ordinary shares upon exercise of share options and restricted stock units

 

9,562

 

1

 

26

 

 

 

 

 

27

 

Purchase of equity shares of Guoxinwangyan

 

 

 

 

 

 

 

(432

)

(432

)

Foreign currency translation adjustments, net of tax

 

 

 

 

 

(4,957

)

 

 

(4,957

)

Balances as of December 31, 2018

 

30,833,390

 

208

 

1,146,253

 

12,903

 

(35,496

)

(1,077,409

)

8,351

 

54,810

 

Share-based compensation expenses

 

 

 

52,450

 

 

 

 

 

52,450

 

Net loss

 

 

 

 

 

 

(537,929

)

1,040

 

(536,889

)

Issuance of ordinary shares through share subscription

 

3,461,902

 

23

 

73,859

 

 

 

 

 

73,882

 

Issuance of ordinary shares upon exercise of share options and restricted stock units

 

281,059

 

2

 

397

 

 

 

 

 

399

 

Foreign currency translation adjustments, net of tax

 

 

 

 

 

(2,362

)

 

 

(2,362

)

Balances as of December 31, 2019

 

34,576,351

 

233

 

1,272,959

 

12,903

 

(37,858

)

(1,615,338

)

9,391

 

(357,710

)

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-5


Table of Contents

 

Gridsum Holding Inc.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

For the Years Ended December 31, 2017, 2018 and 2019

(In thousands, except for share and per share data)

 

 

 

For the Year Ended
December 31,

 

 

 

2017

 

2018

 

2019

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

 

Net Loss

 

(239,124

)

(522,545

)

(536,889

)

(77,119

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

 

 

Provision for allowance for doubtful accounts

 

24,490

 

16,532

 

137,865

 

19,803

 

Share-based compensation expenses

 

22,927

 

39,026

 

52,450

 

7,534

 

Depreciation and amortization expenses

 

31,474

 

34,701

 

35,262

 

5,065

 

Deferred tax expenses

 

(11,296

)

(28,004

)

(27,649

)

(3,972

)

Foreign currency exchange loss, net

 

20,452

 

4,957

 

2,361

 

339

 

Loss on disposal of equipment and leasehold improvement

 

138

 

4,284

 

762

 

109

 

Amortization of operating lease right-of-use assets

 

 

 

33,951

 

4,877

 

Amortization of debt discount

 

 

 

40,918

 

5,878

 

Amortization of discounts and issuance cost of the corporate bond

 

 

 

424

 

61

 

Change in fair value of derivative liabilities

 

 

 

(27,829

)

(3,997

)

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

Accounts receivable

 

(267,554

)

184,779

 

68,805

 

9,883

 

Notes receivable

 

(6,000

)

6,000

 

(3,753

)

(539

)

Prepayments and other current assets

 

(102,361

)

12,946

 

178,590

 

25,653

 

Accounts payable

 

158,588

 

(110,862

)

(18,517

)

(2,660

)

Salary and welfare payable

 

18,570

 

4,756

 

8,941

 

1,284

 

Taxes payable

 

36,473

 

7,198

 

5,462

 

785

 

Deferred revenues

 

(7,666

)

22,735

 

(24,798

)

(3,562

)

Advances from customers

 

7,465

 

37,884

 

(138,601

)

(19,909

)

Accrued expenses and other current liabilities

 

6,720

 

52,483

 

(47,762

)

(6,861

)

Other non-current liabilities

 

 

 

1,248

 

179

 

Operating lease liabilities

 

 

 

(30,787

)

(4,422

)

Net cash used in operating activities

 

(306,704

)

(233,130

)

(289,546

)

(41,591

)

Cash flows from investing activities:

 

 

 

 

 

 

 

 

 

Purchase of property, equipment and software

 

(22,951

)

(52,275

)

(23,437

)

(3,367

)

Proceeds from disposal of property, equipment and software

 

31

 

44

 

122

 

18

 

Maturity of time deposit

 

67,574

 

 

 

 

Acquisition of subsidiaries, net of cash acquired

 

(1,857

)

 

 

 

Long term investment

 

 

(5,000

)

 

 

Net cash provided by/(used in) investing activities

 

42,797

 

(57,231

)

(23,315

)

(3,349

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

 

Proceeds from bank loans

 

266,019

 

5,000

 

60,000

 

8,618

 

Repayment of bank loan

 

(65,000

)

(266,019

)

(27,000

)

(3,878

)

Proceeds from issuance of ordinary shares

 

3,091

 

27

 

74,281

 

10,670

 

Payment for IPO costs

 

(3,362

)

 

 

 

Capital injection from non-controlling interests

 

(9,800

)

 

 

 

Proceeds from convertible note

 

 

234,039

 

 

 

Proceeds from long-term borrowing

 

 

 

120,000

 

17,237

 

Proceeds from issuance of corporate bond, net of discount and issuance cost

 

 

 

18,121

 

2,603

 

Net cash provided by/(used in) financing activities

 

190,948

 

(26,953

)

245,402

 

35,250

 

Effect of exchange rate changes on Cash, cash equivalents and restricted cash

 

(39,485

)

(678

)

36

 

6

 

Net decrease in Cash, cash equivalents and restricted cash

 

(112,444

)

(317,992

)

(67,423

)

(9,684

)

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

 

524,454

 

412,010

 

94,018

 

13,505

 

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

 

412,010

 

94,018

 

26,595

 

3,821

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

 

 

 

Cash paid for income taxes

 

1,820

 

114

 

3,280

 

471

 

Cash paid for interest

 

5,614

 

649

 

3,784

 

544

 

Supplemental schedule of non-cash investing activities:

 

 

 

 

 

 

 

 

 

Property and equipment purchases financed by accrued expenses and other current liabilities

 

6,033

 

4,371

 

2,624

 

377

 

Property and equipment purchases transferred from other non-current assets

 

3,460

 

35,524

 

5,388

 

774

 

Initial recognition of operating lease right-of-use assets and lease liabilities

 

 

 

154,226

 

22,153

 

Allocation of fair value of derivative liabilities for issuance of warrants attached to the loan from related party

 

 

 

29,036

 

4,171

 

 

 

 

 

 

 

 

 

 

 

The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the statement of financial position that sum to the total of the same amounts shown in the statement of cash flows:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

166,690

 

92,684

 

25,206

 

3,621

 

Restricted cash

 

245,320

 

1,334

 

1,389

 

2000

 

Total cash, cash equivalents, and restricted cash shown in the consolidated statements of cash flows

 

412,010

 

94,018

 

26,595

 

3,821

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-6


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

1.

Organization and Principal Activities

 

 

(a)

Principal activities

 

Gridsum Holding Inc. (“Company”), through its consolidated subsidiaries and variable interest entities (“VIEs”) (collectively referred to as the “Group”), provides sophisticated data analysis software for multinational and domestic enterprises and government agencies in the People’s Republic of China (“PRC”).

 

The accompanying consolidated financial statements include the financial statements of the Company, its subsidiaries, VIEs and VIE subsidiaries. As of December 31, 2019, the Company’s operating subsidiaries, operating VIE and operating VIE subsidiaries were as follows:

 

Operating Subsidiaries

 

Equity
interests held

 

Place and Date of Incorporation

 

Gridsum Holding (China) Limited

 

100

%

Hong Kong, July 2014

 

Dissector (Beijing) Technology Co., Ltd.

 

100

%

PRC, October 2014

 

 

Operating VIE

 

Economic
interests held

 

Place and Date of Incorporation

 

Gridsum Holding (Beijing) Co., Ltd

 

100

%

PRC, August 2014

 

 

Operating VIE Subsidiaries

 

Economic
interests held

 

Place and Date of Incorporation

 

Beijing Gridsum Technology Co., Ltd.

 

100

%

PRC, December 2005

 

Beijing Moment Everlasting Ad Co., Ltd.

 

100

%

PRC, January 2011

 

Guoxinjunhe (Beijing) Technology Co., Ltd.

 

100

%

PRC, April 2012

 

Beijing Yunyang Ad Co., Ltd.

 

100

%

PRC, March 2013

 

Beijing Guoxinwangyan Technology Co., Ltd.

 

100

%

PRC, August 2015

 

Beijing Gridsum Yizhun Technology Co., Ltd.

 

100

%

PRC, February 2016

 

Beijing Zhixunyilong Software Co., Ltd.

 

100

%

PRC, May 2017

 

Beijing Gridsum Wang’an Technology Co., Ltd.

 

100

%

PRC, June 2017

 

Beijing Gridsum Hulian Technology Co., Ltd.

 

100

%

PRC, March 2018

 

 

(b)

Reorganization

 

The Company was incorporated in the Cayman Islands on July 21, 2014.

 

The Group began operations in December 2005 through Beijing Gridsum Technology Co., Ltd (“Beijing Gridsum”), a PRC domestic company established by our founders. Beijing Gridsum established two wholly owned subsidiaries, Beijing Moment Everlasting Ad Co., Ltd. (“Beijing Moment”) and Guoxinjunhe (Beijing) Technology Co., Ltd. (“Guoxinjunhe”), in January 2011 and April 2012, respectively. Beijing Moment established a wholly owned subsidiary, Beijing Yunyang Ad Co., Ltd. (“Beijing Yunyang”) in March 2013.

 

From July to December 2014, the Group undertook a reorganization (“2014 Restructuring”) and established the Company under the laws of the Cayman Islands; the Company established a wholly owned Hong Kong subsidiary, Gridsum Holding (China) Limited (“Gridsum HK”), which in turn established a wholly owned subsidiary in China, Dissector (Beijing) Technology Co. Ltd. (“WFOE”). Also as part of this 2014 Restructuring, Gridsum Holding (Beijing) Co., Ltd. (“Gridsum PRC Holding”) was established to acquire full ownership of Beijing Gridsum, Beijing Moment and Guoxinjunhe from Beijing Gridsum.

 

On December 22, 2014, the WFOE entered into a series of contractual agreements (“VIE agreements”) with Gridsum PRC Holding and the shareholders of Gridsum PRC Holding, as a result of which Gridsum PRC Holding became a VIE of which the Company is the primary beneficiary, and the Company consolidates the financial results of Gridsum PRC Holding and its subsidiaries. Prior to the 2014 Restructuring, the Group was controlled by a predecessor Cayman Islands entity, which through another restructuring in 2010 (“2010 Restructuring”) controlled the Group entities in China according to a set of contractual arrangements containing terms and conditions identical to those of the VIE agreements. The 2010 Restructuring was undertaken in order to facilitate an international financing completed in September 2010 as well as to comply with relevant government regulations and policies in the PRC. The VIE agreements have superseded the 2010 contractual arrangements. Prior to the 2010 Restructuring, the Group’s founders and management held 100% of the beneficial ownership interest in Beijing Gridsum. In the 2010 Restructuring, the predecessor Cayman Islands entity was established with the same beneficial ownership structure as Beijing Gridsum. Therefore, the Group’s founders and management held 100% of the beneficial ownership interests in, and maintained control of, the Group immediately before and after the 2010 restructuring.

 

F-7


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

In the 2014 Restructuring, the Company was established with the same beneficial ownership structure as the predecessor Cayman Islands entity. Therefore, the Group’s founders, management and the then outstanding Preferred Shareholders held 100% of the beneficial ownership interests in, and maintained control of, the Group immediately before and after the 2014 restructuring.

 

The entities included in the 2010 Restructuring and 2014 Restructuring were under common control and the two reorganizations have been accounted for in a manner akin to a pooling of interest as if the Company, through its wholly owned subsidiaries, had been in existence and been the primary beneficiary of the VIEs throughout the periods presented in the consolidated financial statements.

 

(c)

Contracts with Variable Interest Entitles

 

To comply with applicable PRC laws and regulations, the Group conducts operations in China principally through Beijing Gridsum, Beijing Moment, Guoxinjunhe, Beijing Yunyang, Beijing Guoxinwangyan Technology Co., Ltd. and Beijing Gridsum Yizhun Technology Co., Ltd. The WFOE has entered into a series of contractual arrangements with the parent of these companies, Gridsum PRC Holding, and the shareholders of Gridsum PRC Holding. These contractual arrangements allow the Company to exercise effective control over Gridsum PRC Holding and to receive substantially all of the economic benefits of Gridsum PRC Holding. As a result of these contractual arrangements, the Company is the primary beneficiary of Gridsum PRC Holding, and the Company treats it as a VIE in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The following is a summary of the currently effective contractual arrangements among the WFOE, Gridsum PRC Holding and the shareholders of Gridsum PRC Holding:

 

Exclusive Business Cooperation Agreement. Under the Exclusive Business Cooperation Agreement dated December 22, 2014, between the WFOE and Gridsum PRC Holding, Gridsum PRC Holding has appointed the WFOE as its exclusive provider of technical support, business support and related consulting services and has agreed to accept all consultations and services provided by the WFOE and, without prior written consent of the WFOE, not to accept the same or any similar consultations and/or services provided by, or establish similar cooperation relationships with, any third party. In consideration of the services provided by the WFOE, Gridsum PRC Holding has agreed to pay the WFOE, on a quarterly basis, service fees equal to 90% of Gridsum PRC Holding’s net income (which equals gross income less mutually agreed costs). The parties can reasonably adjust the calculation of such service fees. The WFOE shall have exclusive and proprietary rights and interests in all rights, ownership, interests and intellectual property owned and used by the WFOE during the performance of the agreement. The term of the agreement is 10 years and may be extended if confirmed in writing by the WFOE prior to expiration (and Gridsum PRC Holding shall unconditionally accept such extension). Gridsum PRC Holding shall not terminate the agreement prior to its expiration, unless the WFOE commits gross negligence or fraudulent act against Gridsum PRC Holding, whereas the WFOE may terminate the agreement upon giving 30 days’ prior written notice to Gridsum PRC Holding at any time.

 

Exclusive Option Agreements. Under the Exclusive Option Agreements dated December 22, 2014, between the WFOE, Gridsum PRC Holding and the shareholders of Gridsum PRC Holding, the shareholders of Gridsum PRC Holding granted to the WFOE an irrevocable and exclusive right to purchase, or designate other person(s) to purchase, to the extent permitted by PRC laws, at any time all or part of such shareholders’ equity interests in Gridsum PRC Holding. The purchase price shall be equal to the registered capital of Gridsum PRC Holding multiplied by the portion of equity interests to be purchased and RMB10.00, or, if there is any mandatory provision regarding the purchase price under PRC laws, the lowest price permitted by PRC laws. Without prior written consent of the WFOE, Gridsum PRC Holding shall not: (i) supplement, change or amend its articles of association, increase or decrease its registered capital or change its capital structure in any manner, (ii) sell, transfer, mortgage or dispose of or create security interest on, its assets, business or legal right to collect interests, (iii) create, succeed to, guarantee or permit any debt, except for debts arising in the course of the ordinary or daily business operation, (iv) enter into any material contract (i.e., any contract with a value exceeding RMB1,000,000), or (v) provide loan or credit to Gridsum PRC Holding’s shareholders in any form; and the shareholders of Gridsum PRC Holding shall not sell, transfer, mortgage or dispose of or create security interest on, such shareholders’ legal or beneficial interest in the equity interests in Gridsum PRC Holding. The term of these agreements is 10 years and may be renewed at the WFOE’s election.

 

F-8


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

Shareholders’ Voting Rights Proxy Agreements. Under the Shareholders’ Voting Rights Proxy Agreements dated December 22, 2014, between the WFOE, Gridsum PRC Holding and the shareholders of Gridsum PRC Holding, the shareholders of Gridsum PRC Holding irrevocably authorize the WFOE or its designee to act on their behalf as their exclusive agent and attorney with respect to all matters concerning their shareholder rights, including, without limitation, to propose, convene and attend shareholder meetings as the proxy of such shareholders and to exercise all of such shareholder’s voting rights provided under PRC laws or the articles of association of Gridsum PRC Holding. Each agreement will remain effective until the equity interest of the respective shareholder in Gridsum PRC Holding is transferred to the WFOE.

 

Equity Pledge Agreements. Under the Equity Pledge Agreements dated December 22, 2014, between the WFOE, Gridsum PRC Holding and the shareholders of Gridsum PRC Holding, the shareholders of Gridsum PRC Holding pledge all of their equity interests in Gridsum PRC Holding to the WFOE as security for the performance of the obligations of Gridsum PRC Holding and its shareholders under the Exclusive Business Cooperation Agreement, the Exclusive Option Agreements and the Shareholders’ Voting Rights Proxy Agreements. In the event of breach of any secured obligation by Gridsum PRC Holding or the respective shareholder, the WFOE is entitled to all remedial rights and powers afforded under PRC laws, including to receive proceeds from auctions or sale-offs of the pledged equity. No dividend or distribution can be paid or made to the shareholders in respect of the pledged equity unless consented by the WFOE, and the dividends or distributions received by the shareholders shall first be applied to satisfy the secured obligations. The pledges will be released upon the full and complete performance of the secured obligations and the full payment of losses and fees resulted from a breach of those agreements by Gridsum PRC Holding or its shareholders. The equity pledges have been registered with the registration authorities of industry and commerce in accordance with PRC laws.

 

In addition to the contractual agreements described above, the Company has entered into an Exclusive Rights Arrangement with the predecessor Cayman Islands entity on December 22, 2014. Under this agreement, the Company exercises effective control over the predecessor Cayman Islands entity and receives substantially all of the economic benefits of the predecessor Cayman Islands entity. As a result of this agreement, the Company is the primary beneficiary of the predecessor Cayman Islands entity, and the Company treats it as a VIE. The Company consolidates the financial results of the predecessor Cayman Islands entity and its subsidiaries in the Company’s consolidated financial statements. The following is a summary of the Exclusive Rights Arrangement among the Company, the predecessor Cayman Islands entity and the shareholders of the predecessor Cayman Islands entity that was in effect until termination on August 10, 2015 in connection with the completion of the 2014 restructuring.

 

All the shareholders agreed to irrevocably assign and entrust to the Company any and all of their respective voting rights and dividends rights with respect to any and all of the equity securities they held in the predecessor Cayman Islands entity. All the actions associated with any shareholder’s voting rights conducted by the Company shall be deemed as such shareholders’ own actions, and all the shareholders’ resolutions executed by the Company shall be deemed to be executed by all of the shareholders themselves. Each shareholder agreed to refrain from exercising any of the voting rights associated with its shareholding in the predecessor Cayman Islands entity, all of which have been authorized and entrusted to the Company. If a dividend or other distribution is declared, paid or set aside, each shareholder shall immediately transfer to the Company any and all of such dividend or distribution. No dividend or distribution, whether in cash, in property or in any other equity securities of the predecessor Cayman Islands entity, shall be declared, paid, set aside or made without the written consent of the Company.

 

Risks in relation to the VIE structure

 

In the opinion of the Company’s management, the contractual arrangements discussed above have resulted in the Company and the WFOE having the power to direct activities that most significantly impact the VIEs and VIE subsidiaries, including appointing key management, setting up operating policies, exerting financial controls and transferring profit or assets out of the VIEs and VIE subsidiaries at its discretion. The Company and the WFOE believe they have the right to receive all the benefits and assets of the VIEs and VIE subsidiaries, except for registered capital of the VIEs and VIE subsidiaries totaling RMB236,000 and RMB216,000 as of December 31, 2018 and 2019, respectively. As the VIEs and VIE subsidiaries organized in the PRC were established as limited liability companies under PRC law, their creditors do not have recourse to the general credit of the WFOE for the liabilities of these VIEs and VIE subsidiaries, and the WFOE does not have the obligation to assume the liabilities of these VIEs and VIE subsidiaries.

 

F-9


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

The Company believes that its contractual arrangements with the VIEs are in compliance with PRC law and are legally enforceable. In addition, the shareholders of Gridsum PRC Holding are also beneficial owners of the Company and therefore have no current interest in seeking to act contrary to the contractual arrangements. However, uncertainties in the PRC legal system could limit the Group’s ability to enforce the VIE agreements.

 

On January 19, 2015, the Ministry of Commerce (“MOFCOM”), released for public comment a proposed PRC law, the Draft FIE Law, that appears to include VIEs within the scope of entities that could be considered to be foreign invested enterprises, or FIEs, that would be subject to restrictions under existing PRC law on foreign investment in certain categories of industry. Specifically, the Draft FIE Law introduces the concept of “actual control” for determining whether an entity is considered to be an FIE. In addition to control through direct or indirect ownership or equity, the Draft FIE Law includes control through contractual arrangements within the definition of “actual control.” If the Draft FIE Law is passed by the People’s Congress of the PRC and goes into effect in its current form, these provisions regarding control through contractual arrangements could be construed to reach our VIE arrangements, and as a result our PRC-organized VIEs could become explicitly subject to the current restrictions on foreign investment in certain categories of industry. The Draft FIE Law includes provisions that would exempt from the definition of foreign invested enterprises entities where the ultimate controlling shareholders are either entities organized under PRC law or individuals who are PRC citizens. The Draft FIE Law is silent as to what type of enforcement action might be taken against existing VIEs, such as Gridsum PRC Holding, that operate in restricted or prohibited industries and are not controlled by entities organized under PRC law or individuals who are PRC citizens. If the restrictions and prohibitions on foreign invested enterprises included in the Draft FIE Law are enacted and enforced in their current form, our ability to use our VIE arrangements and our ability to conduct business through them could be severely limited.

 

F-10


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

The Company’s ability to control Gridsum PRC Holding and its subsidiaries also depends on the WFOE’s rights, under the Shareholders’ Voting Rights Proxy Agreements, to vote on all matters requiring shareholder approval. As noted above, the Company believes these Shareholders’ Voting Rights Proxy Agreements are legally enforceable, but yet they may not be as effective as direct equity ownership. In addition, if the corporate structure of the Group or the contractual arrangements between the WFOE, Gridsum PRC Holding and their respective shareholders were found to be in violation of any existing PRC laws and regulations, the relevant PRC regulatory authorities could:

 

 

·

 

revoke the Group’s business and operating licenses;

 

 

·

 

require the Group to discontinue or restrict its operations;

 

 

·

 

restrict the Group’s right to collect revenues;

 

 

·

 

block Group websites;

 

 

·

 

require the Group to restructure the operations, re-apply for the necessary licenses or relocate its businesses, staff and assets;

 

 

·

 

impose additional conditions or requirements with which the Group may not be able to comply; or

 

 

·

 

take other regulatory or enforcement actions against the Group that could be harmful to the Group’s business.

 

The imposition of any of these restrictions or actions may result in a material adverse effect on the Group’s ability to conduct its business. In addition, if the imposition of any of these restrictions causes the Company to lose the right to direct the activities of the Gridsum PRC Holding or the right to receive its economic benefits, the Company would no longer be able to consolidate the financial statements of Gridsum PRC Holding and its subsidiaries. The Company believes the likelihood of losing the benefits of the Group’s current ownership structure and contractual arrangements with Gridsum PRC Holding is remote based on the current facts and circumstances.

 

There is no VIE in which the Company has a variable interest but is not the primary beneficiary. Currently there is no contractual arrangement that could require the Company to provide additional financial support to the VIEs.

 

The consolidated financial information of the VIEs and VIE subsidiaries, including the inter-group transactions with other entities in the Group, has been included in the accompanying consolidated financial statements of the Group as follows:

 

 

 

As of December 31,

 

 

 

2018

 

2019

 

 

 

RMB

 

RMB

 

Total assets

 

864,934

 

577,905

 

Total liabilities

 

937,801

 

985,706

 

 

 

 

For the year ended December 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

Net revenues

 

558,393

 

722,022

 

403,492

 

Net income/(loss)

 

160,550

 

(131,658

)

(334,934

)

 

F-11


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

 

 

For the year ended December 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

Net cash (used in)/provided by operating activities

 

(148,018

)

268,946

 

180,067

 

Net cash used in investing activities

 

(22,920

)

(57,231

)

(23,315

)

Net cash provided by/(used in) financing activities

 

201,019

 

(261,019

)

171,121

 

 

In accordance with various contractual agreements, the Company has the power to direct the activities of the VIEs and can have assets transferred out of the VIEs. Therefore, the Company considers that there are no assets in the consolidated VIEs that can be used only to settle obligations of the consolidated VIEs, except for registered capital of the VIEs and VIE subsidiaries totaling RMB236,000 and RMB216,000 as of December 31, 2018 and 2019, respectively. As the consolidated VIEs are incorporated as limited liability companies under the Company Law of the People’s Republic of China, creditors do not have recourse to the general credit of the Company for the liabilities of the consolidated VIEs.

 

(d) Liquidity

 

The Group has been incurring recurring losses from operations since inception. Accumulated losses from operations were RMB1,077,409 and RMB1,615,338 as of December 31, 2018 and 2019, respectively. The net cash used in operating activities was RMB306,704, RMB233,130 and RMB289,546 for the years ended December 31, 2017, 2018 and 2019, respectively.

 

The Group’s liquidity is based on its ability to generate cash from operating activities, obtain capital financing from equity interest investors and borrow funds on favorable economic terms to fund its general operations and capital expansion needs. The Group’s ability to continue as a going concern is dependent on management’s ability to successfully execute its business plan, which includes increasing revenue while controlling operating cost and expenses to generate positive operating cash flows and obtaining funds from outside sources of financing to generate positive financing cash flows. As of December 31, 2018 and 2019, the Group’s balance of cash and cash equivalents was RMB92,684 and RMB25,206, respectively.

 

Based on cash flow projections from operating and financing activities and existing balance of cash and cash equivalents, management believes that there is substantial doubt as to whether existing cash and cash equivalents will be sufficient to fund its operations within one year from the date the consolidated financial statements are issued.

 

The Company plans to continue to fund its losses from operations through cash and cash equivalents, as well as through future equity offerings, debt financings, other third party funding, and new business developments to generate profitable operations. Further, the company continues to reduce costs, increase efficiency and apply proactive steps to its collections and working capital management to improve its liquidity. Therefore, the accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and settlement of liabilities in the normal course of business.

 

2.

Principal Accounting Policies

 

(a)

Basis of Presentation

 

The Company’s consolidated financial statements have been prepared in accordance with U.S. GAAP. Significant accounting policies followed by the Company in the preparation of the accompanying consolidated financial statements are summarized below.

 

(b)

Principles of Consolidation

 

The consolidated financial statements of the Company have been prepared in accordance with U.S. GAAP. The consolidated financial statements include the financial statements of the Company, its subsidiaries, VIEs and VIE subsidiaries for which the Company is the ultimate primary beneficiary.

 

Subsidiaries are those entities in which the Company, directly or indirectly, controls more than one half of the voting power or has the power to govern the financial and operating policies, to appoint or remove the majority of the members of the board of directors or to cast a majority of votes at the meeting of directors. A VIE is an entity in which the Company, or its subsidiary, through contractual arrangement exercises effective control over the activities that most impact economic performance and bears the risks of and enjoys the rewards normally associated with ownership of the entity, so that the Company or its subsidiary is the primary beneficiary of the entity. All transactions and balances among the Company, its subsidiaries, VIEs and VIE subsidiaries have been eliminated upon consolidation.

 

F-12


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

(c)

Use of Estimates

 

The preparation of the Company’s 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, related disclosures of contingent liabilities at the balance sheet date and the reported revenues and expenses during the reported period in the consolidated financial statements and accompanying notes. Significant accounting estimates include, but are not limited to, revenue recognition, share-based compensation, redemption value of the redeemable preferred shares, realization of deferred tax assets and determination of the estimated useful lives of property and equipment. Actual results could differ materially from such estimates.

 

(d)

Foreign Currency Translation

 

The Company used RMB as its reporting currency. The functional currency of the Company and its subsidiaries incorporated in Hong Kong is U.S. Dollars, while the functional currency of the other entities in the Group is RMB. Assets and liabilities are translated at the applicable exchange rates on the balance sheet date. Equity amounts are translated at historical exchange rates. Revenues, expenses, gains and losses are translated using the average exchange rate for the periods. Translation adjustments arising from these are reported as foreign currency translation adjustments and are shown as a component of other comprehensive income or loss in the consolidated statement of changes in shareholders’ equity.

 

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

 

(e)

Convenience Translation

 

Translations of balances in the consolidated balance sheets, consolidated statements of operation and comprehensive loss and statements of cash flows from RMB into U.S. Dollars as of and for the year ended December 31, 2019 are solely for the convenience of the reader and were calculated at the rate of US$1.00 = RMB 6.9618, representing the noon buying rate in The City of New York for cable transfers of RMB as certified for customs purposes by the Federal Reserve Bank of New York on December 31, 2019. No representation is made that the RMB amounts represent or could have been, or could be, converted, realized or settled in U.S. Dollars at that rate on December 31, 2019, or at any other rate.

 

(f)

Cash and Cash Equivalents

 

Cash and cash equivalents represent cash on hand and demand deposits with term less than three months which are unrestricted as to withdrawal and use.

 

(g)

Restricted Cash

 

Cash that is restricted as to withdrawal or is used or pledged as security is reported separately on the face of the Consolidated Balance Sheets. The Group’s restricted cash mainly represents (a) security deposits held in designated bank accounts for issuance of bank acceptance and letter of guarantee; (b) time deposits that are pledged for short-term bank loans.

 

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (230): Restricted Cash. The amendments in this Update require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. For public business entities, the amendments in this update are effective for fiscal years beginning after December 15, 2017, and interim periods within those annual periods. Earlier adoption is permitted. The amendments in this Update should be applied using a retrospective transition method to each period presented. On January 1, 2018, the Group adopted this guidance on a retrospective basis and has applied the changes to the consolidated statement of cash flows in the year ended December 31, 2017.

 

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GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

(h)

Accounts Receivable, net

 

Accounts receivable mainly represent amounts due from customers, including revenues earned, output VAT and amounts paid, or will pay, to search engines on behalf of customers, and are recorded net of an allowance for doubtful accounts, if any. The Company considers many factors in assessing the collectability of its accounts receivable, such as the age of the amounts due, the payment history, credit worthiness and the financial condition of the debtor. The Company also makes a specific allowance if there is strong evidence indicating that an accounts receivable is likely to be unrecoverable. Accounts receivable balances are written off after all collection efforts have been exhausted.

 

(i)

Property and Equipment, net

 

Property and equipment are stated at cost less accumulated depreciation and amortization and impairment. Property and equipment are depreciated at rates sufficient to write off their costs less impairment and residual value (estimated at 5% of cost) over their estimated useful lives on a straight-line basis. Leasehold improvements are depreciated on a straight-line basis over the period of the lease or their estimated useful lives, if shorter. The estimated useful lives are as follows:

 

Computers

  

3 years

Furniture, fixtures and equipment

  

5 years

Vehicles

  

5 years

Leasehold improvements

  

Over the shorter of lease terms or the estimated useful lives of assets

 

Expenditures for repairs and maintenance are expensed as incurred, whereas the costs of renewals and betterment that extends the useful lives of property and equipment are capitalized as additions to the related assets. Retirements, sales and disposals of assets are recorded by removing the costs, accumulated depreciation and amortization and impairment with any resulting gain or loss recognized in the consolidated statements of operations and comprehensive loss.

 

(j)

Impairment of Long-lived Assets

 

Long-lived assets are evaluated for impairment whenever events or changes in circumstances (such as a significant adverse change to market conditions that will impact the future use of the assets) indicate that the carrying value of an asset may not be fully recoverable or that the useful life is shorter than the Group had originally estimated. When these events occur, the Group evaluates the impairment for the long-lived assets by comparing the carrying value of the assets to an estimate of future undiscounted cash flows expected to be generated from the use of the assets and their eventual disposition. Such assets are considered to be impaired, if the sum of the expected future undiscounted cash flows is less than the carrying value of the assets. The impairment to be recognized is then measured by the amount by which the carrying amounts of the assets exceed the fair value of the assets based on the discounted cash flow. No impairment charge was recognized for any of the periods presented.

 

(k)

Intangible Assets with Finite Useful Life

 

Intangible assets, comprising acquired computer software, customer relationship and other finite-lived intangible assets, which are separable from the fixed assets, are stated at cost less accumulated amortization. Amortization is computed using the straight-line method over the estimated useful lives of the assets. Acquired customer relationship arising from business combinations (Note 17) is stated at fair value upon acquisition less accumulated amortization, which is recognized using the straight-line method over the estimated useful lives of the assets. The carrying amounts of the finite-lived intangible assets are reviewed for impairment when indicators of impairment are present in accordance with ASC 360-10. In accordance with ASC 360-10, an impairment loss is recognized if the carrying amount of an intangible asset is not recoverable and its carrying amount exceeds its fair value. No impairment loss has been identified for the years ended December 31, 2017, 2018 and 2019.

 

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GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

The estimated economic lives are as follows:

 

 

 

 

Software and other intangible assets

  

3 -10 years

Acquired customer relationship

  

10 years

 

(l)

Goodwill

 

Goodwill represents the excess of the purchase price over the fair value of the identifiable assets and liabilities of Beijing Zhixunyilong Software Co., Ltd (“Zhixun”) when it was acquired by the Group in May 2017.

 

Goodwill is not depreciated or amortized but is tested for impairment at the reporting unit level on an annual basis every December 31, and in between annual tests when an event occurs or circumstances change that could indicate that the asset might be impaired. Commencing September 2011, in accordance with the FASB revised guidance on “Testing of Goodwill for Impairment,” a company first has the option to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the company decides, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is mandatory. Otherwise, no further testing is required. The quantitative impairment test consists of a comparison of the fair value of each reporting unit with its carrying amount, including goodwill. If the carrying amount of each reporting unit exceeds its fair value, an impairment charge equal to the difference between the implied fair value of the reporting unit’s goodwill and the carrying amount of goodwill will be recorded. Application of a goodwill impairment test requires significant management judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit.

 

The Group as a whole, including recently acquired entities, is determined to be one reporting unit for goodwill impairment testing. The Group directly applied the quantitative assessment and performed the goodwill impairment test by quantitatively comparing the fair values of the reporting unit to its carrying amounts, and no impairment loss has been identified for the year ended December 31, 2019.

 

 (m)

Fair Value

 

Fair value represents the price that would be received from selling an asset, or that would be paid to transfer a liability, in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability.

 

Accounting guidance defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Accounting guidance establishes a three-level fair value hierarchy and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of inputs are:

 

Level 1— Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

Level 2— Other inputs that are directly or indirectly observable in the marketplace.

 

Level 3— Unobservable inputs which are supported by little or no market activity.

 

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GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

 

Accounting guidance also describes three main approaches to measuring the fair value of assets and liabilities: (1) market approach; (2) income approach; and (3) cost approach. The market approach uses prices and other relevant information generated from market transactions involving identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future amounts to a single present value amount. The measurement is based on the value indicated by current market expectations about those future amounts. The cost approach is based on the amount that would currently be required to replace an asset.

 

Financial assets and liabilities of the Group primarily consist of cash and cash equivalents, restricted cash, accounts receivable, prepayments and other current assets, accounts payable, amounts due to related parties, taxes payable, advances from customers and accrued expenses and other current liabilities. As of December 31, 2019, the carrying values of these financial instruments approximated their fair values due to the short-term maturity of these instruments.  As of December 31, 2019, the carrying values of the long term loan from related party and corporate bond approximated their fair values due to the interest rate charged by the lenders were similar to interest rate charged by the bank in the PRC.

 

(n)

Financial Instruments

 

The Group analyzes all financial instruments with features of both liabilities and equity under FASB Accounting Standards Codification (“ASC”) Topic 480 “Distinguishing Liabilities from Equity” and FASB ASC Topic 815 “Derivatives and Hedging”. The embedded conversion features of convertible debentures that are classified as derivative liabilities are recorded at fair value as a discount from the face amount of the respective debt instrument. The discount is being amortized to interest expense over the life of the note using the straight-line method, which approximates the effective interest method. These instruments are accounted for as derivative liabilities and marked-to-market each reporting period.

 

The Group issued to warrants to an existing shareholder of the Group in connection with a loan in May 2019. The Warrant shares’ strike price is denominated in US$ and the Group’s functional currency is RMB, therefore, those warrants are not considered indexed to the Company’s own stock which should be classified as derivative liabilities.

 

The change in the value of the derivative liabilities is charged against or credited to income in the captioned “Gain/(loss) on change in fair value of derivative liabilities” in the accompanying consolidated statements of operations and comprehensive loss.

 

 (o)

Revenue Recognition

 

Revenues are generated from sales of the Group’s marketing automation solutions and e-Government and other solutions. The targeted customers for marketing automation solutions are enterprise customers and the targeted customers for e-Government and other solutions are governmental agencies and state-owned entities.

 

Prior to January 1, 2018, revenues are recognized when 1) persuasive evidence of an arrangement exists, 2) the Group’s platform is made available and services have been delivered to the customer, 3) the fee is fixed or determinable and 4) collection is reasonably assured.

 

Revenues received from the incentive programs of search engine providers are based on factors determined by these providers, such as yearly growth in the amount of advertising on the provider’s search engine platform that the Company’s customers purchase through its solutions, and other factors selected at the discretion of these providers. Revenues are recorded net of value-added taxes and surcharges.

 

In accordance with ASC 605-45, Revenue Recognition: Principal Agent Considerations, the Company considers several factors in determining whether it acts as the principal or as an agent in the arrangement of merchandise sales and provision of various related services and thus whether it is appropriate to record the revenues and the related cost of sales on a gross basis or record the net amount earned as service fees.

 

Where customers purchase multiple solutions in a single contract, the Company allocates the total consideration to the various elements based on the relative selling price method and recognizes revenues as services are rendered. In accordance with ASC 605-25, Revenue Recognition—Multiple- Element Arrangements, the following hierarchy are followed when determining the appropriate selling price for each element: (1) vendor specific objective evidence (“VSOE”), (2) third party evidence (“TPE”) and (3) best estimate of selling price (“BESP”). The Company recognizes revenues on the elements delivered and defers the recognition of revenues for the fair value of the undelivered elements until the remaining obligations have been satisfied. Where all of the elements within an arrangement are delivered uniformly over the agreement period, revenues are recognized on a straight-line basis over the contract period.

 

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GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

On January 1, 2018, we adopted Accounting Standards Update (“ASU”) 2014-09 Revenue from Contracts with Customers (FASB ASC Topic 606) using the modified retrospective method for contracts that were not completed as of January 1, 2018. We did not result in an adjustment to the retained earnings upon adoption of this new guidance as the Company’s revenue was recognized based on the amount of consideration we expect to receive in exchange for satisfying the performance obligations.

 

The ASU requires the use of a new five-step model to recognize revenue from customer contracts. The five-step model requires that the Company (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) the Company satisfies the performance obligation. 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 the Company records its revenue. Upon adoption, the Company evaluated its revenue recognition policy for all revenue streams within the scope of the ASU under previous standards and using the five-step model under the new guidance and confirmed that there were no differences in the pattern of revenue recognition.

 

The Group accounts for a contract with a customer when the contract is committed in writing, the rights of the parties, including payment terms, are identified, the contract has commercial substance and consideration to collect is substantially probable.

 

The Group continues to derive its revenues from sales contracts where customers purchase multiple solutions in a single contract with the Group allocates the total consideration to the various elements based on the relative selling price method and recognizes revenues as services are rendered over the period of time. The Company continues to recognize revenues on the elements delivered and defers the recognition of revenues for the fair value of the undelivered elements until the remaining obligations have been satisfied. Where all of the elements within an arrangement are delivered uniformly over the agreement period, revenues are recognized on a straight-line basis over the contract period.

 

Enterprise

 

The Group generates enterprise revenue primarily by providing marketing automation solutions including bid management and data analysis solutions to enterprise customers. The Company earns and records service fee revenues over the contractual period. For certain application development contracts, the Company recognizes revenue upon completion of performance that is stipulated in the contracts. Sometimes, the Company receives revenues from the incentive programs of search engine providers based on factors determined by these providers, such as yearly growth in the amount of advertising on the provider’s search engine platform that the Company’s customers purchase through its solutions, and other factors selected at the discretion of these providers. Revenues from these programs are received on both a quarterly and an annual basis and are calculated in accordance with the Company’s customers’ usage of the search engine providers. In addition, the Company sells distribution rights of public sentiment tracking service provided by certain third party search engine to sub-distributor, due to uncertainty of collection, the revenue is recognized when fees are collected.

 

With respect to the bid management services, the Group considered that: (i) the search engines are responsible for providing the advertisements service to the customers; (ii) the Group lacks the latitude to determine the prices charged by the search engine providers and earns only the fixed service fee from the customers; (iii) the hosting and maintenance of the advertisements are the responsibilities of the search engine providers; (iv) the customers have the discretion in choosing the search engines selection; (v) the Group receive revenues from incentive programs based on the search engine providers’ policies. The Group’s responsibility is to manage the customer’s advertising campaign on the search engines, according to the terms of the customer contracts so the Group views itself as an agent, and records revenues related to these services on a net basis.

 

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Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

e-Government and Other

 

The Group generates e-Government and other revenues by entering into service contracts with governmental agencies for its e-government solutions, including Law Dissector solutions for the court systems and other law communities beginning in 2015. The Group also generates e-Government and other revenues by entering into contracts with state-owned television stations for its new media solutions, including TV Dissector, Streaming Dissector and Video Dissector.

 

(p)

Advances from Customers and Deferred Revenues

 

Upon the entering of contracts, customers pay the contractual balance as prepayments. The Company allocates the prepayments into advances from customers and deferred revenues. Advances from customers are the balance of the advertising campaign spending that would be recognized as the cost payable to search engine providers when advertisements are placed. Deferred revenues are the revenues to be earned by the Group for services and is recognized as revenue according to the prescribed revenue recognition criteria and policies described above.

 

(q)

Cost of Revenues

 

Cost of revenues primarily consists of costs related to hosting the Company’s cloud-based platform, providing implementation and ongoing customer support, data communications expenses, salaries and benefits of operations and support personnel, costs associated with website development activities, allocated overhead and property and equipment depreciation.

 

(r)

Research and Development Expenses

 

Research and development costs include payroll, stock-based compensation expense and other operating costs such as outside services, supplies and allocated overhead costs. Research and development costs are expensed as incurred.

 

The Group expenses all costs that are incurred in connection with the planning and implementation phases of development and costs that are associated with repair or maintenance of the existing websites or the development of software and website content. Costs incurred in the development phase are capitalized and amortized over the estimated product life. However, since the inception of the Company, the amount of costs qualifying for capitalization has been insignificant and as a result, all software development costs have been expensed as incurred.

 

(s)

Marketing Expenses

 

Marketing expenses mainly consist of advertising costs, promotion expenses, payroll and related expenses for personnel engaged in marketing activities. Marketing expenses are expensed when the services are received. Advertising expenses are recorded as sales and marketing expenses when incurred, and totaled RMB14,886, nil and nil for the years ended December 31, 2017, 2018 and 2019, respectively.

 

(t)

General and Administrative Expenses

 

General and administrative expenses mainly consist of payroll and related costs for employees involved in general corporate functions, including accounting, finance, tax, legal and human resources, professional fees and other general corporate expenses as well as costs associated with the use by these functions of facilities and equipment, such as depreciation and rental expenses.

 

(u)

Leases

 

Prior to January 1, 2019, leases are classified as either capital or operating leases. Leases that transfer substantially all the benefits and risks incidental to the ownership of assets are accounted for as if there was an acquisition of an asset and incurrence of an obligation at the inception of the lease. All other leases are accounted for as operating leases expense and is included in the consolidated statements of operations on a straight-line basis over the term of the leases. The Company had no capital lease commitments prior to January 1, 2019.

 

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GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

Effective January 1, 2019, the Company adopted ASU 2016-02, “Leases” (Topic 842), and elected the practical expedients that does not require us to reassess: (1) whether any expired or existing contracts are, or contain, leases, (2) lease classification for any expired or existing leases and (3) initial direct costs for any expired or existing leases. For lease terms of twelve months or fewer, a lessee is permitted to make an accounting policy election not to recognize lease assets and liabilities. The Company also adopted the practical expedient that allows lessees to treat the lease and non-lease components of a lease as a single lease component. The Company recognized RMB 146,872 right of use (“ROU”) assets and RMB 154,226 lease liabilities based on the present value of the future minimum rental payments of leases, using incremental borrowing rate of 4.0%.

 

Operating lease ROU assets and lease liabilities are recognized at the adoption date of January 1, 2019 or the commencement date, whichever is earlier, based on the present value of lease payments over the lease term. Since the implicit rate for the Company’s leases is not readily determinable, the Company use its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The incremental borrowing rate is the rate of interest that the Company would have to pay to borrow, on a collateralized basis, an amount equal to the lease payments, in a similar economic environment and over a similar term.

 

Lease terms used to calculate the present value of lease payments generally do not include any options to extend, renew, or terminate the lease, as the Company does not have reasonable certainty at lease inception that these options will be exercised. The Company generally considers the economic life of its operating lease ROU assets to be comparable to the useful life of similar owned assets. The Company has elected the short-term lease exception, therefore operating lease ROU assets and liabilities do not include leases with a lease term of twelve months or less. Its leases generally do not provide a residual guarantee. The operating lease ROU asset also excludes lease incentives. Lease expense is recognized on a straight-line basis over the lease term.

 

The Company reviews the impairment of its ROU assets consistent with the approach applied for its other long-lived assets. The Company reviews the recoverability of its long-lived assets when events or changes in circumstances occur that indicate that the carrying value of the asset may not be recoverable. The assessment of possible impairment is based on its ability to recover the carrying value of the asset from the expected undiscounted future pre-tax cash flows of the related operations. The Company has elected to include the carrying amount of operating lease liabilities in any tested asset group and include the associated operating lease payments in the undiscounted future pre-tax cash flows.

 

(v)              Share-based Compensation

 

All share-based awards to employees and directors, including stock option awards, are measured at the grant date based on the fair value of the awards. Share-based compensation, net of forfeitures, is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period.

 

The Group uses the binominal option pricing model to determine the fair value of stock options and account for share-based compensation expenses using an estimated forfeiture rate at the time of grant and revising, if necessary, in subsequent periods if actual forfeitures differ from initial estimates. Share-based compensation expenses are recorded net of estimated forfeitures such that expenses are recorded only for those share-based awards that are expected to vest.

 

(w)            Employee Benefits

 

The Company’s subsidiaries, VIEs and VIE subsidiaries established in the PRC participate in a government-mandated, multiemployer, defined contribution plan, pursuant to which certain retirement, medical, housing and other welfare benefits are provided to employees. PRC labor laws require the entities incorporated in mainland China to pay to the local labor bureau a monthly contribution calculated at a stated contribution rate on the monthly basic compensation of qualified employees. The Group has no further commitments beyond its monthly contribution. The fair value of the employee benefits liabilities approximates their carrying value due to the short-term nature of these liabilities. The employee benefits payable amounts to RMB3,660 and RMB3,116 as of December 31, 2018 and 2019, respectively.

 

Employee social benefits included as expenses in the accompanying consolidated statements of operations and comprehensive loss amounted to RMB66,511, RMB75,031 and RMB66,651 for the years ended December 31, 2017, 2018 and 2019, respectively.

 

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GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

(x)              Non-controlling Interests

 

The non-controlling interests are presented in the consolidated balance sheets, separately from equity attributable to the shareholders of the Company. Non-controlling interests are presented on the face of the consolidated statement of operations and comprehensive loss as an allocation of the total income or loss for the year between non-controlling interest holders and the shareholders of the Group.

 

(y)              Income Tax

 

Current income taxes are provided on the basis of net income (loss) for financial reporting purposes and adjusted for income and expense items which are not assessable or deductible for income tax purposes, in accordance with the regulations of the relevant tax jurisdictions. Deferred income taxes are provided using the liability method. Under this method, deferred tax assets and liabilities are recognized for the tax effects of temporary differences and are determined by applying enacted statutory tax rates that will be in effect in the period in which the temporary differences are expected to reverse to the temporary differences between the financial statements’ carrying amounts and the tax bases of assets and liabilities. A valuation allowance is provided to reduce the amount of deferred tax assets if based on the weight of available evidence, it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. The effect on deferred taxes arising from a change in tax rates is recognized in the consolidated statements of operations and comprehensive loss in the period of change.

 

The Group applies a “more likely than not” recognition threshold in the evaluation of uncertain tax positions. The Company recognizes the benefit of a tax position in its consolidated financial statements if the tax position is more likely than not to prevail based on the facts and technical merits of the position. Tax positions that meet the “more likely than not” recognition threshold are measured at the largest amount of tax benefit that has a greater than fifty percent likelihood of being realized upon settlement. Unrecognized tax benefits may be affected by changes in interpretation of laws, rulings of tax authorities, tax audits and expiry of statutory limitations. In addition, changes in facts, circumstances and new information may require the Group to adjust the recognition and measurement estimates with regard to uncertain tax positions. Accordingly, unrecognized tax benefits are periodically reviewed and re-assessed. Adjustments, if required, are recorded in the Company’s consolidated financial statements in the period in which the change that necessitates the adjustments occurs. The ultimate outcome for a particular tax position may not be determined with certainty prior to the conclusion of a tax audit and, in certain circumstances, a tax appeal or litigation process. As of December 31, 2018 and 2019, the Group did not have any significant unrecognized uncertain tax positions.

 

(z)               Comprehensive Loss

 

Comprehensive loss is defined to include all changes in deficit of the Group during a period arising from transactions and other events and circumstances other than those resulting from investments by shareholders and distributions to shareholders. For the years ended December 31, 2017, 2018 and 2019, the Group’s comprehensive loss included net loss and foreign currency translation adjustments.

 

(aa)       Loss per Share

 

Basic loss per share is computed by dividing net loss attributable to holders of ordinary shares, considering the accretions to redemption value of the preferred shares, by the weighted average number of ordinary shares outstanding during the period using the two-class method. Under the two-class method, net loss is allocated between ordinary shares and other participating securities based on their participating rights. Diluted loss per share is calculated by dividing net loss attributable to ordinary shareholders, as adjusted for the accretion and allocation of net income related to the preferred shares, if any, by the weighted average number of ordinary and dilutive ordinary equivalent shares outstanding during the period. Ordinary equivalent shares consist of shares issuable upon the conversion of the preferred shares using the if-converted method and ordinary shares issuable upon the exercise of outstanding stock option (using the treasury stock method). Ordinary equivalent shares are not included in the denominator of the diluted earnings per share calculation when inclusion of such shares would be anti-dilutive.

 

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Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

(bb)       Segment Reporting

 

The Group provided various services to its customers, commercial companies and also government agencies or state-owned entities, including keyword bidding, graphical and non-graphical advertisements placement services, website quality analysis services, subscription for using multiple suites of the Dissector solutions service. The Group’s chief operating decision maker has been identified as the chief executive officer, who reviews consolidated results when making decisions about allocating resources and assessing performance of the Group. The Group does not distinguish between markets or segments for the purpose of internal reporting. Hence, the Group has only one operating segment. As the Group’s assets and liabilities are substantially located in the PRC, substantially all revenues are earned and substantially all expenses are incurred in the PRC, no geographical segments are presented.

 

(cc)         Statutory Reserves

 

The Group’s subsidiaries, VIEs and VIE subsidiaries established in the PRC are required to make appropriations to certain non-distributable reserve funds.

 

In accordance with PRC laws applicable to foreign investment enterprises (“FIE”) established in the PRC, the Company’s subsidiaries registered as wholly foreign owned enterprise have to make appropriations from their after-tax profits (as determined under generally accepted accounting principles in the PRC (“PRC GAAP”) to non-distributable reserve funds including general reserve fund, enterprise expansion fund and staff bonus and welfare fund. The appropriation to the general reserve fund must be at least 10% of the after-tax profits calculated in accordance with PRC GAAP. Appropriation is not required if the general reserve fund has reached 50% of the registered capital of the company. Appropriations to the enterprise expansion fund and staff bonus and welfare fund are made at the respective company’s discretion.

 

In addition, in accordance with the Company Law of the People’s Republic of China, the VIEs and VIE subsidiaries, registered as Chinese domestic companies, must make appropriations from their after-tax profits as determined under the PRC GAAP to non-distributable reserve funds including the statutory surplus fund and discretionary surplus fund. The appropriation to the statutory surplus fund must be 10% of the after-tax profits as determined under PRC GAAP. Appropriation is not required if the statutory surplus fund has reached 50% of the registered capital of the company. Appropriation to the discretionary surplus fund is made at the discretion of the Group.

 

The Group has made RMB 68, RMB 6,173 and RMB 0 appropriations to statutory surplus fund and other reserve funds for the years ended December 31, 2017, 2018 and 2019, respectively.

 

The general reserve fund, enterprise expansion fund, statutory surplus fund and discretionary surplus fund are restricted for use. They may only be applied to offset losses or increase the registered capital of the respective company. The staff bonus and welfare fund is liability in nature and is restricted to make payment of special bonuses to employees and for the collective welfare of employees. None of these reserves is allowed to be transferred to the Company by way of cash dividends, loans or advances, nor can they be distributed except under liquidation.

 

(dd)       Recent Accounting Pronouncements

 

In June 2018, the FASB issued ASU No. 2018-07 to provide guidance to reduce cost and complexity and to improve financial reporting for share-based payments issued to nonemployees (for example, service providers, external legal counsel, suppliers, etc.). The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. The adoption of this ASU did not have a material effect on the Group’s consolidated financial statements.

 

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”). ASU 2018-13 removes, modifies and adds certain disclosure requirements in Topic 820 “Fair Value Measurement”. ASU 2018-13 eliminates certain disclosures related to transfers and the valuations process, modifies disclosures for investments that are valued based on net asset value, clarifies the measurement uncertainty disclosure, and requires additional disclosures for Level 3 fair value measurements. ASU 2018-13 is effective for the Company for annual and interim reporting periods beginning January 1, 2020. The adoption of this guidance on January 1, 2020 did not have a material impact on its consolidated financial statements.

 

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GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

In May 2019, the FASB issued ASU 2019-05, which is an update to ASU Update No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which introduced the expected credit losses methodology for the measurement of credit losses on financial assets measured at amortized cost basis, replacing the previous incurred loss methodology. The amendments in Update 2016-13 added Topic 326, Financial Instruments—Credit Losses, and made several consequential amendments to the Codification. Update 2016-13 also modified the accounting for available-for-sale debt securities, which must be individually assessed for credit losses when fair value is less than the amortized cost basis, in accordance with Subtopic 326-30, Financial Instruments—Credit Losses—Available-for-Sale Debt Securities. The amendments in this Update address those stakeholders’ concerns by providing an option to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost basis. For those entities, the targeted transition relief will increase comparability of financial statement information by providing an option to align measurement methodologies for similar financial assets. Furthermore, the targeted transition relief also may reduce the costs for some entities to comply with the amendments in Update 2016-13 while still providing financial statement users with decision-useful information. ASU 2019-05 is effective for the Company for annual and interim reporting periods beginning January 1, 2020. The adoption of this guidance on January 1, 2020 did not have a material impact on its consolidated financial statements.

 

In January 2020, the FASB issued ASU 2020-01 to clarify the interaction of the accounting for equity securities under ASC 321 and investments accounted for under the equity method of accounting in ASC 323 and the accounting for certain forward contracts and purchased options accounted for under ASC 815. With respect to the interactions between ASC 321 and ASC 323, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting when applying the measurement alternative in ASC 321, immediately before applying or upon discontinuing the equity method of accounting. With respect to forward contracts or purchased options to purchase securities, the amendments clarify that when applying the guidance in ASC 815-10-15-141(a), an entity should not consider whether upon the settlement of the forward contract or exercise of the purchased option, individually or with existing investments, the underlying securities would be accounted for under the equity method in ASC 323 or the fair value option in accordance with ASC 825. The ASU is effective for interim and annual reporting periods beginning after December 15, 2020.  Early adoption is permitted, including adoption in any interim period.  The Group does not expect that the adoption of this guidance will have a material impact on its consolidated financial statements.

 

The Group does not believe other recently issued but not yet effective accounting standards, if currently adopted, would have a material effect on the Group’s consolidated balance sheets, statements of income and comprehensive income and statements of cash flows.

 

3.                   Concentration and Risks

 

Concentration of credit risk

 

Assets that potentially subject the Group to significant concentrations of credit risk primarily consist of cash and cash equivalents and accounts receivable. As of December 31, 2018 and 2019, all of the Group’s cash and cash equivalents were held by reputable financial institutions located in the PRC, Hong Kong and the United States, which management believes are of high credit quality and financially sound based on publicly available information.

 

Accounts receivable is typically unsecured and is generally derived from revenues earned from marketing automation solutions. No customer with a receivable balance exceeding 10% of the total accounts receivable balance as of December 31, 2018 and 2019.

 

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GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

Concentration of customer risk

 

The top 20 customers accounted for 44%, 39% and 45% of the total revenues for the years ended December 31, 2017, 2018 and 2019, respectively.

 

Currency risk

 

The Group’s operations, and its assets and liabilities are primarily denominated in RMB, which is not freely convertible into foreign currencies. The Group’s cash and cash equivalents denominated in RMB are subject to government controls and amounted to RMB58,282 and RMB25,827 as of December 31, 2018 and 2019, respectively. The value of the RMB is subject to changes in the central government policies and international economic and political developments that affect the supply and demand of RMB in the foreign exchange market. In the PRC, certain foreign exchange transactions are required by law to be transacted only by authorized financial institutions at exchange rates set by the People’s Bank of China (the “PBOC”). Remittances from China in currencies other than RMB by the Group must be processed through the PBOC or other China foreign exchange regulatory bodies which require certain supporting documentation in order to effect the remittance.

 

4.                   Accounts Receivable, Net

 

The following summarizes the Group’s accounts receivable as of December 31, 2018 and 2019:

 

 

 

As of December 31,

 

 

 

2018

 

2019

 

 

 

RMB

 

RMB

 

Accounts receivable

 

459,950

 

337,817

 

Less: Allowance for doubtful accounts

 

(61,981

)

(146,518

)

Accounts receivable, net

 

397,969

 

191,299

 

 

The amount of payments to search engines on behalf of customers included in accounts receivable was RMB283,687 and RMB166,138 as of December 31, 2018 and 2019, respectively.

 

The following table sets out the movements of the allowance for doubtful accounts for the years ended December 31, 2018 and 2019:

 

 

 

As of December 31,

 

 

 

2018

 

2019

 

 

 

RMB

 

RMB

 

Balance at beginning of the year

 

(45,449

)

(61,981

)

Charged to costs and expenses

 

(16,532

)

(137,865

)

Write-off

 

 

53,328

 

Balance at end of the year

 

(61,981

)

(146,518

)

 

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GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

5.                   Prepayments and Other Current Assets

 

The following is a summary of prepayments and other current assets:

 

 

 

As of December 31,

 

 

 

2018

 

2019

 

 

 

RMB

 

RMB

 

Deposits to search engine service providers

 

124,668

 

27,821

 

Prepayments to suppliers

 

134,956

 

42,136

 

Advances to employees

 

5,581

 

17,641

 

Prepaid rental and other deposits

 

23,032

 

23,598

 

Receivables in connection with exercise of option from agents

 

 

358

 

Others

 

6,667

 

5,715

 

Total

 

294,904

 

117,269

 

 

Deposits to search engine service providers represent deposits to guarantee the minimum amount of ad spending by the Group’s customers and are refunded annually when the minimum ad spending requirement is met.

 

6.                   Property and Equipment, net

 

The following is a summary of property and equipment, net:

 

 

 

As of December 31,

 

 

 

2018

 

2019

 

 

 

RMB

 

RMB

 

Computers

 

80,667

 

86,249

 

Furniture, fixtures and equipment

 

4,121

 

4,450

 

Vehicles

 

4,291

 

4,291

 

Leasehold improvements

 

63,901

 

67,609

 

Total

 

152,980

 

162,599

 

Less: accumulated depreciation

 

(90,652

)

(116,707

)

Property and equipment, net

 

62,328

 

45,892

 

 

Depreciation expenses for the years ended December 31, 2017, 2018 and 2019 were RMB29,858, RMB31,357 and RMB29,737 respectively.

 

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GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

7.                   Intangible Assets, net

 

The following is a summary of intangible assets, net:

 

 

 

As of December 31,

 

 

 

2018

 

2019

 

 

 

RMB

 

RMB

 

Acquired Software and other intangible assets

 

18,809

 

30,229

 

Customer relationship

 

677

 

677

 

Less: accumulated depreciation and amortization

 

(5,646

)

(11,171

)

Intangible Assets, net

 

13,840

 

19,735

 

 

Amortization expenses for the years ended December 31, 2017, 2018 and 2019 were RMB1,616, RMB3,344 and RMB5,525 respectively.

 

 

 

Expected Future
Amortization Expense

 

Twelve months ending December 31, 2020

 

5,306

 

2021

 

3,668

 

2022

 

2,216

 

2023

 

1,620

 

2024

 

1,619

 

Thereafter

 

5,306

 

Total expected future amortization expense

 

19,735

 

 

8.                   Short-term Bank Loans

 

In 2018 and 2019, the Group entered into several short-term guaranteed loan agreements. Each of the loan agreements provides for a RMB revolving credit facility with a maturity term within three months or twelve months. The guarantees on these loans were provided by Guosheng Qi, the Co-Founder, chief executive officer and chairman of the Company, or provided by Gridsum Holding (Beijing) Co., Ltd. or all the accounts receivable under Beijing Moment Everlasting Ad Co., Ltd.

 

Short-term bank loans as of December 31, 2018 and 2019 amounted to RMB5,000 and RMB38,000, respectively, which consisted of several bank borrowings denominated in RMB. All of these bank borrowings were repayable within one year. The weighted average interest rate for the outstanding borrowings as of 2018 and 2019 was approximately 5.23% and 5.08%, respectively.

 

9.                   Accrued Expenses and Other Current Liabilities

 

The following is a summary of accrued expenses and other current liabilities:

 

 

 

As of December 31,

 

 

 

2018

 

2019

 

 

 

RMB

 

RMB

 

Customer deposits

 

13,453

 

8,220

 

Accrued expenses

 

114,935

 

66,264

 

Accrued property, equipment and software related payables

 

11,545

 

4,294

 

Others

 

8,007

 

16,923

 

Total

 

147,940

 

95,701

 

 

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GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

10.            Convertible Note

 

On May 5, 2018, the Group completed the transactions contemplated by its April 30, 2018 convertible note purchase agreement with FutureX Innovation SPC (“FutureX”). In accordance with the convertible note purchase agreement, the Group received US$40 million (approximately RMB 275,020) and issued the FutureX Convertible Note that is convertible, in whole or in part, into the Company’s Class B ordinary shares at a conversion price of US$6.50 per share, subject to customary adjustments. The FutureX Convertible Note has a term of 18 months and bears interest at 2.80% per annum. The FutureX Convertible Note includes other customary terms and covenants, including certain events of default after which the FutureX Convertible Note may be due and payable immediately. Additionally, in the event of a fundamental change, as defined in the FutureX Convertible Note, the holder of the note may require the Group to repurchase the FutureX Convertible Note at a price equal to 100% of the principal amount of the FutureX Convertible Note, plus accrued and unpaid interest. FutureX Innovation SPC agreed not to transfer or sell the FutureX Convertible Note, the Class B ordinary shares or any of the Company’s other securities, or enter into any swap, short sale or similar arrangements relating to such securities, for a period of six months after the issuance of the FutureX Convertible Note. In connection with this transaction, the Group and FutureX Innovation SPC entered into a registration rights agreement, pursuant to which FutureX Innovation SPC has the right to require the Group, within 15 months following the issuance of the FutureX Convertible Note, to file a registration statement with the SEC covering the offer and sale of the Class B ordinary shares issued upon conversion of the FutureX Convertible Note, as well as certain customary piggyback registration rights.

 

The notes are convertible into the Group’s ordinary shares at conversion price is US$6.50, which is higher than the price of the Group’s ordinary shares on the date of issuance, therefore the conversion feature embedded in the note did not meet the definition of beneficial conversion feature. The Company determined that conversion option embedded in the note meet the definition of a derivative liability instrument and re-measured at fair value at each financial reporting date until such time as the conversion feature is exercised or expired. The Company evaluated the fair value of the embedded conversion feature at the issuance date and recorded the amount as discount to convertible note payable. The discount to convertible note payable is being amortized to interest expense over the life of the note using the straight-line method, which approximates the effective interest method.

 

The fair value of embedded conversion feature were RMB58,486 and calculated using the binomial model based on the following variables at inception on May 5, 2018:

 

·                  Strike price of US$6.50, for the conversion options

 

·                  Expected volatility of 56.0% calculated using the Company’s historical price of its Class B ordinary shares

 

·                  Expected dividend yield of 0%

 

·                  Risk-free interest rate of 3.12%, for the conversion options

 

·                  Expected life of 1.5 years

 

·                  Market price at issuance date of US$5.73

 

The fair value of embedded conversion feature were RMB596 and calculated using the binomial model based on the following variables at inception on December 31, 2018:

 

·                  Strike price of US$6.50, for the conversion options

 

·                  Expected volatility of 56.0% calculated using the Company’s historical price of its Class B ordinary shares

 

·                  Expected dividend yield of 0%

 

·                  Risk-free interest rate of 3.02%, for the conversion options

 

·                  Expected life of 0.83 years

 

·                  Market price at issuance date of US$2.23

 

The fair value of embedded conversion feature became nil on November 5, 2019 upon the expiration of the conversion options.

 

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GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

Convertible note balance as of December 31, 2018 and 2019 were RMB242,702 and RMB278,472, net of debt discount were RMB32,318 and nil, respectively. Amortization of debt discount for the years ended December 31, 2018 and 2019 was RMB25,337 and RMB32,337, respectively. Gain on change in fair value of aforementioned derivative liabilities for the years ended December 31, 2018 and 2019 were RMB57,890 and RMB599 respectively. Interest expenses in relation to this convertible note for the years ended December 31, 2018 and 2019 was RMB4,987 and RMB6,594, respectively.

 

The Company has not yet repaid the FutureX Convertible Note on November 5, 2019. On December 9, 2019, FutureX served a statutory demand on the Company, under which FutureX (i) claims that the Company owes, as of December 9, 2019, a total amount of US$41,913,498 under the Note (the “Debt”), (ii) demands that the Company pay the Debt or secure or compound for it to FutureX’s satisfaction, and (iii) states that if payment of the Debt is not made within 21 days of the date when the statutory demand was served on the Company, the Company will be deemed to be insolvent and a winding up petition may be presented against the Company in accordance with applicable Cayman laws.

 

On March 3, 2020, the Company entered into an extension agreement (the “Extension Agreement”) with FutureX, pursuant to which the parties agreed to extend the maturity date of the Note to May 31, 2020 (the “New Maturity Date”). In consideration of the extension, the Company agreed to pay to the Investor an extension fee on the New Maturity Date, and increase the interest rate of the Note to 24% per year effective from January 1, 2020. Pursuant to the terms of the Extension Agreement, the Investor has waived any prior or current event of default arising out of or in connection with the failure by the Company to pay principal or interest under the Note prior to the date of the Extension Agreement, and withdrawn any prior or current demand made by it or its representatives with respect to repayment of the Note, including without limitation its statutory demand served on the Company on December 9, 2019.

 

As of November 5, 2019, total outstanding amount under the Note due to FutureX was RMB 290,288 (US$41,697) (the “Principal Amount”) with additional RMB 1,995 (US$287) (the “Original Interest”) interest incurred from November 5, 2019 to December 31, 2019. In consideration of the foregoing, the Company shall pay to FutureX, in addition to the Principal Amount and the Original Interest, an extension fee in the amount of RMB 13,934 (US$2,001)(the “Extension Fee”) on the New Maturity Date.

 

11.            Long-term borrowing

 

On May 30, 2019, Beijing Moment Everlasting Ad Co., Ltd. (“Beijing Moment”), a consolidated affiliated entity of Gridsum Holding Inc. (the “Company”), entered into a loan agreement with an entity affiliated with Hammer Capital Private Investments Limited, an existing shareholder with ownership of less than 10% of the Company (the “Lender”). Pursuant to the loan agreement, the Lender provided a working capital loan in the amount of RMB120 million (the “RMB Loan”) to Beijing Moment. The RMB Loan bears interest at 4% per annum and has a term of 24 months, and may be prepaid by the Company before the maturity date. The loan agreement includes other customary terms and covenants, including certain events of default after which the RMB Loan may be due and payable immediately. The RMB Loan is guaranteed by certain of the Company’s consolidated affiliated entities and subsidiaries, including Beijing Gridsum Technology Co., Ltd., Gridsum Holding (Beijing) Co., Ltd., Beijing Yunyang Ad Co., Ltd. and Dissector (Beijing) Technology Co., Ltd., and is secured by the pledge of intellectual properties held by Beijing Moment, Beijing Gridsum Technology Co., Ltd., Beijing Yunyang Ad Co., Ltd. and Dissector (Beijing) Technology Co., Ltd.

 

In connection with and as part of the consideration for the extension of the RMB Loan by the Lender, on May 30, 2019, the Company issued to Hammer Capital China Limited (the “Warrant Holder”), an affiliate of the Lender, a warrant to purchase Class B ordinary shares of the Company (the “Warrant”). Under the Warrant, the Warrant Holder may purchase Class B ordinary shares of the Company at the exercise price of US$4.0261 per share (the “Warrant Price”), for up to a total number of Class B ordinary shares representing the aggregate exercise price of US$14.45 million (the “Maximum Purchase Amount”). The Maximum Purchase Amount will be increased to US$17.34 million if the RMB Loan is not repaid in full by May 30, 2020, and further increased to US$21.68 million if the RMB Loan is not repaid in full by November 30, 2020. The Warrant is exercisable in whole or in part from time to time until May 30, 2022. However, the Warrant Holder may only exercise such portion of the Warrant to the extent that the Warrant Holder, together with its affiliates and any other persons acting as a group together with it or any of its affiliates, would beneficially own up to 19.9% of the total outstanding Class B ordinary shares of the Company after the exercise. The Warrant Holder may waive such beneficial ownership limit by not less than 61 days’ prior notice to the Company.

 

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GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

The Warrant shares’ strike price is denominated in US$ and the Group’s functional currency is RMB, therefore, those warrants are not considered indexed to the Company’s own stock which should be classified as derivative liabilities.

 

The fair value of warrant liabilities were RMB29,005 and calculated using the binomial model based on the following variables at inception on May 30, 2019:

 

·                  Strike price of US$4.0261

 

·                  Expected volatility of 56.0% calculated using the Company’s historical price of its Class B ordinary shares

 

·                  Expected dividend yield of 0%

 

·                  Risk-free interest rate of 2.65%, for the conversion options

 

·                  Expected life of 3.0 years

 

·                  Market price at issuance date of US$3.40

 

The fair value of warrant liabilities were RMB1,974 and calculated using the binomial model based on the following variables at inception on December 31, 2019:

 

·                  Strike price of US$4.0261

 

·                  Expected volatility of 56.0% calculated using the Company’s historical price of its Class B ordinary shares

 

·                  Expected dividend yield of 0%

 

·                  Risk-free interest rate of 2.39%, for the conversion options

 

·                  Expected life of 2.42 years

 

·                  Market price at issuance date of US$1.22

 

Gain on change in fair value of aforementioned derivative liabilities for the years ended December 31, 2019 were RMB27,230.

 

12.            Corporate bond

 

On July 16, 2019, the Company entered into a financing agreement with the Beijing Zhongguancun Technology Finance Guarantee Co., Ltd. (“Beijing Zhongguancun Technology”), pursuant to the Company issued RMB20 million corporate bond with interest at 6.5% per annum and has a term of 36 months. The corporate bond are guaranteed by Beijing Zhongguancun Technology, the originated guarantor. Beijing Gridsum Technology Co., Ltd. (“Gridsum Technology”), Mr. Guocheng Qi, the Co-Founder, chief executive officer and chairman of the Company, Mr. Guofa Yu, the director of the Company, and Michael Yang Xu, the Co-President of the Company, are the joint counter-guarantor of Beijing Zhongguancun Technology, which pledged by Gridsum Technology’s accounts receivables and Mr Qi’s personal tangible assets.

 

The total corporate bond issuance cost including services fees, underwriting fees, guarantee fees and valuation fees amounted to RMB1,992. These issuance costs are recognized as a discount to the cooperate bond and are being amortized to interest expense over the life of the note using the effective interest method. The annual underwriting fees, guarantee fees and valuation fees in aggregate of RMB624 are due annually on each of July 1, 2020 and 2021. 6.5% annual interest of RMB1,300 are due annually on each of the July 1, 2020, 2021 and 2022 along with the principal balance of RMB 20,000 to be due on July 1, 2022. The effective interest rate of this corporate bond with the consideration of the issuance costs, underwriting fees, guarantee fees and valuation fees, is 12.9%. Interest expense in relation to this corporate bond for the year ended December 31, 2019 amounted to RMB1,024.

 

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GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

13.            Taxation

 

(a) Value added tax

 

The Group’s revenues are subject to VAT at the rate of 6%. The Group’s VAT payable balance amounted to RMB11,827 and RMB25,630 as of December 31, 2018 and 2019, respectively.

 

(b) Income tax

 

Cayman Islands

 

Under the current laws of the Cayman Islands, the Group is not subject to tax on income or capital gain. Additionally, the Cayman Islands does not impose a withholding tax on payments of dividends to shareholders.

 

Hong Kong

 

Under the current Hong Kong Inland Revenue Ordinance, the Company’s Hong Kong subsidiary is subject to Hong Kong profits tax at the rate of 16.5% on its taxable income generated from the operations in Hong Kong. Payments of dividends by the subsidiary to the Company are not subject to withholding tax in Hong Kong.

 

PRC

 

The Group’s subsidiaries, VIEs and VIE subsidiaries in the PRC are subject to the PRC Corporate Income Tax Law (“CIT Law”) and are taxed at the statutory income tax rate of 25%.

 

The CIT Law also provides that an enterprise established under the laws of a foreign country or region but whose “de facto management body” is located in the PRC be treated as a resident enterprise for PRC tax purposes and consequently be subject to the PRC income tax at the rate of 25% for its global income. The Implementing Rules of the CIT Law merely define the location of the “de facto management body” as “the place where the exercising, in substance, of the overall management and control of the production and business operation, personnel, accounting, property, etc., of a non-PRC company is located.” Based on a review of surrounding facts and circumstances, the Group does not believe that it is likely that its operations outside the PRC should be considered a resident enterprise for PRC tax purposes.

 

High and new technology enterprises (“HNTE”) will enjoy a preferential enterprise income tax rate of 15% under the CIT Law. Beijing Gridsum Technology Co., Ltd. and Guoxinjunhe (Beijing) Technology Co., Ltd, the Group’s consolidated affiliated entities in the PRC, which are qualified as a HNTE under the CIT Law, is eligible for a preferential enterprise income tax rate of 15% for the period from 2014 to 2019 so long as they obtain approval from relevant tax authority if they are profitable during the period. In 2016, Beijing Moment Everlasting Ad Co., Ltd. and Beijing Yunyang Ad Co., Ltd. obtained the qualification of “HNTE” with a preferential enterprise income tax rate of 15% for the period from 2016 to 2021.

 

Withholding tax on undistributed dividends

 

The CIT law also imposes a withholding income tax of 10% on dividends distributed by a FIE to its immediate holding company outside of China, if such immediate holding company is considered as a non-resident enterprise without any establishment or place within China or if the received dividends have no connection with the establishment or place of such immediate holding company within China, unless such immediate holding company’s jurisdiction of incorporation has a tax treaty with China that provides for a different withholding arrangement. The Cayman Islands, where the Company is incorporated, does not have such tax treaty with China. According to the arrangement between Mainland China and Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion in August 2006, dividends paid by an FIE in China to its immediate holding company in Hong Kong will be subject to withholding tax at a rate of no more than 5% (if the foreign investor owns directly at least 25% of the shares of the FIE). The Group did not record any dividend withholding tax, as Gridsum PRC Holding, the PRC WFOE, has no retained earnings in any of the periods presented.

 

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Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

The following table sets forth the component of income tax expenses of the Group for the years ended December 31, 2017, 2018 and 2019:

 

 

 

For the Year Ended December 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

Current tax expenses

 

15,571

 

12,839

 

639

 

Deferred tax recovery

 

(11,296

)

(28,004

)

(27,649

)

Income tax expenses/(benefit)

 

4,275

 

(15,165

)

(27,010

)

 

Reconciliation of the differences between PRC statutory income tax rate and the Group’s effective income tax rate for the years ended December 31, 2017, 2018 and 2019 is as follows:

 

 

 

For the year ended December 31,

 

 

 

2017

 

2018

 

2019

 

 

 

%

 

%

 

%

 

PRC statutory tax rate

 

25.0

 

25.0

 

25.0

 

Effect of overseas tax-exempt entities

 

(15.5

)

(15.9

)

(8.1

)

Effect of tax holidays

 

(3.1

)

(3.0

)

(6.3

)

Effect of lower tax rate entities

 

(0.1

)

(0.1

)

0.1

 

Permanent book-tax differences

 

(0.5

)

(0.2

)

(0.4

)

Changes in valuation allowance

 

(4.3

)

(2.8

)

(5.4

)

Change of tax rate

 

(3.0

)

0.0

 

0.0

 

Withholding tax

 

(0.3

)

(0.1

)

(0.1

)

Effective tax rate

 

(1.8

)

2.9

 

4.8

 

 

(c) Deferred tax assets and liabilities

 

The following table sets forth the significant components of the aggregate deferred tax assets and liabilities:

 

 

 

As of December 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

Deferred tax assets

 

 

 

 

 

 

 

Education expense

 

10

 

8

 

8

 

Advertising expense

 

179

 

423

 

423

 

Provision for bad debt

 

7,186

 

9,665

 

30,345

 

Accrued expense

 

159

 

367

 

334

 

Charitable donation

 

910

 

2,046

 

2,046

 

Capitalized R&D in PRC tax return

 

13,160

 

13,160

 

13,160

 

Intangible assets under PRC Law

 

1,364

 

3,905

 

7,623

 

Loss carry-forward

 

28,747

 

65,448

 

98,884

 

Total deferred tax assets

 

51,715

 

95,022

 

152,823

 

Less: Valuation allowance

 

33,323

 

48,663

 

78,852

 

Total deferred tax assets, net

 

18,392

 

46,359

 

73,971

 

Intangible assets from acquisitions

 

249

 

212

 

175

 

Total deferred tax liabilities, net

 

249

 

212

 

175

 

 

F-30


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

As of December 31, 2019, the Group had net operating loss carryforwards of approximately RMB9,824 attributable to the Hong Kong subsidiary and of approximately RMB615,154 attributable to the PRC subsidiaries, VIEs and VIEs’ subsidiaries. The loss carried forward by the Hong Kong subsidiary can be carried forward to net against future taxable income without a time limit, while the loss carried forward by the PRC companies will expire from 2019 to 2029.

 

A valuation allowance is provided against deferred tax assets when the Group determines that it is more likely than not that the deferred tax assets will not be utilized in the foreseeable future. In making such determination, the Group evaluates a variety of factors including the Group’s operating history, accumulated deficit, existence of taxable temporary differences and reversal periods.

 

The changes in valuation allowance for the years ended December 31, 2017, 2018 and 2019 are as follows:

 

 

 

As of December 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

Balance at beginning of the year

 

22,909

 

33,323

 

48,663

 

Provision

 

10,414

 

15,340

 

30,189

 

Balance at end of the year

 

33,323

 

48,663

 

78,852

 

 

14.            Redeemable Convertible Preferred Shares

 

In September 2010, the Company issued 3,125,000 Series A convertible and redeemable preferred shares for an aggregate proceeds of RMB35,707 (US$5,250).

 

In July 2011, the Company issued 1,302,084 Series A-1 convertible and redeemable preferred shares for aggregate proceeds of RMB24,251 (US$3,750).

 

In October 2013, the Company issued 2,962,239 Series B convertible and redeemable preferred shares for aggregate proceeds of RMB107,100 (US$17,500).

 

In January and March 2015, the Company issued 4,640,843 Series C convertible and redeemable preferred shares for aggregate proceeds of RMB262,561 (US$42,000).

 

In September 2016, all of the Series A, Series A-1, Series B and Series C preferred shares were automatically converted into 12,030,166 Class B ordinary shares after the closing of IPO.

 

The Company has classified the Series A, A-1, B and C preferred shares as mezzanine equity in the consolidated balance sheets as they are contingently redeemable at the option of the holders at any time after September 6, 2017 if a qualified initial public offering has not occurred.

 

F-31


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

The Company has determined that conversion and redemption features embedded in the Preferred Shares are not required to be bifurcated and accounted for as derivatives, as the economic characteristics and risks of the embedded conversion and redemption features are clearly and closely related to that of the preferred shares. The preferred shares are not readily convertible into cash as there is not a market mechanism in place for trading of the Company’s shares.

 

The Group determined that there was no beneficial conversion feature attributable to any of the preferred shares because the initial effective conversion prices of these preferred shares were higher than the fair value of the Company’s ordinary shares at the relevant commitment dates.

 

In addition, the carrying values of the preferred shares are accreted from the share issuance dates to the redemption value on the earliest redemption dates. The accretions are recorded against retained earnings, or in the absence of retained earnings, by charges against additional paid-in capital. Once additional paid-in capital has been exhausted, additional charges are recorded by increasing the accumulated deficit.

 

The rights, preferences and privileges of the preferred shares prior to the IPO were as follows:

 

Redemption Rights

 

At any time after September 6, 2017 (“Redemption Start Date”), if a qualified initial public offering has not occurred, holders of more than 50% of the then outstanding Series A, A-1, B and C preferred shares may request redemption of the preferred shares of such series. On receipt of a redemption request from the holders, the Company shall redeem all or part, as requested, of the outstanding preferred shares of such series.

 

If any holder of any series of preferred shares exercises its redemption right, any holder of other series of preferred shares shall have the right to exercise the redemption of its series at the same time.

 

The redemption price shall be 125% of original issuance price of Series A, Series A1 and Series B preferred shares, 110% of original issuance price of Series C preferred shares, plus all declared but unpaid dividends up to redemption closing date. The Group shall execute and deliver to each Series A, A1, B and C preferred shares holders a promissory note for the full amount of the redemption payment due but not paid. That such promissory note shall be due and payable no later than one year anniversary of the closing date of the redemption and shall accrue interest daily at a rate of ten percent per annum.

 

Conversion Rights

 

Prior to the IPO, each preferred share was convertible, at the option of the holder, at any time after the date of issuance of such preferred shares, according to a conversion ratio, subject to adjustments for dilution, including but not limited to stock splits, stock dividends and capitalization and certain other events. Each preferred share is convertible into a number of ordinary shares determined by dividing the applicable original issuance price by the conversion price. The conversion price of each preferred share was the same as its original issuance price and no adjustments to conversion price had occurred. At December 31, 2015, each preferred share was convertible into one ordinary Class B share.

 

Each preferred share was automatically converted into ordinary share, at a conversion ratio of one preferred share to one Class B ordinary share, upon closing of the qualified initial public offering, which occurred on September 23, 2016.

 

Prior to the Series B preferred shares issuance on October 1, 2013, a “Qualified Initial Public Offering” was defined as an initial public offering with net offering proceeds no less than US$30 million and implied market capitalization of the Company of no less than US$160 million prior to such initial public offering. Upon the issuance of the Series B preferred shares, the net offering proceeds and market capitalization criteria for a “Qualified Initial Public Offering” was increased to US$100 million and US$235 million, respectively. Upon the issuance of the Series C preferred shares, the market capitalization criterion for a “Qualified Initial Public Offering” was increased to US$360 million. An extraordinary general meeting held in August 2016, the shareholders of the Company passed a special resolution to amend (the “August 2016 Amendment”) the definition of QIPO in the fourth amended and restated memorandum and articles of association of the Company by replacing the existing definition of QIPO with the following: “QIPO means the closing of the first firm commitment fully underwritten public offering of Ordinary Shares of the Company and the listing of such Ordinary Shares on the New York Stock Exchange, the Nasdaq Global Market System, the Main Board of the Hong Kong Stock Exchange, Shanghai Stock Exchange, Shenzhen Stock Exchange or any other reputable international exchange or quotation system that is approved in writing by the Preferred Shareholder Majority.”

 

F-32


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

Voting rights

 

Each preferred share shall be entitled to that number of votes corresponding to the number of ordinary shares on an as-converted basis. Preferred shares shall vote separately as a class with respect to certain specified matters. Otherwise, the holders of preferred shares and ordinary shares shall vote together as a single class.

 

Dividend Rights

 

Preferred shares holders shall be entitled to receive dividends if declared by the Board of Directors, in an amount equal to 10% of the original issuance price of the respective series of preferred shares per annum, prior and in preference to any dividend on the ordinary shares. The dividends for Series A, Series A-1, Series B Preferred Shares shall be accruing and cumulative and non-compounding. The dividends for Series C Preferred Shares shall be non-cumulative and non-compounding.

 

The remaining undistributed earnings of the Company after full payment of the above amounts on the preferred shares, shall be distributed on a prorate basis to the holders of ordinary shares and preferred shares on as-if-converted basis.

 

Liquidation Preferences

 

Upon any liquidation event, including deemed liquidation, dissolution or winding up of the Company, the assets of the Group shall be distributed in the following order:

 

(i)                  First, before any distribution or payment to holders of Series A, A-1 and B preferred shares or ordinary shares, each holder of the Series C preferred shares shall be entitled to receive an amount per share equal to 100% of the Series C preferred shares original issuance price, plus all dividends declared but unpaid with respect thereto.

 

(ii)               Second, following payment in full of the Series C preferred shares amount, but before any distribution or payment to Series A and Series A-1 preferred shares and ordinary shareholders, each holder of the Series B preferred shares shall be entitled to receive an amount per share equal to 125% of the Series B preferred shares original issuance price, plus all dividends accrued but unpaid with respect thereto.

 

(iii)            Third, following payment in full of the Series C and Series B preferred shares amount, but before any distribution or payment to ordinary shareholders, each holder of the Series A and Series A-1 preferred shares shall be entitled to receive an amount per share equal to 150% of the Series A or Series A-1 preferred shares original issuance price, plus all dividends accrued but unpaid with respect thereto.

 

(iv)           If there are assets of the Company available for distribution after payment of the above items i), ii), and iii) the remaining assets shall be distributed ratably among the holders of ordinary shares and preferred shares on an as if converted basis.

 

15.            Ordinary Shares

 

As of December 31, 2018 and 2019, the Company is authorized to issue a maximum of 200,000,000 ordinary shares, comprised of 20,000,000 Class A ordinary shares with a par value of US$0.001 per share and 180,000,000 Class B ordinary shares with a par value of US$0.001 per share. Holders of Class A ordinary shares and Class B ordinary shares have the same rights except for voting and conversion rights. The holders of Class A Ordinary Shares shall have ten votes in respect of each Class A Ordinary Share held, the holders of Class B Ordinary Shares shall have one vote in respect of each Class B Ordinary Share held. 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.

 

F-33


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

On March 4, 2019, the Group completed the transactions contemplated by the share subscription agreement (the “Subscription Agreement”) dated February 28, 2019 between the Company and certain equity investment firms (the “Investors”). In accordance with the Subscription Agreement, the Investors made an aggregate investment of approximately US$11.1 million by subscribing for 3,461,902 newly issued Class B ordinary shares of the Company, par value US$0.001 per share, at a subscription price of US$3.20 per share.

 

As of December 31, 2018 and 2019, 4,543,461 Class A Ordinary Shares were issued and outstanding. As of December 31, 2018 and 2019, 26,289,929 and 30,032,890 Class B Ordinary Shares were issued and outstanding, respectively.

 

16.            Share-based Compensation

 

In March 2017, the Group amended its employment-related stock option plan, which the Group originally adopted in 2011 and amended in 2014 (the “Stock Option Plan”) under which 2,500,000 Class B ordinary shares are available for issuance. The Stock Option Plan will terminate automatically in 2022, unless terminated earlier.

 

In March 2017, the Group also amended its Equity incentive plan, which the Group originally adopted in 2016 (“2017 Equity Incentive Plan) under which 2,500,000 ordinary shares are available for issuance in 2017 and the number of shares available for grant and issuance under the 2017 Equity Incentive Plan shall be increased on January 1, of each of the calendar years 2017 through 2026, by the lesser of (a) two and one-half percent (2.5%) of the number of ordinary shares issued and outstanding on each December 31 immediately prior to the date of increase or (b) such number of Shares determined by the Board. The Stock Option Plan will terminate automatically in 2022, unless terminated earlier. The awards under the 2017 Equity incentive plan include share options, restricted shares, share bonus, share appreciation rights, restricted share units and performance awards.

 

On July 16, 2019, the Group entered into contractual arrangements with certain of its executive officers and key employees, pursuant to which the Company cancelled a total of 1,170,000 options to purchase the Company’s Class B ordinary shares, which were granted to such individuals on January 3, 2017 pursuant to the Gridsum Holding Inc. Equity Incentive Plan (“2017 Equity Incentive Plan”). In exchange, the Company granted to such individuals a total of 866,665 restricted share units under the Equity Incentive Plan.

 

Share-based compensation expenses for the total share-based awards which are based on service conditions are recognized using the straight-line attribution approach. For the years ended December 31, 2017, 2018 and 2019, the Group recognized total share-based compensation expenses of RMB22,927, RMB39,026 and RMB52,450, respectively.

 

Share Options

 

During 2017, the Group granted 1,320,000 stock options with an average exercise price of US$10.11 per share under the Stock Option Plan. All of the options were to be vested over four years, one fourth (1/4) vesting and exercisable upon the first anniversary of the date of grant, and the remaining vesting monthly thereafter in 36 equal monthly installments.

 

During 2018, the Group granted 320,000 stock options with an average exercise price of US$6.34 per share under the Stock Option Plan. All of the options were to be vested over four years, one fourth (1/4) vesting and exercisable upon the first anniversary of the date of grant, and the remaining vesting monthly thereafter in 36 equal monthly installments.

 

During 2019, the Group granted 1,425,000 stock options with an average exercise price of US$2.23 per share under the Stock Option Plan. All of the options were to be vested over four years, one fourth (1/4) vesting and exercisable upon the first anniversary of the date of grant, and the remaining vesting monthly thereafter in 36 equal monthly installments.

 

F-34


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

Valuation Assumptions: The Group estimated the fair value of stock options using the binominal option-pricing model with assistance from an independent valuation firm. The fair value of each option grant is estimated on the date of grant with the following assumptions:

 

 

 

For the year ended December 31,

 

 

 

2017

 

2018

 

2019

 

Exercise price

 

US$

10.11

 

US$

6.34

 

US$

2.23

 

Risk free rate of interest

 

3.14

%

3.02

%

3.03

%

Dividend yield

 

 

 

 

Life of option (years)

 

10

 

10

 

10

 

Volatility

 

46

%

56

%

56

%

 

The Group estimated the risk free rate based on the yield to maturity of U.S. treasury bonds denominated in U.S. Dollars at the option valuation date. The exercise multiple is estimated as the ratio of fair value of underlying shares over the exercise price as at the time the option is exercised, based on a consideration of research study regarding exercise pattern based on historical statistical data. Expected term is the contract life of the option. The expected volatility at the date of grant date and each option valuation date was estimated based on the historical stock prices of comparable companies. The Group has never declared or paid any cash dividends on its capital stock, and the Group does not anticipate any dividend payments on its ordinary shares in the foreseeable future.

 

A summary of the Group’s stock option activities for the years ended December 31, 2017, 2018 and 2019 is presented below:

 

 

 

Number
of
Options

 

Weighted
Average
Exercise
Price
US$

 

Weighted
Average
Remaining
Contractual
Life In
years

 

Aggregate
Intrinsic
Value
US$

 

Outstanding as of December 31, 2016

 

2,436,661

 

$

0.42

 

6.24

 

34,423

 

Granted

 

1,320,000

 

$

10.11

 

 

 

Forfeited/expired

 

(44,606

)

$

0.42

 

 

 

Exercise

 

(1,088,647

)

$

0.42

 

 

 

Outstanding as of December 31, 2017

 

2,623,408

 

$

5.48

 

7.15

 

25,781

 

Granted

 

320,000

 

$

6.34

 

 

 

Forfeited/expired

 

(138,829

)

$

9.49

 

 

 

Exercise

 

(9,317

)

$

0.42

 

 

 

Outstanding as of December 31, 2018

 

2,795,262

 

$

5.15

 

6.45

 

8,763  

 

Granted

 

1,425,000

 

$

2.23

 

 

 

Forfeited/expired

 

(1,171,167

)

$

10.00

 

 

 

Exercise

 

(136,827

)

$

0.42

 

 

 

Outstanding as of December 31, 2019

 

2,912,268

 

$

1.96

 

6.72

 

 

Exercisable as of December 31, 2019

 

1,287,267

 

$

0.97

 

3.82

 

 

 

The weighted average grant date fair value of options granted for the year ended December 31, 2017, 2018 and 2019 was US$4.93, US$4.31 and US$1.52, respectively. For the years ended December 31, 2017, 2018 and 2019, total share-based compensation expenses recognized by the Group for the share options granted were RMB22,927, RMB16,751 and RMB17,106, respectively. As of December 31, 2017, 2018 and 2019, there was RMB38,300, RMB29,200 and RMB26,940 of total unrecognized compensation expense, adjusted for estimated forfeitures, related to non-vested share-based compensation arrangement under the Stock Option Plan, respectively. These expense are expected to be recognized over a weighted average period of 2.1 years, 1.27 years and 2.25 years as of December 31, 2017, 2018 and 2019, respectively. Total unrecognized compensation expense may be adjusted for future changes in estimated forfeitures.

 

F-35


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

Restricted Stock Units

 

During 2019, the Group granted 304,746 restricted stock units (“RSU”). RSU are share awards that, upon vesting, will deliver to the holder shares of the Group’s ordinary shares. All of the RSU were to be vested over four years, one fourth (1/4) vesting and exercisable upon the first anniversary of the date of grant, and the remaining vesting monthly thereafter in 36 equal monthly installments. The Group satisfies RSU vesting through the issuance of new shares or settle by cash.

 

Share-based compensation expenses for the total share-based awards which are based on service conditions are recognized using the straight-line attribution approach. For the years ended December 31, 2017, 2018 and 2019, the Group recognized share-based compensation expenses of nil, RMB22,275 and RMB35,344 respectively, for the restricted stock units.

 

A summary of the Group’s restricted stock activity for the years ended December 31, 2017, 2018 and 2019 is presented below:

 

 

 

Number
of
RSU

 

Weighted
Average
Grant date
fair value
US$

 

Outstanding as of December 31, 2017

 

936,699

 

$

9.75

 

Awarded

 

651,117

 

$

8.62

 

Forfeited

 

(180,620

)

$

9.77

 

Vested

 

(354,982

)

$

8.61

 

Outstanding as of December 31, 2018

 

1,052,214

 

$

9.43

 

Awarded

 

304.746

 

$

3.09

 

Exchanged from options

 

866,665

 

3.05

 

Forfeited

 

(217,938

)

$

9.53

 

Vested

 

(1,191,192

)

$

6.08

 

Outstanding as of December 31, 2019

 

814,495

 

6.29

 

 

17.    Business Combination

 

On May 31, 2017, the Group’s VIE, Gridsum Holding (Beijing) Co., Ltd., acquired Zhixun from three individual shareholders (“Previous Shareholders”) with a purchase price of RMB2.5 million and RMB7.5 million for continuing employment compensation for the Previous Shareholders for the next three years. The Group funded the acquisition with its own working capital. The Group believes that the acquisition will allow it to better manage opportunities and capitalize on the growth potential in the market for applications related to customer relationship management.

 

The transaction was accounted for as a business combination using the purchase method of accounting. The purchase price allocation of the transaction was determined by the Group with the assistance of an independent appraisal firm based on the estimated fair value of the assets acquired and liabilities assumed as of the acquisition date. The purchase price allocation to assets acquired and liabilities assumed as of the date of acquisition was as follows:

 

 

 

May 31,
2017

 

 

 

RMB

 

Cash acquired

 

643

 

Prepayment, deposit and other assets

 

335

 

Property, equipment and software, net

 

888

 

Customer relationship

 

677

 

Accrued expense, other payable and other current liabilities

 

(309

)

Deferred tax liability

 

(271

)

Goodwill

 

537

 

Total

 

2,500

 

 

F-36


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

The customer relationship represents a long term relationship with a large enterprise customers with an estimated useful life of 10 years. The goodwill is mainly attributable to the excess of the consideration paid over the fair value of the net assets acquired that cannot be recognized separately as identifiable assets under U.S. GAAP, and comprise (a) the assembled work force and (b) the expected but unidentifiable business growth as a result of the synergy resulting from the acquisition.

 

18.    Net Loss per Share

 

The following table sets forth the basic and diluted net loss per share computation and provides a reconciliation of the numerator and denominator for the periods presented:

 

 

 

For the year ended December 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

Numerator:

 

 

 

 

 

 

 

Net loss attributable to Gridsum Holding Inc.

 

(238,996

)

(521,325

)

(537,929

)

Numerator for basic and diluted net loss per share

 

(238,996

)

(521,325

)

(537,929

)

Denominator:

 

 

 

 

 

 

 

Weighted average number of ordinary shares outstanding, basic and diluted

 

30,243,250

 

30,827,600

 

33,810,862

 

Net loss per share attributable to Gridsum’s ordinary shareholders—Basic and diluted

 

(7.90

)

(16.91

)

(15.91

)

 

Basic net loss per share is computed using the weighted average number of the ordinary shares outstanding during the period. Diluted net loss per share is computed using the weighted average number of ordinary shares and dilutive ordinary share equivalents outstanding during the period. For the years ended December 31, 2017, 2018 and 2019, options to purchase ordinary shares that were anti-dilutive and excluded from the calculation of diluted net loss per share was 1,605,961, 2,754,327 and 3,462,156 on a weighted average basis, respectively. For the years ended December 31, 2017, 2018 and 2019, the conversion shares from the Group’s convertible note of nil, 4,080,084 and 6,153,846, respectively, on a weighted average basis were also antidilutive and excluded from the calculation of diluted net loss per share.

 

19.    Lease

 

Effective January 1, 2019, the Company adopted ASU 2016-02, “Leases” (Topic 842), and elected the package of practical expedients that does not require the Company to reassess: (1) whether any expired or existing contracts are, or contain, leases, (2) lease classification for any expired or existing leases and (3) initial direct costs for any expired or existing leases. The impact of the adoption of the ASC 842, as of January 1, 2019, the Company recognized RMB146,872 ROU assets and RMB154,226 lease liabilities, primarily related to leases of facilities. The ROU and lease liabilities are determined based on the present value of the future minimum rental payments of the lease as of the adoption date, using an effective interest rate of 4.0%, which is determined using an incremental borrowing rate with similar term in the PRC. The average remaining lease term of its existing leases is 3.09 years. The adoption of this standard resulted in the recording of operating lease assets and operating lease liabilities as of January 1, 2019, with no related impact on the Company’s consolidated statement of changes in stockholders’ equity or consolidated statements of operations and comprehensive loss.

 

F-37


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

The Company occupies various offices under operating lease agreements with a term shorter than 12 months which it elected not to recognize lease assets and lease liabilities under ASC 842. Instead, the Company recognized the lease payments in profit or loss on a straight-line basis over the lease term and variable lease payments in the period in which the obligation for those payments is incurred.

 

The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.

 

Rental expenses were RMB35,553 and RMB60,841 and RMB57,702 for the years ended December 31, 2017, 2018 and 2019, respectively.

 

The following table sets forth the Company’s minimum lease payments in future periods:

 

Twelve Months Ending December 31,

 

Lease payments

 

 

 

RMB

 

2020

 

43,491

 

2021

 

39,625

 

2022

 

32,767

 

2023

 

15,815

 

Total lease payments

 

131,698

 

Less: discount

 

(8,259

)

Present value of lease liabilities

 

123,439

 

 

20.    Commitments and Contingencies

 

(a)     Commitment

 

We have entered into serval donation, services, car rental and other miscellaneous agreements. As of December 31, 2019, future minimum payments under these agreements were as follows:

 

 

 

Total

 

 

 

RMB

 

2020

 

16,557

 

2021

 

3,545

 

2022

 

1,744

 

2023 and thereafter

 

110

 

 Total

 

21,956

 

 

(b)     Litigation

 

From time to time, the Group is involved in claims and legal proceedings that arise in the ordinary course of business. Based on currently available information, management does not believe that the ultimate outcome of these unresolved matters, individually and in the aggregate, is reasonably possible to have a material adverse effect on the Group’s financial position, results of operations or cash flows. However, litigation is subject to inherent uncertainties and the Group’s view of these matters may change in the future. Were an unfavorable outcome to occur, there exists the possibility of a material adverse impact on the Group’s financial position, results of operations or cash flows for the period in which the unfavorable outcome occurs and potentially in future periods.

 

F-38


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

On April 25, 2018 and June 25, 2018, purported securities class action complaints were filed in the United States District Court for the Southern District of New York against the Company, Guosheng Qi and Michael Peng Zhang, among other defendants. These lawsuits, which are captioned Xu v. Gridsum Holding Inc., et al., Case No. 18-CV-3655, and Li v. Gridsum Holding Inc., et al., Case No. 18-CV-5749, alleged, among other things, that “false and/or misleading statements” were made “and/or” the Company failed to disclose its lack of effective controls over financial reporting, in connection with Gridsum’s announcement on April 23, 2018 that its financial statements for the year ended December 31, 2016 should no longer be relied upon. On September 17, 2018, the court appointed a lead plaintiff pursuant to the Private Securities Litigation Reform Act of 1995 and ordered the lawsuits consolidated. A consolidated amended complaint was filed on November 30, 2018 that variously alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, Rule 10b-5 of the Securities Exchange Act of 1934, and Sections 11 and 15 of the Securities Act for a putative class period from September 22, 2016 to April 20, 2018, against the Company and its current and former officers and directors, among other defendants. On March 1, 2019, the lead plaintiff filed a second amended class action complaint, or the SAC, that alleges a putative class period between September 22, 2016 to January 7, 2019. The Company and a defendant who is a former director filed a motion to dismiss the SAC. On March 30, 2020, the court granted the motion with respect to certain claims, dismissing the claims under Sections 11 and 15 of the Securities Act in their entirety, and the Section 10(b) claim of the Exchange Act with respect to the director. The court in the same order also denied the lead plaintiffs’ motion for alternative service on the remaining individual defendants who were named in the SAC, but have not yet been served. The lead plaintiff has been given until May 1, 2020 to amend the SAC should he elect to do so.

 

On July 2, 2018, a third purported securities class action complaint was filed in the Supreme Court of the State of New York against Gridsum and certain of its current and former directors and executive officers, among other defendants, variously alleging violations of Sections 11, 12(a)(2), and 15 of the Securities Act against them. The lawsuit, captioned, Gordon v. Gridsum Holding Inc., et al., Index No. 18-653342, is brought on behalf of a putative class of shareholders who “purchased or otherwise acquired” ADSs in Gridsum’s initial public offering on September 23, 2016, and are based on substantially the same allegations as the consolidated proceeding described above. On January 22, 2019, an amended complaint was filed. On April 10, 2019, the court granted the Company’s motion to stay this action pending the determination of the federal action, and this action remains stayed. The Company believes that the claims against it are without merit and intends to vigorously defend against the litigation.

 

21.    Restricted Net Assets

 

Relevant PRC laws and regulations permit payments of dividends by the subsidiaries and the VIEs incorporated in the PRC only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. In addition, each of the Company’s subsidiaries and VIEs is required to annually appropriate 10% of net after-tax income to the statutory general reserve fund (Note 2(z)) prior to payment of any dividends, unless such reserve funds have reached 50% of its respective registered capital. For the years ended December 31, 2018 and 2019, the statutory reserve amounted to RMB12,903 and RMB12,903, respectively. As a result of these and other restrictions under PRC laws and regulations, the subsidiaries, VIEs and VIE subsidiaries are restricted in their ability to transfer a portion of their net assets to the Company either in the form of dividends, loans or advances of the Group’s total consolidated net assets. As of December 31, 2018 and 2019, the total restricted net assets of the Company’s subsidiaries, VIEs and VIE subsidiaries incorporated in PRC and subjected to restriction amounted to approximately RMB177,408 and RMB70,090, respectively. Even though the Group currently does not require any such dividends, loans or advances from the PRC entities for working capital and other funding purposes, the Company may in the future require additional cash resources from them due to changes in business conditions, to fund future acquisitions and development, or merely to declare and pay dividends or distributions to its shareholders. Except for the above, there is no other restriction on the use of proceeds generated by the Group’s subsidiaries, VIEs and VIE subsidiaries to satisfy any obligations of the Group.

 

22.    Subsequent Events

 

In December 2019, a novel strain of coronavirus, or COVID-19, surfaced and it has spread rapidly to many parts of China and other parts of the world, including the United States. The epidemic has resulted in quarantines, travel restrictions, and the temporary closure of stores and facilities in China and elsewhere. Substantially all of the Company’s revenue is concentrated in China. Consequently, the COVID-19 outbreak may materially adversely affect the Company’s business operations, financial condition and operating results for 2020, including but not limited to material negative impact on the Company’s total revenues, slower collection of accounts receivables and additional allowance for doubtful accounts. Because of the significant uncertainties surrounding the COVID-19 outbreak, the extent of the business disruption and the related financial impact cannot be reasonably estimated at this time.

 

In July 2019, our board of directors received a preliminary non-binding proposal letter from Guosheng Qi, Guofa Yu, their respective affiliated entities, and Beta Dynamic Limited, an affiliate of Hammer Capital Private Investments Limited, to acquire our company in a going private transaction for US$3.80 in cash per ADS or ordinary share. Our board of directors formed a special committee consisting of independent directors to evaluate the proposal and any other alternative transactions. On May 1, 2020, our board of directors received a revised non-binding proposal letter, from Guosheng Qi, Guofa Yu, their respective affiliated entities, Beta Dynamic Limited, Shenzhen Qianhai Banyan Capital Investment & Management Co., Ltd and Hangzhou Yutao Capital Co., Ltd, to acquire our company in a going private transaction for US$2.00 in cash per ADS or ordinary share.

 

F-39


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

ADDITIONAL INFORMATION: CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY

 

Rules 12-04(a) and 4-08(e)(3) of Regulation S-X require condensed financial information as to the financial position, cash flows and results of operations of a parent company as of and for the same periods for which the audited consolidated financial statements have been presented when the restricted net assets of the consolidated and unconsolidated subsidiaries together exceed 25% of consolidated net assets as of the end of the most recently completed fiscal year.

 

The following condensed financial statements of the Company have been prepared using the same accounting policies as set out in the Company’s consolidated financial statements except that the Company used the equity method to account for its investment in its subsidiaries and VIEs. Such investment is presented on the separate condensed balance sheets of the Company as “Investment in subsidiaries and VIEs” and “Accumulated losses in excess of investment in subsidiaries and VIEs.” The Company, its subsidiaries and VIEs were included in the consolidated financial statements whereby the inter-company balances and transactions were eliminated upon consolidation. The Company’s share of income from its subsidiaries and VIEs is reported as share of income from subsidiaries and VIEs in the condensed financial statements.

 

The Company is a Cayman Islands company and, therefore, is not subjected to income taxes for all years presented. The footnote disclosures contain supplemental information relating to the operations of the Company and, as such, these statements should be read in conjunction with the notes to the consolidated financial statements of the Company. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted.

 

As of December 31, 2018 and 2019, there were no material commitments or contingencies, significant provisions for long-term obligations or guarantees of the Company, except for those which have been separately disclosed in the consolidated financial statements, if any.

 

Inter-company charges, share-based compensation and other miscellaneous expenses for the years ended December 31, 2017, 2018 and 2019, which were previously recognized at the parent company level, had been pushed down to the WFOE/VIE level given the majority of services were provided to the WFOE/VIE entities.

 

F-40


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

Condensed Balance Sheets of Parent Company

 

 

 

As of December 31,

 

 

 

2018

 

2019

 

2019

 

 

 

RMB

 

RMB

 

US$

 

ASSETS

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

4,493

 

324

 

47

 

Accounts receivable, net

 

 

81

 

12

 

Amounts due from subsidiaries and VIEs

 

55,460

 

 

 

Prepayments and other current assets

 

9,982

 

15,541

 

2,231

 

Total current assets

 

69,935

 

15,946

 

2,290

 

Total assets

 

69,935

 

15,946

 

2,290

 

LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIENCY)

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accrued expenses and other current liabilities

 

23,476

 

36,849

 

5,293

 

Salaries and welfare payable

 

 

1,367

 

196

 

Amounts due to subsidiaries and VIEs

 

 

344,831

 

49,532

 

Total current liabilities

 

23,476

 

383,047

 

55,021

 

Total liabilities

 

23,476

 

383,047

 

55,021

 

Commitments and contingencies

 

 

 

 

 

 

 

Shareholders’ equity (deficiency)

 

 

 

 

 

 

 

Ordinary shares—Class A (US$0.001 par value; 20,000,000 shares authorized, 4,543,461 shares issued and outstanding as of December 31, 2018 and 2019, respectively)

 

31

 

31

 

4

 

Ordinary shares—Class B (US$0.001 par value; 180,000,000 shares authorized, 26,289,929 and 30,032,890 shares, issued and outstanding as of December 31, 2018 and 2019, respectively)

 

177

 

202

 

30

 

Additional paid-in capital

 

1,146,253

 

1,272,959

 

182,848

 

Statutory Reserve

 

12,903

 

12,903

 

1,853

 

Accumulated other comprehensive loss

 

(35,496

)

(37,858

)

(5,437

)

Accumulated deficit

 

(1,077,409

)

(1,615,338

)

(232,029

)

Gridsum’s shareholders’ equity (deficiency)

 

46,459

 

(367,101

)

(52,731

)

Total liabilities and shareholders’ equity

 

69,935

 

15,946

 

2,290

 

 

F-41


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

Condensed Statements of Operations and Comprehensive Loss of Parent Company

 

 

 

For the year ended December 31,

 

 

 

2017

 

2018

 

2019

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

Revenues

 

 

 

 

 

Cost of revenues

 

 

 

 

 

Gross profit

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing expenses

 

 

 

 

 

Research and development expenses

 

 

 

 

 

General and administrative expenses

 

(872

)

(53

)

(2,839

)

(408

)

Total operating expenses

 

(872

)

(53

)

(2,839

)

(408

)

Loss from operations

 

(872

)

(53

)

(2,839

)

(408

)

Loss from subsidiaries and VIEs

 

(238,124

)

(521,272

)

(535,090

)

(76,861

)

Net loss

 

(238,996

)

(521,325

)

(537,929

)

(77,269

)

Net loss attributable to Gridsum’s ordinary shareholders

 

(238,996

)

(521,325

)

(537,929

)

(77,269

)

Comprehensive loss

 

(259,576

)

(527,502

)

(539,251

)

(77,459

)

 

F-42


Table of Contents

 

GRIDSUM HOLDING INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

(In thousands, except for share and per share data)

 

Condensed Statements of Cash Flows of Parent Company

 

 

 

For the Year Ended
December 31,

 

 

 

2017

 

2018

 

2019

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

 

Net cash provided by/(used in) operating activities

 

2,424

 

(10,753

)

6,260

 

899

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

 

Investment of subsidiaries and VIEs

 

(291,008

)

(12,136

)

(84,710

)

(12,168

)

Net cash used in investing activities

 

(291,008

)

(12,136

)

(84,710

)

(12,168

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

 

Proceeds from issuance of Series C preferred shares

 

 

 

 

 

Proceeds from issuance of ordinary shares

 

3,091

 

27

 

74,281

 

10,670

 

Payment of financing costs in connection with the issuance of Series C preferred shares

 

 

 

 

 

Payment for IPO costs

 

(3,362

)

 

 

 

Net cash provided by/(used in) financing activities

 

(271

)

27

 

74,281

 

10,670

 

Net decrease in Cash, cash equivalents and restricted cash

 

(288,855

)

(22,862

)

(4,169

)

(599

)

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

 

316,210

 

27,355

 

4,493

 

646

 

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

 

27,355

 

4,493

 

324

 

47

 

 

F-43


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