UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 20-F

 

(Mark One)

 

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

 

or

 

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

 

For the fiscal year ended December 31, 2017.

 

or

 

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

 

or

 

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

 

Date of event requiring this shell company report

 

For the transition period from _______________ to _______________

 

Commission file number: 001-34873

 

ChinaCache International Holdings Ltd.

(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)

 

 

 

Section A, Building 3

Dian Tong Creative Square

No.7 Jiuxianqiao North Road, Chaoyang District

Beijing, 100015, China

(Address of principal executive offices)

Guangsheng Meng, Chief Financial Officer

Tel: +86 (10) 6408 5088

Fax: +86 (10) 6408 5888

Section A, Building 3

Dian Tong Creative Square

No.7 Jiuxianqiao North Road, Chaoyang District

Beijing, 100015, China

(Name, Telephone, Email 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 Name of each exchange on which registered
American depositary shares, each
representing 16 ordinary shares
Ordinary shares, par value
US$0.0001 per share*
Nasdaq Global
Select Market
Nasdaq Global
Select Market*

 

*Not for trading, but only in connection with the listing on The Nasdaq Global Select Market of American depositary shares.

 

Securities registered or to be registered pursuant to Section 12(g) of the Act:

 

None

(Title of Class)

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

 

None

(Title of Class)

 

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.

 

426,267,345 ordinary shares, par value US$0.0001 per share, as of December 31, 2017

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

 

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.    Yes  ¨    No  x

 

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.

Yes  x    No   ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes  x    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 the definitions of “large accelerated filer,” “accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer    ¨ Accelerated filer    ¨ Non-accelerated filer    x Emerging growth company    ¨

 

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

 

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

 

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    ¨

Other    ¨

 

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.

 

¨ Item 17    ¨ 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).

 

    Yes  ¨    No  x

 

 

 

 

 

 

TABLE OF CONTENT

 

INTRODUCTION 1
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS 1
PART I. 2
ITEM 1. Identity of Directors, Senior Management and Advisers 2
ITEM 2. Offer Statistics and Expected Timetable 2
ITEM 3. Key Information 2
ITEM 4. INFORMATION ON THE COMPANY 36
ITEM 4A. UNRESOLVED STAFF COMMENTS 61
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 61
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 81
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 89
ITEM 8. FINANCIAL INFORMATION 91
ITEM 9. THE OFFER AND LISTING 93
ITEM 10. ADDITIONAL INFORMATION 94
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 109
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
Item 17. FINANCIAL STATEMENTS 110
Item 18. FINANCIAL STATEMENTS 110
Item 19. EXHIBITS 110

 

i

 

 

INTRODUCTION

 

In this annual report, except where the context otherwise requires and for purpose of this annual report only:

 

·“ADSs” refers to American depositary shares, each of which represents 16 ordinary shares;
·“Beijing Blue I.T.” means Beijing Blue I.T. Technologies Co., Ltd.
·“Beijing Jingtian” means Beijing Jingtian Technologies Co., Ltd.
·“ChinaCache,” “we,” “us,” “our company,” and “our” refer to ChinaCache International Holdings Ltd., its subsidiaries and its consolidated variable interest entities;
·“China” or “PRC” refers to the People’s Republic of China, excluding, for purposes of this annual report only, Taiwan, Hong Kong and Macau;
·“ChinaCache Beijing” means ChinaCache Network Technology (Beijing) Co., Limited;
·“ChinaCache Hong Kong” means ChinaCache Networks (Hong Kong) Limited
·“Renminbi” or “RMB” refers to the legal currency of China;
·“U.S.” refers to the United States of America;
·“U.S. GAAP” refers to generally accepted accounting principles in the U.S.;
·“US$,” “dollars” or “U.S. dollars” refers to the legal currency of the U.S.;
·“Xin Run” means ChinaCache Xin Run Technology (Beijing) Co., Limited; and
·all discrepancies in any table between the amounts identified as total amounts and the sum of the amounts listed therein are due to rounding.

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This annual report on Form 20-F contains forward-looking statements that relate to our current expectations and views of future events. The forward-looking statements are contained principally in the items entitled “Information on the Company,” “Risk Factors,” “Operating and Financial Review and Prospects,” “Financial Information” and “Quantitative and Qualitative Disclosures About Market Risk.” Our forward-looking statements relate to events that involve known and unknown risks, uncertainties and other factors, including those listed under “Risk Factors,” which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. These statements are made under the “safe harbor” provisions of the U.S. Private Securities Litigations Reform Act of 1995. You can identify some of these forward-looking statements by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “is/are likely to,” “potential,” “continue” or other similar expressions, although not all forward-looking statement contain these words. Forward-looking statements include, but are not limited to, statements relating to:

 

·our goals and strategies;
·our expansion plans;
·our future business development, financial condition and results of operations;
·the expected growth of the content and application delivery services market;
·our expectations regarding demand for, and market acceptance of, our services;
·our expectations regarding keeping and strengthening our relationships with customers;
·our plans to invest in research and development to enhance our solution and service offerings; and
·general economic and business conditions in the regions where we provide our solutions and services.

 

We would like to caution you not to place undue reliance on forward-looking statements and you should read these statements in conjunction with the risk factors disclosed in “Item 3 Key Information —D. Risk Factors.” Those risks are not exhaustive. We operate in an emerging and evolving environment. New risk factors emerge from time to time and it is impossible for our management to predict all risk factors, 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 statement. We do not undertake any obligation to update or revise the forward-looking statements except as required under applicable law. You should read this annual report and the documents that we reference in this annual report completely and with the understanding that our actual future results may be materially different from what we expect.

 

 

 

 

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 table presents the selected consolidated financial information of our company. Our selected consolidated financial data presented below for the years ended December 31, 2015, 2016 and 2017 and our balance sheet data as of December 31, 2016 and 2017 have been derived from our audited consolidated financial statements included elsewhere in this annual report. Our selected consolidated financial data presented below for the year ended December 31, 2013 and 2014 and our balance sheet data as of December 31, 2013, 2014 and 2015 have been derived from our audited consolidated financial statements which are not included in this annual report. Our audited consolidated financial statements are prepared in accordance with U.S. GAAP.

 

You should read the summary consolidated financial information in conjunction with our consolidated financial statements and related notes and “Item 5. Operating and Financial Review and Prospects” included elsewhere in this annual report. Our historical results are not necessarily indicative of our results expected for future periods.

 

   For the Year Ended December 31, 
   2013   2014   2015   2016   2017 
   RMB   RMB   RMB   RMB   RMB   US$ 
   (in thousands, except for shares, per share and per ADS data) 
Consolidated Statement of Comprehensive Loss Data:                              
Net Revenues:                              
Third party customers   1,103,243    1,384,273    1,353,627    1,054,235    852,568    131,037 
A related party customer                        
Total Net Revenues:   1,103,243    1,384,273    1,353,627    1,054,235    852,568    131,037 
Cost of revenues(1)(3)   (756,617)   (966,558)   (1,041,412)   (1,077,810)   (781,822)   (120,164)
Gross profit (loss)   346,626    417,715    312,215    (23,575)   70,746    10,873 
Other operating income (loss)           13,911    (19,044)   (19,483)   (2,994)
Operating expenses:(1)                              
Sales and marketing expenses(1)   (124,578)   (127,843)   (115,621)   (93,603)   (61,770)   (9,494)
General and administrative  expenses(1)   (129,846)   (144,003)   (202,518)   (256,007)   (142,721)   (21,936)
Provision (recovery of provision) for doubtful accounts receivable   (23,722)   (46,977)   3,892    (9,010)   (17,514)   (2,692)
Transaction tax on assets transfer           (27,733)            
Research and development  expenses(1)   (102,704)   (116,381)   (103,110)   (104,018)   (81,748)   (12,564)

 

2

 

 

   For the Year Ended December 31, 
   2013   2014   2015   2016   2017 
   RMB   RMB   RMB   RMB   RMB   US$ 
   (in thousands, except for shares, per share and per ADS data) 
Consolidated Statement of Comprehensive Loss Data:                        
Impairment of long-lived assets               (399,094)   (21,757)   (3,344)
Impairment of long-term  investment   (1,217)            (18,240)   (3,690)   (567)
Operating loss   (35,441)   (17,489)   (118,964)   (922,591)   (277,937)   (42,717)
Interest income   2,513    5,529    4,618    4,669    1,430    220 
Interest expense   (3,584)   (8,220)   (13,158)   (11,647)   (18,665)   (2,869)
Other (expense) income   6,886    6,298    2,991    5,336    (5,303)   (815)
Foreign exchange (loss) gain   (3,308)   3,944    13,164    14,209    (11,043)   (1,697)
Loss from continuing operations before income taxes   (32,934)   (9,938)   (111,349)   (910,024)   (311,518)   (47,880)
Income tax (expense) benefit   (1,295)   3,097    22,614    (4,229)   (59,648)   (9,168)
Net loss   (34,229)   (6,841)   (88,735)   (914,253)   (371,166)   (57,048)
Net loss attributable to the non-controlling interest           (44)   (776)   (2,005)   (308)
Net loss attributable to the Company’s shareholders   (34,229)   (6,841)   (88,691)   (913,477)   (369,161)   (56,740)
Loss per ordinary share:                              
Basic   (0.09)   (0.02)   (0.22)   (2.24)   (0.87)   (0.13)
Diluted   (0.09)   (0.02)   (0.22)   (2.24)   (0.87)   (0.13)
Loss per ADS(2)                              
Basic   (1.51)   (0.27)   (3.49)   (35.84)   (13.92)   (2.08)
Diluted   (1.51)   (0.27)   (3.49)   (35.84)   (13.92)   (2.08)
Shares used in basic loss per share computation   362,916,540    403,401,928    407,149,509    408,189,722    425,589,746    425,589,746 
Shares used in diluted loss per share computation   362,916,540    403,401,928    407,149,509    408,189,722    425,589,746    425,589,746 

 

 

(1)Includes share-based compensation expenses as follows:

 

   For the year ended December 31, 
   2013   2014   2015   2016   2017 
   RMB   RMB   RMB   RMB   RMB   US$ 
   (in thousands) 
Allocation of share-based compensation expenses:                        
Cost of revenues   1,665    951    3,670    5,961    490    75 
Sales and marketing expenses   3,853    2,167    2,882    2,753    254    39 
General and administrative expenses   3,833    10,612    38,796    72,483    9,631    1,480 
Research and development expenses   2,501    3,307    3,258    3,828    562    86 
Total share-based compensation expenses included in cost of revenues and operating expenses   11,852    17,037    48,606    85,025    10,937    1,680 

 

 

(2)Each ADS represents 16 ordinary shares.

 

(3)Includes amount to a related party of nil, nil and nil for the years ended December 31, 2015, 2016 and 2017, respectively.

 

3

 

 

A summary of our selected consolidated balance sheet data is as follows:

 

   For the year ended December 31, 
   2013   2014   2015   2016   2017 
   RMB   RMB   RMB   RMB   RMB   US$ 
   (in thousands) 
Consolidated Balance Sheet Data:                              
Cash and cash equivalents   338,092    375,879    606,796    134,924    106,709    16,401 
Accounts receivable, net   306,237    319,494    243,431    190,587    161,043    24,752 
Assets held for sale           1,060,543    1,285,961    581,731    89,410 
Total current assets   786,751    864,815    1,986,857    1,735,143    1,064,491    163,608 
Property, plant and equipment, net   240,650    418,886    499,946        53,326    8,196 
Cloud infrastructure construction in progress   12,236    283,475            416,352    63,992 
Intangible assets, net   5,563    10,321    10,898        165    25 
Total assets   1,167,168    1,731,208    2,618,616    1,805,827    1,606,035    246,842 
Liabilities held for sale           1,014,449    1,318,136    3,888    597 
Total current liabilities   511,908    864,105    1,779,700    1,893,188    1,887,363    290,082 
Total liabilities   514,035    896,261    1,896,929    1,948,347    2,106,942    323,831 
Total shareholders’ equity   653,133    834,947    721,687    (142,520)   (500,907)   (76,989)

 

Exchange Rate Information

 

A majority of our operations are conducted in China and our revenues are mainly denominated in RMB. This annual report contains translations of RMB amounts into U.S. dollars at specific rates solely for the convenience of the reader. Unless otherwise noted, all translations from RMB to U.S. dollars and from U.S. dollars to RMB in this annual report were made at a rate of RMB6.5063 to US$1.00, the exchange rate set forth in the H.10 statistical release of the Board of Governors of the Federal Reserve System on December 29, 2017. 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, the rates stated below, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of RMB into foreign exchange and through restrictions on foreign trade. On April  20, 2018, the certified exchange rate was RMB 6.2945 to US$1.00.

 

The following table sets forth information concerning exchange rates between the RMB and the U.S. dollar for the periods indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this annual report or will use in the preparation of any other periodic reports or any other information to be provided to you. The source of these rates is the Federal Reserve Statistical Release.

 

   Exchange rate 
Period  Period End   Average(1)   Low   High 
   (RMB Per US$1.00) 
2013   6.0537    6.1412    6.2438    6.0537 
2014   6.2046    6.1704    6.2591    6.0402 
2015   6.4778    6.2869    6.4896    6.1870 
2016   6.9430    6.6549    6.9580    6.4480 
2017   6.5063    6.7350    6.9575    6.4773 
October   6.6328    6.6254    6.6533    6.5712 
November   6.6090    6.6200    6.6385    6.5967 
December   6.5063    6.5932    6.6210    6.5063 
2018                    
January   6.2841    6.3952    6.2841    6.5263 
February   6.3280    6.3061    6.2649    6.3471 
March   6.2726    6.3003    6.2685    6.3565 
April  (through April 20)   6.2945    6.2858    6.2655    6.3045 

 

 

Source: Federal Reserve Statistical Release

 

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

 

B.Capitalization and Indebtedness

 

Not applicable.

 

4

 

 

C.Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

D.Risk Factors

 

Risks Related to Our Business and Industry

 

We have incurred losses in the past and may incur losses in the future. There is substantial doubt about our ability to continue as a going concern.

 

We had net losses in recent years. For the three years ended December 31, 2015, 2016, and 2017, our net loss was RMB88.7 million, RMB914.3 million, and RMB371.2 million (US$57.0 million), respectively. As of December 31, 2017, we had an accumulated deficit of RMB2,076.2 million (US$319.1 million) and a deficit in working capital of RMB822.9 million (US$126.5 million).  In 2017, we had net cash used in operating activities of RMB99.0 million (US$15.2million), net cash used in investing activities of RMB89.3 million (US$13.7 million) and net cash provided by financing activities of RMB149.0 million (US$22.9 million). We cannot anticipate when, if ever, we will become profitable. Although we have improved the efficiency of our networks and operations and adopted related cost reduction measures, we cannot assure you that we will continue to achieve such efficiency or sustain such cost reductions. If we are unable to generate revenues that significantly exceed our costs and expenses, we will continue to incur losses in the future.

 

Our ability to continue as a going concern is dependent upon our continued operations, which in turn is dependent upon our ability to meet our financial requirements. Our ability to meet the working capital requirements is subject to the risks relating to the demand for and prices of our services in the market, the economic conditions in our target markets, the construction and successful operation of our cloud infrastructure projects, the timely collection of payment from our customers and the availability of additional funding. In the next twelve months, we will use the cash inflows to be funded by a combination of sources, including a) the advance of RMB368,000,000 (US$56,561,000) to be received from a third party buyer pursuant to a sales and lease back framework contract signed for a cloud infrastructure building under construction, b) the credit facilities of RMB20,000,000 (US$3,074,000) provided by a bank in PRC, c) a letter of intention signed with a third party for a facility of RMB300,000,000 (US$46,109,000) for the construction payment of the Company’s cloud infrastructure, and d) improvement in the net cash inflow from the CDN operations as the Company controls its operating costs and negotiates with vendors for more favorable payment terms. Together with our existing cash and cash equivalents, bank borrowing and the anticipated improvement in the cash inflow from the operations, we expect to have sufficient capital to meet our anticipated working capital requirements and capital expenditure for at least the next 12 months.

 

The audited consolidated financial statements included in this annual report on Form 20-F were prepared on the basis of our continuing as a going concern. Facts and circumstances including recurring losses, negative working capital and net cash outflows raise substantial doubt about our ability to continue as a going concern. In particular, there can be no assurance that the credit facilities can be drawn down in a timely manner, the cash flows from CDN operations can be improved as planned or the afore-mentioned financing measures can be achieved as expected. 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 audited 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 raise new capital or to continue our operations.

 

5

 

 

We generate substantially all of our revenues from sales of content and application delivery total solutions, and the failure of the market for these services to expand as we expect or the reduction in spending on these services by our current or potential customers would seriously harm our business.

 

We have generated substantially all of our revenues from sales of content and application delivery total solutions. We expect such services to continue to be the primary source of our revenues in the foreseeable future. Our success, therefore, depends on our customers’ continued and increasing reliance on the internet for delivery of services and applications and our ability to deliver these services and applications cost-effectively. Factors that may have a general tendency to limit or reduce the number of users relying on the internet for services and applications or the number of providers making services and applications available online would harm our business. As the content and application delivery services industry is still emerging, our success also depends on our ability to convince potential customers to entrust their services and applications to an external service provider, that content and application delivery technologies and services are valuable and that it is more cost-effective for them to utilize external services than for them to develop similar services in-house. A decline in the demand for content and application delivery services in general would negatively affect demand for our services. Even if demand for our services continues to grow, this demand may not grow as quickly as we anticipate. The influence of any of these factors may cause our current or potential customers to reduce their spending on our services, which would have a material adverse impact on our business, results of operations and financial condition.

 

Our costs and expenses may increase, and our results of operations may be adversely affected if we cannot pass on the increased costs to our customers.

 

We invest heavily in capital equipment and infrastructure to increase our network capacity. For example, we had capital expenditures of RMB417.8 million, RMB356.0 million and RMB162.8 million (US$25.0 million) in 2015, 2016 and 2017, respectively, which relate to our additions of intangible assets and property and equipment. In 2018 and beyond, we may increase our costs and expenses, including investments in cloud infrastructure and additional bandwidth, servers and other equipment. In particular, we plan to continue the development of our internet data centers(IDC), High Performance Cloud Cache, or HPCC, and Bandwidth Schedule Platform to optimize bandwidth usage and improve network efficiency in order to meet the needs of new product development and our evolving businesses. We expect these projects, upon completion, to result in substantial increase in IDC related sales revenues and reduction in our future operation expenses and capital expenditures on equipment. However, since the aforementioned technologies are relatively new, we cannot assure you that their implementation will benefit us with the cost and expense reduction as expected, or at all. Furthermore, our capital expenditures are based upon our assumptions regarding the potential future demand. If we overestimate future demand for our services, we may not be able to achieve acceptable rates of return on our capital expenditures and our results of operations may suffer dramatically. In addition, if our bandwidth and other third-party providers raise the prices of their services and products, we will incur increased costs in order to provide our services. If we cannot pass on the increased costs and expenses to our customers, or if our costs to deliver our services do not decline commensurate with any future declines in the prices we charge our customers, we may fail to achieve profitability.

 

If we are unable to attract new customers or to retain existing customers, our revenues may decline.

 

To increase our revenues, we plan to sell additional services to existing customers, encourage existing customers to increase their purchase volume and attract new customers. If our existing and prospective customers do not perceive our services to be of sufficiently high value and quality, we may not be able to sell additional services to our current customers, retain our current customers or attract new customers. We typically sell our services pursuant to service agreements that are generally one year in duration. Although most of our service agreements contain renewal provisions, our customers have no obligation to renew the contracts after the expiration of their initial commitment period, and these service agreements may not be renewed at the same or higher level of service, if at all. Moreover, some of our service agreements provide that customers have the right to cancel their service agreements prior to the expiration of the terms of their agreements under certain circumstances. This, in addition to the changing competitive landscape in our market, means that we may not accurately predict future customer renewal rates. Our customers’ renewal rates may decline or fluctuate as a result of a number of factors, including their level of satisfaction or dissatisfaction with our services, the prices of our services, the prices of services offered by our competitors and reductions in our customers’ spending levels. In 2015, 2016 and 2017, 24.7%, 32.7% and 36.4%, respectively, of our total number of customers decided not to renew their contracts with us. If we cannot attract a sufficient number of new customers, control our existing customer attrition rate, or increase the purchase volume of our existing customers to cover the loss of existing customers, our revenues may decline and our business will suffer. In addition, we plan to attract additional customers for our cloud infrastructure and charge fees for facilities development and/or on-going management and operation. If we cannot attract enough customers for our cloud infrastructure project, we may not be able to recoup our investments and our profitability in connection with this business line will suffer adverse impact, which will in turn affect our overall results of operation.

 

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We may lose customers if they elect to develop solutions internally for the delivery of their own content and applications.

 

Our customers and potential customers may decide to develop their own content and applications delivery service solutions rather than outsource these solutions to service providers like us. This is particularly true as our customers expand their operations and begin expending greater resources on delivering their internet services and applications using their own resources. If we fail to offer services that are competitive to in-house developed solutions, we may continue to lose customers or fail to attract customers that develop their own solutions in-house, and our business and financial results would suffer.

 

The decline in the price of our services could negatively impact our gross margins.

 

The average prices we can charge for our content and application delivery total solutions have declined, and are expected to decline over time, as a result of, among other things, the increasing number of new entrants into the CDN market and continued competition of pricing in the marketplace. Also, we may be forced to reduce the price of our services due to reduced bargaining power with our customers. If the price that we are able to charge customers falls to a greater extent than we anticipate and we are not able to offset this decline with reduction in our cost of revenues, our results of operations would be adversely affected.

 

Rapidly evolving technologies or new business models could cause demand for our services to decline or become obsolete.

 

Third parties may develop technological or business model innovations that address internet services and applications delivery requirements in a manner that is, or is perceived to be, the equivalent or superior to our services. For instance, companies are looking to offer internet-related solutions, such as peer-to-peer file sharing networks, to address certain content and application delivery needs. Our existing and future competitors may introduce new products or services that compete with or surpass the quality, price or performance of our services. We may not anticipate such developments and our services may be unable to adequately compete with these potential solutions. In addition, our customers’ business models may change in ways that we do not anticipate and these changes could reduce or eliminate our customers’ demand for our services. If this occurred, we could lose customers or potential customers, and our business and financial results would suffer. As a result of these or similar potential developments, it is possible that competitive dynamics in our market may require us to reduce our prices, which could harm our revenue, gross margin and results of operations.

 

If we are unable to successfully develop new services and enhancements to existing services or fail to predict and respond to emerging technological trends and customers’ changing needs, our results of operations may suffer.

 

The market for content and application delivery services is characterized by rapidly changing technology, evolving customer needs and requirements, and frequent new product and service introductions. Our results of operations depend on our ability to develop and introduce new services into existing and emerging markets. The process of developing new technologies is complex and uncertain. We must commit significant resources to developing new services or enhancements to our existing services before we are able to develop services that are widely accepted by the market. For example, individuals are increasingly using mobile devices to access internet content. Our ability to provide new and innovative solutions to address challenges posed by mobile device users is important to our future growth potential. Furthermore, we may not successfully execute our technology initiatives or our new services initiatives, such as the internet exchange and data center business, because of unexpected complexities in planning or timing, technical hurdles that we fail to overcome in a timely manner, misunderstandings about market demand or a lack of appropriate resources. In 2015 and 2016, we experienced an interruption in our services to our clients as a result of technical difficulties we encountered when migrating our services from our existing platform to our high capacity platform. Due to the resulting decrease in user traffic, our revenue from this line of business was adversely affected in 2015, 2016 and 2017. In 2016 and 2017, we continued improving the performance of the HPCC platform for a number of products including downloading, VOD and webpage services and in these areas the capacity of the platform reached its designed level. We also improved the performance of the platform’s certain technical specifications such as the response time and achieved progresses into 2017. However, because the technology underlying our HPCC platform is relatively new, we may face new technical issues in the future. If we fail to timely and effectively address those issues as they arise, our system performance may be affected, resulting in further decrease in customer traffic and loss in our number of customers. This may in turn materially and adversely affect our results of operations. Failures in execution or market acceptance of new services we introduce could also result in competitors providing those solutions before we do, which could lead to loss of market share, revenues and earnings.

 

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We may continue to record impairments charges in the future.

 

If our business conditions deteriorate, our long-lived assets need to be reviewed for possible impairment. An impairment loss needs to be recognized to the extent that the carrying amount exceeds the fair value. In the year ended December 31, 2017, we recorded impairment of long-lived assets in the total amount of RMB21.8 million (US$3.3million), consisting of impairment loss of intangible assets of RMB3.9 million (US$0.6 million) and impairment loss of property, plant and equipment of RMB17.9 million (US$2.8million). We cannot guarantee that we will not incur increased impairment loss in the future, for various reasons including, but not limited to, a sustained decline in the price of our securities, strategic decisions made in response to changes in economic and competitive conditions, any material adverse change in our relationship with significant customers or the impact of the economic environment on our customer base. If we record significant impairment charges, our results of operations may be materially and adversely affected.

 

The internet and internet-based services in China may fail to grow as quickly as expected.

 

Our future success depends on the growth of the internet in China. In particular, our business strategy and growth depends on the continued development and utilization of internet-based services such as online games, rich media content, online advertising, e-commerce and mobile internet. Online games, rich media content, e-commerce and mobile internet are relatively new developments in China and may be impacted by regulatory changes in China. Our business prospects and future growth could suffer if the internet or the markets for these internet-based services in China fail to grow as quickly as anticipated. Furthermore, even if the internet and internet-based services in China grow as expected, we may fail to successfully implement our growth strategies, which could have a material adverse impact over our business prospects, results of operations and financial condition.

 

Many of our existing and potential customers are pursuing emerging or unproven business models which, if unsuccessful, could lead to a substantial decline in demand for our services.

 

Because the proliferation of broadband internet connections and the subsequent monetization of internet services and applications are relatively recent phenomena in China, the business models of many of our existing and potential customers primarily focus on the delivery of internet content and applications to users and remain unproven. For example, user-generated content websites, media companies and online game operators have been among our customers and are pursuing emerging strategies for monetizing their internet services and applications or traffic on their websites. These companies will not continue to purchase our content and application delivery total solutions if their internet services or applications fail to generate a sufficient return on their investment or if their own business models fail to succeed. Moreover, some of our existing and potential customers are pursuing business in areas which have undefined regulatory parameters in China, and such companies face a risk of having their activities restricted or shut down for regulatory reasons. A reduction in spending on our services by our existing and potential customers or our customers’ inability or refusal to pay us due to their own financial condition or other reasons would harm our results of operations, financial condition and liquidity, and our growth and prospects may be materially and adversely affected.

 

We depend on a limited number of customers for a substantial portion of our revenues, and the loss of, or a significant shortfall in demand from, these customers could significantly harm our results of operations.

 

During any given fiscal period, a relatively small number of customers typically account for a significant percentage of our revenue. Our five largest customers contributed 37.5%, 48.2% and 57.2 % of our total net revenues for the years ended December 31, 2015, 2016 and 2017, respectively. In the past, our top five customers have continually changed, and we also have experienced significant fluctuations in our individual customers’ usage of our services. Our large customers may decrease the amount of services they purchase from us, ask for price reduction or may stop purchasing our services altogether as a result of a number of factors, including their level of satisfaction or dissatisfaction with our services, the prices of our services, the prices of services offered by our competitors and reductions in our customers’ spending levels.

 

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Our operating costs, although with a forecast of downward tendency in the mid- to long term, are relatively fixed in the near term. As a consequence, we may not be able to adjust our expenses in the short term to address the unanticipated loss of a large customer during any particular period. As such, we may experience significant and unanticipated fluctuations in our results of operations which may cause us to not meet our expectations or those of stock market analysts, which could cause our stock price to decline.

 

Our business substantially depends on telecommunications carriers and other third-party providers for communications and storage capacity. Any change that adversely affects our communications and storage capacity could result in interruptions in our services.

 

Our business and operations are dependent upon telecommunications carriers and other third-party providers for communications and storage capacity, including bandwidth, servers and other equipment. We obtain all of our bandwidth from telecommunications carriers who are compliant with Chinese laws and regulations. We purchase servers and other equipment from suppliers and deploy our servers in numerous third-party co-location facilities. In addition, we need access to end-user access networks operated by telecommunications carriers and internet service providers, or ISPs, in order to complete the delivery of internet content and applications to end-users.

 

We believe that we currently have good business relationships with telecommunications carriers and major third-party providers, and we have access to adequate communications and storage capacity to provide our services. However, there can be no assurance that we will always be able to secure communications and storage capacity on commercially acceptable terms, and that we are adequately prepared for unexpected increases in bandwidth demands or unplanned network interruptions. Furthermore, the changes in regulatory environment and the operating policies of the telecommunications carriers could also adversely affect our business relationships with telecommunications carriers and third-party service providers. If we are unable to obtain transmission capacity on terms commercially acceptable to us or at all, our business and financial results could suffer.

 

In the past, system disruptions in the networks of certain regional telecommunications carriers and ISPs have affected our ability to provide our services. Some telecommunications carriers or ISPs may also take measures, such as the deployment of filters, that could degrade, disrupt or increase the cost of our or our customers’ access to networks operated by them. Telecommunications carriers and ISPs could also decide to limit or prohibit the use of their networks to support or facilitate our services, or charge additional fees to us, our customers or end-users in connection with our services. Third-party suppliers may not be able to meet our demand for servers or other equipment in a timely manner. In addition, as we deploy our servers in numerous third-party co-location facilities, any system outages or other disruptions in these third-party facilities could constrain our ability to deliver our services. Any of these interruptions, interferences or restrictions could result in a loss of existing customers, increased costs and impairment of our ability to attract new customers, thereby harming our revenues and growth.

 

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

 

The global macroeconomic environment is facing challenges, including the end of quantitative easing by the U.S. Federal Reserve and the economic slowdown in the Eurozone since 2014. The growth of the Chinese economy has slowed since 2012 and such slowdown may continue. According to the National Bureau of Statistics of China, China’s gross domestic product (GDP) growth was 6.9% in 2017. There is considerable uncertainty over the long-term effects of the monetary and fiscal policies adopted by the central banks and financial authorities of some of the world’s leading economies, including the U.S. and China. There have been concerns over unrest and terrorist threats in the Middle East and Africa, which have resulted in volatility in oil and other markets, and over the conflicts involving Ukraine and Syria. 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. Economic conditions in China are sensitive to global economic conditions, as well as changes in domestic economic and political policies and the expected or perceived overall economic growth rate in China. As near as very recently in March 2018, there has been growing concerns over foreign trade conflicts between China and the United States and some European and Asian countries, and the United States government is seen as becoming more stringent on Chinese high-tech companies offering substitute technology, products and services in the U.S. If such trade frictions evolve unfortunately into a larger scale trade war, market access to these countries by Chinese companies will be severely impacted or completed stemmed, thus inflicting unexpected severe blow to Chinese high-tech companies including ChinaCache. ChinaCache has business presence in the United States and some European and Asian countries and some of the customers from the afore-mentioned countries contributed significant percentage of ChinaCache’s total revenue. If such trade war breaks out and governments of these countries opt to adopt restrict measures against ChinaCache, among like Chinese high-tech companies, our global market share, number of international customers will decline, impacting our business, financial conditions and results of operations to an extent beyond our best estimate.

 

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To the extent customers are unable to profitably monetize the content we deliver on their behalf due to an economic slowdown or otherwise, they may reduce or eliminate the traffic we deliver on their behalf. Such reductions in traffic would lead to a reduction in our revenues. Additionally, in economic downturns, we may experience the negative effects of increased competitive pricing pressure, customer loss, slowdown in commerce over the internet and corresponding decrease in traffic delivered over our network and failures by customers to pay amounts owed to us on a timely basis or at all. Suppliers on which we rely for servers, bandwidth, co-location and other services could also be negatively impacted by economic conditions which, in turn, could have a negative impact on our operations or expenses. Any prolonged slowdown in the global or Chinese economy may have a negative impact on our business, results of operations and financial condition, and continued turbulence in the international markets may adversely affect our ability to access the capital markets to meet liquidity needs.

 

We expect to continue to experience intense competition.

 

We compete in a market that is intensely competitive and rapidly changing. We have experienced and expect to continue to experience intense competition. In China, and in our existing CDN business, we primarily compete with domestic content and application delivery service providers, some of which boast abundance of financing and are industry leaders in the field of cloud hosting and electronic commerce. Although multinational companies currently do not have a significant presence in the content and application delivery services market in China, in part due to regulatory restrictions in China’s telecommunications sector, we may face competition from multinational companies if regulatory restrictions in China are lifted in the future. Also, as a result of the growth of the content delivery services market, a number of companies are currently attempting to enter our market, either directly or indirectly, some of which may become significant competitors in the future. Some of our current or potential competitors may have greater financial, marketing and other resources than we do and may have stronger governmental support. Some of our competitors may offer lower prices on competing services in order to gain market share. Our competitors may be able to respond more quickly than we can to new or emerging technologies and changes in customer requirements. Furthermore, some of our current or potential competitors may bundle their offerings with other services, software or hardware in a manner that may discourage content providers from purchasing the services that we offer. Increased competition could result in price reductions and revenue decline, loss of customers and loss of market share, which could harm our business, financial condition and results of operations.

 

Any unplanned interruption in the functioning of our network or services could lead to significant costs and disruptions.

 

Our business is dependent on providing our customers with fast, efficient and reliable delivery of internet content and applications. Many of our customers depend on our services to operate their businesses. Consequently, any disruption of our services could have a material impact on our customers’ businesses. Our network or services could be disrupted by numerous events, including natural disasters, power losses, changes in our service providers’ practices and failure of our software or network. From time to time, we need to correct errors and defects in our platform software or in other aspects of our network. There may be errors and defects originating with third-party networks or software on which we rely that harm our ability to deliver our services. We may also experience disruptions caused by software viruses or other attacks by unauthorized users. Despite our significant capital investments, we may have insufficient communications and server capacity to address these or other disruptions, which could result in interruptions in our services. Any widespread interruption of the functioning of our networks and related services for any reason would reduce our revenues and could harm our business and financial results. In 2016, the internet connection at one of our third-party co-location facilities was interrupted for several hours and as a result our services to certain customers were affected. This is a one-time incident and did not have any material impact on our business or results of operation, and in 2017 there’s no recurring like incidents. If in the future similar incidents or a more widespread interruption occurred or if we failed to deliver internet services and applications to users as expected during a high-profile media event or well-publicized circumstance, our reputation could be severely damaged. Moreover, any disruptions could undermine confidence in our services and cause us to lose customers or make it more difficult to attract new ones, either of which could harm our business and results of operations.

 

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The occurrence of cyber incidents, or a deficiency in our cybersecurity, could disrupt our services, cause damage to our brand and adversely affect our results of operations.

 

Our computer networks may be vulnerable to cyber incidents, including but not limited to unauthorized access, computer hacking, computer viruses and other security problems caused by unauthorized access to, or improper use of, systems by third parties or employees. A hacker who circumvents our cybersecurity measures could misappropriate proprietary information or cause interruptions, malfunctions or disruptions to our operations. Our electronic data may also be vulnerable to attacks, unauthorized access and misappropriation, which may corrupt our electronic data. We have not experienced a major cybersecurity breach to date. However, if a major cybersecurity breach were to occur, the losses or liabilities associated with such breach could have a material adverse effect on our business. We have implemented solutions, processes, and procedures to help mitigate our exposure to these types of cybersecurity risks, but these measures do not guarantee that we will not in the future experience a major cybersecurity breach. Actual or perceived concerns that our systems may be vulnerable to such cyber-attacks or disruptions may deter customers from using our solutions or services and could result in our customers making claims for damages. As a result, we may be required to devote significant incremental amounts of resources to protect against the threat or perceived threat of these cybersecurity risks or to alleviate problems caused by cyber incidents, if and when they were to occur.

 

We may have difficulty scaling and adapting our existing network to accommodate increased traffic and technology advances or changing business requirements.

 

Our services are complex and are designed to be deployed in and across numerous large and complex networks. Our network must perform well and be reliable in order for us to be successful. The greater the user traffic and the greater the complexity of our products and services, the more resources we will need to invest in additional network capacity and support. We have spent and expect to continue to spend on the purchase and lease of equipment and data centers and the upgrade of our technology and network to handle increased traffic over our network and to roll out new products and services. This expansion is expensive and complicated and could result in inefficiencies, operational failures or defects in our network and related software. If we do not expand successfully, or if we experience inefficiencies and operational failures, the quality of our products and services and user experience could decline. These occurrences could damage our reputation and lead to a loss of current and potential customers. We must continuously upgrade our network in order to keep pace with our customers’ evolving demands. Cost increases or the failure to accommodate increased traffic or these evolving business demands without disruption could harm our results of operations and financial condition.

 

If we fail to manage future growth effectively, our business and results of operations could be adversely affected.

 

Starting from 2015, we have spent significantly on the continued development of internet data centers in order for the company to enhance its capability to offer CND, IDC, cloud hosting, or a portfolio of service packages. The planned service capability enhancement initiativeshave placed, and will continue to place, substantial demands on our managerial, operational, technological, financial and other resources. Our planned service enhancement requires us to rapidly build up a wealth of knowledge on the targeted service offeering and at the same time offer consistent and high quality service to customers forexisting business. Our future results of operations depend to a large extent on our ability to manage this technical enhancement successfully. Risks that we face in undertaking this expansion include:

 

·training new sales personnel to become productive and generate revenue;
·controlling expenses and investments in anticipation of expanded operations;

 

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·implementing and enhancing our network;
·launching new products and services; and
·addressing new markets.

 

A failure to manage our growth effectively could materially and adversely affect our business, results of operations or financial condition.

 

Any difficulties identifying and consummating future acquisitions or integrating current and future acquisitions may have a material and adverse effect on our business, results of operations or financial condition.

 

Selective acquisitions and strategic investments form part of our strategy to further expand our business. However, acquisitions present challenges, including the difficulty of integrating the operations and personnel of the acquired companies, the potential disruption of our ongoing business, the potential distraction of management, expenses related to the acquisition, potential unknown liabilities or penalties associated with acquired businesses. Any inability to integrate operations or personnel in an efficient and timely manner could harm our results of operations.

 

We may be unsuccessful in identifying and consummating future acquisitions and strategic investments, which could impair our growth potential. In addition, future acquisitions and strategic investments will require the use of our available cash or dilutive issuances of securities. We may also experience significant turnover from the acquired operations or from our current operations as we integrate businesses. Such difficulties in identifying and consummating future acquisitions and strategic investments or any difficulties encountered in integrating current and future acquisitions may have a material and adverse effect on our business, results of operations or financial condition.

 

Our results of operations may fluctuate in the future. This may result in significant volatility in, and otherwise adversely affect, the market for our ADSs.

 

Our results of operations may fluctuate as a result of various factors, many of which are outside of our control. These fluctuations are often not seasonable but could result in significant volatility in, and otherwise adversely affect, the market price of our ordinary shares. Fluctuations in our results of operations may be due to a number of factors, including:

 

·our ability to increase sales to existing customers and attract new customers;
·the loss of major customers, or a significant variation in their use of our services;
·service outages or security breaches;
·the amount and timing of operating costs and capital expenditures related to the maintenance and expansion of our business, operations and network;
·the occurrence of significant events in a particular period that results in an increase in the use of our services, such as a major media event or a customer’s online release of a new or updated video game;
·changes in our pricing policies or those of our competitors;
·share-based compensation expenses associated with attracting and retaining key personnel;
·limitations of the capacity of our platform and related systems;
·the timing of costs related to the development or acquisition of technologies, services or businesses;
·general economic, industry, market and regulatory conditions and those conditions specific to internet usage and online businesses;
·

reduced usage of our services by our customers. and

  · the results of the legal proceedings involving Xin Run and BFSMC and the equity transfer transactions between us and People.cn as described further below.

 

Our revenues and results of operations may vary significantly in the future and period-to-period comparisons of our results of operations may not be meaningful. You should not rely on the results of one period as an indication of future performance.

 

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We may face intellectual property infringement claims that could be time-consuming and costly to defend. If we fail to defend ourselves against such claims, we may lose significant intellectual property rights and may be unable to continue providing our services.

 

Our technologies and business methods may be subject to third-party claims or rights that limit or prevent their use. Companies, organizations or individuals, including our competitors, may hold or obtain patents or other proprietary rights that would prevent, limit or interfere with our ability to make, use or sell our services or develop new services, which could make it more difficult for us to operate our business. Intellectual property registrations or applications by others relating to the type of services that we provide may give rise to potential infringement claims against us. In addition, due to being a public company, we may face a higher risk of being subject to intellectual property infringement claims from third parties. The global content and application delivery services industry is characterized by the existence of a large number of patents, trademarks and copyrights and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. We expect that infringement claims may further increase as the number of products, services and competitors in our market increases. Further, continued success in this market may provide an impetus to those who might use intellectual property litigation as a tool against us.

 

It is critical that we use and develop our technology and services without infringing the intellectual property rights of third parties, including but not limited to patents, copyrights, trade secrets and trademarks. Intellectual property litigation is expensive and time-consuming and could divert management’s attention from our business. Any successful infringement claim against us, whether with or without merit, could, among others things, require us to pay substantial damages, develop non-infringing technology or enter into royalty or license agreements that may not be available on acceptable terms, if at all, and cease making, licensing or using products that have infringed a third party’s intellectual property rights. Protracted litigation could also result in existing or potential customers deferring or limiting their purchase or use of our products until resolution of such litigation, or could require us to indemnify our customers against infringement claims in certain instances. Any intellectual property litigation could have a material adverse effect on our business, results of operations or financial condition.

 

We have patents, patent applications and software copyright registrations in China and the U.S. relating to the technologies used in our business. Certain U.S.-based companies have been granted patents or have licensed patents in the U.S. relating to the content and application delivery business. In the past, we have conducted substantially all of our business operations in China. We primarily rely upon our local business partners in the U.S. to address our content and application delivery needs in those markets. However, the possibility of intellectual property rights infringement claims against us may still increase as we expand outside China.

 

If we fail to defend ourselves against any intellectual property infringement claim, we may lose significant intellectual property rights and may be unable to continue providing our services, which could have a material adverse effect on our results of operations and business prospects.

 

We may not be able to prevent others from unauthorized use of our intellectual property.

 

We rely on a combination of patent, copyright, trademark, software registration and trade secret laws, as well as nondisclosure agreements and other methods to protect our intellectual property rights. As of the date of this annual report, we have 55 PRC patents, two U.S. patents, three PRC patent applications and 23 software copyright registrations. To protect our trade secrets and other proprietary information, employees, consultants, advisors and collaborators are required to enter into confidentiality agreements. However, a patent filing may not result in an issued patent and an issued patent may not sufficiently protect our intellectual property rights and our current patent portfolio may not be broad enough to protect our technologies. In addition, implementation of intellectual property-related laws in China has historically been lacking, primarily because of ambiguities in the PRC laws and difficulties in enforcement. Accordingly, intellectual property rights and confidentiality protections in China may not be as effective as in the U.S. or other countries, and infringement of intellectual property rights continues to pose a serious risk of doing business in China. Policing unauthorized use of proprietary technology is difficult and expensive. The steps we have taken may be inadequate to prevent the misappropriation of our proprietary technology. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technologies could enable third parties to benefit from our technologies without paying us for doing so, which could harm our business and competitive position. Although we are not currently involved in any litigation with respect to intellectual property, we may need to enforce our intellectual property rights through litigation. Litigation relating to our intellectual property may not prove successful and might result in substantial costs and diversion of resources and management attention.

 

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If our ability to deliver services and applications in popular proprietary formats is restricted or becomes cost-prohibitive, demand for our services could decline, we could lose customers and our financial results could suffer.

 

Our business partially depends on our ability to deliver internet services and applications in all major formats. If our legal right or technical ability to store and deliver internet services and applications in one or more popular proprietary formats, such as Adobe Flash or Windows Media, is limited, our ability to serve our customers in these formats would be impaired and the demand for our content and application delivery total solutions by customers using these formats would decline. Owners of proprietary formats may be able to block, restrict, or impose fees or other costs on, our use of such formats, which could lead to additional expenses for us and for our customers, or which could prevent our delivery of this type of internet services and applications altogether. Such interference could result in a loss of existing customers, increased costs and impairment of our ability to attract new customers, which would harm our revenues, results of operations and growth.

 

If we are unable to retain our key employees and hire qualified sales and technical personnel, our ability to compete could be harmed.

 

Our future success depends upon the continued services of our executive officers and other key technology, sales, marketing and support personnel who have critical industry experience and relationships that they rely on in implementing our business plan. We do not have “key person” insurance policies covering any of our officers or other key employees, and we therefore have no way of mitigating our financial loss were we to lose their services. The loss of the services of any of our key employees could disrupt our operations, delay the development and introduction of our services, and negatively impact our ability to sell our services. There is increasing competition for qualified individuals with the specialized knowledge relevant to providing content and application network services and this competition affects both our ability to retain key employees and hire new ones. If we cannot identify and hire additional qualified employees, or if we fail to provide appropriate training, career opportunities or otherwise motivate and retain our quality employees, we may not be able to successfully execute our growth strategies and our business could suffer.

 

We may not be able to recoup our investment in international expansions.

 

As part of our growth strategy, we may continue to expand our international network. Such expansion could require us to make significant expenditures, including the purchase of additional network equipment and the hiring of local employees, in advance of generating any revenues. As a consequence, we may fail to achieve profitability or recoup our investment in international locations.

 

If we fail to maintain a strong brand identity, our business may not grow and our financial results may be adversely impacted.

 

Maintaining and enhancing the value of our “ChinaCache” and “Blue I.T.” brands is important to attracting customers. Our success in maintaining brand awareness and recognition in the content and application delivery services market in China will depend on our ability to consistently provide high-quality, value-added services and solutions. As our business grows, we plan to continue to focus our efforts to establish a wider recognition of our “ChinaCache” and “Blue I.T.” brands to attract potential customers, which may require additional marketing resources.We cannot assure you that we will effectively allocate our resources for these activities or succeed in maintaining and broadening our brand recognition and appeal. If we fail to maintain a strong brand identity, our business and financial results may be adversely impacted.

 

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If we are required to seek additional funding, such funding may not be available on commercially acceptable terms, if at all.

 

We may need to obtain additional funding due to a number of factors beyond our control, including a shortfall in revenues, increased expenses, increased investment in capital equipment or the acquisition of significant businesses or technologies. In addition, although we have completed building constructions for our cloud infrastructure, we may need to incur substantial investments in the future to equip the buildings with hardware according to potential customers’ specifications. Also, we utilized the funds prepaid by People.cn and Beijing Federation of Supply and Marketing Cooperatives, or BFSMC, for the construction of the buildings to be sold to People.cn and BFSMC, respectively. Under our agreement with BFSMC, we agreed to sell two buildings to a subsidiary of BFSMC through transferring the equity interest of our subsidiary Beijing Zhao Du, the owner of the buildings. In addition, we agreed to lease back the buildings from the subsidiary of BFSMC starting from an agreed earlier date. We also reached a supplemental company letter with BFSMC, pursuant to which we agreed that September 30, 2015 should be deemed as the date of delivery as long as we complete the actual delivery of the buildings as well as the equity transfer by December 31, 2016. If the equity transfer and other agreed procedures are completed on time, our liabilities shall be deemed fully discharged. However, BFSMC has not accepted the buildings by December 31, 2016 due to our disagreement with BFSMC on the standard of delivery and acceptance of the buildings. Therefore, we re-negotiated with BFSMC and reached a series of new agreements with BFSMC in July 2017. Pursuant to the new agreements, BFSMC agreed to make the payments of RMB105.6 million to us immediately upon the completion of equity transfer of Beijing Zhao Du. Although we have completed the transfer of the equity interest in Beijing Zhao Du and the ownership of the buildings in July 2017, BFSMC failed to make the payments of RMB105.6 million to us as agreed. We have filed a lawsuit with the court, claiming the payment of the outstanding amount of consideration and the interest accrued thereon in August 2017. In September 2017, BFSMC filed a counterclaim to sue for, among others, the late delivery penalties and other relating losses. Thereafter we filed a motion to dismiss BFSMC’s counterclaim arguing that the court does not have the jurisdiction. In April 2018, we were notified by the court that our motion was rejected and Xin Run’s bank deposits and other assets in a total amount of approximately RMB 50.5 million were sealed up, distrained or frozen by the court. On April 24, 2018, we amended our claim requesting, among other things, the defendant pay the additional purchase price of RMB96 million, damages for breach of contract in an amount of RMB14.4 million and the relating interest of RMB8.86 million. Management is of the view that these proceedings are at a preliminary stage, therefore it is impossible at this stage to properly evaluate the outcome.Therefore, no provision has been made for this case.

 

In addition, in October 2017, a subsidiary of BFSMC filed a lawsuit against Xin Run in the Shunyi District Court of Beijing requesting Xin Run pay overdue rent and the relating interest in a total amount of approximately RMB30 million. We filed a motion to dismiss for lack of jurisdiction. However, the motion was rejected by the court and as a result, this lawsuit is still pending. Management is of the view that these proceedings are at a preliminary stage, therefore it is impossible at this stage to properly evaluate the outcome.Therefore, no provision has been made for this case.

 

Please see “Item 8. Financial information — A. Consolidated Statements and Other Financial Information-Legal Proceedings-Litigation” for more information. With respect to the sale of data center building to People.cn, on December 29, 2017, Xin Run entered into a framework agreement with People.cn, under which, among others, Xin Run will transfer 100% equity interest in Beijing Shuoge Technology Co., Ltd. to People.cn subject to terms and conditions to be set forth in a definitive equity transfer agreement. If we cannot successfully complete the sales and transfer, People.cn may demand their prepayment, which could have a material adverse impact on our cash position.

 

We believe that our cash and cash equivalents, and anticipated cash from operating and financing activities will be sufficient to fund our operations and proposed capital expenditures for at least the next 12 months. If for unforeseen circumstances we do need to obtain additional funding, it may not be available on commercially acceptable terms, if at all. If we are unable to obtain sufficient funding, our business would be harmed. Even if we are able to find outside funding sources, we may be required to issue securities in a transaction that could be highly dilutive to our investors or we may be required to issue securities with greater rights than the securities we have outstanding today. We may also be required to take other actions that could lessen the value of our ADSs, including borrowing money on terms that are not favorable to us. If we are unable to generate or raise capital that is sufficient to fund our operations, we may be required to curtail operations, reduce our capabilities or cease operations in certain jurisdictions or completely. Similarly, if we are unable to generate or raise capital that is sufficient to fund proposed investments in our cloud infrastructure hardware, we may not be able to provide our customers with cloud data centers that meet their requirements. We may, as a result, not be able to fully implement our cloud infrastructure strategy.

 

If our preferential tax treatment for ChinaCache Beijing and Beijing Blue I.T. becomes unavailable, our results of operations may be materially and adversely affected.

 

The Enterprise Income Tax Law, effective as of January 1, 2008, as recently amended on February 24, 2017, permits certain “high and new enterprises strongly supported by the state” which hold independent ownership of core intellectual property and simultaneously meet a list of other financial or non-financial criteria to enjoy a reduced 15% enterprise income tax rate subject to certain qualification criteria. In November 2013, ChinaCache Beijing obtained the certificate of “high and new- technology enterprise” jointly issued by the Beijing Science and Technology Commission, Beijing Finance Bureau, Beijing Administration of State Taxation and Beijing Administration of Local Taxation, and has since then continued to qualify as a “high and new- technology enterprise” and been entitled to a reduced income tax rate of 15%. In December 2016, ChinaCache Beijing was recognized as a “high and new- technology enterprise” again and became eligible for a preferential tax rate of 15% effective from 2016 to 2018.

 

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In November 2012, Beijing Blue I.T. was recognized as a “high and new- technology enterprise” and was eligible for a preferential tax rate of 15% effective retrospectively from 2012 to 2014. In July 2015, Beijing Blue I.T. was recognized as a “high and new- technology enterprise” again and became eligible for a preferential tax rate of 15% effective from 2015 to 2017. Beijing Blue I.T. is currently in the process of applying for the renewal of such certification. We cannot assure you that Beijing Blue I.T. will continue to be recognized as a “high and new- technology enterprise” and enjoy the tax benefits from 2018 and forward.

 

In December 2013, Beijing Blue I.T. was recognized as a key software enterprise covered by the national planning layout scheme, or Key Software Enterprise, jointly by the National Development and Reform Commission, the Ministry of Industry and Information Technology, or the MIIT, Ministry of Commerce and State Administration of Taxation, or the SAT, which entitled it to enjoy a preferential income tax rate of 10% for 2013 and 2014. According to a Circular issued by the MIIT and the SAT on Matters relating to Preferential Corporate Income Tax Policies for Software Enterprises in May 27, 2015, the recognition of “Key Software Enterprise” was stopped since May 2015. In May 2016, Ministry of Finance, SAT, National Development and Reform Commission and MIIT jointly issued a circular to restart the recognition of Key Software Enterprise. Companies may be entitled to the preferential tax rate of 10%, at time of tax return filing, by filing application with the local tax authority with supporting documentation proving its qualifications to be a “Key Software Enterprise” during its annual income tax settlement process. Beijing Blue I.T. plans to file application for the preferential tax benefit of 10% rate in due time and when such tax benefits policy is still effective.

 

In addition, our PRC subsidiaries would be entitled to exempt fifty percent (50%) of their income from tax and enjoy a reduced enterprise income tax rate of 20% if their financial data are determined to meet the standard of “small scale and low profit” enterprise when filing with the tax bureau. See “Item 5. Operating and Financial Review and Prospects—A. Operating Results —Taxation — PRC.”

 

If our preferential tax treatment of ChinaCache Beijing and Beijing Blue I.T. becomes unavailable, their enterprise income tax rate would increase to 25% and thus our income tax expenses would increase, which may have a material adverse effect on our net income and results of operations.

 

Failure to maintain effective internal control over financial reporting could have a material and adverse effect on the trading price of our ADSs.

 

We are subject to the reporting obligations under the U.S. securities laws. Although our management concluded that we maintained effective internal control over financial reporting as of December 31, 2017, we cannot assure you that we will maintain effective internal control over financial reporting on an ongoing basis. If we fail to maintain effective internal control over financial reporting, we will not be able to conclude that we have effective internal control over financial reporting in accordance with the Sarbanes-Oxley Act of 2002 in our future annual report on Form 20-F covering the fiscal year in which this failure occurs. Effective internal control over financial reporting is necessary for us to produce reliable financial reports. Any failure to maintain effective internal control over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could have a material and adverse effect on the trading price of our ADSs. Furthermore, we may need to incur additional costs and use additional management and other resources as our business and operations further expand or in an effort to remediate any material control weakness that may be identified in the future.

 

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We have granted, and may continue to grant, stock options and restricted share units under our stock incentive plans, resulting in increased share based compensation expenses and, therefore, adversely affecting our results of operations.

 

We have adopted a total of four stock incentive plans, in the years 2007, 2008, 2010 and 2011. As of December 31, 2017, there were outstanding options to purchase 25,986,816 of our ordinary shares and 49,477,040 vested restricted share units granted in accordance with these plans. See “Item 6 Directors, Senior Management and Employees — B. Compensation — Stock Incentive Plans.” For the years ended December 31, 2015, 2016 and 2017, we recorded RMB48.6 million, RMB85.0 million and RMB9.9 million (US$1.5 million), respectively, in share-based compensation expenses for employees. If we grant more stock options or restricted share units to attract and retain key personnel, the expenses associated with share based compensation may adversely affect our results of operations. However, if we do not grant stock options or restricted share units or reduce the number of stock options or restricted share units that we grant, we may not be able to attract and retain key personnel.

 

We may incur losses due to business interruptions resulting from occurrence of natural catastrophes, acts of terrorism or fires, and we have limited insurance coverage.

 

The occurrence of natural catastrophes such as earthquakes, floods, typhoons or any acts of terrorism may result in significant property damages as well as loss of revenues due to interruptions in our business operations. In addition, the provision of our services depends on the continuing operation of our information technology and communications systems, which are also vulnerable to damage or interruption from natural catastrophes and acts of terrorism. Some of our data centers are located in areas with a high risk of typhoons or earthquakes. Our disaster recovery planning cannot account for every conceivable possibility. Any damage to or failure of our systems could result in interruptions in our services, which could reduce our revenues and profits, and our brand could be damaged if people believe our systems are unreliable.

 

The insurance industry in China is not fully developed. Insurance companies in China offer limited business insurance products. While business disruption insurance may be available to a limited extent in China, we have determined that the risks of disruption and the difficulties and costs associated with acquiring such insurance render it commercially impractical for us to have such insurance. As a result, we do not have any business liability, disruption or litigation insurance coverage for our operations in China. Any business disruption or litigation might result in our incurring substantial costs and the diversion of resources.

 

We face risks related to natural disasters, health epidemics and other outbreaks, which could significantly disrupt our operations.

 

Our business could be materially and adversely affected by natural disasters or the outbreak of health epidemic. Any such occurrences could cause severe disruption to our daily operations, and may even require a temporary closure of our facilities. In May 2008, a severe earthquake hit part of Sichuan province in southwestern China, and in April 2010, another severe earthquake hit part of Qinghai province in western China, and in August 2014, another strong earthquake hit part of Yunnan province in southern China, each of which resulted in significant casualties and property damage. While we did not suffer any loss or experience any significant increase in cost resulting from these earthquakes, if a similar disaster were to occur in the future affecting Beijing or another city where we have major operations in China, our operations could be materially and adversely affected due to loss of personnel and damages to property. In addition, any outbreak of avian flu, severe acute respiratory syndrome (SARS), influenza A (H1N1), H7N9, Ebola, or other adverse public health epidemic in China may have a material and adverse effect on our business operations. These occurrences could require the temporary closure of our offices or prevent our staff from traveling to our customers’ offices to provide on-site services. Such closures could severely disrupt our business operations and adversely affect our results of operations.

 

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We are subject to China’s anti-corruption laws and the U.S. Foreign Corrupt Practices Act. Our failure to comply with these laws could result in penalties, which could harm our reputation and have an adverse effect on our business, results of operations and financial condition.

 

We are subject to the U.S. Foreign Corrupt Practices Act, or the FCPA, which generally prohibits companies and anyone acting on their behalf from offering or making improper payments or providing benefits to foreign officials for the purpose of obtaining or keeping business, along with various other anti-corruption laws, including China’s anti-corruption laws. Our company policies strictly prohibit any such conduct and require that we the Company, our employees and intermediaries comply with the FCPA and other anti-corruption laws to which we are subject. There is, however, no assurance that such policies or procedures will work effectively all the time or protect us against liability under the FCPA or other anti-corruption laws for actions taken by our employees and intermediaries with respect to our business or any businesses that we may acquire. We operate in the content and application delivery services industry in China and generally purchase bandwidth from state or government-owned telecommunications carriers and provide a portfolio of services and solutions to government agencies. This puts us in frequent contact with persons who may be considered “foreign officials” under the FCPA, resulting in an elevated risk of potential FCPA violations. If we are found to be not in compliance with the FCPA and other applicable anti-corruption laws governing the conduct of business with government entities or officials, we may be subject to criminal and civil penalties and other remedial measures, which could have an adverse impact on our business, financial condition and results of operations. Any investigation of any potential violations of the FCPA or other anti-corruption laws by U.S. or foreign authorities, including Chinese authorities, could adversely impact our reputation, cause us to lose customer sales and access to end-user access networks, and lead to other adverse impacts on our business, financial condition and results of operations.

 

Risks Related to Our Corporate Structure

 

If the PRC government finds that the arrangements that establish the structure for operating our business do not comply with PRC government restrictions on foreign investment in the telecommunications business, we could be subject to severe penalties.

 

The PRC government regulates telecommunications-related businesses through strict business licensing requirements and other government regulations. These laws and regulations also include limitations on foreign ownership of PRC companies that engage in telecommunications-related business. Specifically, foreign investors are not allowed to own more than a 50% equity interest in any PRC company engaging in value-added telecommunications business (except e-commerce) and any such foreign investor must have experience in providing value-added telecommunications services overseas and maintain a good track record in accordance with the Guidance Catalog of Industries for Foreign Investment promulgated in 2007, as amended in 2011 ,2015 and 2017 respectively, and other applicable laws and regulations.

 

Because we are a Cayman Islands company, we are classified as a foreign enterprise under PRC laws and regulations, and our PRC subsidiaries, ChinaCache Beijing and Xin Run, are foreign-invested enterprises. To comply with PRC laws and regulations, we conduct our content and application delivery total solution business in China through a set of contractual arrangements with each of Beijing Blue I.T. and Beijing Jingtian and their respective shareholders. These contractual arrangements provide us with effective control over Beijing Blue I.T. and Beijing Jingtian. For a description of these contractual arrangements, see “Item 4. Information on the Company —C. Organizational Structure — Contractual Arrangements with Our Consolidated Variable Interest Entities.”

 

The MIIT issued a circular in July 2006 requiring a foreign investor to set up a foreign-invested enterprise and obtain a value-added telecommunications business operating license, or VAT license, in order to conduct any value-added telecommunications business in China. Pursuant to this circular, a domestic VAT license holder is prohibited from leasing, transferring or selling the license to foreign investors in any form, and from providing any assistance, including providing resources, sites or facilities, to foreign investors that conduct value-added telecommunications business illegally in China. Furthermore, the relevant trademarks and domain names that are used in the value-added telecommunications business must be owned by the local VAT license holder or its shareholder. The circular further requires each VAT license holder to have the necessary facilities for its approved business operations and to maintain such facilities in the regions covered by its license. In addition, all value-added telecommunications service providers are required to maintain network and information security in accordance with the standards set forth under relevant PRC regulations. Due to a lack of interpretations from the regulator, it is unclear what impact this circular will have on us or other similarly situated companies.

 

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In the opinion of Han Kun Law Offices, our PRC legal counsel, except as otherwise disclosed herein (i) the ownership structure of our PRC subsidiary, our PRC consolidated variable interest entities and their branches and subsidiaries comply with all existing PRC laws and regulations; (ii) each of the documents currently effective under the contractual arrangements among us, our PRC subsidiary, PRC consolidated variable interest entities and their shareholders governed by PRC law are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect and (iii) the business operations of our PRC subsidiary, our PRC consolidated variable interest entities and their branches and subsidiaries are in all material respects in compliance with existing PRC laws and regulations and the terms of their licenses and permits. However, there are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rules, and the above circular. Accordingly, there can be no assurance that the PRC regulatory authorities that regulate providers of content and application delivery services and other participants in the telecommunications industry, in particular, the MIIT, will ultimately take a view that is consistent with the opinion of our PRC legal counsel.

 

The relevant PRC regulatory authorities have broad discretion in determining whether a particular contractual structure is in violation of PRC laws and regulations. If our corporate and contractual structure is deemed by the relevant PRC regulatory authorities to be illegal, either in whole or in part, we may have to modify such structure to comply with regulatory requirements. However, we cannot assure you that we can achieve this without material disruption to our business. Further, if our corporate and contractual structure is found to be in violation of any existing or future PRC laws or regulations, the relevant regulatory authorities would have broad discretion in dealing with such violations, including:

 

·revoking our business and operating licenses;
·levying fines on us;
·confiscating any of our income that they deem to be obtained through illegal operations;
·shutting down a portion or all of our networks and servers;
·discontinuing or restricting our operations in China;
·imposing conditions or requirements with which we may not be able to comply;
·requiring us to restructure our corporate and contractual structure;
·restricting or prohibiting our use of the proceeds from a public offering to finance our PRC consolidated variable interest entities’ business and operations; and
·taking other regulatory or enforcement actions that could be harmful to our business.

 

Occurrence of any of these events could materially and adversely affect our business, financial condition and results of operations.

 

ChinaCache Beijing’s contractual arrangements with Beijing Blue I.T. and Beijing Jingtian may result in adverse tax consequences to us.

 

We could face material and adverse tax consequences if the PRC tax authorities determine that ChinaCache Beijing’s contractual arrangements with Beijing Blue I.T. and Beijing Jingtian were not made on an arm’s length basis and adjust our income and expenses for PRC tax purposes in the form of a transfer pricing adjustment. A transfer pricing adjustment could adversely affect us by (i) increasing the respective tax liabilities of Beijing Blue I.T. and Beijing Jingtian without reducing ChinaCache Beijing’s tax liability, which could further result in late payment fees and other penalties to Beijing Blue I.T. and Beijing Jingtian for underpaid taxes; or (ii) limiting the ability of ChinaCache Beijing, Beijing Blue I.T. or Beijing Jingtian to obtain or maintain preferential tax treatments and other financial incentives.

 

We rely on contractual arrangements with Beijing Blue I.T. and Beijing Jingtian and their respective shareholders for our China operations, which may not be as effective as direct ownership in providing operational control.

 

We rely on contractual arrangements with our consolidated variable interest entities, Beijing Blue I.T. and Beijing Jingtian, and their respective shareholders, to operate our business in China. For a description of these contractual arrangements, see “Item 7. Major Shareholders and Related Party Transactions — B. Related Party Transactions — Contractual Arrangements with Our Consolidated Variable Interest Entities.” These contractual arrangements may not be as effective as direct ownership in providing us with control over our consolidated variable interest entities. Under the current contractual arrangements, as a legal matter, if our consolidated variable interest entities or their shareholders fail to perform their respective obligations under these contractual arrangements, we may have to incur substantial costs and expend significant resources to enforce such arrangements in reliance on legal remedies under PRC law. These remedies may not always be effective, particularly in light of uncertainties in the PRC legal system and we may incur substantial costs and expend significant resources in pursuing such enforcement actions.

 

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All of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the U.S. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements, which may make it difficult to exert effective control over our consolidated variable interest entities, and our ability to conduct our business may be negatively affected. See “—Risks Related to Doing Business in China—Uncertainties with respect to the PRC legal system could limit legal protections available to you and us.”

 

The shareholders of our consolidated variable interest entities may have potential conflicts of interest with us, which may materially and adversely affect our business and financial condition.

 

The shareholders of our consolidated variable interest entities, Beijing Blue I.T. and Beijing Jingtian, are also the founders, directors, executive officers, employees or shareholders of our company. Conflicts of interests between their roles may arise. We cannot assure you that when conflicts of interest arise, any or all of these individuals will act in the best interests of our company or that conflicts of interest will be resolved in our favor. In addition, these individuals may breach or cause our consolidated variable interest entities to breach the existing contractual arrangements. Currently, we do not have arrangements to address potential conflicts of interest between these individuals and our company. We rely on these individuals to abide by the laws of the Cayman Islands and China. If we cannot resolve any conflicts of interest or disputes between us and the shareholders of our two consolidated variable interest entities, we would have to rely on legal proceedings, which could result in disruption of our business and substantial uncertainty as to the outcome of any such legal proceedings.

 

Our ability to enforce the share pledge agreements between us and the shareholders of Beijing Blue I.T. and Beijing Jingtian may be subject to limitations based on PRC laws and regulations.

 

Pursuant to the share pledge agreements which our wholly-owned subsidiary, ChinaCache Beijing, has entered into with Beijing Blue I.T. and Beijing Jingtian and their respective shareholders, the shareholders of Beijing Blue I.T. and Beijing Jingtian have agreed to pledge their respective equity interests in Beijing Blue I.T. and Beijing Jingtian to ChinaCache Beijing to secure Beijing Blue I.T.’s and Beijing Jingtian’s performance of their obligations under the relevant contractual arrangements. The share pledges of Beijing Blue I.T. and Beijing Jingtian under these share pledge agreements have been registered with the relevant local branch of the State Administration for Industry and Commerce, now the State Administration for Market Regulation, or SAIC.

 

In addition, when registering the pledges over the equity interests under the share pledge agreements with the local branch of SAIC, the amount of secured liabilities as stated on the application forms was RMB40.0 million for Beijing Blue I.T. and RMB10.0 million for Beijing Jingtian, corresponding to the pledged equity interests. The share pledge agreements with the shareholders of Beijing Blue I.T. provide that the pledged equity interest constitutes continuing security for any and all of the payment obligations under all of the principal service agreements. The share pledge agreements with the shareholders of Beijing Jingtian provide that the pledged equity interest constitutes continuing security for any and all of payment obligations, including payment of consulting and service fees, under the business cooperation agreement. However, it is possible that a PRC court may take the position that RMB10.0 million or RMB40.0 million, as applicable, represents the full amount of the collateral that has been registered and perfected. If this is the case, the obligations that are supposed to be secured in the share pledge agreements and are in excess of RMB10.0 million or RMB40.0 million, as applicable, could be determined by the PRC court as unsecured debt, which takes secondary priority comparing with other creditors of secured debts.

 

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Risks Related to Doing Business in China

 

Our business may be adversely affected by government policies and regulations in China.

 

Laws and regulations that apply to communications and commerce conducted over the internet are becoming more prevalent in China, and may impose additional burdens on companies conducting business online or providing internet-related services such as us and many of our customers. Increased regulation could negatively affect our business directly, as well as the businesses of our customers, which could reduce their demand for our services.

 

The PRC government has adopted regulations governing internet access and the distribution of news and other information over the internet. Under these regulations, internet content providers and internet publishers are prohibited from posting or displaying over the internet content that, among other things, violates PRC laws and regulations, impairs the national dignity of China, or is reactionary, obscene, superstitious, fraudulent or defamatory. Failure to comply with these requirements may result in the revocation of licenses to provide internet content and other licenses and the closure of the concerned websites. In the past, failure to comply with such requirements has resulted in the closure of certain websites. In addition, the MIIT has published regulations that subject website operators to potential liability for content displayed on their websites and the actions of users and others using their systems, including liability for violations of PRC laws and regulations prohibiting the dissemination of content deemed to be socially destabilizing. The Ministry of Public Security has the authority to order any local internet service provider to block any internet website at its sole discretion. From time to time, the Ministry of Public Security has stopped the dissemination over the internet of information which it believes to be socially destabilizing. The State Secrecy Bureau is also authorized to block any website it deems to be leaking state secrets or failing to comply with the relevant regulations relating to the protection of state secrets in the dissemination of online information. Our business may be adversely affected if any of our customers’ websites are restricted, blocked or closed or if we face liability for content distributed over our network. If we need to take costly measures to reduce our exposure to these risks, or are required to defend ourselves against such claims, our financial results could be negatively affected.

 

In April 2007, the General Administration of Press and Publication of China, now the State Administration of Radio and Television of China, or SAPPRFT, and several other governmental authorities issued a circular requiring the implementation of an “anti-fatigue system” and a real-name registration system by all PRC online game operators in an effort to curb addictive game play behaviors of minors under the age of eighteen. In addition, it is also possible that the PRC government authorities may decide to adopt more stringent policies to monitor the online game industry as a result of adverse public reaction or otherwise. The implementation of these regulations may discourage or otherwise prevent or restrict minors from playing online games, which could limit the growth of online game operators, one of our key customer groups, thus adversely affecting our business and results of operations.

 

The SAPPRFT and the MIIT issued the Administrative Measures Regarding Internet Audio-Video Program Services, or the Internet Audio-Video Program Measures, which became effective on January 31, 2008. Among other things, the Internet Audio-Video Program Measures stipulate that only entities wholly owned or controlled by state-owned enterprises may apply for the “Internet Audio-Video Program Operating License” to engage in the production, editing, integration or consolidation, and transfer to the public through the internet, of audio-video programs, and the provision of audio-video program uploading and transmission services. In addition, the nternet Audio-Video Program Measures require that, when providing signal transmission for internet Audio-Video programs, network operators are obligated to examine the licenses or permits of the internet Audio-Video Programs service providers and must provide internet access services within the scope of such licenses or registration documents. The Internet Audio-Video Program Measures further provide that no entity may provide signal transmission, internet data center services, fee collection or other financial or technical services to internet Audio-Video Programs service providers that do not have applicable licenses or permits. Although we do not provide audio-video programs on our own, our content and application delivery total solutions include provision of technical assistance to customers, social networking operators in particular, in the uploading and transmission of user-generated content, including audio-video programs. There are significant uncertainties relating to the interpretation and implementation of the internet Audio-Video Program Measures. Accordingly, if we are required to verify our customers’ internet Audio-Video Program Operating Licenses, such requirements may impose additional obligations on us, which may increase our expenses and adversely affect our business and results of operations. Any of these factors could cause significant disruption to our operations and may materially and adversely affect our business, financial condition and results of operations.

 

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In February 2018, MIIT issued an internal notice, or the MIIT Internal Notice, pursuant to which telecommunication authorities will carry out a special enforcement campaign to inspect the operations of certain licensed telecommunications operators according to applicable regulations and rules, including without limitation, the Circular on Clearing Up and Regulatory the Internet Access Service Market issued by the MIIT in January 2017. In particular, the authorities will pay special attention to any improper operational activities, such as unauthorized establishment of transmission network, unlicensed operation of cross-border business and improper sublease of broadband resources. If the enterprise is found to be engaged in non-compliant operations, it may be subject to various penalties, including suspension of network access, suspension of approving its application for new operation permit until rectification being completed, being publicized as an operator with discredit record or non-compliance record, enhanced oversight of the authority and limitation on new telecommunication business, depending on the seriousness of the violations and the rectification result. The MIIT Internal Notice mandates that the foregoing inspection and scrutiny to be completed by September 30, 2018. According to the MIIT Internal Notice, 47 industry players are subject to the special inspection, including one of our VIEs, Beijing Blue I.T. As of the date of this annual report, we have not received any investigation notice or rectification order from the government authorities. We are closely communicating with the in-charge authority to clarify the above. Nevertheless, although we believe the Company has been conducting its business in compliance with Chinese law and government regulations and been partnering with all telecommunication carriers for their legally compliant network resources we cannot assure you that the governmental authorities will determine that we have been in full compliance with the regulatory requirements. If we are found to violate any operation requirements, we may be imposed any of the administrative penalties mentioned in the MIIT Internal Notice, which may result in a material and adverse effect on our ability to conduct our operations and our financial conditions.

 

If we fail to acquire, obtain or maintain applicable telecommunications licenses, or are deemed by relevant governmental authorities to be operating outside the terms of our existing license, our business would be materially and adversely affected.

 

Pursuant to the Telecommunications Regulations promulgated by the PRC State Council effective from September 2000 and amended in July 2014 and February 2016, respectively, telecommunications businesses are divided into two categories, namely, (i) “basic telecommunications business,” which refers to a business that provides public network infrastructure, public data transmission and basic voice communications services, and (ii) “value-added telecommunications business,” which refers to a business that provides telecommunications and information services through the public network infrastructure. Pursuant to the VAT license issued to Beijing Blue I.T. by the MIIT on February 7, 2018, Beijing Blue I.T. is permitted to carry out its internet data center business (excluding internet resource coordination service), content delivery network business, its domestic internet virtual private networks business and internet access service business under the first category of “value-added telecommunications business”.

 

On January 17, 2017, the MIIT issued a Circular on Clearing up and Regulating the Internet Access Service Market, or MIIT Circular No. 32, aiming to regulate illegal operations in the field of internet data center (IDC) service, internet access (ISP) service and content delivery network (CDN) service business. In particular, the MIIT Circular No. 32 reiterates that an entity is prohibited from operating any of the IDC, ISP or CDN services without proper telecommunication business operation permit, or engaging in activities beyond the permitted business scope or permitted geographical scope specified on its operation permit, nor shall a qualified telecommunication business operator lease or transfer its qualification or resources to an unauthorized entity in the form of technology cooperation or in other disguised form. In addition, pursuant to the MIIT Circular No. 32, if an entity had obtained a VAT License for IDC service business prior to the implementation of the Catalog of Telecommunications Business (2015 Version) and has actually engaged in CDN service or internet resource coordination business, it must undertake in a written commitment to the issuing authority of its VAT License by March 31, 2017 that it will satisfy relevant requirements for CDN service or internet resource coordination service, as applicable, and obtain the corresponding VAT License by the end of 2017. If it fails to obtain the VAT License by the deadline, it must cease to operate the CDN service and internet resource coordination service business from January 1, 2018. If an entity fails to submit the above commitment by March 31, 2017, it shall be refrained from engaging in CDN service and internet resource coordination service since April 1, 2017. Beijing Blue I.T. had submitted the written commitment on March 30, 2017 in compliance with the relevant requirement and has obtained the relevant VAT License for CDN services issued by MIIT on September 18, 2017, which was subsequently amended on February 7, 2018.

 

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However, since China’s content and application delivery services market is at an early stage of development, the scope of content and application delivery businesses has been expanding constantly and the concept of content and application delivery services is evolving. We have been continuously developing our content and application delivery business to better serve our customers, and as a result, we introduce new technologies and services from time to time to support and improve our current business. We cannot assure you that PRC governmental authorities will continue to deem of our newly developed technologies, network and services used in our business as a type of value-added telecommunications business covered under the VAT license of Beijing Blue I.T. As we expand our networks across China, it is also possible that the MIIT, in the future, may deem our operations to have exceeded the terms of our existing license. Further, we cannot assure you that Beijing Blue I.T. will be able to successfully renew its VAT license upon its expiration, or that its VAT license will continue to cover all aspects of our content and application delivery business and operations upon its renewal. In addition, new laws, regulations or government interpretations may also be promulgated from time to time to regulate the content and application delivery business or any of our related technology or services, which may require us to obtain additional, or expand existing, operating licenses or permits. Any of these factors could result in Beijing Blue I.T. being disqualified from carrying out its current business, causing significant disruption to our business operations which may materially and adversely affect our business, financial condition and results of operations.

 

Adverse changes in political and economic policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could reduce the demand for our services and adversely affect our competitive position.

 

A large portion of our operations are conducted in China and a significant part of our sales are made in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The PRC economy differs from the economies of most developed countries in many respects, including the amount of government involvement, the level of development, the growth rate, the control of foreign exchange and allocation of resources. While the PRC economy has grown significantly over the past several decades, the growth has been uneven across different periods, regions and among various economic sectors of China, and the rate of growth has been slowing. We cannot assure you that the Chinese economy will continue to grow, or that if there is growth, such growth will be steady and uniform, or that if there is a slowdown, such a slowdown will not have a negative effect on our business.

 

The PRC government exercises significant control over China’s economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. It is unclear whether PRC economic policies will be effective in maintaining stable economic growth in the future. Any slowdown in the economic growth of China could lead to reduced demand for our solutions, which could materially and adversely affect our business, as well as our financial condition and results of operations.

 

Uncertainties with respect to the PRC legal system could limit legal protections available to you and us.

 

We conduct our business primarily through our subsidiaries and consolidated variable interest entities in China. Our operations in China are governed by PRC laws and regulations. ChinaCache Beijing is a foreign-invested enterprise and is subject to laws and regulations applicable to foreign investment in China and, in particular, laws applicable to foreign-invested enterprises. 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 are not binding.

 

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In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general. The overall effect of legislation over the past several decades has significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system, and recently enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all, which may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until some time after the violation. Any administrative and court proceedings in China may be protracted, resulting in substantial costs and diversion of resources and management attention. However, since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to evaluate the outcome of administrative and court proceedings and the level of legal protection we enjoy than in more developed legal systems. These uncertainties may also impede our ability to enforce the contracts we have entered into. As a result, these uncertainties could materially and adversely affect our business and results of operations.

 

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

 

The Ministry of Commerce published a discussion draft of the proposed Foreign Investment Law in January 2015 aiming to, upon its enactment, replace the trio of 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-invested Enterprise Law, together with their implementation rules and ancillary regulations. The draft Foreign Investment Law embodies an expected PRC regulatory trend to rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic investments. The Ministry of Commerce is currently soliciting comments on this draft and substantial uncertainties exist with respect to its enactment timetable, interpretation and implementation. The draft Foreign Investment Law, if enacted as proposed, may materially impact the viability of our current corporate structure, corporate governance and business operations in many aspects.

 

Among other things, the draft Foreign Investment Law expands the definition of foreign investment and introduces the principle of “actual control” in determining whether a company is considered a foreign-invested enterprise, or an FIE. The draft Foreign Investment Law specifically provides that entities established in China but “controlled” by foreign investors will be treated as FIEs. The draft Foreign Investment Law further provides that if a foreign entity is controlled by PRC investors, when it invests in the restricted industry as indicated in the “negative list” and upon market entry clearance by the Ministry of Commerce, its investments would be treated as investment made by PRC domestic investors. In this connection, “control” is broadly defined in the draft law to cover the following summarized categories: (i) holding 50% of more of the voting rights of the subject entity; (ii) holding less than 50% of the voting rights of the subject entity but having the power to secure at least 50% of the seats on the board or other equivalent decision making bodies, or having the voting power to exert material influence on the board, the shareholders’ meeting or other equivalent decision making bodies; or (iii) having the power to exert decisive influence, via contractual or trust arrangements, over the subject entity’s operations, financial matters or other key aspects of business operations. Once an entity is determined to be a foreign invested enterprise, or FIE, it will be subject to the foreign investment restrictions or prohibitions set forth in a “negative list,” to be separately approved by the State Council later. Unless the underlying business of the FIE falls within the negative list, which calls for market entry clearance by the Ministry of Commerce or its local branches, prior approval from the government authorities as mandated by the existing foreign investment legal regime would no longer be required for establishment of the FIE.

 

The “variable interest entity” structure, or VIE structure, has been adopted by many PRC-based companies, including us, to obtain necessary licenses and permits in the industries that are currently subject to foreign investment restrictions in China. See “— Risks Related to Our Corporate Structure” and “Item 4. Information on the Company — C. Organizational Structure.” Under the draft Foreign Investment Law, variable interest entities that are controlled via contractual arrangement would also be deemed as FIEs, if they are ultimately “controlled” by foreign investors. Therefore, for any companies with a VIE structure in an industry category that is included in the “negative list” as restricted industry, the VIE structure may be deemed legitimate only if the ultimate controlling person(s) is/are of PRC nationality (either PRC companies or PRC citizens). Conversely, if the actual controlling person(s) is/are of foreign nationalities, then the variable interest entities will be treated as FIEs and any operation in the industry category on the “negative list” without market entry clearance may be considered as illegal.

 

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Beijing Blue I.T. and Beijing Jingtian might be found as controlled by foreign investors if the draft Foreign Investment Law is enacted as proposed. However, the draft Foreign Investment Law has not taken a position on what actions shall be taken with respect to the existing companies with a VIE structure, whether or not these companies are controlled by Chinese parties, while it is soliciting comments from the public on this point. In addition, it is uncertain whether the business that Beijing Blue I.T. and Beijing Jingtian operates will be subject to the foreign investment restrictions or prohibitions set forth in the “negative list” to be issued. If the enacted version of the Foreign Investment Law and the final “negative list” mandate further actions, such as MOC market entry clearance, to be completed by companies with existing VIE structure like us, we face uncertainties as to whether such clearance can be timely obtained, or at all.

 

The draft Foreign Investment Law, if enacted as proposed, may also materially impact our corporate governance practice and increase our compliance costs. For instance, the draft Foreign Investment Law imposes stringent ad hoc and periodic information reporting requirements on foreign investors and the applicable FIEs. Aside from investment implementation report and investment amendment report that are required at each investment and alteration of investment specifics, an annual report is mandatory, and large foreign investors meeting certain criteria are required to report on a quarterly basis. Any company found to be non-compliant with these information reporting obligations may potentially be subject to fines and/or administrative or criminal liabilities, and the persons directly responsible may be subject to criminal liabilities.

 

We rely principally on dividends paid by our operating subsidiaries to fund cash and financing requirements, and limitations on the ability of our operating subsidiary to make payments to us could have a material adverse effect on our ability to conduct our business and fund our operations.

 

We are a holding company and conduct a significant part of our business through our operating subsidiaries and consolidated variable interest entities, which are limited liability companies established in China. We rely principally on dividends paid by our subsidiaries for our cash needs, including the funds necessary to pay dividends and other cash distributions to our shareholders, to service any debt we may incur and to pay our operating expenses, if any. The payment of dividends by entities organized in China is subject to certain limitations. In particular, regulations in China currently permit payment of dividends only out of accumulated profits as determined in accordance with PRC accounting standards and regulations. Our PRC subsidiaries, ChinaCache Beijing and Xin Run, are also required to set aside at least 10% of their after-tax profit based on PRC accounting standards each year to its general reserves until the accumulative amount of such reserves reaches 50% of its registered capital. These reserves are not distributable as cash dividends. In addition, it is required to allocate a portion of its after-tax profit to its staff welfare and bonus fund at the discretion of its board of directors.

 

Moreover, if ChinaCache Beijing or Xin Run incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us. Any limitation on the ability of ChinaCache Beijing or Xin Run to distribute dividends and other distributions to us could materially and adversely limit our ability to make investments or acquisitions that could be beneficial to our businesses, pay dividends or otherwise fund and conduct our business.

 

Under China’s Enterprise Income Tax Law, we may be classified as a “resident enterprise” of China. Such classification could result in unfavorable tax consequences to us and our non-PRC resident shareholders.

 

Pursuant to the Enterprise Income Tax Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. The term “de facto management body” is defined as the management body that exercises full and substantial control and overall management over the business, productions, personnel, accounts and properties of an enterprise. The SAT issued SAT Circular 82 in April 2009, which provides certain specific criteria for determining whether the “de facto management body” of a Chinese-controlled overseas-incorporated enterprise is located in China. In July 2011, the SAT issued additional rules to provide more guidance on the implementation of SAT Circular 82. The additional rules specify that when provided with a copy of Chinese tax resident determination certificate from a resident Chinese controlled offshore incorporated enterprise, the payer should not withhold 10% income tax when paying the Chinese-sourced dividends, interest, royalties, etc. to the Chinese controlled offshore incorporated enterprise. Although SAT Circular 82 and the additional guidance apply only to overseas registered enterprises controlled by PRC enterprises, not to those controlled by PRC individuals or foreigners, the criteria set forth in SAT Circular 82 may reflect the SAT’s general position on how the “de facto management body” test should be applied in determining the tax resident status of offshore enterprises, regardless of whether they are controlled by PRC enterprises or individuals.

 

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If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow: (i) we may be subject to enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations, and (ii) a 10% withholding tax may be imposed on dividends we pay to our non-PRC resident shareholders and a 10% PRC tax may apply to gains derived by our non-PRC resident shareholders from transferring our shares or ADSs, if such income is considered PRC-sourced income. Similarly, such unfavorable tax consequences could apply to our subsidiaries outside China, including ChinaCache North America Inc. and ChinaCache Network (Hong Kong) Limited or their overseas subsidiaries if they are deemed to be “resident enterprises” by the PRC tax authorities. Notwithstanding the foregoing provisions, the Enterprise Income Tax Law also provides that the dividends paid between “qualified resident enterprises” are exempt from enterprise income tax. If our Cayman Islands holding company is deemed a “resident enterprise” for PRC enterprise income tax purposes, the dividends it receives from its PRC subsidiaries, ChinaCache Beijing and Xin Run, may constitute dividends between “qualified resident enterprises” and therefore qualify for tax exemption. However, the definition of qualified resident enterprises is unclear and the relevant PRC government authorities have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Even if such dividends qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to any withholding tax.

 

Enhanced scrutiny over acquisition transactions by the PRC tax authorities may have a negative impact on potential acquisitions we may pursue in the future.

 

In connection with the EIT Law, the Ministry of Finance and the SAT jointly issued a SAT Circular 59 in April 2009, and the SAT issued a SAT Circular 698 in December 2009. Both SAT Circular 59 and Circular 698 became effective retroactively on January 1, 2008, and a Public Notice 7 in replacement of some of the existing rules in Circular 698, which became effective in February 2015.

 

According to SAT Circular 698, where a non-resident enterprise transfers the equity interests of a PRC “resident enterprise” indirectly by disposition of the equity interests of an overseas holding company, the non-resident enterprise, being the transferor, may be subject to PRC enterprise income tax, if the indirect transfer is considered to be an abusive use of company structure without reasonable commercial purposes. As a result, gains derived from such Indirect Transfer may be subject to PRC withholding tax at a rate of up to 10%. In addition, the PRC “resident enterprise” is supposed to provide necessary assistance to support the enforcement of SAT Circular 698.

 

On February 3, 2015, the SAT issued a Public Notice Regarding Certain Corporate Income Tax Matters on Indirect Transfer of Properties by Non-Tax Resident Enterprises, or Public Notice 7. Public Notice 7 has introduced a new tax regime that is significantly different from that under Circular 698. Public Notice 7 extends its tax jurisdiction to not only indirect transfers set forth under Circular 698 but also transactions involving transfer of other taxable assets, through the offshore transfer of a foreign intermediate holding company. Public Notice 7 also brings challenges to both the foreign transferor and transferee (or other person who is obligated to pay for the transfer) of the taxable assets. Where a non-tax resident enterprise conducts an “indirect transfer” by transferring the taxable assets indirectly by disposing of the equity interests of an overseas holding company, the non-tax resident enterprise being the transferor, or the transferee, or the PRC entity which directly owned the taxable assets may report to the relevant tax authority such indirect transfer. Using a “substance over form” principle, the PRC tax authority may re-characterize such indirect transfer as a direct transfer of the equity interests in the PRC tax resident enterprise and other properties in China. As a result, gains derived from such indirect transfer may be subject to PRC enterprise income tax, and the transferee or other person who is obligated to pay for the transfer is obligated to withhold the applicable taxes, currently at a rate of up to 10% for the transfer of equity interests in a PRC resident enterprise. Nevertheless, Circular 7 has introduced safe harbors for internal group restructurings and the purchase and sale of equity through a public securities market.

 

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On October 17, 2017, the State Administration of Tax issued the Announcement of the State Administration of Taxation on Issues Concerning the Withholding of Non-resident Enterprise Income Tax at Source, or SAT Bulletin 37, which came into effect on December 1, 2017 and concurrently abolished Circular 698. The SAT Bulletin 37 further clarifies the practice and procedure of the withholding of non-tax resident enterprise income tax. Pursuant to Circular 7 and SAT Bulletin 37, both the transferor and the transferee may be subject to penalties under PRC tax laws if the transferee fails to withhold the taxes and the transferor fails to pay the taxes.

 

We face uncertainties on the reporting and consequences on private equity financing transactions, share exchange or other transactions involving the transfer of shares in our company by investors that are non-PRC resident enterprises, or sale or purchase of shares in other non-PRC resident companies or other taxable assets by us. Our company and other non-resident enterprises in our group may be subject to filing obligations or being taxed if our company and other non-resident enterprises in our group are transferors in such transactions, and may be subject to withholding obligations if our company and other non-resident enterprises in our group are transferees in such transactions, under Public Notice 7 and/or SAT Bulletin 37. For the transfer of shares in our company by investors that are non-PRC resident enterprises, our PRC subsidiaries may be requested to assist in the filing under Public Notice 7 and/or SAT Bulletin 37. As a result, we may be required to expend valuable resources to comply with Public Notice 7 and/or SAT Bulletin 37 or to request the relevant transferors from whom we purchase taxable assets to comply with these circulars, or to establish that our company and other non-resident enterprises in our group should not be taxed under these rules and notice, which may have a material adverse effect on our financial condition and results of operations.

 

The PRC tax authorities have the discretion under Public Notice 7 and/or SAT Bulletin 37 to make adjustments to the taxable capital gains based on the difference between the fair value of the taxable assets transferred and the cost of investment. If the PRC tax authorities make adjustments to the taxable income of the transactions under Public Notice 7 and/or SAT Bulletin 37, our income tax costs associated with such potential acquisitions will be increased, which may have an adverse effect on our financial condition and results of operations.

 

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

 

The M&A Rules include provisions that purport to require approval of the Ministry of Commerce for acquisitions by offshore entities established or controlled by domestic companies, enterprises or natural persons of onshore entities that are related to such domestic companies, enterprises or natural persons, and prohibit offshore entities from using their foreign-invested subsidiaries in China, or through “other means,” to circumvent such requirement. As part of our growth strategy, we obtained control over Beijing Jingtian in July 2008 by entering into contractual arrangements with Beijing Jingtian and its shareholders. We did not seek the approval of the Ministry of Commerce for this transaction based on the legal advice we obtained from our PRC legal counsel in those transactions that such approval was unnecessary. However, the M&A Rules also prohibit companies from using any “other means” to circumvent the approval requirement set forth therein and there is no clear interpretation as to what constitutes “other means” of circumvention of the requirement under the M&A Rules. The Ministry of Commerce and other applicable government authorities would therefore have broad discretion in determining whether an acquisition is in violation of the M&A Rules. If PRC regulatory authorities take a view that is contrary to ours, we could be subject to severe penalties. In addition, we may in the future grow our business in part by acquiring complementary businesses in China. If we are required to obtain the approval from the Ministry of Commerce, completion of such transaction may be delayed or even inhibited. Our ability to expand our business or maintain or expand our market share through future acquisitions would as such be materially and adversely affected.

 

In addition, in August 2011 the Ministry of Commerce issued the Rules of Ministry of Commerce on Implementation of Security Review System of Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the MOFCOM Security Review Rules. The MOFCOM Security Review Rules, effective from September 1, 2011, require certain merger and acquisition transactions to be subject to merger control review or security review. The MOFCOM Security Review Rules further provide that, when deciding whether a specific merger or acquisition of a PRC enterprise by foreign investors is subject to the security review by the Ministry of Commerce, the principle of substance over form should be applied and foreign investors are prohibited from bypassing the security review requirement by structuring transactions through proxies, trusts, indirect investments, leases, loans, control through contractual arrangements or offshore transactions. There is no explicit provision in the MOFCOM Security Review Rules stating that our content and application delivery business fall into the scope subject to the security review. However, there is a lack of clear statutory interpretation on the implementation of these new rules, there can be no assurance that the Ministry of Commerce will not apply these rules to our contractual arrangements with Beijing Blue I.T. and Beijing Jingtian. If we are found to be in violation of the MOFCOM Security Review Rules, or fail to obtain any required approvals, the relevant regulatory authorities would have broad discretion in dealing with such violation, including levying fines, confiscating income, revoking our PRC affiliates’ business or operating licenses or requiring us to restructure or unwind the relevant ownership structure or operations. Any of these actions could cause significant disruption to our business operations and may materially and adversely affect our business, financial condition and results of operations. Further, if the business of any target company that we would like to acquire in the future falls into the ambit of security review, complying with the requirements of the relevant rules could be prohibitively time consuming or we may be legally prohibited from acquiring such company either by equity or asset acquisition, capital contribution or through any contractual arrangement, which could have a material and adverse impact on our ability to expand our business or maintain our market share.

 

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PRC regulation of loans and direct investment by offshore holding companies to PRC entities may delay or prevent us from using the proceeds from a public offering to make loans or additional capital contributions to our PRC subsidiaries or consolidated variable interest entities, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

 

As an offshore holding company, we may make loans to our PRC subsidiaries, ChinaCache Beijing and Xin Run, or consolidated variable interest entities, or we may make additional capital contributions to ChinaCache Beijing or Xin Run. Any loans to ChinaCache Beijing or Xin Run or consolidated variable interest entities are subject to PRC regulations. For example, loans by us to ChinaCache Beijing or Xin Run, each of which is a foreign-invested enterprise, to finance its activities cannot exceed statutory upper limit and must be filed with the State Administration of Foreign Exchange through the online filing system of SAFE after the loan agreement is signed and at least three business days prior to the borrower withdraws any amount from the foreign loan.

 

We may also decide to finance our operations in China by means of capital contributions. These capital contributions must be approved by or subsequently filed with the Ministry of Commerce or its local counterpart. We cannot assure you that we will be able to obtain these government approvals on a timely basis, if at all, with respect to future capital contributions by us to our PRC subsidiaries. If we fail to receive such approvals, our ability to use the proceeds from a public offering and to capitalize our PRC operations may be negatively affected, which could adversely affect our liquidity and our ability to fund and expand our business.

 

Governmental control of currency conversion may limit our ability to utilize our revenues.

 

A significant part of our revenues and expenses are denominated in Renminbi. Under PRC laws, the Renminbi is currently convertible under the “current account,” which includes dividends, trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans, without the prior approval of the State Administration of Foreign Exchange. Currently, our PRC subsidiaries, ChinaCache Beijing and Xin Run, may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, without the approval of the State Administration of Foreign Exchange. However, foreign exchange transactions by ChinaCache Beijing or Xin Run under the capital account continue to be subject to significant foreign exchange controls and require the approval of or need to register or file with PRC governmental authorities, including the State Administration of Foreign Exchange. In particular, if ChinaCache Beijing or Xin Run borrows foreign currency loans from us or other foreign lenders, these loans must be filed with the State Administration of Foreign Exchange after the loan agreement is signed and at least three business days before the borrower draws any amount from the foreign loan, and the accumulative amount of its foreign currency loans borrowed by ChinaCache Beijing or Xin Run may not exceed a statutory upper limit. If we finance ChinaCache Beijing by means of additional capital contributions, these capital contributions must be approved by or made post-contribution filing with certain government authorities. Any existing and future restrictions on currency exchange may affect the ability of our PRC subsidiaries or consolidated variable interest entities to obtain foreign currencies, limit our ability to meet our foreign currency obligations or otherwise materially and adversely affect our business.

 

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In March 2015, SAFE promulgated the Circular on Reforming the Management Approach Regarding the Foreign Exchange Capital Settlement of Foreign-invested Enterprises, or SAFE Circular No. 19, which came into effect as of June 1, 2015. SAFE Circular No. 19 provides that, among other things, a foreign-invested company may convert foreign currency capital in its capital account into RMB on a “at will” basis. On June 9, 2016, SAFE promulgated the Circular on Reforming and Regulating Policies on the Control over Foreign Exchange Settlement of Capital Accounts, or SAFE Circular No. 16, to further expand and strengthen such “at will” conversion reform under SAFE Circular No. 19. SAFE Circular No. 16 provides an integrated standard for conversion of foreign exchange under capital account items on an “at will” basis which applies to all enterprises registered in the PRC. Pursuant to SAFE Circular No. 16, in addition to foreign currency capital, enterprises registered in the PRC may also convert their foreign debts, as well as repatriated funds raised through overseas listing, from foreign currency to RMB on an “at will” basis. SAFE Circular No. 16 reiterates that the RMB funds so converted shall not be used for the purpose of, whether directly or indirectly, (i) paying expenditures out of the ordinary course of business or prohibited by laws or regulations; (ii) making securities investment or other investments (except for banks’ principal-secured products); (iii) extending loans to non-affiliated enterprises (except as expressly permitted in the business license); and (iv) purchasing non-self-used real properties (except for real estate enterprises).

 

The audit report included in this Annual Report is prepared by auditors who are not inspected fully by the Public Company Accounting Oversight Board, or the PCAOB, and, as such, our shareholders are deprived of the benefits of such inspection.

 

As an auditor of companies that are publicly traded in the U.S. and a firm registered with the Public Company Accounting Oversight Board (U.S.), or PCAOB, Ernst & Young Hua Ming LLP is required under the laws of the U.S. to undergo regular inspections by the PCAOB. However, because we have substantial operations within the PRC, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese government authorities, our auditor and its audit work is not currently inspected fully by the PCAOB.

 

Inspections of other auditors conducted by the PCAOB outside China have at times identified deficiencies in those auditors’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. The lack of PCAOB inspections of audit work undertaken in China prevents the PCAOB from regularly evaluating our auditor’s audits and its quality control procedures. As a result, shareholders may be deprived of the benefits of PCAOB inspections, and may lose confidence in our reported financial information and procedures and the quality of our financial statements.

 

Proceedings instituted recently by the SEC against five PRC-based accounting firms, including our independent registered public accounting firm, could result in financial statements being determined to not be in compliance with the requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act.

 

In December 2012, the SEC brought administrative proceedings against the Big 4 accounting firms in China, including our independent registered public accounting firm, alleging that these accounting firms had violated U.S. securities laws and the SEC’s rules and regulations thereunder by failing to provide to the SEC the firms’ audit papers and other documents related to certain PRC-based companies that are publicly traded in the U.S.

 

On January 22, 2014, the Administrative Law Judge presiding over the matter reached an initial decision that the firms had each violated the SEC’s rules of practice by failing to produce the audit work papers and related documents directly to the SEC. The initial decision further determined that each of the firms should be censured and barred from practicing before the SEC for a period of six months. On February 12, 2014, the Big 4 accounting firms in China appealed to the SEC against this decision. In February 2015, each of the Big 4 accounting firms in China agreed to a censure and to pay a fine to the SEC to settle the dispute and avoid suspension of their ability to practice before the SEC. The settlement requires the firms to follow detailed procedures to seek to provide the SEC with access to Chinese firms’ audit documents via the CSRC. If the firms do not follow these procedures, the SEC could impose penalties such as suspensions, or it could restart the administrative proceedings.

 

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

 

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

 

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

 

The conversion of Renminbi into foreign currencies, including U.S. dollars, is based on rates set by the People’s Bank of China. The PRC government allowed the Renminbi to appreciate by more than 20% against the U.S. dollar between July 2005 and July 2008. Between July 2008 and June 2010, this appreciation was halted and the exchange rate between the Renminbi and the U.S. dollar remained within a narrow band. Since June 2010, the Renminbi 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, Renminbi has joined the International Monetary Fund (IMF)’s basket of currencies that make up the Special Drawing Right (SDR), along with the U.S. dollar, the Euro, the Japanese yen and the British pound. In the fourth quarter of 2016, Renminbi has depreciated significantly in the backdrop of a surging U.S. dollar and persistent capital outflows of China. With the development of the foreign exchange market and progress towards interest rate liberalization and Renminbi internationalization, the PRC government may in the future announce further changes to the exchange rate system and there is no guarantee that Renminbi will not appreciate or depreciate significantly in value against the U.S. dollar in the future. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between the RMB and the U.S. dollar in the future.

 

To the extent that we need to convert U.S. dollars into RMB for capital expenditures and working capital and other business purposes, appreciation of the RMB against the U.S. dollar would have an adverse effect on the RMB amount we would receive from the conversion. Conversely, if we decide to convert RMB into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs, strategic acquisitions or investments or other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect on the U.S. dollar amount available to us.

 

Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedging transactions may be limited and we may not be able to successfully hedge our exposure at all. In addition, our currency exchange losses may be magnified by Chinese exchange control regulations that restrict our ability to convert Renminbi into foreign currency.

 

PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident beneficial owners to personal liability and limit our ability to acquire PRC companies or to inject capital into our PRC subsidiary, limit our PRC subsidiary’s ability to distribute profits to us, or otherwise materially and adversely affect us.

 

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

 

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SAFE Circular 37 is issued to replace the Notice on Relevant Issues Concerning Foreign Exchange Administration for PRC Residents Engaging in Financing and Roundtrip Investments via Overseas Special Purpose Vehicles, or SAFE Circular 75.

 

We are aware that our PRC resident beneficial owners subject to these SAFE registration requirements have registered with the Beijing SAFE branch and will amend the registration to reflect the recent changes to our corporate structure.  However, we cannot assure you that our current and future beneficial owners who are PRC residents will continue to comply with Circular 37; nor can we assure you that there will not be further filing or registration requirements imposed by the PRC government concerning ownership in foreign companies of PRC residents. The failure or inability of our PRC resident beneficial owners to make any required registrations or comply with these requirements may subject such beneficial owners to fines and legal sanctions and may also limit our ability to contribute additional capital into or provide loans to ChinaCache Beijing and Xin Run, and consolidated variable interest entities, limit ChinaCache Beijing’s and Xin Run’s ability to pay dividends or otherwise distribute profits to us, or otherwise materially and adversely affect us.

 

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

 

Under the SAFE regulations, PRC residents who participate in an employee stock ownership plan or stock option plan in an overseas publicly-listed company are required to register with SAFE or its local branch and complete certain other procedures. Participants of a stock incentive plan who are PRC residents must retain a qualified PRC agent, which could be a PRC subsidiary of such overseas publicly listed company, to conduct the SAFE registration and other procedures with respect to the stock incentive plan on behalf of these participants. Such participants must also retain an overseas entrusted institution to handle matters in connection with their exercise or sale of stock options. In addition, the PRC agent is required to amend the SAFE registration with respect to the stock incentive plan if there is any material change to the stock incentive plan, the PRC agent or the overseas entrusted institution or other material changes.

 

We and our PRC resident employees who participate in our stock incentive plan are subject to these regulations. We have registered our 2007 Stock Incentive Plan, 2008 Stock Incentive Plan, 2010 Stock Incentive Plan and 2011 Share Incentive Plan with Beijing branch of SAFE. If we or our PRC resident option grantees fail to comply with these regulations, we or our PRC resident option grantees may be subject to fines and other legal or administrative sanctions. See “Item 4. Information on the Company— B. Business Overview — Regulation—Regulations on Employee Stock Options Granted by Listed Companies.”

 

Our ability to transfer ownership of the buildings of our cloud infrastructure may be restricted if we fail to obtain requisite governmental approvals.

 

In March 2013, we acquired land use right in Tianzhu Comprehensive Bonded Zone in Beijing, upon which we plan to partner with our clients to construct cloud infrastructure. We have entered into agreements with two clients, pursuant to which they agreed to purchase part of the cloud infrastructure from us. The final equity transfer agreement with one of the two clients, People.cn, will be effective when the requisite governmental approvals are obtained. The land we acquired for the development of our cloud infrastructure is categorized as land for industrial use and hence if we need to sell other buildings in the future, the transfer of ownership of the buildings constructed on such land, along with relevant land use rights, is subject to the prior approval by multiple administrative authorities. If we fail to obtain such approvals, our ability to transfer ownership of the buildings in our cloud infrastructure to potential investors or clients will be restricted and our financial condition may thereby be adversely affected. See “Item 4. Information on the Company — B. Business Overview — Regulation — Regulations on Transfer of Real Estate Properties”.

 

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Risks Related to Our ADSs

 

The market price for our ADSs has fluctuated and may continue to be volatile.

 

The market price for our ADSs has fluctuated significantly since we first listed our ADSs. The market prices of our ADSs have ranged from US$0.72 to US$3.16 per ADS in 2017.

 

The market price for our ADSs may be highly volatile and subject to wide fluctuations in response to factors including the following:

 

·actual or anticipated fluctuations in our quarterly results of operations;
·changes in financial estimates by securities research analysts;
·announcements by us or our competitors of acquisitions, strategic partnerships, joint ventures or capital commitments;
·changes in the operating performance or market valuations of other internet content and application delivery service businesses or other internet-related businesses;
·addition or departure of key personnel;
·fluctuations of exchange rates between the RMB and U.S. dollar;
·intellectual property litigation;
·general economic or political conditions in China and the U.S.;
·changes in governmental regulations; and
·detrimental negative publicity about us, our products and services, our financial results or our compliance with applicable law.

 

In addition, the stock market in general, and the market prices for internet-related companies and companies with operations in China in particular, have experienced volatility that often has been unrelated to the operating performance of such companies. The securities of some China-based companies that have listed their securities in the U.S. 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 these Chinese companies’ securities after their offerings may affect the attitudes of investors toward Chinese companies listed in the U.S., which consequently may impact the trading performance of our 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 other 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. Further, the global financial crisis and the ensuing economic recessions in many countries have contributed and may continue to contribute to extreme volatility in the global stock markets. These broad market and industry fluctuations may adversely affect operating performance. Volatility or a lack of positive performance in our ADS price may also adversely affect our ability to retain key employees, most of whom have been granted options or other equity incentives.

 

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.

 

Additional sales of our ordinary shares in the public market, or the perception that these sales could occur, could cause the market price of our ADSs to decline. All of our shares are freely transferable without restriction or additional registration under the Securities Act of 1933, as amended, or the Securities Act. If any existing shareholder or shareholders sell a substantial amount of ADSs, the prevailing market price for our ADSs could be adversely affected. Such sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.

 

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

 

We will have to defend against the putative shareholder class action lawsuit described in “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings—Litigation,” including any appeals of such lawsuit should our initial defense be unsuccessful. We may become subject to similar lawsuits from time to time. On March 28, 2018, the lead plaintiff of the putative class action filed an unopposed motion for preliminary approval of class action settlement, requesting that, among others, the Court preliminarily approve a settlement agreement that the parties reached to settle the case for USD 990,000. In the event that the proposed settlement is not approved by the Court and/or is not consummated for any other reason, we will not be able estimate the possible loss or possible range of loss, if any, associated with the resolution of this lawsuit. In the event that our initial defense of these lawsuits is unsuccessful, there can be no assurance that we will prevail in any appeal. Any adverse outcome of these cases, including any plaintiff’s appeal of a judgment in these lawsuits, could have a material adverse effect on our business, financial condition, results of operation, cash flows and reputation. In addition, there can be no assurance that our insurance carriers will cover all or part of the defense costs, or any liabilities that may arise from these matters. The litigation process may utilize a significant portion of our cash resources and divert management’s attention from the day-to-day operations of our company, all of which could harm our business. We also may be subject to claims for indemnification related to these matters, and we cannot predict the impact that indemnification claims may have on our business or financial results.

 

We are a “foreign private issuer,” and have disclosure obligations that are different from those of U.S. domestic reporting companies; as a result, you should not expect to receive the same information about us at the same time when a U.S. domestic reporting company provides the information required to be disclosed.

 

We are a foreign private issuer and, as a result, we are not subject to the same requirements that are imposed upon U.S. domestic issuers by the U.S. Securities and Exchange Commission, or SEC. Under the Securities Exchange Act of 1934, or the Exchange Act, we are subject to reporting obligations that, to some extent, are more lenient and less frequent than those of U.S. domestic reporting companies. For example, we are not required to issue quarterly reports or proxy statements. We must file our annual report within four months after the end of our fiscal year, which is December 31 of each year. We are not required to disclose detailed individual executive compensation information that is required to be disclosed by U.S. domestic issuers. Further, our directors and executive officers are not required to report equity holdings under Section 16 of the Securities Act and are not subject to the insider short-swing profit disclosure and recovery regime. As a foreign private issuer, we are also exempt from the requirements of Regulation FD (Fair Disclosure) which, generally, are meant to ensure that select groups of investors are not privy to specific information about an issuer before other investors. We are, however, still subject to the anti-fraud and anti-manipulation rules of the SEC, such as Rule 10b-5 under the Exchange Act. Since many of the disclosure obligations imposed on us as a foreign private issuer are different than those imposed on U.S. domestic reporting companies, our shareholders should not expect to receive the same information about us and at the same time as the information received from, or provided by, U.S. domestic reporting companies.

 

We may be classified as a passive foreign investment company for U.S. federal income tax purposes, which could result in adverse U.S. federal income tax consequences to U.S. holders of our ADSs or ordinary shares.

 

Depending upon the value of our assets, the market value of our ADSs and ordinary shares and the nature of our assets and income over time, we could be classified as a passive foreign investment company (a “PFIC”), for U.S. federal income tax purposes. Based on our income and assets and the value of our ADSs and ordinary shares, we do not believe that we were a PFIC for the taxable year ended December 31, 2017 and we do not expect to be a PFIC for the current taxable year. However, we can give no assurances with respect to our PFIC status for past or future taxable years as the PFIC determination is inherently factual and the application of the PFIC rules is subject to ambiguity in several aspects.

 

A non-U.S. corporation, such as our company, will be classified as a PFIC for any taxable year if either (i) at least 75% of its gross income for the taxable year is passive income or (ii) at least 50% of the value of its assets (based on the average quarterly value of its assets during the taxable year) is attributable to assets that produce or are held for the production of passive income.

 

Although the law in this regard is not entirely clear, we treat Beijing Blue I.T. and Beijing Jingtian as being owned by us for U.S. federal income tax purposes because we control their management decisions and we are entitled to substantially all of their economic benefits, and, as a result, we consolidate these entities’ results of operations in our consolidated U.S. GAAP financial statements. If it were determined, however, that we are not the owner of Beijing Blue I.T. and Beijing Jingtian for U.S. federal income tax purposes, we would likely be treated as a PFIC for our current taxable year and any subsequent taxable year.

 

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Because of the uncertainties in the application of the relevant rules 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 year or any subsequent taxable year. The overall level of our passive assets will be affected by how, and how quickly, we spend our liquid assets and the cash raised in any transaction. Under circumstances where revenues from activities that produce royalty 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 in our operations or for other active purposes, our risk of becoming classified as a PFIC may substantially increase.

 

If we were to be or become classified as a PFIC, a U.S. Holder (as defined in “Item 10.. Additional Information— E. Taxation—U.S. Federal Income Tax Considerations—General”) may incur significantly increased U.S. income tax on gain recognized on the sale or other disposition of the ADSs or ordinary shares and on the receipt of distributions on the ADSs or ordinary shares to the extent such gain or distribution is treated as an “excess distribution” under the U.S. federal income tax rules. Further, a U.S. Holder will generally be treated as holding an equity interest in a PFIC in the first taxable year of the U.S. Holder’s holding period in which we become a PFIC and subsequent taxable years even if, we, in fact, cease to be a PFIC in subsequent taxable years. 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—U.S. Federal Income Tax Considerations—Passive Foreign Investment Company Considerations.”

 

Holders of our ADSs may not be able to participate in rights offerings and may experience dilution of their holdings and may not receive cash dividends if it is impractical to make them available.

 

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

 

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

 

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

 

The ADSs represented by the ADRs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deem it advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

 

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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, conduct a significant part of our operations in China and a majority of our officers and directors reside outside the U.S.

 

We are incorporated in the Cayman Islands and substantially all of our assets are located outside of the U.S. We conduct a significant part of our operations in China through our wholly-owned subsidiaries and VIEs in China. The majority of our officers and directors reside outside the U.S. and a substantial portion of the assets of those persons are located outside of the U.S. As a result, it may be difficult for the holders of our ADSs to bring an action against us or against these individuals in the Cayman Islands or in China in the event that they believe that their rights have been infringed under the securities laws or otherwise. Even if the holders of our ADSs are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render the holders of our ADSs unable to enforce a judgment against our assets or the assets of our directors and officers. In addition, there is uncertainty as to whether the courts of the Cayman Islands or the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the U.S. or any state, and it is uncertain whether such Cayman Islands or PRC courts would be competent to hear original actions brought in the Cayman Islands or the PRC against us or such persons predicated upon the securities laws of the U.S. or any state.

 

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

 

As a result of all of the above, our public shareholders may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than they would as shareholders of a public company of the U.S.

 

Our memorandum and articles of association contain anti-takeover provisions that could adversely affect the rights of holders of our ordinary shares and ADSs.

 

Our memorandum and articles of association contain certain provisions that could limit the ability of others to acquire control of our company, including a provision that grants authority to our board of directors to establish from time to time one or more series of preferred shares without action by our shareholders and to determine, with respect to any series of preferred shares, the terms and rights of that series. The provisions could have the effect of depriving our shareholders of the opportunity to sell their shares at a premium over the prevailing market price by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transactions.

 

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

 

As a public company, we incur significant accounting, legal and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act, as well as new rules subsequently implemented by the SEC and the Nasdaq have detailed requirements concerning corporate governance practices of public companies including Section 404 of the Sarbanes-Oxley Act relating to internal controls over financial reporting. These rules and regulations have increased our director and officer liability insurance, accounting, legal and financial compliance costs and have made certain corporate activities more time-consuming and costly. In addition, we incur additional costs associated with our public company reporting requirements. We are currently evaluating and monitoring developments with respect to these rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.

 

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If securities or industry analysts do not actively follow our business or if they publish unfavorable research about our business, our ADS price and trading volume could decline.

 

The trading market for our ADSs depends in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who covers us downgrades our ADSs or publishes unfavorable research about our business, our ADS price would likely decline. If one or more of these analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our ADSs could decrease, which could cause our ADS price and trading volume to decline.

 

ITEM 4.INFORMATION ON THE COMPANY

 

A.History and Development of the Company

 

We commenced operations through Beijing Blue I.T., a company incorporated in China in June 1998. In June 2005, we incorporated ChinaCache International Holdings Ltd., or ChinaCache Holdings, under the laws of the Cayman Islands to become our offshore holding company through a series of corporate restructuring transactions.

 

In August 2005, we established our wholly-owned PRC subsidiary, ChinaCache Network Technology (Beijing) Limited, or ChinaCache Beijing.

 

In August 2007, we incorporated ChinaCache North America, Inc., or ChinaCache U.S., a wholly-owned subsidiary of ChinaCache Holdings, in California, the U.S.

 

In July 2008, we obtained control over Beijing Jingtian, through contractual arrangements.

 

In October 2010, we completed our initial public offering and our ADSs commenced trading on the Nasdaq Global Market under the symbol “CCIH”.

 

In July 2011, we established Xin Run, a PRC-incorporated company, primarily for the purpose of cloud infrastructure business.

 

In November 2012, we transferred our equity interests in ChinaCache Beijing and Xin Run to ChinaCache Networks (Hong Kong) Limited, or ChinaCache Hong Kong, a wholly owned subsidiary of ours.

 

In November 2013, we established ChinaCache Ireland Limited, or ChinaCache Ireland, a wholly owned subsidiary of ChinaCache Hong Kong.

 

In January 2014, our ADSs were transferred to and listed on the Nasdaq Global Select Market.

 

In March 2014, we issued and sold an aggregate of 53,855,569 ordinary shares, represented by 3,365,973 ADSs, to a group of institutional investors affiliated with Wellington Management Company, LLP for an aggregate purchase price of approximately US$55.0 million.

 

In March 2014, we repurchased an aggregate of 28,960,922 ordinary shares of us from certain of our existing shareholders for an aggregate purchase price of approximately US$29.6 million.

 

In August 2014, we established (i) Beijing Shouming Technology Co., Limited, or Beijing Shouming, (ii) Beijing Zhao Du Technology Co., Limited, or Beijing Zhao Du and (iii) Beijing Shuoge Technology Co., Limited, or Beijing Shuoge, each a 100% subsidiary of Xin Run. In July 2017, Xin Run transferred all of its equity interests in Beijing Zhao Du to a subsidiary of BFSMC.

 

In January 2015, ChinaCache Ireland established a branch office in London. In March 2016, we incorporated ChinaCache Networks (UK) Limited, or ChinaCache UK, in the United Kingdom and are in the process of transferring our Ireland operations to ChinaCache UK.

 

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In September 2015, Xin Run increased its registered capital by US$0.2 million, which was subscribed by Tianjin Shuishan Technology Co., Ltd, or Tianjin Shuishan, a PRC company owned by Mr. Song Wang and Ms. Jean Xiaohong Kou. As a result, Xin Run was converted from a wholly foreign-owned enterprise to a sino-foreign joint venture.

 

In August 2016, we incorporated ChinaCache Assets LLC, or CCAL, a wholly owned subsidiary of ChinaCache U.S., in California, the U.S.

 

Our headquarters are located at Section A, Building 3, Dian Tong Creative Square, No. 7 Jiuixianqiao North Road, Chaoyang District, Beijing, PRC. Our telephone number at this address is +86 10 6408 5088. Beijing Blue I.T. currently has 13 branch offices in 13 cities in China, namely, Beijing, Tianjin, Shenyang, Harbin, Shanghai, Nanjing, Guangzhou, Shenzhen, Wuhan, Chongqing, Chengdu, Xi’an and Taiyuan. ChinaCache Beijing currently has two branch offices in Tianjin, and Xin Run currently has one branch office in Tianjin. In addition to ChinaCache U.S., ChinaCache Ireland, ChinaCache UK and CCAL, we have three other subsidiaries outside of mainland China, namely ChinaCache Hong Kong Limited, established in Hong Kong in April 2008, Metasequoia Investment Limited, established in the British Virgin Islands in March 2012, and JNet Holdings Limited, established in the British Virgin Islands in September 2007. Our agent for service of process in the U.S. in connection with our registration statement on Form F-1 for our initial public offering is Law Debenture Corporate Services Inc., located at 400 Madison Avenue, 4th Floor, New York, New York 10017.

 

B.Business Overview

 

We provide a portfolio of services and solutions to businesses, government agencies and other enterprises to enhance the reliability and scalability of their online services and applications and improve end-user experience. Our nationwide service platform, which consists of our network, servers and proprietary intelligent software, is designed to handle planned and unplanned peaks without significant upfront and ongoing capital outlay and other investments on the part of our customers.

 

We began providing content and application delivery services in China in 2000 and were the first non-carrier company to be licensed by MIIT to provide content and application delivery services throughout China. As an early mover, we expanded our business along with the internet market growth in China and have acquired extensive knowledge about the internet infrastructure and telecommunications environment in China. We conduct our businesses internationally, covering mainland China, other Asian countries, U.S and Europe and our revenues are derived from all across the above regions. . Building on our knowledge and experience, we have developed a portfolio of services and solutions designed to address complex and unique issues arising from internet infrastructure and to meet the specific needs of the company’s customers.

 

As a carrier-neutral service provider, our network in China is interconnected with those operated by all major telecommunications carriers and local internet service providers in mainland China. We deploy servers and nodes across networks covering most regions in China and we use a transmission backbone that connects our nodes and data centers, thereby optimizing our content and applications delivery performance and reliability. Our wide range of services makes us a top choice for customers requiring content and application delivery total solutions in different regions in China. We believe that our robust nationwide service platform, which is the result of our significant investments of capital, time and human resources, is not easy to replicate and provides us with a competitive advantage.

 

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Our Services and Solutions

 

We provide a portfolio of content and application delivery total solutions and solutions tailored to our customers’ needs to improve the performance and reliability of their online services and applications, without significant upfront and ongoing capital outlay and other investments on the part of our customers. In 2012, we further enhanced the technical sophistication of our content and application delivery total solutions and rebranded our content delivery network services into “content-aware network service”, which integrates telecommunications network with internet applications. Our content-aware network service is device-aware, network-aware and application-aware. Our content-aware network service is device-aware in the sense that we are able to identify each end user device and optimize data for consumption on such user’s iOS or Android mobile device. Our content-aware network service is network-aware in that its capabilities enable us to determine what kind of network online content is going through, whether it is a fixed or mobile network, and whether data is traveling on a 2G, 3G and 4G. Our content-aware network service is application-aware in that through this service we can provide network services tailored to specific applications such as e-commerce and online video, which require different capabilities and resources.

 

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Rich Media Streaming Services

 

The live streaming of media files to end-users has become an important web application. When media files are streamed to an end-user, the files are not stored on the end-user’s computer, but are played by the end-user’s media player software. We offer a portfolio of rich media streaming services to improve the transmission efficiency of media files, significantly offloading the pressure at the origin server and improving the quality of end-user experience. We combine peer-to-peer technology with streaming technology by facilitating data sharing during the transmission of live streaming content. Through our Rich Media Streaming services, we are able to provide nearly all types of streaming acceleration services comparing to major market players.

 

Guaranteed Application Services

 

Our Guaranteed Application Services are designed for websites that incorporate applications that have dynamic features, such as on-line booking and ordering, real-time stock quotes and on-line surveys. Utilizing our widely deployed servers and reliable and legally compliant carrier network, our services enable interactions between end-users and the origin servers to bypass public network congestion. As a result, we ensure reliable and efficient application processing and significantly improve end-user experience.

 

Managed Internet Data Services

 

Our Managed Internet Data Services are a “one-stop-shop” services designed to meet customers’ needs for content and application delivery, network infrastructure and network security. Managed Internet Data Services are based on a combination of the traditional internet data center services and our high performance content and application delivery total solutions. The offerings allow us to expand the reach of our content and application delivery total solutions to customers who wish to take advantage of locating their content and applications in secure, high-performance facilities. To our best financial advantage, we primarily use third-party facilities for hosting customers’ network and other equipment with redundant power, environmental controls and security protection. In addition, we distinguish ourselves from conventional internet data services providers by bundling our high performance content and application delivery total solutions and internet data management services. Customers using our Managed Internet Data Services include enterprises, internet companies, media and entertainment companies, government agencies and financial institution.

 

ChinaCache Cloud Hosting Services

 

Our ChinaCache Cloud Hosting Services are designed to meet customer needs for cloud hosting. The services provide high performance computing environment and storage, supported by our established content and application delivery network. Customers using our ChinaCache Cloud Hosting Services include, but not limited to, companies that operate internet social networks, online games, e-commerce or internet media. In July 2014, we received a credible cloud hosting service certificate from Data Center Alliance, a non-profit organization founded by over 60 leading technology enterprises in the cloud hosting, data center, content delivery, and big data services industry and supervised by the Academy of Telecommunication Research of the Chinese Ministry of Industry and Information Technology, or the MIIT. Our cloud hosting service and block storage service satisfied all the 13 stringent accreditation criteria required by the MIIT such as durability, mobility, privacy protection, resource allocation and failure recovery.

 

Content Bridging Services

 

Our Content Bridging Services utilize our nationwide service platform interconnected with networks operated by all telecommunications carriers to “bridge” internet content exchanges amongst networks. Content Bridging Services effectively reduce cross traffic amongst carriers and significantly help improve end-user experience. Our primary target customers for Content Bridging Services are mobile telecommunications carriers.

 

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Internet Exchange and Data Center Services

 

We have formed a strategic cooperation with an industry leading independent internet exchange service provider to jointly develop internet exchange centers in China to be branded “CHN-IX”. Upon completion, CHN-IX is expected to provide interconnected data center platform and internet exchange related services for domestic Chinese and international ISPs, cloud and IT services providers, content providers, financial companies, enterprises and network, online games operators and mobile services providers to promote efficient exchanges of internet traffic and interconnections with lower operating cost and increased business opportunities.

 

Mobile Internet Solutions

 

Aiming to provide mobile acceleration services to the projected growing mobile internet market, our mobile internet solutions try to help APP owners and mobile websites to achieve high quality content delivery regardless of the type of mobile access network used by the end users. Furthermore, our mobile internet solutions also feature effortless set-up and seamless integration with users’ traditional CDN deployment scheme, if any.

 

In early 2015, we introduced mobile internet intelligence aware solution — MPlus. MPlus extends more advantages to mobile e-commerce, mobile games, mobile social and other mobile Internet companies that generate heavy data traffic, allowing them to achieve transmission speeds that are substantially higher than average. MPlus is a network-aware, terminal-aware and application-aware intelligence solution. MPlus realizes intelligent acceleration through the implementation of file merge, deferred loading and HTML intelligent analysis.

 

In February 2017, we entered into an exclusive partnership with PacketZoom, a provider of in-app technology that boosts mobile app performance. We were granted exclusive right in China to build mobile-friendly infrastructure to deliver Packet Zoom ExpresslaneTM aimed to accelerate and improve reliability of mobile app content delivery in China. The term of partnership is initially three years, subject to renewal.

 

Value-added Services

 

We also offer a wide variety of value-added services, which include the following:

 

·Geo-Content Acceleration service. Geo-Content Acceleration service enables websites to automatically provide content to end-users corresponding to each end-user’s specific geographic location.
·Performance Evaluation Module. Performance Evaluation Module allows our customers to monitor their own websites on a real-time basis and to measure the effect of our services.
·Scalable Service Routing service. Scalable Service Routing service provides domain name server resolution and global load balancing for multiple servers located across different regions to address the complex and often-unreliable network issues in China.
·Link Anti-Hijack service. Link Anti-Hijack service helps to prevent unauthorized links to content on our customers’ websites.
·NetStorage service. NetStorage service provides high performance data storage over the internet, supported by our network infrastructure with multi-level back-ups and security measures.
·User Behavior Analysis service. User Behavior Analysis service clusters and evaluates the targeted audiences’ specific online behavior to assist our customers to better engage the visitors to their websites and improve the interactions between the websites and their visitors.
·Website Performance Evaluation service. Website Performance Evaluation service assists customers to identify popular web content and products and determine the geographical locations of their targeted audiences so as to improve the effectiveness of their online marketing.
·All-around Application Acceleration Solution. Our network service portfolio has expanded from external web site acceleration to the enterprise’s intranet connection, especially for multi-national companies that have globally distributed data hubs. Our service offering provides both secure and accelerated connections between these data hubs.
·Cloud Extension Solution. Cloud Extension is developed for cloud hosting service providers to improve their service quality and end user experience. Our Cloud Extension Solution can provide security for cloud applications, and we are able to protect our customers’ data centers through our approximately 25,000 edge servers.

 

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·CC Index. CC Index is China’s first analytics platform that provides internet users real-time data on traffic, bandwidth and usage habits, as well as other key statistics. We gather data on the internet landscape and usage patterns across the country, covering the fixed-line, Wi-Fi, 2G and 3G networks of various carriers. We believe that the analytics provided by CC Index are valuable to government agencies, major carriers and other ISPs as well as end-users looking to increase online speed and improve the overall web experience. CC Index also has 24-hour real-time data that provides additional analysis of internet speeds across China and is available at www.ccindex.cn, which is a free service to the public.
·File Aware Download. For game developers and enterprise portals who distribute software electronically, we have introduced “File Aware Download,” or FAD. FAD is a one-stop solution, which not only offers CDN technology, end-user control ability and a fully customizable user interface, but also provides insight into download analytics and content usage information. It guarantees download performance and enhances user experience, which is crucial to game publishers.

 

Cloud Infrastructure Development

 

In early 2013, we acquired land use right in Tianzhu Comprehensive Bonded Zone in Beijing and intended to develop cloud infrastructure in collaboration with our clients. In December 2015, we entered into definitive agreements for Xin Run, which owns and operates ChinaCache’s Atecsys Cloud Data Center, or Atecsys, for investors to acquire 60% of Xin Run’s equity interest for a total consideration of RMB375 million. The transaction valued Xin Run’s shareholders’ equity (pre-money) at approximately RMB250 million. The agreements were later terminated. As an alternative to the proposed transaction, on March 6, 2017, the Company announced that it has entered into definitive agreements to sell 79.0% equity interest of Xin Run to Tianjin Shuishan, Shanghai Qiaoyong Equity Investment Fund Management Co., Ltd., or Shanghai Qiaoyong, and Tianjin Dingsheng Zhida Technology Co., Ltd., or Tianjin Dingsheng, for a total consideration of RMB221.2 million in cash before fees and expenses. The newly proposed transaction valued Xin Run’s shareholders’ equity by an independent third-party firm at approximately RMB280 million. Pursuant to the agreements, Tianjin Shuishan, Shanghai Qiaoyong and Tianjin Dingsheng agreed to purchase 47.67%, 26.33% and 5.0%, respectively, of the equity interest in Xin Run. The Company’s strategic decision to terminate the Agreement was approved by board in December 2017 in recognition of the perceived value of the assets in light of increasing market demand for Internet data center services and the belief that Xin Run can effectively be leveraged as part of the Company’s offering package to customers, thus better positioning the Company for long-term growth.

 

China is rapidly adopting a digital lifestyle and Cloud and new data-intensive technologies, such as AI and big data analytics, are fanning demand for increasing Internet data center capacity and related services. With ten internet data centers in Beijing hosting capacity for 12,400 racks, a catalyst for the Company to offer enhance packaged CDN/IDC product services, Xin Run is growing quickly and capturing wide-spread demand from government agencies and businesses, including several leading Internet and Cloud service enterprises. Against this backdrop, we see a compelling value proposition as we offer customers total solution services, comprised of our Internet data centers, Cloud hosting and Internet exchange centers and our extensive content delivery network. We believe this three-layered structured network will provide an integrated and broad-base of operations from which we can capitalize on our strengths and deliver sustained shareholder value.

 

In early 2015, we officially launched our next generation cloud-based CDN platform, HPCC. HPCC is designed to offer our customers enhanced stability and utilization through a unified distribution platform that dispatches available bandwidth across all customer verticals. The HPCC platform is expected to result in better traffic load balance, higher bandwidth reuse rates, lower maintenance costs, and greater efficiency through automated dispatching that maximizes bandwidth utilization, accelerates bandwidth allocation, and minimizes the potential for human error as compared with traditional CDN architectures.

 

Given the increasing demand for cloud hosting service in China and that more large enterprises in China desire to have their own cloud data centers, ChinaCache is well positioned to be a innovative cloud CDN provider in China, thanks to its work-in-progress cloud infrastructure and cloud platform.

 

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Our Customer-tailored Integrated Solutions

 

We divide our customer base into five industry groups, and, based on the needs and preferences of customers in each group, we have developed a wide range of integrated solutions that are tailored to the characteristics of each industry.

 

Media and Entertainment. As more and more advertising spending is being shifted to online media, our customers in the media industry are adapting to this trend and investing significant resources in online content delivery. To capitalize on this opportunity, we customize our services aimed at media companies, enabling them to carry online broadcasting of major events, such as the CCTV Spring Festival Gala, and other rich media content to audiences. We customize our Rich Media Streaming Services and File Transfer Services to specifically address media companies’ rich media delivery needs. In addition, our services for media companies typically include our Link Anti-Hijack and certain other value-added services. Entertainment or online game operators seek to cost-effectively deliver large files to hundreds of thousands of game players simultaneously accessing the same online game through different networks. In addition, due to the unreliable interconnectivity among different telecommunications networks in China, players located in different regions often cannot simultaneously play in the same game zone. Our online game solution is designed to address these problems by enabling online game operators to bypass traditional server and bandwidth limitations to ensure reliable and efficient file downloading, handle peak traffic conditions and substantially increase the level of interconnectivity. Our online game solution typically includes our Guaranteed Application Services, Web Page Content Services and File Transfer Services and certain other value-added services.

 

Enterprises. Our enterprise customers place importance on having their website give visitors from around the world a uniform experience, thereby projecting a consistent brand image. They also want to minimize or avoid interruptions or delays when implementing major promotions or other major events on their websites. We tailor our content and application delivery total solutions to address these needs, ensuring the same satisfactory internet experience for end-users throughout different parts of the world. Our enterprise solution also includes our Web Page Content Services, Rich Media Streaming Services and additional value-added services.

 

E-commerce. Companies engaged in the fast-growing e-commerce sector in China face significant internet-related problems specific to China’s internet infrastructure. Internet congestion may affect the performance of websites or otherwise reduce the operating efficiency, thereby frustrating consumers. In addition, e-commerce companies need to effectively control internet security risks. To address the needs of our e-commerce customers, we have designed our e-commerce solution to allow proactive monitoring and rapid response to security-related incidents and anomalies. Our server network is designed to reduce the possibility of a single point of failure and reduce the impact of security attacks. Our e-commerce solution typically includes our Guaranteed Application Services.

 

Internet and Software Services. Internet portals often provide geographic-specific advertisements or other information and contain rich media content and applications, which require Rich Media Streaming and Guaranteed Application Services. Software providers typically have significant download traffic. Surges in traffic due to new software launches or the distribution of security updates can overwhelm traditional delivery system, impacting website performance and causing end-user downloads to be disrupted or fail. Our internet and software services solution helps these customers to address these needs. For instance, our Geo-Content Acceleration service enables customers’ websites to automatically provide geographic-specific content to end-users corresponding to each end-user’s specific geographic location. Our File Transfer Services can significantly increase the speed and reliability of software download.

 

Mobile Internet. Mobile internet refers to access to the internet from a mobile device, such as a smartphone. While mobile internet is a fast growing industry in China, mainstream mobile service providers in China are confronted with certain challenges in capitalizing on this development: Specifically, when accessing internet content from a mobile device, there are generally internet interconnection bottlenecks with other networks operated by fixed-line operators and general congestion within the mobile network. Leveraging our carrier-neutral network, our customized mobile internet solutions effectively address the interconnectivity bottleneck issues by facilitating the data exchanges between the networks operated by the mobile service providers and those operated by fix-line service providers.

 

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Customers and Customer Support

 

Our customer base has decreased from approximately 1,999 active customers as of December 31, 2016 to approximately 1789 active customers as of December 31, 2017 and includes some of China’s and the world’s leading companies in the areas of media, mobile internet, online game, e-commerce, internet and software, enterprises, financial institutions and government agencies.

 

In 2015, 2016 and 2017, our five largest customers contributed 37.5%, 48.2% and57.2%of our total net revenues, respectively.

 

Our customer contracts typically provide for a one-year service term, with automatic renewal provisions. For the years ended December 31, 2015, 2016 and 2017, approximately 75.3%, 67.3% and 63.6%, respectively, of our existing customers chose to renew their contract or enter into new contract with us.

 

We devote significant resources to developing customers support and services. We have a dedicated customer service team. Our customers may directly contact the customer service team to seek assistance or enquire about the status of a reported issue. The team actively follows up with our operations team to ensure that the problem is addressed in an effective and timely manner. Each of our customer accounts is assigned a service manager who is responsible for ensuring that all our services are performed in a satisfactory manner. We offer a broad range of internet-based customer-care tools. We operate, for example, an e-mail service center where our customers can contact and receive responses from our customer service representatives by e-mail.

 

We also offer service level agreements on most of our services to our customers. Such agreements set the expectations on service level between us and our customers and drive our internal process to meet or exceed the customer’s expectations.

 

Our Network and Technologies

 

Inadequate interconnectivity within China’s public internet infrastructure between different regions of China, among competing telecommunications networks and across different areas within the same operator network is a significant problem in China. There are several telecommunications carriers that operate internet backbone in China, including China Telecom, the predominant carrier in Southern China, and China Netcom, the predominant carrier in Northern China. Each of these companies runs its own independent network, which is constrained by respective networks’ coverage. Different networks must connect to one another in order to allow the users to communicate. Due to inadequate cooperation among telecommunications carriers, interconnectivity bottlenecks remain a major problem in China, contributing to a slow transmission speed across services and applications.

 

As a carrier-neutral service provider, we have developed an extensive network and a series of innovative technologies to effectively address network complexity issues with respect to content and applications delivery. Through our highly scalable and intelligent network platform, widely distributed edge servers and advanced operating support system, among others, we increase the level of interconnectivity and ensure the quality and reliability of our services.

 

Our network has the following key elements:

 

Architecture

 

Our network architecture consists of three layers: the data center layer, the edge server layer and the peer-assistance layer. The following diagram illustrates our network architecture:

 

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The first layer of our network architecture is the data center layer, which is composed of super nodes, clusters of specially-configured servers and storage systems, interconnected with public networks and other legally compliant transmission backbones. This layer ensures the delivery quality from origin servers to the super nodes residing at strategic locations throughout China and effectively addresses the issue of inadequate interconnectivity across different telecommunications carriers in China.

 

The second layer of our network architecture is the edge server layer, which is composed of clusters of edge nodes connected to different telecommunications carriers and ISPs. Each edge node consists of edge servers programmed to answer domain name inquiries, replicate and refresh content, receive and forward uploads from end-users, record usage information for billing purposes and provide network performance data. The edge server layer allows end-users to connect to the appropriate ChinaCache edge servers to optimize the performance of the delivery process.

 

The last layer of our network architecture is the peer-assistance layer, which is composed of multiple public internet access networks belonging to different service providers. We do not own or operate any of these internet access networks. Instead, we deploy our peer-assistance technology over this layer by installing our proprietary software on the operating systems of end-users. As a result, we are able to facilitate data sharing among network end-users, which significantly improves the user experience and enhances the scalability of our services.

 

Widely Deployed Servers

 

As of December 31, 2017, we deployed approximately 17120 servers in China and over 340 servers overseas.

 

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As a carrier-neutral service provider, our networks in China are interconnected with: (i) networks operated by all three telecommunications carriers in China, namely China Telecom, China Unicom and China Mobile; (ii) non-carrier networks operated by China Education and Research Network and China Science and Technology Network; and (iii) networks operated by major local ISPs, including Beijing Gehua CATV Networks and Shanghai Oriental Network.

 

We purchase bandwidth usage, co-location services and data storage from telecommunications carriers or ISPs. For the years ended December 31, 2015, 2016 and 2017, 95%, 91% and 86%, respectively, of our bandwidth, co-location and data storage fees were paid for services purchased from the three major PRC telecommunications carriers, China Telecom, China Mobile and China Unicom, through their respective subsidiaries and sales agents. Our agreements with the telecommunication carriers typically use a standard form provided by the carriers, with pricing terms individually negotiated with the carriers’ local subsidiaries or sales agents. The agreements are typically of a one-year term with renewal options. We pay monthly service fees based on the number of internet gateways, bandwidth usage and the number of server clusters.

 

We have also deployed service nodes in 120 cities worldwide covering Asia, North America, Western Europe, the Middle East and North Africa to allow our customers in China to distribute internet services and applications to end-users in those regions and vice versa. We have also obtained access to networks operated by international ISPs through contractual arrangements to further extend the geographic coverage of our services for the benefit of our customers.

 

Technologies

 

Our content-aware network service, is an enhanced next-generation of CDN technology that improved our capabilities of delivering content and application delivery total solutions. Our content-aware network service is device-aware, network-aware and application-aware. Our content-aware network service is device-aware in the sense that we are able to identify each end user device and optimize data for consumption on such user’s iOS or Android mobile device. Our content-aware network service is network-aware in that its capabilities enable us to determine what kind of network online content is going through, whether it is a fixed or mobile network, and whether data is traveling on a 2G, 3G or 4G mobile network. Our content-aware network service is application-aware in that through this service we can provide network services tailored to specific applications such as e-commerce and online video, which require different capabilities and resources.

 

Our key technologies include the following:

 

Request routing technology. Our request routing technology routes client requests to an appropriate server for the delivery of content. Utilizing our proprietary Scalable Service Routing technology, we are able to use a set of metrics, such as network proximity, client perceived latency, distance and replica server load, to direct users to the most suitable servers that can best serve the request. We have developed a system that can assess the link quality between users and our servers/nodes, so we can collect the quality topology of China internet and Global internet.

 

Content distribution and management technology. Our content distribution and management technology includes content storage, content outsourcing, content delivery, and content management technologies. We have developed and deployed various software tools on our platform, such as Flexible Cache (FC), Purging, Configurations, and Log Configurations, to deliver caching, streaming and dynamic services. We have also developed a system that meets the demand of governmental administration.

 

System management technology. Our system management technology includes our Operational Support Systems, or OSS, and Business Support Systems, or BSS. OSS primarily deals with supporting processes such as maintaining inventory, providing services, configuring components, security, monitoring service quality and managing faults. BSS typically deals with customer supporting processes, such as taking orders, processing bills and collecting payments.

 

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Intelligent Traffic Reduction Technology. Our Intelligent traffic reduction technology, known as ITR, can deliver the same content over a mobile network with significantly less data transmitted than the same content delivered to a PC.

 

Mobile Internet Technology. In mid-2013, we started pilot testing to extend our caching solution from the core network level into radio base stations, and for some content, we aim to eventually be able to deliver directly to mobile devices. We call this solution “mobile Content-aware Network”, or mCaN. It is a multi-layer caching solution, through which we can cache different content in different network layers, and best utilize network resources. In July 2013, we signed a frame work agreement with Altobridge, to deliver multi-layered technology solutions for mobile internet content delivery. Traditionally, content delivery network, or CDN, provides caching for a single network layer, but the technology we developed in joint efforts with Altobridge enables caching of data on all three layers of the network. In 2015, our mobile acceleration solutions evolved to MPlus, a smart system conglomerating abilities of network awareness, terminal awareness and application awareness.

 

Multiple purpose cloud hosting. Stemmed from cache system’s underlying storage module, we gradually rebuilt the storage components into a KV schemed multiple hosts clusters with flexible deployment choices: either with dedicated storage server or cohabitated with our cache systems. This storage becomes a vital building block for our customer source solutions, caching systems, and big data solutions.

 

Research and Development

 

We believe that the continual development of our technology will be vital to maintaining our long-term competitiveness. Therefore, we intend to continue to devote a significant amount of time and resources to carrying out our market-oriented research and development efforts.

 

Our internal research and development team consisted of 271 engineers as of December 31, 2017, representing approximately 44% of our staff. Our senior management team leads our research and development efforts and sets strategic initiatives to improve our services and products, focusing on efforts to sustain our technology leadership, raise our productivity and enhance the competitiveness of our services. We send selected engineers in China to our research and development center in Silicon Valley for training purposes. Our North America research and development center in Silicon Valley focuses on developing our next-generation content-aware network services and provide additional resources for our North American customers. It allows us to maintain close communications with international clients and also strengthens our ability to provide services overseas while also supporting the international business development goals of Chinese companies. This research and development center’s research works mainly focus on technological developments in mobile internet, cloud hosting service and network safety and reliance.

 

We instituted our ChinaCache Engineering Process to increase productivity and ensure a well-managed product lifecycle. Our ChinaCache Engineering Process is comprised of policies and procedures that facilitate the exchange of information, the collaboration of research and development activities and joint development of new services and solutions among our different divisions. With the implementation of these policies and procedures, we increase the marketability of new services and solutions, and lower the costs of developing new technologies by reducing duplicated research efforts.

 

Intellectual Property

 

As of December 31, 2017, we have 55 patents issued by, and three PRC patent applications the State Intellectual Property Offices of China, and two U.S. patents issued by the U.S. Patent and Trademark Office, all relating to different aspects of content and application delivery service technologies. In addition, we have 23 PRC software copyright registrations relating to media streaming services, operation support systems, caching services and dynamic content services. We also have 56 trademark registrations issued by the Trademark Bureau of the State Administration for Industry and Commerce, now the State Intellectual Property Office under the State Administration for Market Regulation, covering our company name, logo and service.

 

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We rely on a combination of copyright, patent, trademark, trade secret and other intellectual property laws, nondisclosure agreements and other protective measures to protect our intellectual property rights. We generally control access to and use of our proprietary software and other confidential information through the use of internal and external controls, including physical and electronic security, contractual protections, and intellectual property law. We have implemented a strict security and information technology management system, including the prohibition of copying and transferring of codes. We educate our staff on the need to, and require them to, comply with such security procedures. We also promote protection through contractual prohibitions, such as requiring our employees to enter into confidentiality and non-compete agreements.

 

Sales and Marketing

 

We have both domestic and international sales and marketing teams. Our domestic sales and marketing team is primarily based in four regions in China, namely, Beijing, Shanghai and Guangzhou and Shenzhen. We also have overseas sales offices in Hong Kong, U.S. and Europe for international business. We sell our services and solutions through our direct sales force and, to a lesser extent, sale agencies. We up-sell and cross-sell our broad portfolio of services and solutions to our existing customer base. We actively market our portfolio of services and solutions through our sales personnel. In addition, in an effort to better anticipate and respond to our customers’ needs, we require and foster the collaborations among our sales teams, product development teams and research and development teams to develop additional services and solutions that meet the needs of our customers.

 

Up to December 31, 2017, we have nine sales units, with each of these sales units providing our services to a particular type of customers. These ten sales units are (1) North China sales unit, (2) East China sales unit, (3) South China sales unit, (4) government sales unit, (5) key account sales unit, (6) key account development unit, (7) Asia sales unit, (8) North America sales unit and (9) Europe sales unit.

 

We also utilize a variety of other methods to raise awareness of our company, our services and our brand. We promote our technologies and solutions to different types of customers, especially mobile internet and enterprise customers, in various ways, such as customer activities, media publicity and online coverage. For example, we host and sponsor seminars, conferences and special events, such as our China CDN Summit and US-China Internet Strategy Summit, to raise our profile with potential customers. We also participate in events, such as Global and CDN Summit, Mobile World Congress and Global Internet Technology Conference, which are organized by third parties. Additionally, we collaborate with equipment vendors, software developers, internet solution providers and other companies to market our services. We release to the public various industry data and the China internet Report on a regular basis by collecting data from our CCIndex. We also market our company through social media, such as Weibo, WeChat and other mobile APPs. We have a special marketing team responsible for generating demand for our services and solutions and work with our other teams to secure new customers.

 

We also have a designated product marketing team, which mainly focuses on product definition and product analysis. It is also responsible for establishing and maintaining product quality monitoring system as well as leading the long term product strategy planning. Internally, this team supports and collaborates with sales, marketing and research and development teams to ensure seamless communication. Externally, it participates in promotion activities to enhance communications with customers.

 

Competition

 

In China, we primarily compete with domestic content and application delivery service providers. Our primary domestic competitors include ChinaNetCenter, Dnion Technology, and 21Vianet, which acquired FastWeb in 2012, and Alibaba, which launched its Ali Cloud CDN commercial services in 2014 to offer third-party CDN services. In March 2015, Tencent also announced its launch of TencentCloud CDN. In addition, a number of small cloud hosting service companies also began to offer CDN services. We believe that the principal competitive factors affecting the content and application delivery services market include:

 

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·performance, as measured by response time and end-user experience;
·quality and reliability of services;
·network coverage and scale;
·technologies and network capabilities;
·price;
·industry knowledge;
·scope and range of service offering; and
·scalability and flexibility of platforms.

 

We believe that, rather than competing head-on with companies such as Tencent and Alibaba on pricing, we need to promote to customers our technical capability, quality of customer service, and flexibility of our product offering built on 3-tier internet infrastructure

 

We believe that there will be no foreign competitors with a significant presence in the content and application delivery services market in China in the near future, partly due to the regulatory barriers in China’s telecommunications sector. However, as China represents a potentially lucrative market for foreign competitors, some foreign providers may seek to enter the China market by way of collaboration with local CDN and IDC players. We believe that we are one strong candidate for such partnership with potential international new entrants into the China market. we have accumulated a deep understanding of the requirements of China’s content and application delivery services market through our extensive operational experience and have developed a comprehensive suite of services and solutions tailored to the unique characteristics of the internet market in China.

 

Regulation

 

This section sets forth a summary of the most significant regulations or requirements that affect our business activities in China or our shareholders’ rights to receive dividends and other distributions from us.

 

As the content and application delivery industry is at an early stage of development in China, new laws and regulations may be adopted from time to time that will require us to obtain additional licenses and permits in addition to those that we currently have, and address new issues that arise from time to time. As a result, substantial uncertainties exist regarding the interpretation and implementation of current and any future PRC laws and regulations applicable to the content and application delivery services industry. See “Item 3. Key Information — D. Risk Factors — Risks Related to Doing Business in China.”

 

Regulations on Value-Added Telecommunications Business and Content and Application Delivery Business

 

Our content and application delivery business is regarded as telecommunications services, which are primarily regulated by the MIIT, the Ministry of Commerce, and SAIC. Pursuant to the applicable PRC laws and regulations, telecommunications businesses are defined as the activities of delivering, transmitting or receiving voice, text, data, graphics and other form of information via wired or wireless electromagnetic systems or optoelectronic systems. Telecommunications businesses are divided into two categories under the Telecommunications Regulations, namely (i) the “basic telecommunications business,” which refers to the business of providing public network infrastructure, public data transmission and basic voice communications services, and (ii) “value-added telecommunications business,” which refers to the telecommunications and information services provided through the public network infrastructure.

 

In the Telecommunications Services Classification Catalogue 2015 version promulgated by MIIT in December 2015, the internet data service business and content and application delivery business is listed under the first category of the value-added telecommunications business. Pursuant to the Value-Added Telecommunications Business Operating License, or the VAT license, issued to Beijing Blue I.T. by the MIIT on February 7, 2018, Beijing Blue I.T. is permitted to carry out internet data center business (excluding internet resource coordination service), content delivery network business, domestic internet virtual private networks business and internet access service business under the first category of “value-added telecommunications business”.

 

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Pursuant to the Telecommunications Regulations, value-added telecommunications services covering two or more provinces, autonomous regions, and/or municipalities directly under the central government shall be approved by the MIIT, and the providers of such cross-regional value-added telecommunications services are required to obtain the Cross-Regional Value-Added Telecommunications Business Operating Licenses, or the Cross-Regional VAT licenses. Value-added telecommunications services covering certain area within one province, autonomous region, and/or municipality directly under the central government shall be approved by the local telecommunications administration authority of in such region and the providers of such value-added telecommunications services are required to obtain the VAT licenses. Pursuant to the Administrative Measures for Telecommunications Business Operating Licenses, Cross-Regional VAT licenses shall be approved and issued by the MIIT with five-year terms.

 

Currently, Beijing Blue I.T. holds a Cross-Regional VAT license, issued by the MIIT with an effective term until September 18, 2022 under the first category of the “value-added telecommunications services.” As specified in this Cross-Regional VAT license, Beijing Blue I.T. is permitted to carry out (i) the internet data center business (excluding internet resource coordination service) across 16 cities in China; (ii) the content distribution network business throughout China; (iii) the domestic internet virtual private networks business across 20 cities in China; and (iv) the internet access business across 17 provinces in China. Beijing Blue I.T. also holds an ICP License with an effective term until January 3, 2023. Beijing Jingtian holds an ICP License with an effective term until July 9, 2019.

 

On January 17, 2017, the MIIT issued a Circular on Clearing up and Regulating the Internet Access Service Market, or Circular No. 32, aiming to regulate illegal operations in the field of internet data center (IDC) service, internet access (ISP) service and content delivery network (CDN) service businesses. In particular, the MIIT Circular No. 32 reiterates that an entity is prohibited from operating any of the IDC, ISP or CDN services without proper telecommunication business operation permit, or engaging in activities beyond the permitted business scope or permitted geographical scope specified on its operation permit, nor shall a qualified telecommunication business operator lease or transfer its qualification or resources to an unauthorized entity in the form of technology cooperation or in other disguised form. In addition, pursuant to the MIIT Circular No. 32, if an entity had obtained a VAT License for IDC service business prior to the implementation of the Catalog of Telecommunications Business (2015 Version) and has actually engaged in CDN service or internet resource coordination business, it must undertake in a written commitment to the issuing authority of its VAT License by March 31, 2017 that it will satisfy relevant requirements for CDN service or internet resource coordination service, as applicable, and obtain the corresponding VAT License by the end of 2017. If it fails to obtain the VAT License by the deadline, it must cease to operate the CDN service and internet resource coordination service business from January 1, 2018. If an entity fails to submit the aforesaid commitment by March 31, 2017, it shall be refrained from engaging in CDN service and internet resource coordination service since April 1, 2017. Beijing Blue I.T. had submitted the written commitment on March 30, 2017 in compliance with the relevant requirement and has obtained the relevant VAT License issued by the MIIT on September 18, 2017, subsequently as amended on February 7, 2018.

 

In February 2018, MIIT issued an internal notice, or the MIIT Internal Notice, pursuant to which telecommunication authorities will carry out a special enforcement campaign to inspect the operations of certain licensed telecommunications operators according to applicable regulations and rules, including without limitation, the Circular on Clearing Up and Regulatory the Internet Access Service Market issued by the MIIT in January 2017. In particular, the authorities will pay special attention to any improper operational activities, such as unauthorized establishment of transmission network, unlicensed operation of cross-border business and improper sublease of broadband resources. If the enterprise is found to be engaged in non-compliant operations, it may be subject to various penalties, including suspension of network access, suspension of approving its application for new operation permit until rectification being completed, being publicized as an operator with discredit record or non-compliance record, enhanced oversight of the authority and limitation on new telecommunication business, depending on the seriousness of the violations and the rectification result. The MIIT Internal Notice mandates that the foregoing inspection and scrutiny to be completed by September 30, 2018. According to the MIIT Internal Notice, 47 industry players are subject to the special inspection, including one of our VIEs, Beijing Blue I.T. As of the date of this annual report, we have not received any investigation notice or rectification order from the government authorities. We are closely communicating with the in-charge authority to clarify the above.

 

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Regulations on Internet Information Services

 

Beijing Blue I.T. operates one website, www.chinacache.com, to provide information related to its business. Internet information services in China are primarily regulated by the MIIT. Pursuant to the applicable regulations, to engage in commercial internet information services, the service providers shall obtain a VAT license for internet information services, or an “ICP License.” Beijing Blue I.T. holds an ICP License, issued by the Beijing Telecommunications Administration Department, with an effective term until January 3, 2023.Beijing Blue I.T.’s ICP License permits it to carry out commercial internet information services. Beijing Jingtian also has an ICP License issued by Beijing Telecommunications Administration Department, effective until July 9, 2019.

 

The PRC government regulates and restricts internet content in China to protect state security and ensure the legality of the internet content. The National People’s Congress has enacted legislation that may subject to criminal punishment in China any person who: (i) gains improper entry into a computer or system of strategic importance; (ii) disseminates politically disruptive information; (iii) leaks state secrets; (iv) spreads false commercial information; or (v) infringes intellectual property rights. The Ministry of Public Security has also promulgated measures that prohibit use of the internet in ways that, among other things, result in a leakage of state secrets or a spread of socially destabilizing content. The Ministry of Public Security has supervision and inspection rights in this regard.

 

Regulation on Internet Security

 

On November 7, 2016, the Standing Committee of the National People’s Congress promulgated the Cyber Security Law, which became effective on June 1, 2017. In accordance with the Cyber Security Law, internet operators must set up internal security management systems and take technical and other necessary measures as required by applicable laws and regulations to safeguard the operation of networks, prevent illegal and criminal activities, and maintain the integrity, confidentiality and usability of network data. In addition, the Cyber Security Law requires internet operators to make emergency response plans for cyber security incidents and report to the competent governmental departments once any incident endangering cyber security occurs.

 

In September 2016, the General Office of MIIT issued the Trial Administration Measures on the Use and Operation Maintenance of Internet Information Security Management System. According to these measures, internet operators that are engaged in the internet data center, internet access and content and application delivery businesses must set up and maintain an internet information security management system. By using the internet information security management system, such internet operators are obligated to monitor the information they transmit and take timely measures in relation to any illicit content. Furthermore, such internet operators are also obligated to report security incidents to the authorities and accept their inspection.

 

Beijing Blue I.T. has already established an internet information security management system pursuant to applicable laws and regulations.

 

On May 2, 2017, the Cyberspace Administration of China issued the Measures on Security Review of Network Products and Services (for Trial Implementation) which went into effect on June 1, 2017. According to these Measures, important network products and services purchased by networks and information system concerning national security and network products and services purchased by operators in certain key industries and sectors relating to public services and infrastructure or critical information infrastructure in connection with national security are subject to cybersecurity review. The detailed scope of network products and services subject to security review will be determined by the relevant critical information infrastructure protection authority.

 

In November 2017, MIIT promulgated the Circular on Regulating the Use of Domain Names for Internet Information Services, which became effective on January 1, 2018. Pursuant to this circular, the ISP service provider shall verify the identity of each internet information service provider. If the internet information service provider fails to provide its true and accurate identity information, the ISP service provider shall not provide ISP services to it. In addition, the ISP service provider shall regularly check the status of domain names used by the internet information service providers, and if relevant domain name is invalid and the real identity information of the user is absent, it shall cease providing ISP services.

 

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Regulations on Foreign Investment in Telecommunications Enterprises

 

The PRC government imposes limitations on foreign ownership of PRC companies that engage in telecommunications-related business. Under the Administrative Rules for Foreign Investments in Telecommunications Enterprises, a foreign investor is currently prohibited from owning more than 50% of the equity interest in a PRC company that engages in value-added telecommunications business. The Guidance Catalog of Industries for Foreign Investment amended in 2017 and Circular of the Ministry of Industry and Information Technology on Removing the Restrictions on Shareholding Ratio Held by Foreign Investors in Online Data Processing and Transaction Processing (Operating E-commerce) Business, or Circular 196 promulgated by MIIT in June 2015 allows a foreign investor to own more than 50% of the total equity interest in an E-Commerce business.

 

The Circular on Strengthening the Administration of Foreign Investment in and Operation of Value-Added Telecommunications Business, among others, requires a foreign investor to set up a foreign-invested enterprise and obtain an operating permit in order to carry out any value-added telecommunications business in China. Under this circular, a domestic value-added telecommunications service operator that holds a VAT license is prohibited from leasing, transferring or selling such license to foreign investors, and from providing any assistance in the form of resources, sites or facilities to foreign investors that conduct value-added telecommunications business illegally in China. Furthermore, the relevant trademarks and domain names that are used in the value-added telecommunications business of domestic operators must be owned by such domestic operators or their shareholders. The circular further requires each VAT license holder to have the necessary facilities for its approved business operations and to maintain such facilities in the regions covered by its VAT license. In addition, all value-added telecommunications service operators are required to maintain network and information security in accordance with the standards set forth under relevant PRC regulations. Due to a lack of interpretations from the regulator, it remains unclear what impact this circular would have on us.

 

We conduct our businesses in China primarily through two sets of contractual arrangements. In this regard, we have contractual arrangements with Beijing Blue I.T. and Beijing Jingtian and their respective shareholders. Beijing Blue I.T. holds a Cross-Regional VAT license and currently owns all necessary trademarks and domain names in connection with our business covered by its VAT license. In the opinion of Han Kun Law Offices, our PRC legal counsel, each of the currently effective documents under the VIE arrangements among us, our PRC subsidiary, PRC consolidated variable interest entities and their shareholders governed by PRC law are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect. However, there are substantial uncertainties regarding the interpretation and application of PRC laws and regulations. Accordingly, there can be no assurance that the PRC regulatory authorities may not in the future take a view that is contrary to the above opinion of our PRC legal counsel. If the PRC government finds that the arrangements that establish the structure for operating our business do not comply with PRC law and regulations restricting foreign investment in the telecommunications business, we could be subject to severe penalties.

 

In addition, the Circular on Strengthening the Administration of Foreign Investment in and Operation of Value-Added Telecommunications Business provides that domestic telecommunications companies that intend to be listed overseas must obtain the approval from the MIIT for such overseas listing. Up to the date of this annual report, the MIIT has not issued any definitive rule concerning whether offerings like ours would be deemed an indirect overseas listing of our PRC affiliates that engage in telecommunications business. Based on our oral consultation with certain officials of the MIIT, in practice, our offerings should not be deemed an overseas listing of a domestic company. If the MIIT subsequently requires that we obtain its approval, it may have a material adverse effect on the trading price of our ADSs.

 

Regulations on Foreign Exchange Registration of Overseas Investment by PRC Residents

 

SAFE issued SAFE Circular on Relevant Issues Relating to Domestic Resident’s Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, that became effective in July 2014, replacing the previous SAFE Circular 75. SAFE Circular 37 regulates foreign exchange matters in relation to the use of special purpose vehicles, or SPVs, by PRC residents or entities to seek offshore investment and financing or conduct round trip investment in China. Under SAFE Circular 37, a SPV refers to an offshore entity established or controlled, directly or indirectly, by PRC residents or entities for the purpose of seeking offshore financing or making offshore investment, using legitimate onshore or offshore assets or interests, while “round trip investment” refers to direct investment in China by PRC residents or entities through SPVs, namely, establishing foreign-invested enterprises to obtain the ownership, control rights and management rights. SAFE Circular 37 provides that, before making contribution into an SPV, PRC residents or entities are required to complete foreign exchange registration with SAFE or its local branch. In addition, SAFE issued Circular on Further Simplifying and Improving the Direct Investment-related Foreign Exchange Administration Policies, or SAFE Circular 13, which became effective on June 1, 2015. SAFE Circular 13 provides that the foreign exchange registration under domestic direct investment and the foreign exchange registration under overseas direct investment will be directly reviewed and handled by banks, cancelling the administrative examination and approval procedure.

 

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PRC residents or entities who had contributed legitimate onshore or offshore interests or assets to SPVs but had not obtained SAFE registration before the implementation of the SAFE Circular 37 must register their ownership interests or control in the SPVs with SAFE or its local branch. An amendment to the registration is required if there is a material change with respect to the SPV registered, such as any change of basic information (including change of the PRC residents, name and operation term), increases or decreases in investment amount, transfers or exchanges of shares, and mergers or divisions. Failure to comply with the registration procedures set forth in SAFE Circular 37, or making misrepresentation on or failure to disclose controllers of the foreign-invested enterprise that is established through round-trip investment, may result in restrictions being imposed on the foreign exchange activities of the relevant foreign-invested enterprise, including payment of dividends and other distributions, such as proceeds from any reduction in capital, share transfer or liquidation, to its offshore parent or affiliate, and the capital inflow from the offshore parent, and may also subject relevant PRC residents or entities to penalties under PRC foreign exchange administration regulations.

 

We are aware that our PRC resident beneficial owners subject to these SAFE registration requirements have registered with the Beijing SAFE branch and will amend the registration to reflect the recent changes to our corporate structure. However, we cannot assure you that our current and future beneficial owners who are PRC residents will continue to comply with Circular 37; nor can we assure you that there will not be further filing or registration requirements imposed by the PRC government concerning ownership in foreign companies of PRC residents. See “Item 3. Key Information — D. Risk Factors — Risks Related to Doing Business in China— PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident beneficial owners to personal liability and limit our ability to acquire PRC companies or to inject capital into our PRC subsidiary, limit our PRC subsidiary’s ability to distribute profits to us, or otherwise materially and adversely affect us.”

 

Regulations on Employee Stock Options Granted by Listed Companies

 

Pursuant to the Notices on Issues concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plans of Overseas Publicly-Listed Companies, or the Stock Option Rules, which was promulgated by SAFE in February 2012, PRC individuals who are granted shares or share options under a share incentive plan of a company listed on an overseas stock exchange are required to register with the SAFE or its local counterparts. Pursuant to the Stock Option Rules, PRC residents participating in the employee stock option plans of the overseas listed companies shall retain a qualified PRC agent, which could be a PRC subsidiary of such overseas publicly-listed company or another qualified institution selected by such PRC subsidiary, to conduct the SAFE registration and other procedures with respect to the stock incentive plans on behalf of these participants. Such participant must also retain an overseas entrusted institution to handle matters in connection with their exercise of stock options, purchase and sale of corresponding stocks or interests and fund transfer. In addition, the PRC agents are required to amend the SAFE registration with respect to the stock incentive plan if there is any material change to the stock incentive plan, the PRC agent, the overseas entrusted institution or other material change. The PRC agents or the employers shall, on behalf of the PRC residents who have the right to exercise the employee stock options, apply annually to SAFE or its local offices for a quota for the conversion and/or payment of foreign currencies in connection with the domestic individuals’ exercise of the employee stock options. The foreign exchange proceeds received by the PRC residents from sale of shares under the stock option plans granted by the overseas listed companies must be remitted into the bank accounts in China opened by the PRC agents. In addition, the PRC agents shall file with SAFE or its local branches each quarter a form in relation to the Domestic Individuals Participating in the Stock Incentive Plans of Overseas Listed Companies.

 

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On October 16, 2008, May 22, 2009, May 28, 2010 and June 20, 2011, we adopted our 2007, 2008 and 2010 Stock Incentive Plans and our 2011 Share Incentive Plan, respectively. Pursuant to these four plans, we issue employee stock options to our qualified employees and directors on a regular basis. In the application documents filed with the Beijing office of the State Administration of Foreign Exchange in connection with the registration of Mr. Song Wang’s and Ms. Jean Xiaohong Kou’s overseas investment in ChinaCache Holdings, it was indicated that approximately 7% of the share capital of ChinaCache Holdings are reserved for the employee stock options and service incentive shares. As of the date of this annual report, we have granted employee stock options and incentive shares within the scope noted in the application documents which were filed with the Beijing office of the State Administration of Foreign Exchange. After our initial public offering, we have advised our employees and directors participating in the Stock Incentive Plan to handle foreign exchange matters in accordance with the relevant SAFE rules. We have registered our 2007 Stock Incentive Plan, 2008 Stock Incentive Plan, 2010 Stock Incentive Plan and 2011 Share Incentive Plan with Beijing branch of SAFE. The failure of our PRC stock options holders to complete their registration pursuant to Stock Option Rules and other foreign exchange requirements may subject us or our PRC stock options holders to fines and legal sanctions.

 

Further, a notice concerning the individual income tax on earnings from employee stock options, jointly issued by the Ministry of Finance and the SAT, provides that domestic companies that implement employee share option programs shall (1) file the employee share option plans and other relevant documents to the local tax authorities having jurisdiction over them before implementing such employee share option plans; and (2) file share option exercise notices and other relevant documents to the local tax authorities having jurisdiction over them before exercise by the employees of the share options, and clarify whether the shares issuable under the employee share options mentioned in the notice are the shares of publicly listed companies.

 

M&A Regulations and Overseas Listings

 

The M&A Rules, effective on September 8, 2006 and as amended subsequently, include provisions that purport to require an offshore “special purpose vehicle” to obtain the approval of the CSRC prior to the listing and trading of such special purpose vehicle’s securities on an overseas stock exchange. Under the M&A Rules, “special purpose vehicle” is defined as an offshore company directly or indirectly controlled by PRC domestic companies or individuals for the purposes of listing the equity interest in PRC companies on overseas stock exchanges. On September 21, 2006, the CSRC published on its official website the procedures regarding its approval of overseas listings by special purpose vehicles. The approval procedures require the filing of a number of documents and would take several months. However, it remains unclear whether the M&A Rules and the requirement of the CSRC approval apply. Up to the date of this annual report, the CSRC has not issued any rules or written interpretation clarifying whether offerings like our initial public offering are subject to this new procedure.

 

Our PRC legal counsel, Han Kun Law Offices, has advised us that the M&A Rules do not require an application to be submitted to the CSRC for its approval of the listing and trading of the ordinary shares on the Nasdaq Global Market, given that we have completed our restructuring in all material respects prior to the effective date of the M&A Rules, and that ChinaCache Beijing was established in 2005 through new incorporation rather than acquisition of any equity or assets of a “PRC domestic company” as defined under the M&A Rules and no explicit provision in the M&A Rules classifies the contractual arrangements as a type of transaction falling under the M&A Rules.

 

Regulations on Foreign Currency Exchange

 

Pursuant to applicable PRC regulations on foreign currency exchange, Renminbi is freely convertible only to the extent of current account items, such as trade-related receipts and payments, interest and dividends. Capital account items, such as direct equity investments, loans and repatriation of investment, unless expressly exempted by laws and regulations, require the prior registration at designated foreign exchange banks for conversion of Renminbi into a foreign currency, such as U.S. dollars. Payments for transactions that take place within the PRC must be made in Renminbi. Domestic companies or individuals can repatriate foreign currency payments received from abroad, or deposit these payments abroad subject to the requirement that such payments by repatriated within a certain period of time. Foreign-invested enterprises may retain foreign exchange in accounts with designated foreign exchange banks. Foreign currencies received for current account items can be either retained or sold to financial institutions that have foreign exchange settlement or sales business without prior approval from the State Administration for Foreign Exchange, subject to certain regulations. Foreign exchange income under capital account can be retained or sold to financial institutions that have foreign exchange settlement and sales business, with prior approval from the State Administration for Foreign Exchange, unless otherwise provided.

 

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On February 28, 2015, the SAFE promulgated the Notice on Further Simplifying and Improving the Administration of the Foreign Exchange Concerning Direct Investment, or SAFE Circular 13. After SAFE Circular 13 became effective on June 1, 2015, instead of applying for approvals regarding foreign exchange registrations of foreign direct investment and overseas direct investment from SAFE, entities and individuals will be required to apply for such foreign exchange registrations from qualified banks. The qualified banks, under the supervision of the SAFE, will directly examine the applications and conduct the registration.

 

In March 2015, SAFE promulgated the Circular on Reforming the Management Approach Regarding the Foreign Exchange Capital Settlement of Foreign-invested Enterprises, or SAFE Circular No. 19, which effected as of June 1, 2015. SAFE Circular No. 19 provides that, among other things, a foreign-invested company may convert foreign currency capital in its capital account into RMB on a “at will” basis. On June 9, 2016, SAFE promulgated the Circular on Reforming and Regulating Policies on the Control over Foreign Exchange Settlement of Capital Accounts, or SAFE Circular No. 16, to further expand and strengthen such “at will” conversion reform under SAFE Circular No. 19. SAFE Circular No. 16 provides an integrated standard for conversion of foreign exchange under capital account items on an “at will” basis which applies to all enterprises registered in the PRC. Pursuant to SAFE Circular No. 16, in addition to foreign currency capital, enterprises registered in the PRC may also convert their foreign debts, as well as repatriated funds raised through overseas listing, from foreign currency to RMB on an “at will” basis. SAFE Circular No. 16 reiterates that the RMB funds so converted shall not be used for the purpose of, whether directly or indirectly, (i) paying expenditures out of the ordinary course of business or prohibited by laws or regulations; (ii) making securities investment or other investments (except for banks’ principal-secured products); (iii) extending loans to non-affiliated enterprises (except as expressly permitted in the business license); and (iv) purchasing non-self-used real properties (except for real estate enterprises).

 

Regulations on Dividend Distribution

 

Under applicable PRC laws and regulations, foreign-invested enterprises in China may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, foreign-invested enterprises in China are required to allocate at least 10% of their respective accumulated profits each year, if any, to fund statutory reserve funds unless these reserves have reached 50% of the registered capital of the respective enterprises. These reserves are not distributable as cash dividends.

 

Regulations on Transfer of Real Estate Properties

 

According to applicable PRC laws and regulations when a property owner transfers a building, the ownership of the building and the land use right associated with the site on which the building is situated are transferred simultaneously. Pursuant to the applicable regulations, with respect to the transfer of land use right and ownership of the above-ground buildings, the parties must enter into a transfer contract in writing and register the transfer with the relevant property administration authority within 90 days of the execution of the transfer contract. If the land is divided into several parcels during the transfer and the transferee will obtain a separate land use right certificate for each parcel of the land so divided, the transfer of land use right and the relevant transfer of the above-ground building must be approved by the relevant land and housing administration departments of relevant municipal or county level governments.

 

On October 8, 2010, the Beijing Municipal Bureau of Land and Resources issued the Notice on Further Strengthening the Administration of Research and Development Projects and Industrial Projects. Pursuant to the notice, application for transfer of an industrial project must be submitted to Beijing Municipal Commission of Housing and Urban-Rural Development, which will, after preliminary review together with other relevant administrative departments, submit the application to the People’s Government of Beijing Municipality for final approval.

 

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Regulations on Tax

 

For a discussion of applicable PRC tax regulations, see “Item 5. Operating and Financial Review and Prospects — A. Operating Results — Taxation — PRC.”

 

C.Organizational Structure

 

The following diagram sets out details of our subsidiaries and consolidated variable interest entities as of the date of this annual report:

 

 

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Contractual Arrangements with Our Consolidated Variable Interest Entities

 

PRC laws and regulations currently restrict foreign ownership of telecommunications value-added services, including content and application delivery services. Because we are a Cayman Islands company, we are classified as a foreign enterprise under PRC laws and regulations and our wholly-owned PRC subsidiary, ChinaCache Beijing, is a foreign-invested enterprise. To comply with PRC laws and regulations, we conduct our operations in China through a series of contractual arrangements with Beijing Blue I.T. and Beijing Jingtian, and their respective shareholders. Beijing Blue I.T. is currently 55% owned by Song Wang, our co-founder, chairman of our board of directors, our chief executive officer and our shareholder, and 45% owned by Jean Xiaohong Kou, our co-founder, director, senior vice president and our shareholder. Beijing Jingtian is 50% owned by Ms. Huiling Ying, and 50% owned by Mr. Lei Wang, who replaced the previous shareholder and became a shareholder of Beijing Jingtian in July 2013. All current shareholders of Beijing Blue I.T. and Beijing Jingtian are PRC citizens and accordingly these two entities are domestic companies under the PRC laws.

 

We have been and are expected to continue to rely on our consolidated variable interest entities to operate our content and application delivery business in China as long as PRC laws and regulations do not allow us to directly operate such business in China. Our contractual arrangements with Beijing Blue I.T. and Beijing Jingtian, and their respective shareholders enable us to:

 

·exercise effective control over Beijing Blue I.T. and Beijing Jingtian;
·receive substantially all of the economic benefits of Beijing Blue I.T. and Beijing Jingtian in consideration for the services provided by our subsidiaries in China, and incur substantially all the losses of Beijing Blue I.T. and Beijing Jingtian; and
·have an exclusive option to purchase all of the equity interest in Beijing Blue I.T. and Beijing Jingtian when and to the extent permitted under PRC law.

 

Accordingly, under U.S. GAAP, we consolidate Beijing Blue I.T. and Beijing Jingtian as our “variable interest entities” in our consolidated financial statements.

 

Our contractual arrangements with our consolidated variable interest entities and their shareholders are described in further detail as follows:

 

Agreements that Provide Us Effective Control

 

Share Pledge Agreements. Pursuant to the share pledge agreements entered into on September 23, 2005 and supplemented on December 19, 2016 among ChinaCache Beijing, each shareholder of Beijing Blue I.T. and Beijing Blue I.T., each shareholder pledged his or her equity interest in Beijing Blue I.T. to ChinaCache Beijing to secure Beijing Blue I.T.’s obligations under the exclusive business cooperation agreement with ChinaCache Beijing. Each shareholder also agreed not to transfer or create any new encumbrance adverse to ChinaCache Beijing on his or her equity interest in Beijing Blue I.T. without the prior written consent of ChinaCache Beijing. During the term of the share pledge agreement, ChinaCache Beijing is entitled to all the dividends declared on the pledged equity interest. If Beijing Blue I.T. fails to perform its contractual obligations, ChinaCache Beijing, as pledgee, will be entitled to certain rights, including the right to take possession and to dispose of the pledged equity interest. The share pledge agreements shall terminate once Beijing Blue I.T. fulfilled its obligations under the principal agreements between ChinaCache Beijing and Beijing Blue I.T., including the full payment of consulting and service fees and license fees under the principal agreements.

 

Pursuant to the share pledge agreement entered into on December 3, 2012 among ChinaCache Beijing, Ms. Huiling Ying and Beijing Jingtian, which superseded the share pledge agreements entered into on July 31, 2008 and the share pledge agreement entered into on July 1, 2013 among ChinaCache Beijing, Mr. Lei Wang and Beijing Jingtian, each shareholder of Beijing Jingtian pledged his or her equity interest in Beijing Jingtian to ChinaCache Beijing to secure Beijing Jingtian’s obligations under the exclusive business cooperation agreement with ChinaCache Beijing. The other terms of the share pledge agreements are substantially the same as those of the share pledge agreements between ChinaCache Beijing, each shareholder of Beijing Blue I.T. and Beijing Blue I.T.

 

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We have registered the pledges of the equity interests in Beijing Blue I.T. and Beijing Jingtian with the local counterpart of SAIC.

 

Irrevocable Power of Attorney. Each shareholder of Beijing Blue I.T. executed an irrevocable power of attorney on September 23, 2005, which was superseded by an irrevocable power of attorney executed by such shareholder of Beijing Blue I.T. on December 19, 2016 appointing ChinaCache Beijing or a person designated by ChinaCache Beijing as his or her attorney-in-fact to attend shareholders’ meetings of Beijing Blue I.T. and to vote on his or her behalf on all matters requiring shareholder approval, including but not limited to, the sale, transfer, pledge, or disposition of his or her shareholding in Beijing Blue I.T. The power of attorney remains valid and irrevocable from the date of its execution, so long as he or she remains the shareholder of Beijing Blue I.T.

 

Pursuant to the irrevocable power of attorney entered into on July 31, 2008 by Ms. Huiling Ying and on July 1, 2013 by Mr. Lei Wang, each shareholder of Beijing Jingtian appointed ChinaCache Beijing or a person designated by ChinaCache Beijing as his or her attorney-in-fact to attend shareholders’ meetings and to vote on his or her behalf on all matters requiring shareholder approval. These powers of attorneys are substantially the same as those granted by each of the shareholders of Beijing Blue I.T. to ChinaCache Beijing. On May 10, 2010, the board of directors and the shareholders of ChinaCache Beijing each approved resolutions whereby, among other things, all shareholder rights that ChinaCache Beijing has in Beijing Blue I.T. pursuant to the irrevocable powers of attorney executed by the shareholders of Beijing Blue I.T. on September 23, 2005, and all shareholder rights that ChinaCache Beijing has in Beijing Jingtian pursuant to the irrevocable powers of attorney executed by the shareholders of Beijing Jingtian on July 31, 2008, were re-assigned to ChinaCache Beijing’s shareholders or a party designated by ChinaCache Beijing’s shareholders.

 

Exclusive Option Agreements. On September 23, 2005, ChinaCache Holdings entered into exclusive option agreements with Beijing Blue I.T. and each of its two shareholders, Mr. Song Wang and Ms. Jean Xiaohong Kou. Such agreements were amended and supplemented on May 10, 2010 and superseded by the exclusive option agreements entered into by and among ChinaCache Holdings, Beijing Blue I.T. and each of its two shareholders on January 20, 2016 and further superseded by the exclusive option agreements entered into by and among ChinaCache Holdings, Beijing Blue I.T. and each of its two shareholders on December 19, 2016. Pursuant to these agreements, the shareholders irrevocably granted ChinaCache Holdings or its designated representative an exclusive option to purchase, when and to the extent permitted under PRC law, all or part of the equity interest in Beijing Blue I.T. The consideration in excess of the outstanding loan amount when received by the shareholders upon the exercise of the exclusive option is required to be remitted to ChinaCache Beijing in accordance with PRC law. The shareholders must remit any funds received from Beijing Blue I.T. to ChinaCache Beijing in the manner permitted under PRC law, in the event that any distributions are made by Beijing Blue I.T. pursuant to any written consents by ChinaCache Holdings. ChinaCache Holdings or its designated representative has sole discretion to decide when to exercise the option and whether in part or in full. The term of these agreements is 10 years and will expire on December 19, 2026. The agreements may be renewed for an additional 10 years at ChinaCache Holdings’ sole discretion, and the times of such renewals are unlimited.

 

On December 3, 2012, ChinaCache Beijing entered into an exclusive option agreement with Beijing Jingtian and Ms. Huiling Ying, which superseded the exclusive option agreements entered into on July 31, 2008 and their supplementary agreements entered into on May 10, 2010. On July 1, 2013, ChinaCache Beijing entered into an exclusive option agreement with Beijing Jingtian and Mr. Lei Wang. Pursuant to the exclusive option agreements, the shareholders irrevocably granted ChinaCache Beijing or its designated representative an exclusive option to purchase, to the extent permitted under PRC law, all or part of the equity interest in Beijing Jingtian. ChinaCache Beijing has sole discretion to decide when to exercise the option and whether in part or in full. The term of these exclusive option agreements is 10 years. The term of the agreements may be renewed at ChinaCache Beijing’s sole discretion. Other terms of the exclusive purchase option agreement with Beijing Jingtian are substantially the same as those of the agreement between ChinaCache Holdings and Beijing Blue I.T.

 

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Agreements that Transfer Economic Benefits to Us or Absorb Losses

 

Exclusive Business Cooperation Agreement. Pursuant to the exclusive business cooperation agreement between ChinaCache Beijing and Beijing Blue I.T. entered into on September 23, 2005, ChinaCache Beijing agreed to provide Beijing Blue I.T. with exclusive business support and technical and consulting services, including technical services, business consultations, intellectual property licensing, equipment or property leasing, marketing consultancy, system integration, research and development, and system maintenance in return for fees determined at the sole discretion of ChinaCache Beijing. Beijing Blue I.T. agreed that it will not accept any consultation or services provided by any third party without ChinaCache Beijing’s prior written consent. ChinaCache Beijing is entitled to have exclusive and proprietary rights and interests to any intellectual properties or technologies arising out of or created during the performance of this agreement. Pursuant to the exclusive business cooperation agreement, ChinaCache Beijing and Beijing Blue I.T. entered into the exclusive technical consultation and training agreement and exclusive technical support and service agreement (both described below), under which service fees are paid by Beijing Blue I.T. to ChinaCache Beijing. The initial term of the exclusive business cooperation agreement is 10 years and it was extended for another ten years upon ChinaCache Beijing’s written confirmation on September 20 2015, which will expire on September 23, 2025. Prior to this agreement’s and subsequent agreements’ expiration dates, ChinaCache Beijing can at its sole discretion renew at a term of its choice through written confirmation.

 

The exclusive business cooperation agreement dated July 31, 2008 between ChinaCache Beijing and Beijing Jingtian contains terms substantially similar to those of the exclusive business cooperation agreement between ChinaCache Beijing and Beijing Blue I.T.

 

Exclusive Technical Consultation and Training Agreement. On September 23, 2005, ChinaCache Beijing and Beijing Blue I.T. entered into an exclusive technical consultation and training agreement. Under this agreement, ChinaCache Beijing agreed to provide Beijing Blue I.T. with evaluation and analysis of Beijing Blue I.T.’s research and development system, process and results of operations, and training service. In return, Beijing Blue I.T. agreed to pay ChinaCache Beijing service fees determined at the sole discretion of ChinaCache Beijing. Beijing Blue I.T. agreed that it will not accept any consultation or services provided by any third party without ChinaCache Beijing’s prior written consent. ChinaCache Beijing is entitled to have exclusive and proprietary rights and interests arising out of or created during the performance of this agreement, whether by ChinaCache Beijing or Beijing Blue I.T., including but not limited to, patent, copyright, and know-how property. The initial term of this agreement was five years and it was extended for another five years upon ChinaCache Beijing’s written confirmation in September 2010 and was extended again for another five years upon ChinaCache Beijing’s written confirmation on September 20, 2015 which will expire on September 23, 2020. The term can be extended at the sole discretion of ChinaCache Beijing by written notice prior to the expiration of the term, and the extended term shall be determined by ChinaCache Beijing.

 

Exclusive Technical Support and Service Agreement. Pursuant to the exclusive technical support and service agreement between ChinaCache Beijing and Beijing Blue I.T., entered into on September 23, 2005, ChinaCache Beijing has the exclusive right to provide Beijing Blue I.T. with technical support and services, including but not limited to, research and development of technology, daily maintenance, monitoring, testing and malfunction resolution of Beijing Blue I.T.’s equipment, and consultation on Beijing Blue I.T.’s network equipment, products and software. In return, Beijing Blue I.T. agreed to pay ChinaCache Beijing service fees determined at the sole discretion of ChinaCache Beijing. Beijing Blue I.T. agreed that it will not accept any consultation or services provided by any third party without ChinaCache Beijing’s prior written consent. ChinaCache Beijing is entitled to have exclusive and proprietary rights and interests arising out of or created during the performance of this agreement, whether by ChinaCache Beijing or Beijing Blue I.T., including but not limited to, patent, copyright, and know-how property. The initial term of this agreement was five years and it was extended for another five years upon ChinaCache Beijing’s written confirmation in September 2010 and was extended again for another five years upon ChinaCache Beijing’s written confirmation on September 20, 2015 which will expire on September 23, 2020. The term can be extended solely by ChinaCache Beijing by written notice prior to the expiration of the term, and the extended term shall be determined by ChinaCache Beijing.

 

Equipment Leasing Agreement. Under the equipment leasing agreement between ChinaCache Beijing and Beijing Blue I.T. dated September 23, 2005, ChinaCache Beijing agreed to lease its equipment to Beijing Blue I.T. and Beijing Blue I.T. agreed to pay the rent within five business days of the first month of each quarter. Beijing Blue I.T. can only use the equipment to conduct business according to its authorized business scope. The initial term of this agreement was five years. The agreement may be renewed at ChinaCache Beijing’s sole discretion. The agreement was extended for another five years upon ChinaCache Beijing’s written confirmation in September 2010 and was extended again for another five years upon ChinaCache Beijing’s written confirmation on September 20, 2015 which will expire on September 23, 2020. The term can be extended solely by ChinaCache Beijing by written notice prior to the expiration of the term, and the extended term shall be determined by ChinaCache Beijing.

 

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Loan Agreements. Each shareholder of Beijing Blue I.T. entered into a loan agreement on September 23, 2005 and a supplementary agreement on May 10, 2010 with ChinaCache Holdings. Pursuant to these agreements, ChinaCache Holdings provided an interest-free loan facility of RMB5.5 million and RMB4.5 million, respectively, to the two shareholders of Beijing Blue I.T., Mr. Song Wang and Ms. Jean Xiaohong Kou, for the purpose of providing capital to Beijing Blue I.T. to develop its business. In addition, ChinaCache Holdings also agreed to provide continuous financial support to the shareholders of Beijing Blue I.T. to be used for the operations of Beijing Blue I.T. The term of the loan agreement is ten years and it was extended for another ten years upon the contracting parties’ written confirmation on September 20, 2015, which will expire on September 23, 2025. The term of the loan agreement may be extended upon mutual written consent of the parties. On January 20, 2016, each shareholder of Beijing Blue I.T. entered into another loan agreement with ChinaCache Holdings. Pursuant to these agreements, ChinaCache Holdings provided an interest-free loan facility of RMB5.5 million and RMB 4.5 million, respectively, to the two shareholders of Beijing Blue I.T., Mr. Song Wang and Ms. Jean Xiaohong Kou, for the purpose of subscribe for the capital increase of Beijing Blue I.T. The term of the loan agreement is ten years and expires on January 20, 2026. The term of the loan agreement may be extended upon mutual written consent of the parties. On December 19, 2016, each shareholder of Beijing Blue I.T. entered into another loan agreement with ChinaCache Holdings. Pursuant to these agreements, ChinaCache Holdings provided an interest-free loan facility of RMB11 million and RMB9 million, respectively, to the two shareholders of Beijing Blue I.T., Mr. Song Wang and Ms. Jean Xiaohong Kou, for the purpose of purchasing the increased capital of Beijing Blue I.T. The term of the loan agreement is ten years and expires on December 19, 2026. The term of the loan agreement may be extended upon mutual written consent of the parties. In each loan agreement, the method of repayment shall be at the sole discretion of ChinaCache Holdings and the proceeds from the transfer of the shareholder’s equity interest in Beijing Blue I.T. to ChinaCache Holdings or another person designated by ChinaCache Holdings as permitted under PRC law shall be used to repay the loan. The shareholders shall repay the loans immediately upon certain events, including the shareholder leaving our employment, a third-party filing a claim against the shareholder which exceeds RMB100,000 or ChinaCache Holdings exercising its option to purchase the shareholder’s equity interest in Beijing Blue I.T. pursuant to the exclusive option agreement described above. Each loan agreement contains a number of covenants that restrict the actions the shareholders can take or cause Beijing Blue I.T. to take. For example, these covenants provide that the shareholder will:

 

·not transfer, pledge or otherwise dispose of or encumber his or her equity interest in Beijing Blue I.T. without the prior written consent of ChinaCache Holdings;
·not take any action without the prior written consent of ChinaCache Holdings, if such action will have a material impact on the assets, business and liabilities of Beijing Blue I.T.;
·not vote for, or execute any resolutions to approve, any merger or consolidation with any person, or any acquisition of or investment in any person by Beijing Blue I.T. without the prior written consent of ChinaCache Holdings; and
·vote to elect the director candidates nominated by ChinaCache Holdings.

 

Ms. Huiling Ying and Ms. Xinxin Zheng, who were then shareholders of Beijing Jingtian, entered into a loan agreement on July 31, 2008, which was supplemented on May 10, 2010 and December 3, 2012 with ChinaCache Beijing. Pursuant to these agreements, ChinaCache Beijing provided an interest-free loan of RMB4,250,000 to Ms. Xinxin Zheng and Ms. Huiling Ying, as shareholders of Beijing Jingtian at that time, for their investment in the registered share capital of Beijing Jingtian. On July 1, 2013, as a result of a transfer by Ms. Xinxin Zheng of all her equity interests in Beijing Jingtian to Mr. Lei Wang. Ms. Zheng and Mr. Wang entered into a loan assignment agreement, pursuant to which all liabilities of Ms. Zheng under the previous loan agreements were assigned to and assumed by Mr. Wang. The other terms of these agreements are substantially the same as those of the loan agreement and supplementary agreement between ChinaCache Holdings and the shareholders of Beijing Blue I.T. The term of these loan agreements is ten years from the date of execution. Such agreement can be extended upon mutual written consent of ChinaCache Beijing and two shareholders of Beijing Jingtian. ChinaCache Holdings also agreed to provide continuous financial support to the shareholders of Beijing Jingtian to be used for the operations of Beijing Jingtian and agreed to forego the right to seek repayment in the event that the shareholders of Beijing Jingtian are unable to repay such funding, to the extent permitted by PRC law.

 

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In the opinion of Han Kun Law Offices, our PRC legal counsel, except as otherwise disclosed herein:

 

·the ownership structure of our PRC subsidiary, our PRC consolidated variable interest entities and their branches and subsidiaries comply with all existing PRC laws and regulations;
·each and all of the currently effective documents under the VIE arrangements among us, our PRC subsidiary, PRC consolidated variable interest entities and their shareholders governed by PRC law are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect; and
·the business operations of our PRC subsidiary, our PRC consolidated variable interest entities and their branches and subsidiaries are in all material respects in compliance with existing PRC laws and regulations and the terms of their licenses and permits.

 

We have been advised by our PRC legal counsel, however, that there are substantial uncertainties regarding the interpretation and application of current and future PRC laws and regulations. Accordingly, there can be no assurance that the PRC regulatory authorities, in particular the MIIT, which regulates providers of content and application delivery services and other participants in the PRC telecommunications industry, and the Ministry of Commerce, will not in the future take a view that is contrary to the above opinion of our PRC legal counsel. We have been further advised by our PRC legal counsel that if the PRC government finds that the agreements that establish the structure for operating our content and application delivery business in China do not comply with PRC government restrictions on foreign investment in the telecommunications industry, we could be subject to severe penalties including being prohibited from continuing our operations. See “Item 3. Key Information — D. Risk Factors — Risks Related to Our Corporate Structure—If the PRC government finds that the arrangements that establish the structure for operating our business do not comply with PRC government restrictions on foreign investment in the telecommunications business, we could be subject to severe penalties.” In addition, these contractual arrangements may not be as effective in providing us with control over Beijing Blue I.T. and Beijing Jingtian as would direct ownership of such entities. See “Item 3 Key Information — D. Risk Factors — Risks Related to Our Corporate Structure — We rely on contractual arrangements with Beijing Blue I.T. and Beijing Jingtian and their respective shareholders for our China operations, which may not be as effective as direct ownership in providing operational control.”

 

D.Property, Plants and Equipment

 

Our headquarters are located at Section A, Building 3, Dian Tong Creative Square, No. 7 Jiuxianqiao North Road, Chaoyang District, Beijing 100015, PRC, where we lease approximately 9,116 square meters of office space. As of December 31, 2017, our other offices in mainland China occupied an aggregate of 943 square meters of leased space, and we also leased an aggregate of 7,922 square feet in the U.S., London and Hong Kong. In addition, we owned two office buildings of, in aggregate, approximately 10,000 square meters in California, the U.S., to expand our research and development capacity and support our global operations. One of these two buildings is currently leased out.

 

We have paid RMB51.9 million to acquire land use right in relation to approximately 39,000 square meters of land in Tianzhu Comprehensive Bonded Zone in Beijing. See “Item 5. Operating and Financial Review and Prospects — B. Liquidity and Capital Resources — Capital Expenditures.” In December 2014, we entered into agreements with BFSMC, pursuant to which we agreed to sell to BFSMC one of the data center buildings with construction areas of approximately 14,208 square meters, which has been constructed on the aforementioned land in the Tianzhu Comprehensive Bonded Zone. Under our framework agreement with BFSMC, we agreed to sell two buildings to a subsidiary of BFSMC through transferring the equity interest of our subsidiary Beijing Zhao Du, the owner of the buildings. In addition, we agreed to lease back the buildings from the subsidiary of BFSMC starting from an agreed earlier date. We also reached a supplemental company letter with BFSMC, pursuant to which we agreed that September 30, 2015 should be deemed as the date of delivery as long as we complete the actual delivery of the buildings as well as the equity transfer by December 31, 2016. If the equity transfer and other agreed procedures are completed on time, our liabilities shall be deemed fully discharged. However, BFSMC has not accepted the buildings by December 31, 2016 due to our disagreement with BFSMC on the standard of delivery and acceptance of the buildings. Therefore, we re-negotiated with BFSMC and reached a series of new agreements with BFSMC in July 2017. Pursuant to the new agreements, BFSMC agreed to make the payments of RMB105.6 million to us immediately upon the completion of equity transfer of Beijing Zhao Du. Although we have completed the transfer of the equity interest in Beijing Zhao Du and the ownership of the buildings in July 2017, BFSMC failed to make the payments of RMB105.6 million to us as agreed. We have filed a lawsuit with the court, claiming the payment of the outstanding amount of consideration and the interest accrued thereon in August 2017. In September 2017, BFSMC filed a counterclaim to sue for, among others, the late delivery penalties and other relating losses. Thereafter we filed a motion to dismiss BFSMC’s counterclaim arguing that the court does not have the jurisdiction. Management is of the view that these proceedings are at a preliminary stage, therefore it is impossible at this stage to properly evaluate the outcome. Therefore, no provision has been made for this case. In April 2018, we were notified by the court that our motion was rejected and Xin Run’s bank deposits and other assets in a total amount of approximately RMB 50.5 million were sealed up, distrained or frozen by the court. On April 24, 2018, we amended our claim requesting, among other things, the defendant pay the additional purchase price of RMB96 million, damages for breach of contract in an amount of RMB14.4 million and the relating interest of RMB8.86 million. In addition, in October 2017, a subsidiary of BFSMC filed a lawsuit against Xin Run in the Shunyi District Court of Beijing requesting Xin Run pay overdue rent and the relating interest in a total amount of approximately RMB30 million. We filed a motion to dismiss for lack of jurisdiction. However, the motion was rejected by the court and as a result, this lawsuit is still pending. Management is of the view that these proceedings are at a preliminary stage, therefore it is impossible at this stage to properly evaluate the outcome.Therefore, no provision has been made for this case. Please see “Item 8. Financial Information – A. Consolidated Statements and Other Financial Information – Legal Proceedings” for more information. In April 2014, we entered into a framework agreement with People.cn, pursuant to which we agreed to sell to People.cn one of the data center buildings to be constructed in the Tianzhu Comprehensive Bonded Zone. This building has been put into use. On December 29, 2017, Xin Run entered into a framework agreement with People.cn, under which, among others, Xin Run will transfer 100% equity interest in Beijing Shuoge Technology Co., Ltd. to People.cn subject to terms and conditions to be set forth in a definitive equity transfer agreement. We are still negotiating with People.cn on the terms of the equity transfer agreement and the final equity transfer agreement for the People.cn transfer will be effective when the requisite governmental approvals are obtained. In the event that we cannot successfully complete the sales of the data center building to People.cn, People.cn may demand their prepayment, which could have a material adverse impact on our cash position.

 

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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 should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this annual report on Form 20-F. This discussion and analysis may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Item 3. Key Information — D. Risk Factors” or in other parts of this annual report on Form 20-F.

 

A.Operating Results

 

Key Factors Affecting Our Results of Operations

 

Our financial condition and results of operations are mainly affected by the following factors:

 

Number of active customers and customer mix

 

The number of active customers affects our revenues. We had approximately 2,169, 1,999 and 1789 active customers as of December 31, 2015, 2016 and 2017, respectively. Revenues from our top five customers accounted for 37.5%, 48.2% and 57.2% of our total net revenues in 2015, 2016 and 2017, respectively.

 

Our revenues are also affected by the composition of our customer base, which we refer to as customer mix. Our revenues in 2017 decreased as compared to that in 2016, mainly due to the interruption of our services we experienced caused by certain platform issues and intensified industry competition. We intend to attract and retain more high-value customers to increase our revenues and to maintain our margin at a stable level, meanwhile, we target gradual improvement in margins as our scale grow to stable and maintain an optimal level of customer mix.

 

Selling price

 

We operate in a competitive market and we face pricing pressure for our services. We typically charge customers on a per-gigabit per-second basis for the bandwidth usage or per-gigabyte basis for traffic volume used. Prices for our services are affected by a variety of factors, including supply and demand conditions and pricing pressures from our competitors. In recent years, the selling prices for our services have declined. The price erosion was partially due to price discounts granted at the outset of the arrangement to customers with large contractual service commitments. Furthermore, increased competition has also caused price declines. We expect that we will continue experiencing pricing pressure in the future and thus we must reduce our cost of revenues to offset the price decline and to maintain and increase our gross profit.

 

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Cost reductions

 

Our ability to achieve and increase profitability depends on our ability to effectively reduce our cost of revenues. Our cost of revenues as a percentage of our total net revenues increased from 76.9% in 2015 to 102.2% in 2016, primarily as a result of the decrease of our total net revenues, and decreased to 91.7% in 2017, primarily as a result of improved bandwidth using efficiency. We plan to devote significant resources to enhancing the efficiency of our operations and further to improve our bandwidth usage. However, if we fail to effectively reduce our cost of revenues, our profitability and competitiveness will be adversely affected.

 

A significant component of our cost of revenues is the depreciation of our network equipment, which is related to our capital expenditures. We had capital expenditures of RMB417.8 million, RMB356.0 million and RMB162.8 million (US$25.0 million) in 2015, 2016 and 2017, respectively. We make our investment decisions based upon evaluation of a number of factors, such as the amount of bandwidth and storage that our customers may demand, the cost of the physical network equipment required to meet such requirements and the forecasted capacity utilization of our network. If we over-estimate or under-estimate future demand for our services, our results of operations may suffer.

 

Components of Results of Operations

 

Revenues

 

In 2015, 2016 and 2017, we generated net revenues of RMB1,353.6 million, RMB1,054.2 million and RMB852.6million (US$131 million), respectively.

 

Most of our revenues were derived from the sale of our content and application delivery total solutions to our customers. We typically charge customers on a per-gigabit per-second basis for the bandwidth usage or per-gigabyte basis for traffic volume used. Our customer service agreements generally commit the customers to a minimum level of usage and specify the rate that the customers must pay for actual usage above the minimum usage commitment. These agreements typically provide for a one-year term with a one-year renewal option.

 

The number of our active customers has decreased from 2,169 as of December 31, 2015 to 1,999 as of December 31, 2016 and further decreased to 1789 as of December 31, 2017. We categorize our customers into five industry groups: internet and software, mobile internet, media and entertainment, enterprises and e-commerce and government agencies. Due to the changing competition landscape, our sales to customers in the media and entertainment, internet and software, mobile internet, enterprises and e-commerce industry groups fluctuated over time. During any given period, a relatively small number of customers typically accounts for a significant percentage of our total net revenues.

 

In September 2012, 6% of VAT, has replaced the original 5% business tax in Beijing as a result of the PRC government’s pilot VAT reform program, and applied to all services provided by ChinaCache Beijing and Beijing Jingtian and certain services provided by Beijing Blue I.T. Effective from June 2014, all services provided by Beijing Blue I.T. fall within the scope of the pilot program on telecom industry, and revenues generated by these services are subject to VAT instead of business tax. Our revenues are presented net of such VAT taxes and related charges in the same period in which the related revenues are recognized.

 

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Cost of Revenues and Operating Expenses

 

The following table sets forth, for the periods indicated, our cost of revenues and operating expenses, in absolute amount and as a percentage of total net revenues:

 

   For the Year Ended December 31, 
   2015   2016   2017 
   RMB   %   RMB   %   RMB   US$   % 
   (in thousands, except percentages) 
Net Revenues                                   
Third party customers   1,353,627    100.0%   1,054,235    100.0%   852,568    131,037    100.00%
Total Net Revenues   1,353,627    100.0%   1,054,235    100.0%   852,568    131,037    100.00%
Cost of revenues(1)(2)                                   
Bandwidth, co-location and storage fees   793,498    58.6%   842,726    79.9%   681,134    104,688    80.0%
Depreciation of network equipment   133,854    9.9%   134,079    12.7%   9,244    1,421    1.08%
Payroll and other compensation costs of network operations personnel   81,309    6.0%   76,702    7.3%   56,455    8,677    6.6%
Other cost of revenues   32,751    2.4%   24,303    2.3%   34,989    5,378    4.1%
Total cost of revenues   1,041,412    76.9%   1,077,810    102.2%   781,822    120,164    91.70%
Other operating (income) loss   (13,911)   (1.0)%   19,044    1.8%   19,483    2,994    -2.28%
Operating expenses(1)                                   
Sales and marketing expenses   115,621    8.5%   93,603    8.9%   61,770    9,494    7.25%
General and administrative expenses   202,518    15.0%   256,007    24.3%   142,721    21,936    16.74%
Provision (recovery of provision) for doubtful accounts receivable   (3,892)   (0.3)%   9,010    0.8%   17,514    2,692    2.05%
Transaction tax on assets transfer   27,733    2.0%                    
Research and development expenses   103,110    7.6%   104,018    9.9%   81,748    12,564    9.59%
Impairment of long-lived assets           399,094    37.9%   21,757    3,344    2.12%
Impairment of long-term investments           18,240    1.7%   3,690    567    0.43%
Total operating expenses   445,090    32.8%   879,972    83.5%   329,200    50,597    38.17%

  

 

(1)Includes share-based compensation expenses as follows:

 

   For the Year Ended December 31, 
   2015   2016   2017 
   RMB   %   RMB   %   RMB   US$   % 
   (in thousands, except percentages) 
Allocation of share-based compensation expense                            
Cost of revenues   3,670    7.6%   5,961    7.0%   490    75    4.5%
Sales and marketing expenses   2,882    5.9%   2,753    3.2%   254    39    2.3%
General and administrative expenses   38,796    79.8%   72,483    85.3%   9,631    1,480    88.1%
Research and development expenses   3,258    6.7%   3,828    4.5%   562    86    5.1%
Total share-based compensation expenses included in cost of revenues and operating expenses   48,606    100.0%   85,025    100.0%   10,937    1,680    100.0%

 

 

(2)Includes amount to a related party of RMB0.1 million, nil and nil for the years ended December 31, 2015, 2016 and 2017, respectively.

 

Cost of Revenues

 

Our cost of revenues primarily consists principally of the following:

 

·bandwidth, co-location and storage fees;
·depreciation of network equipment;
·payroll and other compensation costs of network operations personnel; and
·other cost and expenses that are directly attributable to the provisions of our content and application delivery total solutions.

 

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Bandwidth, co-location and storage fees are the amounts we pay to purchase bandwidth usage, co-location services and data storage from telecommunications carriers or ISPs. For the years ended December 31, 2015, 2016 and 2017, 95%, 91% and 86%, respectively, of our bandwidth, co-location and data storage were purchased from three major PRC telecommunications carriers, China Telecom, China Mobile and China Unicom, through their respective subsidiaries and sale agents. Our agreements with the telecommunication carriers typically use a standard form provided by the carriers, with pricing terms individually negotiated with the carriers’ local subsidiaries or sale agents. The agreements are typically of a one-year term with renewal options. We pay monthly service fees based on the number of internet gateways, bandwidth usage and the number of server clusters.

 

Depreciation of network equipment expenses primarily consists of the depreciation associated with our network servers and backbone. In April 2008, we entered into an agreement with Tong Zhen Networks Co., Ltd., an independent third party, pursuant to which we agreed to lease an optical fiber cable from Beijing to Hangzhou for a term of 20 years commencing from the date of the agreement. We have prepaid an aggregate amount of RMB13.1 million in rental fees for the entire 20-year period. We also have the right to renew the lease by notifying the lessor within 12 months prior to the expiration date of the lease. Depreciation of network equipment and amortization of intangible assets increased from RMB133.9 million in 2015 to RMB134.1 million in 2016 and decreased to RMB11.5 million (US$1.8 million) in 2017, due to impairment charges of RMB 21.8 million of long-lived assets recognized for the year ended December 31, 2017(2015: Nil and 2016: RMB399 million). Our depreciation expense in each period is closely correlated to the amount of equipment we purchased. We had capital expenditures of RMB417.8 million, RMB356.0 million and RMB162.8 million (US$25.0 million) in 2015, 2016 and 2017, respectively.

 

Our cost of revenues increased from RMB1,041.4 million in 2015 to RMB1,077.8 million in 2016 and decreased to RMB781.8million (US$120.2million) in 2017. Our cost of revenues as a percentage of our total net revenues increased from 76.9% in 2015 to 102.2% in 2016 and decreased to 91.7% in 2017. The decrease from 2016 to 2017 in terms of percentage was primarily due to the improvement of operating efficiency from 2016 to 2017. Overall, we expect that our cost rate will continue to decrease as we expand our operations; however, such improvement is likely to be partially offset by lower unit price from the existing or potential customers.

 

Other Operating Loss

 

Our other operating loss was RMB19.5million (US$3 million) for the year ended December 31, 2017, which was primarily due to the provision of late delivery penalties accrued on our agreements with BFSMC.

 

As a percentage of our total net revenues, our other operating loss was 2.3% for the year ended December 31, 2017.

 

Operating Expenses

 

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

 

Sales and Marketing Expenses.

 

Our sales and marketing expenses primarily consist of the following:

 

·salary and benefit expenses for our sales and marketing staff, including share-based compensation expenses;
·promotion and marketing expenses, including costs for sponsoring special promotional and marketing events and organizing and participating in industry conferences and related expenses for business development activities; and
·travel-related expenses to support sales and marketing functions.

 

Our sales and marketing expenses decreased from RMB115.6 million for the year ended December 31, 2015 to RMB93.6 million for the year ended December 31, 2016 and further decreased to RMB61.8 million (US$9.5 million) for the year ended December 31, 2017. The decrease from 2016 to 2017 was primarily due to our improved cost control measures.

 

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As a percentage of our total net revenues, our sales and marketing expenses increased from 8.5% for the year ended December 31, 2015 to 8.9% for the year ended December 31, 2016 and decreased to 7.2% for the year ended December 31, 2017. Going forward, we expect our sales and marketing expenses to decrease in absolute dollar amount as we expect our existing marketing initiatives will be more effectively aligned with CDN business consolidation while gearing towards promoting internet data center service offerings.

 

General and Administrative Expenses.

 

Our general and administrative expenses primarily consist of the following:

 

·salary and benefit expenses for management and administrative staff, including share-based compensation expenses;
·depreciation of facilities and office equipment; and
·professional service expenses.

 

Our general and administrative expenses increased from RMB202.5 million for the year ended December 31, 2015 to RMB256.0 million for the year ended December 31, 2016 and decreased to RMB142.7 million (US$21.9 million) for the year ended December 31, 2017. The decrease from 2016 to 2017 was primarily due to the decreased option fees and declined legal expenses.

 

As a percentage of our total net revenues, our general and administrative expenses increased from 15.0% for the year ended December 31, 2015 to 24.3% for the year ended December 31, 2016 and further decreased to 16.7% for the year ended December 31, 2017. We expect that our general and administrative expenses in absolute amount will continue to decrease.

 

Provision for doubtful accounts receivable. Our provision for doubtful accounts receivable increased from negative RMB3.9 million for the year ended December 31, 2015 to RMB9.0 million for the year ended December 31, 2016 and increased to RMB17.5 million (US$2.7 million) for the year ended December 31, 2017. The increase from 2016 to 2017 was primarily due to prudence principal basing on the analysis of customers’ aging.

 

As a percentage of our total net revenues, our provision for doubtful accounts receivable increased from negative 0.3% for the year ended December 31, 2015 to 0.9% for the year ended December 31, 2016 and further increased to 2.1% for the year ended December 31, 2017.

 

Research and Development Expenses. Our research and development expenses primarily consist of payroll and related personnel costs, including share-based compensation expenses. Research and development costs are expensed as incurred. Our research and development expenses increased from RMB103.1 million for the year ended December 31, 2015 to RMB104.0 million for the year ended December 31, 2016 and decreased to RMB81.7 million (US$12.6 million) for the year ended December 31, 2017.

 

As a percentage of our total net revenues, our research and development expenses increased from 7.6% for the year ended December 31, 2015 to 9.9% for the year ended December 31, 2016 and decreased to 9.6% for the year ended December 31, 2017. We anticipate that our research and development expenses will decrease in the absolute dollar amount as we believe that we will better align our R&D resources to consolidate our product support platforms in response to a mature CDN market and the need to exercise cost control in all areas of operations.

 

Impairments of long-lived assets. We did not incur the impairments of long-lived assets in the year ended December 31, 2015. We recorded the impairment of long-lived assets of RMB399.1 million and RMB21.8 million (US$3.3 million) for the year ended December 31, 2016 and December 31, 2017, respectively, due to the deterioration of our operating results.

 

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Impairment of long term investments. Our impairment of long term investments was nil, RMB18.2 million and RMB3.7 million (US$0.6 million) for the year ended December 31, 2015, December 31, 2016, and December 31, 2017, respectively.

 

Critical Accounting Policies

 

We prepare our financial statements in accordance with U.S. GAAP, which requires us to make significant judgments, estimates and assumptions that affect, among other things, the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the end of each reporting period, and the reported amounts of revenues and expenses during each reporting period. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates.

 

Some of our accounting policies require higher degrees of judgment than others in their application. When reviewing our consolidated financial statements, you should consider our selection of critical accounting policies, the judgment and other uncertainties affecting the application of such policies, and the sensitivity of reported results to changes in conditions and assumptions. We consider the policies discussed below to be critical to an understanding of our consolidated financial statements as their application places significant demands on the judgment of our management. The following descriptions of our critical accounting policies, judgments and estimates should be read in conjunction with our consolidated financial statements, the risks and uncertainties described under “Item 3. Key Information — D. Risk Factors” and other disclosures included in this annual report.

 

Revenue Recognition

 

We provide a portfolio of content and application delivery total solutions, including web page content services, file transfer services, rich media streaming services, guaranteed application delivery, managed internet data services, cloud hosting services, content bridging services, mobile internet solution and value-added services to our customers to improve the performance, reliability and scalability of their online services and applications. Consistent with the criteria of ASC 605, “Revenue Recognition,” we recognize revenue from sales of these services when there is a signed sales agreement with fixed or determinable fees, services have been provided to the customer and collection of the resulting customer’s receivable is reasonably assured.

 

Our services are provided under the terms of a one-year master service agreement, which is typically accompanied with a one-year term renewal option with the same terms and conditions. Customers choose at the outset of the arrangement to either use our services through a monthly fixed bandwidth or traffic volume usage and fee arrangement or choose a plan based on actual bandwidth or traffic volume used during the period at fixed pre-set rates. We recognize and bill for revenue for excess usage, if any, in the month of its occurrence to the extent a customer’s usage of the services exceeds their pre-set monthly fixed bandwidth usage and fee arrangements. The rates as specified in the master service agreements are fixed for the duration of the contract term and are not subject to adjustment.

 

We may charge our customers an initial set-up fee prior to the commencement of their services. To date, these amounts have been insignificant; however, we record these initial set-up fees as deferred revenue and recognizes them as revenue ratably over the estimated life of the customer arrangement.

 

Fair Value of Financial Instruments

 

The carrying amounts of financial assets and liabilities, such as cash and cash equivalents, restricted cash, accounts receivable, short-term investments, other receivables included in prepaid expenses and other current assets, short term loan, accounts payable, balances with related parties and other payables, approximate their fair values because of the short-term maturity of these instruments. The carrying amounts of long-term loan approximate its fair value since it bears interest rate which approximates market interest rates. Available-for-sale investments were initially recognized at cost and subsequently remeasured at the end of each reporting period with the adjustment in its fair value recognized in accumulated other comprehensive income. We, with the assistance of an independent third party valuation firm, determined the estimated fair value of its available-for-sale investments that are recognized in the consolidated financial statements.

 

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Consolidation of Variable Interest Entity

 

We have adopted ASC 810-10, “Consolidation: Overall.” ASC 810-10 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.

 

PRC laws and regulations currently restrict foreign ownership of telecommunications value-added services, including content and application delivery services. To comply with these foreign ownership restrictions, we operate our business in China through our consolidated variable interest entities, Beijing Blue I.T. and Beijing Jingtian, which are wholly owned by PRC citizens. Beijing Blue I.T. and Beijing Jingtian hold the licenses and approvals that are required to operate our business. The Company and ChinaCache Beijing have entered into a series of contractual arrangements with Beijing Blue I.T. and Beijing Jingtian and their shareholders. See “Item 4. Information on the Company — C. Organizational Structure — Contractual Arrangements with Our Consolidated Variable Interest Entities.” As a result of these contractual agreements, we have the substantial ability to control Beijing Blue I.T. and Beijing Jingtian and receive substantially all the profits and absorb all the expected losses of Beijing Blue I.T. and Beijing Jingtian. Therefore we are considered the primary beneficiary of Beijing Blue I.T. and Beijing Jingtian. Accordingly, Beijing Blue I.T. and Beijing Jingtian are our VIEs under U.S. GAAP and we consolidate their results in our consolidated financial statements. We have confirmed with our PRC legal counsel on the compliance and validity of such ownership structure with PRC laws and regulations.Any changes in PRC laws and regulations that affect our ability to control Beijing Blue I.T. and Beijing Jingtian might preclude us from consolidating Beijing Blue I.T. and Beijing Jingtian in the future.

 

Impairment of Long-lived Assets

 

We evaluate our long-lived assets or asset group, including intangible assets with finite lives, 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 amount of an asset or a group of long-lived assets may not be recoverable. When these events occur, we evaluate potential impairment by comparing the carrying amount of the assets to future undiscounted net cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flow is less than the carrying amount of the assets, we would recognize an impairment loss based on the excess of the carrying amount of the asset group over its fair value. For long-lived assets held for sale, assets are written down to fair value less cost to sell. Fair value is generally determined by discounting the cash flows expected to be generated by the assets, when the market prices are not readily available for the long-lived assets.

 

Due to the deterioration of the operating results, we recognized an impairment charge based on the excess of the carrying amount of the asset group over its fair value. We determined the fair value of the asset group using the income approach based on the discounted expected cash flows associated with the asset group. The discounted cash flow for the asset group were based on three year projections which is consistent with its remained useful lives of the principal assets. Cash flow projections were based on past experience, actual results of operations and management best estimates about future developments as well as certain market assumptions.

 

We fully impaired the net value of our property and equipment and intangible assets excluding CHN-IX as of December 31, 2017.

 

Impairment charge was nil, RMB399.1 million and RMB21.8 million (US$3.3 million) for the year ended December 31, 2015, 2016, and 2017, respectively.

 

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Long-lived assets (disposal group) to be disposed of by sale

 

We classify long-lived assets and disposal groups as held for sale if their carrying amounts will be recovered principally through disposal by sale rather than through continuing use. Such long-lived assets and disposal groups are measured at the lower of their carrying amount and fair value less costs to sell. Costs to sell are the incremental costs directly attributable to the sale, excluding the finance costs and income tax expense.

 

The criteria for held for sale classification is regarded as met only when the sale is highly probable and the asset or disposal group is available for immediate sale in its present condition. Actions required to complete the sale should indicate that it is unlikely that significant changes to the sale will be made or that the decision to sell will be withdrawn.

 

Property and equipment and intangible assets are not depreciated or amortized once classified as held for distribution.

 

Assets and liabilities classified as held for sale are presented separately as current items in the consolidated balance sheets.

 

A disposal group qualifies as discontinued operation if it is a component of an entity that either has been disposed of, or is classified as held for sale, and the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.

 

Available-for-sale investments

 

We have classified our investments in convertible redeemable investments of certain unlisted companies and mutual funds as available-for-sale in accordance with ASC320-10, Investments — Debt and Equity Securities. Such available-for-sale investments are reported at fair value, with unrealized gains and losses recorded in accumulated other comprehensive income in shareholders’ equity. Realized gains or losses are charged to earnings during the period in which the gain or loss is realized. If we determine a decline in fair value is other-than-temporary, the cost basis of the individual security is written down to its estimated fair value. The new cost basis will not be adjusted for subsequent recoveries in fair value. Determination of whether declines in value are other-than-temporary requires significant judgment. Subsequent increases and decreases in the fair value of available-for-sale securities will be included in other comprehensive income except for an other-than-temporary impairment, which would be charged to current period earnings. Impairment of available-for-sale investment for the years ended December 31, 2015, 2016 and 2017 were nil, nil and RMB3.2 million (US$0.5 million) respectively.

 

Dividend and interest income, including the amortization of the premium and discount arising at acquisition, for all categories of investments in securities are included in earnings.

 

Cost Method Investment

 

In accordance with ASC subtopic 325-20 (“ASC 325-20”), Investments-Other: Cost Method Investments, for investments which are not in-substance common stock and hence, do not have readily determinable fair values or investments in an investee over which we do not have significant influence, we carry the investment at cost and only adjust for other-than-temporary declines in fair value and distributions of earnings that exceed our share of earnings since its investment. We regularly evaluate the impairment of the cost method investments based on performance and financial position of the investee as well as other evidence of market value. Such evaluation includes, but is not limited to, reviewing the investee’s cash position, recent financing, projected and historical financial performance, cash flow forecasts and financing needs. An impairment loss is recognized in earnings equal to the excess of the investment’s cost over its fair value at the balance sheet date of the reporting period for which the assessment is made. The fair value would then become the new cost basis of investment.

 

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Income Taxes

 

We follow the liability method in accounting for income taxes in accordance with ASC topic 740 (“ASC 740”). Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax rates that will be in effect in the period in which the differences are expected to reverse. We record a valuation allowance against 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.

 

We adopted ASC 740 to account for uncertainty in income taxes. ASC 740 clarifies the accounting for uncertainty in income taxes by prescribing the recognition threshold a tax position is required to meet before being recognized in the consolidated financial statements. We have elected to classify interest and penalties related to unrecognized tax benefits, if and when required, as part of “interest expense” and “other expenses,” respectively, in the consolidated statements of comprehensive loss.

 

Share-based Compensation

 

We account for share options and restricted share units award issued to employees in accordance with ASC topic 718, or ASC 718, “Compensation-Stock Compensation.” In accordance with ASC 718, we determine whether a share option or restricted share units award should be classified and accounted for as a liability award or an equity award. All grants of share options and restricted share units award to employees classified as equity awards are recognized in the financial statements over their requisite service period based on their grant date fair values. All grants of shares options to employees classified as liability awards are remeasured at the end of each reporting period with any fair value adjustments recorded to the current period expenses. We have elected to recognize compensation expenses using the accelerated method for our share options and restricted share units award granted. For restricted share awards granted with performance conditions, we commence recognition of the related compensation expense if it is probable the defined performance condition will be met. To the extent that we determine that it is probable that a different number of share-based awards will vest depending on the outcome of the performance condition, the cumulative effect of the change in estimate is recognized in the period of change.

 

ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in the subsequent period if actual forfeitures differ from initial estimates. Forfeiture rate is estimated based on historical and future expectations of employee turnover rates and are adjusted to reflect future changes in circumstances and facts, if any. Share-based compensation expense is recorded net of estimated forfeitures such that expense was recorded only for those share-based awards that are expected to vest. During the years ended December 31, 2014, 2015 and 2016, we estimated that the forfeiture rate for both the management group and the non-management group was zero. To the extent we revise this estimate in the future, the share-based payments could be materially impacted in the period of revision, as well as in following periods.

 

We account for share options issued to non-employees in accordance with the provisions of ASC 718 and ASC sub-topic 505-50, or ASC 505-50, “Equity: Equity-Based Payment to Non-employees.” For the awards granted to non-employees, we will record compensation expenses equal to the fair value of the share options at the measurement date, which is determined to be the earlier of the performance commitment date or the service completion date.

 

We, with the assistance of an independent third party valuation firm, determined the estimated fair values of the share options granted to employees and non-employees using the binomial option pricing model.

 

Taxation

 

Cayman Islands

 

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 or an investor in ADSs or ordinary shares 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. There are no exchange control regulations or currency restrictions in the Cayman Islands.

 

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United States of America

 

ChinaCache U.S. and CCAL were incorporated in the State of California in the U.S. and is subject to both California State income tax and U.S. federal income tax on its income and capital gains under the current laws of the State of California and the U.S.

 

Hong Kong

 

Our subsidiary in Hong Kong, ChinaCache Network (Hong Kong) Limited, is subject to a corporate income tax of 16.5% on the estimated assessable profit derived from its Hong Kong operation. ChinaCache Network (Hong Kong) Limited had no taxable profits during the years ended December 31, 2015, 2016 and 2017, and accordingly we have made no provision for its income tax.

 

PRC

 

ChinaCache Beijing, Beijing Blue I.T., Beijing Jingtian and Xin Run are companies incorporated in the PRC and are subject to PRC enterprise income tax on their taxable income in accordance with the relevant PRC income tax laws.

 

The PRC Enterprise Income Tax Law applies a uniform 25% enterprise income tax rate to both foreign-invested enterprises and domestic enterprises, except where a special preferential rate applies. The PRC Enterprise Income Tax Law and related tax rules provide a five-year transitional period for those entities that were established before March 16, 2007 and enjoyed a favorable income tax rate of less than 25% under the previous income tax laws and rules, to gradually change their rates to 25%, and in the case of preferential tax exemption or reduction for a specified term, until the expiration of such term. Under the PRC Enterprise Income Tax Law and related implementation rules, enterprises that are qualified as “high and new technology enterprises strongly supported by the State” are entitled to a reduced enterprise income tax rate of 15%. According to relevant PRC tax laws, enterprises that obtain the qualification of “Key Software Enterprises Covered by the National Planning Layout Scheme” are entitled to a reduced income tax rate of 10%. A “Key Software Enterprise” used to be designated and recognized jointly by the National Development and Reform Commission, the MIIT, the Ministry of Commerce, the Ministry of Finance and the State Administration of Taxation. However, according to a Circular issued by the MIIT and the SAT on Matters relating to Preferential Corporate Income Tax Policies for Software Enterprises in May 27, 2015, the recognition of “Key Software Enterprise” was stopped in May 2015. Subsequently in May 2016, Ministry of Finance, SAT, National Development and Reform Commission and MIIT jointly issued a Circular on Issues concerning Preferential Enterprise Income Tax Policies for Software and Integrated Circuit Industries, or the Circular No. 49. Pursuant to the Circular No. 49, an enterprise may be entitled to the preferential tax rate of 10% by filing with the local tax authority with supporting documentation proving its qualifications to be a Key Software Enterprise during its annual income tax settlement process. The tax authority will transfer the filed documentations to the national development and reform department and the industry and information technology department for examination. If an enterprise that has enjoyed the preferential tax treatment is found to be unqualified to be a Key Software Enterprise, the tax authority will require it to pay the delinquent taxes and may impose administrative penalties.

 

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In November 2013, ChinaCache Beijing obtained the certificate of “high and new technology enterprise” jointly issued by the Beijing Science and Technology Commission, Beijing Finance Bureau, Beijing Administration of State Taxation and Beijing Administration of Local Taxation, and has since then continued to qualify as a “high and new technology enterprise” and been entitled to a reduced income tax rate of 15%. In December 2016, ChinaCache Beijing was recognized as a “high and new technology enterprise” again and became eligible for a preferential tax rate of 15% effective from 2016 to 2018.

 

In November 2012, Beijing Blue I.T. was recognized as a “high and new technology enterprise” and was eligible for a preferential tax rate of 15% effective retrospectively from 2012 to 2014. In July 2015, Beijing Blue I.T. was recognized as a “high and new technology enterprise” again and became eligible for a preferential tax rate of 15% effective from 2015 to 2017, Beijing Blue I.T. is currently in the process of applying for the renewal of such qualification.. In December 2013, Beijing Blue I.T. was recognized as a Key Software Enterprise jointly by the National Development and Reform Commission, the MIIT, Ministry of Commerce and the SAT, which entitled it to enjoy a preferential income tax rate of 10% for 2013 and 2014. The recognition of “Key Software Enterprise” was stopped since May 2015 and Beijing Blue I.T. has not made such filings with the authorities pursuant to Circular No. 49 yet and therefore does not enjoy the preferential tax rate of 10% for “Key Software Enterprise”.

 

Our other PRC subsidiaries are currently subject to an enterprise income tax rate of 25% unless they are qualified as Small Scale and Low Profit Enterprises which would be entitled to exempt fifty percent (50%) of their income from tax and enjoy a reduced enterprise income tax rate of 20%. Our PRC subsidiaries can enjoy such reduced enterprise income tax rate if their financial data are determined to meet the standard of “small scale and low profit” enterprise when filing with the tax bureau.

 

Pursuant to the Enterprise Income Tax Law and its implementation rules, if a non-resident enterprise has not set up an organization or establishment in the PRC, or has set up an organization or establishment but the income derived has no actual connection with such organization or establishment, it will be subject to a withholding tax on its PRC-sourced income at a rate of 10%. Pursuant to the Arrangement between Mainland China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and Tax Evasion on Income, the withholding tax rate in respect to the payment of dividends by a PRC enterprise to a Hong Kong enterprise is reduced to 5% from a standard rate of 10% if the Hong Kong enterprise directly holds at least 25% of the PRC enterprise. Pursuant to the Notice of the State Administration of Taxation on the Issues concerning the Application of the Dividend Clauses of Tax Agreements, or Circular 81, a Hong Kong resident enterprise must meet the following conditions, among others, in order to enjoy the reduced withholding tax: (i) it must directly own the required percentage of equity interests and voting rights in the PRC resident enterprise; and (ii) it must have directly owned such percentage in the PRC resident enterprise throughout the 12 months prior to receiving the dividends. There are also other conditions for enjoying the reduced withholding tax rate according to other relevant tax rules and regulations.

 

In August 2015, the SAT promulgated the Administrative Measures for Non-Resident Taxpayers to Enjoy Treatments under Tax Treaties, or Circular 60, which became effective on November 1, 2015. Circular 60 provides that non-resident enterprises are not required to obtain pre-approval from the relevant tax authority in order to enjoy the reduced withholding tax rate. Instead, non-resident enterprises and their withholding agents may, by self-assessment and on confirmation that the prescribed criteria to enjoy the tax treaty benefits are met, directly apply the reduced withholding tax rate, and file necessary forms and supporting documents when performing tax filings, which will be subject to post-tax filing examinations by the relevant tax authorities. According to the Circular on Several Questions regarding the “Beneficial Owner” in Tax Treaties, or Circular 9, which was issued on February 3, 2018 by the SAT and became effective on April 1, 2018, when determining the applicant’s status of the “beneficial owner” regarding tax treatments in connection with dividends, interests or royalties in the tax treaties, several factors, including without limitation, whether the applicant is obligated to pay more than 50% of his or her income in twelve months to residents in third country or region, whether the business operated by the applicant constitutes the actual business activities, and whether the counterparty country or region to the tax treaties does not levy any tax or grant tax exemption on relevant incomes or levy tax at an extremely low rate, will be taken into account, and it will be analyzed according to the actual circumstances of the specific cases. Circular 9 further provides that applicants who intend to prove his or her status of the “beneficial owner” shall submit the relevant documents to the relevant tax bureau according to the Circular 60. Accordingly, ChinaCache (Hong Kong), our Hong Kong subsidiary, may be able to enjoy the 5% withholding tax rate for the dividends they receive from ChinaCache Beijing and Xin Run, our PRC subsidiaries, if it satisfies the conditions prescribed under Circular 81 and other relevant tax rules and regulations. However, according to Circular 81, Circular 60 and Circular 9, if the relevant tax authorities consider the transactions or arrangements we have are for the primary purpose of enjoying a favorable tax treatment, the relevant tax authorities may adjust the favorable withholding tax in the future.

 

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Under the PRC Enterprise Income Tax Law, enterprises that are established under the laws of foreign countries or regions and whose “de facto management bodies” are located within the PRC territory are considered PRC resident enterprises, and will be subject to the PRC enterprise income tax at the rate of 25% on their worldwide income. Under the implementation rules of the PRC Enterprise Income Tax Law, “de facto management bodies” are defined as the bodies that have material and overall management and control over the manufacturing and business operations, personnel and human resources, finances and treasury, and acquisition and disposition of properties and other assets of an enterprise. We cannot assure you that our Cayman Islands holding company, ChinaCache Holdings will not be deemed to be a PRC resident enterprise under the PRC Enterprise Income Tax Law and be subject to the PRC enterprise income tax at the rate of 25% on its worldwide income. It is also unclear whether the dividends ChinaCache Holdings receives from its PRC subsidiary, ChinaCache Beijing, will constitute dividends between “qualified resident enterprises” and therefore qualify for exemption from withholding tax, even if ChinaCache Holdings is deemed to be a “resident enterprise” for PRC enterprise income tax purposes. See “Item 3. Key Information — D. Risk Factors — Risks Related to Doing Business in China — Under China’s Enterprise Income Tax Law, we may be classified as a ‘resident enterprise’ of China. Such classification could result in unfavorable tax consequences to us and our non-PRC resident shareholders.”

 

In November 2011, the PRC Ministry of Finance and the SAT jointly issued two circulars setting out the details of the pilot VAT reform program, which change the charge of sales tax from business tax to VAT for certain pilot industries. The pilot VAT reform program initially applied only to the pilot industries in Shanghai, and have been expanded to eight additional regions, including, among others, Beijing, in 2012. According to two circulars jointly issued by the PRC Ministry of Finance and the SAT in May and December 2013, the pilot program has also been expanded nationwide. On April 29, 2014, the Ministry of Finance and the SAT issued the Circular on the Inclusion of Telecommunications Industry in the Pilot Collection of Value-added Tax in Lieu of Business Tax.  On March 23, 2016, the Ministry of Finance and the SAT issued the Circular on Comprehensively Promoting the Pilot Program of the Collection of Value-added Tax in Lieu of Business Tax.  Effective from May 1, 2016, the PRC tax authorities collect VAT in lieu of Business Tax on a trial basis within the territory of China, and in industries such as construction industries, real estate industries, financial industries, and living service industries. In November 2017, PRC State Counsel issued State Counsel Order 691 to abolish business tax, and issued the amendment to Interim Regulations of PRC Value Added Taxes, or the VAT Regulation, pursuant to which certain other industries are subject to VAT.

 

All services provided by ChinaCache Beijing and Beijing Jingtian and certain services provided by Beijing Blue I.T. fall within the scope of the pilot program, and beginning in September 2012, revenues generated by these services are subject to VAT instead of business tax. All services provided by Beijing Blue I.T. fall within the scope of the pilot program on telecom industry, and beginning from June 2014, revenues generated by these services are subject to VAT instead of business tax.

 

Inflation

 

In the last three years, inflation in China has impacted our results of operations in varying degrees. According to the National Bureau of Statistics of China, the year-over-year percent changes in the consumer price index for December 2015, 2016 and 2017 wer 6.1%, 6.8% and 5.8% respectively. We may be affected significantly if China experiences higher rates of inflation in the future.

 

Results of Operations

 

The following table sets forth a summary of our consolidated results of operations for the periods indicated both in absolute amount and as a percentage of our total net revenues. This information should be read together with our consolidated financial statements and related notes included elsewhere in this annual report.

 

   For the Year Ended December 31, 
   2015   2016   2017 
   RMB   %   RMB   %   RMB   USD   % 
   (in thousands, except percentages) 
Net revenues   1,353,627    100.0%   1,054,235    100.0%   852,568    131,037    100.0%
Cost of revenues(1)(2)   (1,041,412)   (76.9)%   (1,077,810)   (102.2)%   (781,822)   (120,164)   (91.7)%
Gross profit (loss)   312,215    23.1%   (23,575)   (2.2)%   70,746    10,873    8.3%
Other operating income (loss)   13,911    1.0%   (19,044)   (1.8)%   (19,483)   (2,994)   (2.3)%
Operating expenses(1)                                   
Sales and marketing expenses(1)   (115,621)   (8.5)%   (93,603)   (8.9)%   (61,770)   (9,494)   (7.2)%
General and administrative expenses(1)   (202,518)   (15.0)%   (256,007)   (24.3)%   (142,721)   (21,936)   (16.7)%
Provision (recovery of provision) for doubtful accounts receivable   3,892    0.3%   (9,010)   (0.8)%   (17,514)   (2,692)   (2.1)%
Transaction tax on assets transfer   (27,733)   (2.0)%                    
Research and development expenses(1)   (103,110)   (7.6)%   (104,018)   (9.9)%   (81,748)   (12,564)   (9.6)%
Impairment of long-lived assets           (399,094)   (37.9)%   (21,757)   (3,344)   (3.0)%
Impairment of long term investments           (18,240)   (1.7)%   (3,690)   (567)   (0.4)%
Total operating expenses   (445,090)   (32.8)%   (879,972)   (83.5)%   (329,200)   (50,597)   (39.0)%
Operating loss   (118,964)   (8.7)%   (922,591)   (87.5)%   (277,937)   (42,719)   (30.8)%
Interest income   4,618    0.3%   4,669    0.4%   1,430    220    (0.2)%
Interest expense   (13,158)   (1.0)%   (11,647)   (1.1)%   (18,665)   (2,869)   (2.2)%
Other income   2,991    0.2%   5,336    0.5%   (5,303)   (815)   (0.6)%
Foreign exchange gain, net   13,164    1.0%   14,209    1.4%   (11,043)   (1,697)   (1.3)%
Loss before income taxes   (111,349)   (8.2)%   (910,024)   (86.3)%   (311,518)   (47,880)   (36.1)%
Income tax benefit (expense)   22,614    1.7%   (4,229)   (0.4)%   (59,648)   (9,168)   (8.5)%
Net loss   (88,735)   (6.5)%   (914,253)   (86.7)%   (371,166)   (57,048)   (44.6)%
Net loss attributable to the noncontrolling interest   (44)   (0.0)%   (776)   (0.1)%   (2,005)   (308)   (0.3)%
Net loss attributable to ChinaCache   (88,691)   (6.5)%   (913,477)   (86.6)%   (369,161)   (56,740)   (44.3)%

 

 

(1)Includes share-based compensation expenses as follows:

 

   For the year ended December 31, 
   2015   2016   2017 
   RMB   RMB   RMB   US$ 
   (in thousands) 
Allocation of share-based compensation expenses:                
Cost of revenues   3,670    5,961    490    75 
Sales and marketing expenses   2,882    2,753    254    39 
General and administrative expenses   38,796    72,483    9,631    1,480 
Research and development expenses   3,258    3,828    562    86 
Total share-based compensation expense included in cost of revenues and operating expenses   48,606    85,025    10,937    1,680 

 

 

(2)Includes amount to a related party of nil, nil and nil for the years ended December 31, 2015, 2016 and 2017, respectively.

 

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Year Ended December 31, 2017 Compared to Year Ended December 31, 2016

 

Net Revenues

 

Our net revenues decreased by 19.1% from RMB1,054.2 million for the year ended December 31, 2016 to RMB852.6million (US$131million) for the year ended December 31, 2017. The decrease was primarily due to the interruption of our services we experienced caused by certain platform issues and intensified industry competition. The number of our active customers decreased by 10.5% from 1,999 as of December 31, 2016 to 1789 as of December 31, 2017.

 

Cost of Revenues

 

Our cost of revenues decreased by 27.5% from RMB1,077.8 million for the year ended December 31, 2016 to RMB781.8million (US$120.2million) for the year ended December 31, 2017. The decrease was primarily due to a decrease in our bandwidth, co-location and storage fees of RMB161.6 million (US$24.8 million),, a decrease in depreciation of network equipment and amortization of intangible assets of RMB124.8 million (US$19.2 million), a decrease of other cost of revenues of RMB10.7 million (US$ 1.6 million), and a decrease of our payroll and other compensation costs of network operations personnel of RMB20.2million (US$3.1 million).. Cost of revenues included share-based compensation expenses of RMB0.5 million (US$0.1 million) for the year ended December 31, 2017, compared to RMB6.0 million for the year ended December 31, 2016.

 

Cost of revenues was comprised of the following:

 

   For the Year Ended December 31, 
   2016   2017 
   RMB   RMB   US$ 
   (in thousands) 
Bandwidth, co-location and storage fees   842,726    681,134    104,688 
Depreciation of network equipment and amortization of intangible assets   134,079    9,244    1,421 
Payroll and other compensation costs of network operations personnel   76,702    56,455    8,677 
Other cost of revenues   24,303    34,989    5,378 
Total cost of revenues   1,077,810    781,822    120,164 

 

Other Operating Loss

 

Our other operating loss was RMB19.5 million (US$3 million) for the year ended December 31, 2017 which was due to the provision of late delivery penalties accrued upon our agreement with BFSMC,as compared to our other operating income of RMB19.0 million for the year ended December 31, 2016.

 

Operating Expenses

 

Our operating expenses decreased from RMB880.0 million for the year ended December 31, 2016 to RMB329.2 million (US$50.6 million) for the year ended December 31, 2017, We expect our operating expense, as percentage of sales revenue, will decrease going forward as we exercise stringent cost control to fend off margin erosion to CDN business as a result of pricing-centric competition in the market.

 

Sales and Marketing Expenses. Our sales and marketing expenses decreased by 34% from RMB93.6 million for the year ended December 31, 2016 to RMB61.8 million (US$9.5 million) for the year ended December 31, 2017. The year-over-year decrease was primarily due to improved cost control measures implemented throughout our company.

 

General and Administrative Expenses. Our general and administrative expenses decreased by 44% from RMB256.0 million for the year ended December 31, 2016 to RMB142.7 million (US$21.9million) for the year ended December 31, 2017, primarily due to

 

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·a decrease of RMB63.8 million (US$9.8 million) in share-based compensation expenses associated with newly granted restricted share units in 2017;
·a decrease of RMB20.4 million (US$3.1million) in general operating fees related to reduction of counsel fees;
·a decrease of RMB81.9 million (US$12.6 million) in salary expenses including option fees related to strategic hires in 2016; and
·a decrease of RMB10.8million (US$1.7 million) in depreciation of facilities and office equipment.

 

Provision for doubtful accounts receivable. Our provision for doubtful accounts receivable was RMB17.5 million (US$2.7 million) for the year ended December 31, 2017, as compared to RMB9.0 million for the year ended December 31, 2016. The increase from 2016 to 2017 was primarily due to the Company electing to adopt a more prudent doubtful account provision.

 

Research and Development Expenses. Our research and development expenses decreased by 21.4% from RMB104.0 million for the year ended December 31, 2016 to RMB81.7million (US$12.6 million) for the year ended December 31, 2017. The decrease was primarily due to a decrease of RMB10.8 million (US$1.7million) of down-sized R&D staff as a result of the Company’s integrating several development platforms, as well as RMB 12.6 million (US$1.9 million) in depreciation expense reduction from R&D related asset impairment.

 

Impairment of long-lived assets. We recorded the impairment of long-lived assets of RMB399.1 million and RMB21.8 million (US$3.3 million) for the years ended December 31, 2016 and December 31, 2017, respectively. The result was due to the deterioration of our operating results.

 

Impairment of long term investments. Our impairment of long term investments was RMB18.2 million and RMB3.7 million (US$0.6 million) for the years ended December 31, 2016 and December 31, 2017, respectively.

 

Operating Loss

 

As a result of the above, operating loss for the year ended December 31, 2017 was RMB 277.9 million (US$42.7 million), as compared to operating loss for the year ended December 31, 2016 of RMB922.6 million.

 

Income Tax Expense

 

We had income tax expense of RMB59.6 million (US$9.2 million) for the year ended December 31, 2017, as compared to income tax benefit of RMB4.2 million for the year ended December 31, 2016. Our income tax expense for the year ended December 31, 2017 was mainly composed of RMB29.4 million (US$4.5 million) of current income tax expenses and RMB30.2million (US$4.6 million) of deferred tax expenses.

 

Net Loss

 

As a result of the above, we had net loss of RMB RMB371.2million (US$57.0 million) for the year ended December 31, 2017, as compared to a net loss of RMB914.3 million for the year ended December 31, 2016.

 

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

 

Net Revenues

 

Our net revenues decreased by 22.1% from RMB1,353.6 million for the year ended December 31, 2015 to RMB1,054.2 million for the year ended December 31, 2016. The decrease was primarily due to the interruption of our services we experienced caused by certain platform issues and intensified industry competition. The number of our active customers decreased by 7.8% from 2,169 as of December 31, 2015 to 1,999 as of December 31, 2016.

 

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Cost of Revenues

 

Our cost of revenues increased by 3.5% from RMB1,041.4 million for the year ended December 31, 2015 to RMB1,077.8 million for the year ended December 31, 2016. The increase was primarily due to an increase in our bandwidth, co-location and storage fees of RMB49.2 million, and an increase in depreciation of network equipment and amortization of intangible assets of RMB0.2 million, partially offset by a decrease of other cost of revenues of RMB8.4 million , and a decrease of our payroll and other compensation costs of network operations personnel of RMB4.6 million. Cost of revenues included share-based compensation expenses of RMB6.0 million for the year ended December 31, 2016, compared to RMB3.7 million for the year ended December 31, 2015.

 

Cost of revenues was comprised of the following:

 

   For the Year Ended December 31, 
   2015   2016 
   RMB   RMB 
   (in thousands) 
Bandwidth, co-location and storage fees   793,498    842,726 
Depreciation of network equipment and amortization of intangible assets   133,854    134,079 
Payroll and other compensation costs of network operations personnel   81,309    76,702 
Other cost of revenues   32,751    24,303 
Total cost of revenues   1,041,412    1,077,810 

 

Other Operating Loss

 

Our other operating loss was RMB19.0 million for the year ended December 31, 2016, which was due to the provision of late delivery penalties accrued upon our agreement with BFSMC, as compared to our other operating income of RMB13.9 million for the year ended December 31, 2015.

 

Operating Expenses

 

Our operating expenses increased from RMB445.1 million for the year ended December 31, 2015 to RMB880.0 million for the year ended December 31, 2016, mainly attributable to our losses from impairment of long-lived assets in 2016. We expect our operating expenses related to daily operation, to increase as we expand our business.

 

Sales and Marketing Expenses. Our sales and marketing expenses decreased by 19.0% from RMB115.6 million for the year ended December 31, 2015 to RMB93.6 million for the year ended December 31, 2016. The year-over-year decrease was primarily due to improved cost control measures implemented throughout our company.

 

General and Administrative Expenses. Our general and administrative expenses increased by 26.4% from RMB202.5 million for the year ended December 31, 2015 to RMB256.0 million for the year ended December 31, 2016, primarily due to

 

·an increase of RMB33.7 million in share-based compensation expenses associated with newly granted restricted share units in 2016;
·an increase of RMB12.2 million in professional fees related to transactional and other consulting services;
·an increase of RMB4.3 million in salary expenses related to strategic hires; and
·an increase of RMB2.3 million in depreciation of facilities and office equipment.

 

Provision for doubtful accounts receivable. Our provision for doubtful accounts receivable was RMB9.0 million for the year ended December 31, 2016, as compared to negative RMB3.9 million for the year ended December 31, 2015. The increase from 2015 to 2016 was primarily due to reversals of provision for doubtful accounts receivable from certain customers for the year ended December 31, 2015.

 

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Transaction tax on assets transfer. Our transaction tax on assets transfer was RMB27.7 million for the year ended December 31, 2015, which was related to an asset transaction within our company, and we did not incur any transaction tax on assets transfer for the year ended December 31, 2016.

 

Research and Development Expenses. Our research and development expenses increased by 0.9% from RMB103.1 million for the year ended December 31, 2015 to RMB104.0 million for the year ended December 31, 2016. The increase was primarily due to an increase of RMB2.7 million in salary expenses, including share-based compensation expenses, for continued efforts in online service solutions development.

 

Impairment of long-lived assets. We recorded the impairment of long-lived assets of RMB399.1 million for the year ended December 31, 2016 due to the deterioration of our operating results. We did not incur the impairments of long-lived assets in the year ended December 31, 2015.

 

Impairment of long term investments. Our impairment of long term investments was nil and RMB18.2 million for the year ended December 31, 2015 and 2016, respectively.

 

Operating Loss

 

As a result of the above, operating loss for the year ended December 31, 2016 was RMB922.6 million, as compared to operating loss for the year ended December 31, 2015 of RMB119.0 million.

 

Income Tax Expense

 

We had income tax expense of RMB4.2 million for the year ended December 31, 2016, as compared to income tax benefit of RMB22.6 million for the year ended December 31, 2015. Our income tax expense for the year ended December 31, 2016 was mainly composed of RMB1.1 million of current income tax expenses and RMB3.1 million of deferred tax expenses.

 

Net Loss

 

As a result of the above, we had net loss of RMB914.3 million for the year ended December 31, 2016, as compared to a net loss of RMB88.7 million for the year ended December 31, 2015.

 

B.Liquidity and Capital Resources

 

Cash Flows and Working Capital

 

To date, we have financed our operations primarily through cash flows from bank borrowings, operating activities, and the proceeds from our initial public offering in 2010 and subsequent private placement in 2014. In October 2010, we completed our initial public offering in which we issued and sold 5,923,247 ADSs representing 94,771,952 ordinary shares, resulting in net proceeds to us of approximately US$76.6 million. In March 2014, we issued and sold an aggregate of 53,855,569 ordinary shares, represented by 3,365,973 ADSs, to a group of institutional investors affiliated with Wellington Management Company, LLP for an aggregate purchase price of approximately US$55.0 million.

 

As of December 31, 2017, we had RMB106.7million (US$16.4million) in cash and cash equivalents.

 

Our board and management are now reviewing strategy and priorities for the next 12 months. We will be focusing on a number of business initiatives and strategies to improve cash revenue from operation assets and operation efficiency, together with obtaining credit facilities. First, we will focus on generating cash revenue from the improvement of  CDN operations to increase our liquidity and reinvest in potential project pipeline. Second, we plan to use the cash inflows to be funded by the credit facilities to support and complete our cloud infrastracture. Third, we will explore strategies to enhance the company’s competitiveness in high-level data center operation and service. . Lastly, we plan to better manage our selling and general administrative expenses to improve operation efficiency.

 

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We believe that our current cash and cash equivalents and anticipated cash flow from operations will be sufficient to meet our anticipated cash needs, including our cash needs for working capital and capital expenditures, for at least the next 12 months. We may, however, require additional cash due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our existing cash is insufficient to meet our requirements, we may seek to sell additional equity securities or debt securities or borrow from banks. We cannot assure you that financing will be available in the amounts we need or on terms acceptable to us, if at all. The sale of additional equity securities, including convertible debt securities, would dilute our shareholders. The incurrence of debt would divert cash from working capital and capital expenditures to service debt obligations and could result in operating and financial covenants that would restrict our operations and our ability to pay dividends to our shareholders. If we are unable to obtain additional equity or debt financing as required, our business, operations and prospects may suffer. See “Item 3. Risk Factors — D. Risks Related to Our Business and Industry — We have incurred losses in the past and may incur losses in the future. There is substantial doubt about our ability to continue as a going concern.”

 

Although we consolidate the results of Beijing Blue I.T. and Beijing Jingtian and their respective subsidiaries, our access to the cash balances or future earnings of these entities is only through our contractual arrangements with Beijing Blue I.T. and Beijing Jingtian and their respective shareholders. See “Item 4. Information on the Company —C. Organizational Structure — Contractual Arrangements with Our Consolidated Variable Interest Entities.” For restrictions and limitations on liquidity and capital resources as a result of our corporate structure, see “—Holding Company Structure.”

 

The following table sets forth a summary of our cash flows for the periods indicated:

 

   For the Year Ended December 31, 
   2015   2016   2017 
   RMB   RMB   RMB   US$ 
   (in thousands) 
Net cash provided by (used in) operating activities   770,476    (187,180)   (99,041)   (15,220)
Net cash used in investing activities   (432,349)   (202,390)   (88,295)   (13,724)
Net cash provided by (used in) financing activities   (106,797)   (84,645)   149,007    22,902 
Net increase (decrease) in cash and cash equivalents   231,330    (474,215)   (39,329)   (6,045)
Effect of foreign exchange rate changes on cash   9,009    14,617    (10,584)   (1,628)
Cash and cash equivalents at beginning of the period   375,879    616,218    156,620    24,072 
Cash and cash equivalents at end of the period   616,218    156,620    106,709    16,401 

 

Operating Activities

 

Net cash used in operating activities was RMB99.0 million (US$15.2million) for the year ended December 31, 2017. Net cash used in operating activities for the year ended December 31, 2017 reflects a net loss of RMB371.2 million (US$57.0 million), adjusted by reconciling items in the total amount of RMB272.1 million (US$41.9 million), which primarily include depreciation of property and equipment of RMB9.1 million (US$1.4 million), share-based compensation expenses of RMB10.9 million (US$1.7 million), impairment of long-lived assets of RMB21.8 million (US$3.3 million), impairment of long term investments of RMB3.7 million (US$0.6 million), foreign exchanges loss of RMB11.0 million (US$1.7 million), allowance for doubtful accounts of RMB17.5 million (US$2.7million), amortization of intangible assets and land use right of RMB2.4 million (US$0.4million), deferred tax expense of RMB30.2million (US$4.6 million), loss from disposal of property and equipment of RMB0.6 million (US$0.1 million) and interest expense of RMB4.3million (US$0.7 million). Additional major factors that affected operating cash flows for the year ended December 31, 2017 include: (i) an increase of RMB60.9 million (US$9.4 million) in accounts payable in connection with accrued bandwidth, co-location and storage expenses to the carriers; (ii) an increase of accrued expenses and other payables of RMB61.4 million (US$9.4million) primarily due to the decrease in payables for purchase of property and equipment; (iii) a increase of RMB14.0 million (US$2.2 million) in accounts receivable primarily due to improved accounts receivable collection; (iv) an increase of RMB58.3 million (US$9.0 million) in long term deposits and other non-current assets; (v) a decrease of RMB26.5 million (US$4.1million) in prepaid expense and other current assets; and (vi) a decrease of RMB4.6 million (US$0.7 million) in Deferred government grant.

 

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Net cash used in operating activities was RMB187.2 million for the year ended December 31, 2016. Net cash used in operating activities for the year ended December 31, 2016 reflects a net loss of RMB914.3 million, adjusted by reconciling items in the total amount of RMB659.3 million, which primarily include depreciation of property and equipment of RMB155.2 million, share-based compensation expenses of RMB85.0 million , impairment of long-lived assets of RMB399.1 million, impairment of long term investments of RMB18.2 million, foreign exchanges gain of RMB14.2 million, allowance for doubtful accounts of RMB9.0 million, amortization of intangible assets and land use right of RMB3.9 million, gain from sale of short term investments of RMB3.6 million, deferred tax expense of RMB3.1 million, loss from disposal of property and equipment of RMB2.0 million and interest expense of RMB1.4 million. Additional major factors that affected operating cash flows for the year ended December 31, 2016 include: (i) an increase of RMB101.4 million in accounts payable in connection with accrued bandwidth, co-location and storage expenses to the carriers; (ii) a decrease of accrued expenses and other payables of RMB73.2 million primarily due to the decrease in payables for purchase of property and equipment; (iii) a decrease of RMB41.8 million in accounts receivable primarily due to improved accounts receivable collection; (iv) an increase of RMB1.2 million in long term deposits and other non-current assets; (v) an increase of RMB1.1 million in prepaid expense and other current assets; and (vi) an increase of RMB1.1 million in accrued employee benefits.

 

Net cash provided by operating activities was RMB770.5 million for the year ended December 31, 2015. Net cash provided by operating activities for the year ended December 31, 2015 reflects net loss of RMB88.7 million, adjusted by reconciling items in the total amount of RMB172.9 million, which primarily include depreciation of property and equipment of RMB153.3 million, share-based compensation expenses of RMB48.6 million, deferred tax benefit of RMB25.3 million, foreign exchanges gain of RMB9.0 million, amortization of intangible assets and land use right of RMB4.3 million, and allowance for doubtful accounts of RMB3.9 million. Additional major factors that affected operating cash flows for the year ended December 31, 2015 include: (i) an increase of accrued expenses and other payables of RMB789.4 million primarily due to the increase in advance from certain buyers of part of our cloud infrastructure; (ii) a decrease of RMB80.3 million in accounts receivable primarily due to improved accounts receivable collection; (iii) an increase of RMB77.4 million in prepaid expense and other current assets; (iv) a decrease of RMB50.2 million in accounts payable in connection with accrued bandwidth, co-location and storage expenses to the carriers; (v) an increase of RMB35.0 million in long term deposits and other non-current assets; (vi) a decrease of RMB12.6 million in deferred government grant received; and (vii) a decrease of RMB9.3 million in income tax payable.

 

Investing Activities

 

Net cash used in investing activities was RMB89.3million (US$13.7million) for the year ended December 31, 2017. Net cash used in investing activities for the year ended December 31, 2017 resulted primarily from (i) cash paid for cloud infrastructure construction in progress of RMB73.7 million (US$11.3 million); ; (ii) cash paid for purchases of property and equipment and intangible assets of RMB15.2 million (US$2.3 million); and (iii) cash paid for long term investments of RMB0.4 million (US$0.1 million); and (iv) cash received from sales of short term investment of RMB10.0 million (US$1.5 million).

 

Net cash used in investing activities was RMB202.4 million for the year ended December 31, 2016. Net cash used in investing activities for the year ended December 31, 2016 resulted primarily from (i) cash paid for cloud infrastructure construction in progress of RMB222.3 million; (ii) cash paid for purchases of property and equipment and intangible assets of RMB59.2 million (US$8.5 million); and (iii) cash paid for long term investments of RMB2.2 million; partially offset by (i) cash received from sales of short term investment of RMB53.6 million; and (ii) cash received from sales of short term investment of RMB26.8 million;

 

Net cash used in investing activities was RMB432.3 million for the year ended December 31, 2015. Net cash used in investing activities for the year ended December 31, 2015 resulted primarily from (i) cash paid for cloud infrastructure construction in progress of RMB290.3 million; (ii) cash paid for purchases of property and equipment of RMB90.2 million; and (iii) cash paid for short term investments of RMB50.0 million.

 

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Financing Activities

 

Our financing activities primarily consist of sale of our ADSs, capital contributions and borrowings from commercial banks.

 

Net cash used in financing activities was RMB411.7 million (US$63.3 million) for the year ended December 31, 2017. Net cash used in financing activities for the year ended December 31, 2017 resulted primarily from (i) proceeds from bank borrowings of RMB411.7 million (US$63.3 million).

 

Net cash used in financing activities was RMB84.6 million for the year ended December 31, 2016. Net cash used in financing activities for the year ended December 31, 2016 resulted primarily from (i) payment of capital lease obligation of RMB74.5 million; (ii) payment for repurchase of ordinary shares of RMB39.4 million; and (iii) repayment of bank borrowings of RMB7.7 million (US$1.1 million); partially offset by (i) proceeds from bank borrowings of RMB29.3 million; and (ii) proceeds from employee share options exercised of RMB7.6 million.

 

Net cash used in financing activities was RMB106.8 million for the year ended December 31, 2015. Net cash used in financing activities for the year ended December 31, 2015 resulted primarily from (i) payment for repurchase of ordinary shares of RMB93.9 million; (ii) repayment of bank borrowings of RMB67.2 million; and (iii) payment of capital lease obligation of RMB32.2 million, partially offset by (i) changes in restricted cash of RMB68.2 million; and (ii) proceeds from employee share options exercised of RMB17.0 million.

 

Holding Company Structure

 

Overview

 

We are a holding company with no material operations of our own. We conduct our operations in China through a series of contractual arrangements between our company, ChinaCache Beijing, which is our wholly-owned PRC subsidiary, Beijing Blue I.T. and Beijing Jingtian, which are our consolidated variable interest entities in China, and the respective shareholders of Beijing Blue I.T. and Beijing Jingtian. See “Item 4. Information on the Company — C. Organizational Structure — Contractual Arrangements with Our Consolidated Variable Interest Entities” for a summary of these contractual arrangements. Beijing Blue I.T. contributed to 77.1%, 61.9% and 55.1% of our total net revenues in 2015, 2016 and 2017, respectively. Beijing Jingtian’s contribution to our total net revenues in 2015, 2016 and 2017 was immaterial.

 

Conducting our operations through contractual arrangements with our consolidated variable interest entities in China entails a risk that we may lose effective control over our consolidated variable interest entities, which may result in our being unable to consolidate their financial results with our results and may impair our access to their cash flow from operations and thereby reduce our liquidity. See “Item 3. Key Information — D. Risk Factors — Risks Related to Our Corporate Structure” for more information, including the risk factors titled “If the PRC government finds that the arrangements that establish the structure for operating our business do not comply with PRC government restrictions on foreign investment in the telecommunications business, we could be subject to severe penalties” and “We rely on contractual arrangements with Beijing Blue I.T. and Beijing Jingtian and their respective shareholders for our China operations, which may not be as effective as direct ownership in providing operational control.”

 

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Dividend Distributions

 

As a holding company, our ability to pay dividends and other cash distributions to our shareholders depends solely upon dividends and other distributions paid to us by our PRC subsidiaries ChinaCache Beijing and Xin Run. The amount of dividends paid by ChinaCache Beijing to us depends solely on the service fees paid to ChinaCache Beijing from our consolidated variable interest entities, Beijing Blue I.T. and Beijing Jingtian. In 2015, 2016 and 2017, the aggregate amount of service fees that ChinaCache Beijing charged Beijing Blue I.T. and Beijing Jingtian was RMB83.5 million, RMB46.7 million and RMB32.1 million (US$4.9 million), respectively, which accounted for 6.2%, 4.4% and 3.8%, respectively, of our total net revenues.

 

Under PRC law, ChinaCache Beijing, Xin Run and each of our consolidated variable interest entities in China is required to set aside at least 10% of its after-tax profits each year, if any, to fund a statutory reserve until such reserve reaches 50% of its registered capital. Although the statutory reserves can be used, among other ways, to increase the registered capital and eliminate future losses in excess of retained earnings of the respective companies, the reserve funds are not distributable as cash dividends except in the event of liquidation. ChinaCache Beijing and Xin Run are permitted to pay dividends to us only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations.

 

Pursuant to contractual arrangements that ChinaCache Beijing has with each of Beijing Blue I.T. and Beijing Jingtian, the earnings and cash of each of Beijing Blue I.T. and Beijing Jingtian (including dividends received from their respective subsidiaries) are used to pay service fees in RMB to ChinaCache Beijing, in the manner and amount set forth in these agreements.

 

After paying the withholding taxes applicable to ChinaCache Beijing and Xin Run’s revenue and earnings, making appropriations for its statutory reserve requirement and retaining any profits from accumulated profits, the remaining net profits of ChinaCache Beijing and Xin Run would be available for distribution to us, ChinaCache Beijing and Xin Run’s shareholder, although we have not, and do not have such plan at present to, make such distributions. As of December 31, 2017, the amount of the net assets of ChinaCache Beijing, Xin Run and our consolidated variable interest entities, which includes the paid-in-capital and statutory reserves of ChinaCache Beijing and Xin Run and the equity of our consolidated variable interest entities which were restricted due to statutory reserve requirements and other applicable laws and regulations, and thus not available for distribution, was in aggregate a deficit of RMB767.2 million (US$117.9 million). We do not believe that these restrictions on the distribution of our net assets will have a significant impact on our ability to timely meet our financial obligations in the future. See “Item 3. Key Information — D. Risk Factors — Risks Related to Doing Business in China—We rely principally on dividends paid by our operating subsidiary to fund cash and financing requirements, and limitations on the ability of our operating subsidiary to make payments to us could have a material adverse effect on our ability to conduct our business and fund our operations” for more information.

 

Furthermore, cash transfers from ChinaCache Beijing and Xin Run to our subsidiaries outside of China are subject to PRC government control of currency conversion. Restrictions on the availability of foreign currency may affect the ability of ChinaCache Beijing, Xin Run and our consolidated variable interest entities to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency denominated obligations. See “Item 3. Key Information — D. Risk Factors — Risks Related to Doing Business in China—Governmental control of currency conversion may limit our ability to utilize our revenues.”

 

Capital Expenditures

 

We had capital expenditures of RMB417.8 million, RMB356.0 million and RMB162.8 million (US$25.0 million) in 2015, 2016 and 2017, respectively, representing 30.9%, 33.8% and 19.1% of our total net revenues for such years, respectively. Our capital expenditures were primarily for the purchase of land use right, servers, other property and equipment and certain intangible assets and cash paid for cloud infrastructure construction in progress, for our business. Our capital expenditures have been primarily funded by net cash provided by financing activities. We expect that our capital expenditures in 2018 will increase from 2017 as we will focus on completing the cloud infrastructure to prepare the company’s expanded IDC business.

 

C.Research and Development

 

Our internal research and development team consisted of 271 engineers as of December 31, 2017, representing approximately 44% of our work force. Our senior management team leads our research and development efforts and sets strategic initiatives to improve our services and products, focusing on efforts to sustain our technology leadership, raise our productivity and enhance the competitiveness of our services. We devote our market-oriented research and development efforts to focus on bringing innovative services and solutions to the market quickly. As of the date of this annual report, we have 55 PRC patents, two U.S. patents, three PRC patent applications and 23 software copyright registrations in China relating to the technologies used in our business.

 

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Our research and development expenses primarily consist of payroll and related personnel costs, including share-based compensation expenses. We incurred RMB103.1 million, RMB104.0 million and RMB81.7 million (US$12. 6 million) of research and development expenses in 2015, 2016 and 2017, 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 year ended December 31, 2017 that are reasonably likely to have a material adverse 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.Off-Balance Sheet Arrangements

 

Other than the operating lease obligations and purchase commitments set forth in the table below, we have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder’s equity, or that are not reflected in our consolidated 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.

 

E.Tabular Disclosure of Contractual Obligations

 

The following table sets forth our contractual obligations and commercial commitments as of December 31, 2017:

 

   Payment Due by Period 
   Total   Less than 1
year
   1-3 years   3-5 years   More than 5
years
 
   (in thousands of RMB) 
Capital lease obligations(1)   45,026    43,587    1,439    -    - 
Operating lease obligations(2)   39,767    20,458    19,309    -    - 
Purchase commitments(3)   188,203    188,203    -    -    - 
Total   272,996    252,248    20,748         

 

 

(1)Capital lease obligations refers to our obligations for leasing certain computer equipment and optical fibers, and the total amount of interest to be paid is RMB1.0 million (US$0.1 million).

 

(2)Operating lease obligations refers to our future minimum lease payments for office space under non-cancelable operating leases.

 

(3)Purchase commitments refers to our commitment to purchase bandwidth and cloud infrastructure from our bandwidth and construction providers.

 

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.

 

Directors and Executive Officers   Age   Position/Title
Song Wang   54   Chairman and Chief Executive Officer
Jean Xiaohong Kou   56   Director and Senior Vice President
Yunjie Liu   75   Director
Fuya Zheng   53   Director
Bang Zhang   50   Director
Guangsheng Meng   50   Chief Financial Officer

 

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Mr. Song Wang is our co-founder, chairman of our board of directors and chief executive officer. He co-founded our company in 1998. Mr. Wang oversees the strategic direction of the company and has transformed the company from a small start-up to an established and leading content and application delivery total solution provider in China. Prior to co-founding our company, Mr. Wang served as the chief representative of Business 2000 Resources Beijing Office from 1996 to 1998. Prior to that, Mr. Wang served as Greater China senior counsel for Boston Technology, Inc. from 1995 to 1996. Mr. Wang worked for Northern China Computer Technologies Institute as a computer-aided design engineer from 1987 to 1995. Mr. Wang studied French at the China Foreign Affairs University and attended EMBA training courses on top manager management at the Guanghua School of Management, Peking University. Mr. Wang is the husband of Ms. Jean Xiaohong Kou, our co-founder, director and senior vice president.

 

Ms. Jean Xiaohong Kou is our co-founder, director and senior vice president. She co-founded our company in 1998. Ms. Kou is in charge of developing human resources strategy, business development functionality and financial strategy development, and supervises day-to-day administrative matters. Prior to co-founding our company, Ms. Kou worked for seven years at Town Sky Technology Group, an information technology company based in Hong Kong, as senior sales manager for Greater China area. Ms. Kou studied computer applications at Beijing Jiaotong University and attended training courses on human resources and financial management at the Guanghua School of Management, Peking University. Ms. Kou is the wife of Mr. Song Wang, our co-founder, chairman of the board of directors and chief executive officer.

 

Mr. Yunjie Liu has served as our director since October 2005. Our board of directors has determined that Mr. Liu satisfies the “independence” requirements of Rule 5605 of Nasdaq Stock Market Rules and Rule 10A-3 under the Securities Exchange Act. Mr. Liu has extensive experience in telecommunications technology and management, particularly in the area of data communications. He currently serves as chief scientist of the Technology Committee of China United Network Communications (Group) Limited, formerly known as China United Telecommunications Corporation (Group) Limited, or Unicom Group. From April 1999 to December 2003, Mr. Liu served as the Chief Engineer and later vice president of Unicom Group. From May 2000 to January 2004, Mr. Liu was vice president of China Unicom (Hong Kong) Limited (formerly known as China Unicom Limited), a company listed on the New York Stock Exchange. Unicom Group is an indirect controlling shareholder of China Unicom (Hong Kong) Limited. Mr. Liu served as a non-executive director of China Unicom (Hong Kong) Limited from February 2004 to April 2006. Prior to joining Unicom Group, Mr. Liu held various high-ranking positions at the Ministry of Posts and Telecommunications, including director general of the Institute of Data Communication Research and president of the Institute of Postal. Mr. Liu serves as an independent director of Telling Telecommunication Holding Co., Ltd., a Shenzhen Stock Exchange-listed company which is primarily engaged in the distribution and repairing of communication products in China, and as the director-general of the China (Nanjing) Future Network Industry Innovation Center. Mr. Liu received a bachelor’s degree in physics from Peking University and is a member of the Chinese Academy of Engineering.

 

Mr. Fuya Zheng, aged 53, has served as our director since February 2018. He was an independent non-executive director of Yindge Gases Group Company Limited from September 2009 to September 2017. Mr. Zheng was a director of Cogo Group, Inc., a company listed on the NASDAQ and has since January 1, 2008 served as the chief financial officer of the same company. Mr. Zheng was previously vice president of travel service at eLong, Inc., one of the leading online travel service companies in China and listed on the NASDAQ, where Mr. Zheng was responsible for the overall operation of eLong Inc.’s travel services. Mr. Zheng has more than ten years of experience in the service industry. Mr. Zheng received a Bachelor of Business Administration majoring in accounting from City University of New York in 1994.

 

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Mr. Bang Zhang has served as our director since July 2017. Our board of directors has determined that Mr. Zhang satisfies the “independence” requirements of Rule 5605 of Nasdaq Stock Market Rules and Rule 10A-3 under the Securities Exchange Act. Mr. Zhang has been the chief financial officer of DG Group, a social network and media company, since 2016. Prior to that, he served as the chief financial officer and senior vice president of Golden Jaguar, one of the largest buffet restaurant chains in China, from 2013 to 2015. During 2009 to 2013, Mr. Zhang was the senior vice president and the chief financial officer of Mecox Lane (Nasdaq: MCOX). Prior to joining Mecox Lane, Bang Zhang worked at McDonald’s China for more than 15 years with his last role as China chief financial officer. Before joining McDonald’s, Mr. Zhang worked for couple other U.S. and European companies and China’s state-owned enterprises as a financial controller and accounting manager for 11 years. Mr. Zhang received his MBA degree from Jinan University in 2001.

 

Mr. Guangsheng Meng joined the Company as its Senior Vice President in January 2018, and was subsequently appointed as Chief Financial Officer on April 20, 2018. With over two decades of senior financial management record, Mr. Meng is experienced in leading and advising both public and private companies through complex restructurings, financial engineering and capital market transactions. From 2009 to 2017, Mr. Meng was the Chief Financial Officer of China Gerui Advanced Materials Group Limited. Prior to that, Mr. Meng served as Senior Vice President/Chief Financial Officer with A-Power Energy Generation Systems Ltd., Terex (China) Ltd., Shell (China) Ltd., Koch Materials (China) Company (a subsidiary of Koch Industries Inc.), etc. A Certified Public Accountant, Mr. Meng received his Master of Business Administration in Finance from Georgetown University in 1997 and is fluent in English and Mandarin.

 

Employment Agreements

 

We have entered into employment agreements with each of our executive officers. Under these agreements, each of our senior executive officers is employed for a specified time period. We may terminate employment for cause, at any time, without advance notice or remuneration, for certain acts of the executive officer, such as conviction or plea of guilty to a felony or any crime involving moral turpitude, negligent or dishonest acts to our detriment, or misconduct or a failure to perform agreed duties. In such case, the executive officer will not be entitled to receive payment of any severance benefits or other amounts by reason of the termination, and the executive officer’s right to all other benefits will terminate, except as required by any applicable law. We may also terminate an executive officer’s employment without cause upon one-month advance written notice. In such case of termination by us, we are required to provide compensation to the executive officer, including severance pay, as expressly required by the applicable law of the jurisdiction where the executive officer is based. The executive officer may terminate the employment at any time with a one-month advance written notice, if there is any significant change in the executive officer’s duties and responsibilities inconsistent in any material and adverse respect with his or her title and position or a material reduction in the executive officer’s annual salary before the next annual salary review, or if otherwise approved by the board of directors.

 

Each executive officer has agreed to hold, both during and after the termination or expiry of his or her employment agreement, in strict confidence and not to use, except as required in the performance of his or her duties in connection with the employment, any of our confidential information or trade secrets, any confidential information or trade secrets of our clients or prospective clients, or the confidential or proprietary information of any third party received by us and for which we have confidential obligations. The executive officers have also agreed to disclose in confidence to us all inventions, designs and trade secrets which they conceive, develop or reduce to practice and to assign all right, title and interest in them to us, and assist us in obtaining patents, copyrights and other legal rights for these inventions, designs and trade secrets.

 

In addition, each executive officer has agreed to be bound by non-competition and non-solicitation restrictions during the term of his or her employment and for one year following the last date of employment. Specifically, each executive officer has agreed not to (i) approach our clients, customers or contacts or other persons or entities introduced to the executive officer for the purpose of doing business with such persons or entities that will harm our business relationships with these persons or entities; (ii) assume employment with or provide services to any of our competitors, or engage, whether as principal, partner, licensor or otherwise, any of our competitors; or (iii) seek directly or indirectly, to solicit the services of any of our employees who is employed by us on or after the date of the executive officer’s termination, or in the year preceding such termination.

 

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B.Compensation

 

For the fiscal year ended December 31, 2017, the aggregate compensation we paid to our executive officers was approximately RMB9.5million (US$1.5 million) and the aggregate compensation we paid to our non-executive directors for the same period was approximately RMB1.2million (US$0.2 million). For the same period, we paid RMB0.3million (approximately US$48000 for pension, retirement, medical insurance or other similar benefits for our executive officers. Other than the amounts stated above, no pension, retirement or similar benefits has been set aside or accrued for our executive officers or directors.

 

Stock Incentive Plans

 

In October 2008, May 2009, May 2010 and July 2011, we adopted our 2007 Stock Incentive Plan, 2008 Stock Incentive Plan, 2010 Stock Incentive Plan and 2011 Share Incentive Plan, respectively. These four plans are referred to herein as the “Stock Incentive Plans.” The Stock Incentive Plans were adopted to attract and retain the best available personnel, provide additional incentives to employees, directors and consultants and promote the success of our business. The Stock Incentive Plans permit the grant of options to purchase our ordinary shares, share appreciation rights, restricted share units, restricted share units, dividend equivalent rights and other instruments as deemed appropriate by the administrator under the plans. The maximum aggregate number of ordinary shares that may be issued pursuant to all awards under the 2007, 2008, 2010 and 2011 plans is 14,000,000 shares, 8,600,000 shares, 9,000,000 shares and 22,000,000 shares, respectively. On July 2, 2012, our shareholders approved amendments to our 2011 plan which provide, in effect, that the maximum aggregate number of ordinary shares that may be issued pursuant to all awards, or the Award Pool, under the 2011 plan shall be equal to five percent of the total issued and outstanding ordinary shares as of July 2, 2012; provided that, the ordinary shares reserved in the Award Pool shall be increased automatically if and whenever the unissued ordinary shares reserved in the Award Pool accounts for less than one percent of the total then issued and outstanding ordinary shares, as a result of which increase the unused ordinary shares reserved in the Award Pool immediately after each such increase shall equal to five percent of the then issued and outstanding ordinary shares.

 

As of March 31, 2018, we had granted options to purchase 14,000,000 ordinary shares under our 2007 Stock Incentive Plan, options to purchase 8,600,000 ordinary shares under our 2008 Stock Incentive Plan, options to purchase 9,099,872 ordinary shares under our 2010 Stock Incentive Plan, and options to purchase 49,017,808 ordinary shares and 76,634,512 restricted share units under our 2011 Share Incentive Plan.

 

The following table summarizes, as of March 31, 2018, the stock options granted under our Stock Incentive Plans to our directors and executive officers, directors and executive officers as a group and other individuals as a group.

 

   Option
Granted
   Exercise Price
(US$/Share)
   Vesting
Commencement
Date
  Date of Grant  Date of
Expiration
Song Wang   2,400,000    0.24   April 1, 2011  June 20, 2011  June 19, 2021
    1,600,000    0.24   January 1, 2013  July 8, 2013  July 7, 2023
    320,000    0.24   January 1, 2014  July 8, 2013  July 7, 2023
    1,692,608    0.5294   January 1, 2014  December 23, 2014  December 22, 2024
    8,960,000    0.0725   January 1, 2016  December 13, 2017  December 12, 2027
Jean Xiaohong Kou   430,000    0.24   January 1, 2013  July 8,2013  July 7, 2023
    160,000    0.24   January 1, 2014  July 8,2013  July 7, 2023
Yunjie Liu   *    0.01   April 1, 2007  March 31, 2007  March 30, 2016
    *    0.01   October 1, 2007  September 30, 2007  September 29, 2016
    *    0.24   October 1, 2013  July 8, 2013  July 7, 2023
Fuya Zheng             
Bang Zhang             
Guangsheng Meng             
Directors and officers as a group   16,922,608    0.01 to 0.5294          
Other individuals as a group(1)   63,795,072    0.01 to 0.5294          

 

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The following table summarizes, as of the March 31, 2018, the restricted share units granted under our Stock Incentive Plans to our directors and executive officers, directors and executive officers as a group and other individuals as a group.

 

   Restricted Share
Units Granted
   Vesting
Commencement Date
  Date of
Grant
Song Wang   960,000   January 1, 2013  July 8, 2013
    1,600,000   January 1, 2014  December 23, 2014
    3,680,000   January 1,2015  December 11,2015
    11,440,000   January 1,2015  December 11,2015
    7,920,000   December 1, 2017  December 13, 2017
Jean Xiaohong Kou   320,000   January 1, 2013  July 8, 2013
    1,646,304   January 1, 2014  December 23, 2014
    9,493,328   January 1,2015  December 11,2015
    1,645,328   January 1,2015  December 11,2015
    7,933,344   December 1, 2017  December 13, 2017
Yunjie Liu       
Fuya Zheng       
Bang Zhang   *   December 1, 2017  December 13, 2017
Guangsheng Meng       
Directors and officers as a group   47,598,304       
Other individuals as a group(1)   29,036,208       

 

 

*             In aggregate owns options and/or restricted share units to acquire less than 1% of our outstanding ordinary shares on an as-converted basis.

 

(1)Includes a director who has left the company.

 

Principal Terms of the 2007, 2008 and 2010 Stock Incentive Plans

 

The following paragraphs describe the principal terms of the 2007, 2008 and 2010 Stock Incentive Plans.

 

Plan Administration. Our board of directors or a committee designated by our board will administer the plans. The committee or our board of directors, as appropriate, will determine the provisions and terms and conditions of each award grant. It shall also have discretionary power to interpret the terms of the plans.

 

Award Agreement. Awards granted under the plans are evidenced by an award agreement that sets forth terms, conditions and limitations for each award. In addition, the award agreement may also provide that securities granted are subject to a 90-day lockup period following the effective date of a registration statement filed by us under the Securities Act, if so requested by us or any representative of the underwriters in connection with any registration of the offering of any of our securities.

 

Eligibility. We may grant awards to our employees, directors and consultants, including those of our affiliates. However, we may grant options that are intended to qualify as incentive share options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, only to our employees.

 

Acceleration of Awards upon Change in Control. The outstanding awards will terminate and accelerate upon occurrence of a change-of-control corporate transaction, including amalgamations, mergers or consolidations, liquidations or dissolutions, sales of substantially all or all of the assets, reverse takeovers or acquisitions unless the successor entity assumes or replaces our outstanding awards under the plans. If the successor entity does not assume or replace our outstanding awards, each outstanding award will become fully vested and immediately exercisable and payable, and will be released from any repurchase or forfeiture rights immediately before the date of the change-of-control transaction, provided that the grantee’s continuous service with us has not been terminated before that date.

 

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Exercise Price and Term of Awards. The plan administrator shall determine the exercise price and the exercisable term for each option which shall be stated in the award document. For options that that are intended to qualify as incentive share options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, the per share exercise price must not be less than 85% of the fair market value per share on the date of grant, unless the administrator determines otherwise.

 

Vesting Schedule. The vesting periods of the options under the plans are specified in individual award agreements.

 

Termination of the Plans. Unless terminated earlier, the stock incentives plans will continue in effect for nine years. Our board of directors has the authority to amend or terminate the plan subject to shareholder approval to the extent such approval is required by applicable law. Shareholder approval is required for any amendment to our plans, if the amendment would adversely affect the grantee’s rights under an outstanding award without the grantee’s written consent, or change the board’s authority to amend the plans subject to shareholders’ approval.

 

Principal Terms of the 2011 Share Incentive Plan

 

The following paragraphs describe the principal terms of the 2011 Share Incentive Plan.

 

Plan Administration. The administrator of the 2011 Share Incentive Plan is our board of directors or the compensation committee of our board. The compensation committee or our board of directors, as appropriate, determines the provisions and terms and conditions of each award grant, and has discretionary power to interpret the terms of the plan. The plan administrator may delegate to a committee of one or more members of our board the authority to grant or amend awards to participants other than independent directors and executive officers of our company. Any grant or amendment of awards to any member of our board shall require approval by our board in accordance with our company’s articles of association.

 

Award Agreement. Awards granted under the plan are evidenced by an award agreement that sets forth the terms, conditions and limitations for each award, which may include the term of an award, the provisions applicable in the event the participant’s employment or service terminates, and our company’s authority to unilaterally or bilaterally amend, modify, suspend, cancel or rescind an award.

 

Eligibility. We may grant awards to our employees, directors and consultants, including those of our affiliates. However, options that are intended to qualify as incentive share options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, may not be granted to employees of our affiliates or to independent directors or consultants.

 

Acceleration of Awards upon Change in Control. If the plan administrator anticipates the occurrence, or upon the occurrence, of a corporate transaction, the plan administrator may, in its sole discretion, provide for (i) any and all awards outstanding to terminate at a specific time in the future and shall give each participant the right to exercise the vested portion of such awards during a period of time as the plan administrator shall determine, or (ii) the purchase of any award for an amount of cash equal to the amount that could have been attained upon the exercise of such award, or (iii) the replacement of such award with other rights or property selected by the plan administrator in its sole discretion or the assumption of or substitution of such award by the successor or surviving corporation, or a parent or subsidiary thereof, with appropriate adjustments as to the number and kind of shares and prices, or (iv) payment of award in cash based on the value of shares on the date of the corporate transaction plus reasonable interest on the award through the date when such award would otherwise be vested or have been paid in accordance with its original terms, if necessary to comply with Section 409A of the Internal Revenue Code of 1986.

 

Exercise Price and Term of Awards. The exercise price per share subject to an option shall be determined by the plan administrator and set forth in the award agreement which may be a fixed or variable price related to the fair market value of the ordinary shares. The exercise price per share subject to an option may be amended or adjusted in the absolute discretion of the plan administrator, the determination of which shall be final, binding and conclusive. For options that are intended to qualify as incentive share options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, the exercise price of any incentive share option granted to any individual who, at the date of grant, owns shares possessing more than ten percent of the total combined voting power of all classes of our shares may not be less than 110% of fair market value on the date of grant and such option may not be exercisable for more than five years from the date of grant.

 

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Vesting Schedule. In general, our plan administrator determines or the evidence of the award specifies, the vesting schedule.

 

Termination of the Plan. The plan will expire on, and no award may be granted pursuant to the plan after, June 3, 2020. Awards that are outstanding after such date shall remain in force according to the terms of the plan and the applicable award agreement.

 

C.Board Practices

 

Board of Directors

 

Our board of directors consists of five directors. A director is not required to hold any shares in the company by way of qualification. Under our memorandum and articles of association, subject to any separate requirement for audit committee approval or compensation committee approval or unless disqualified by the chairman of the relevant board meeting, so long as a director discloses the nature of his or her interest in any contract, proposal or arrangement (including arrangement with respect to compensation to himself or herself or any other members of the board) in which he or she is materially interested, such a director may vote in respect of such contract, proposal or arrangement and may be counted in the quorum at such a meeting. A director may exercise all the powers of the company to borrow money, mortgage its undertaking, property and uncalled capital, and issue debentures or other securities whenever money is borrowed or as security for any obligation of the company or of any third party. None of our non-executive directors has a service contract with us that provides for benefits upon termination of service.

 

Committees of the Board of Directors

 

We have established three committees under the board of directors: the audit committee, the compensation committee and the nominating and corporate governance committee. We have adopted a charter for each of the three committees. Each committee’s members and functions are described below.

 

Audit Committee. Our audit committee consists of Bang Zhang, Yunjie Liu and Fuya Zheng. Mr. Zhang, Mr. Liu and Mr. Zheng satisfy the “independence” requirements of Rule 5605 of Nasdaq Stock Market Rules and Rule 10A-3 under the Securities Exchange Act of 1934. Bang Zhang is the chair of our audit committee. The purpose of the audit committee is to assist our board of directors with its oversight responsibilities regarding: (i) the integrity of our financial statements, (ii) our compliance with legal and regulatory requirements, (iii) the independent auditor’s qualifications and independence and (iv) the performance of our internal audit function and independent auditor. The audit committee is responsible for, among other things:

 

·appointing the independent auditors and pre-approving all auditing and non-auditing services permitted to be performed by the independent auditors;
·reviewing with the independent auditors any audit problems or difficulties and management’s response;
·discussing the annual audited financial statements with management and the independent auditors;
·reviewing the adequacy and effectiveness of our accounting and internal control policies and procedures and any steps taken to monitor and control major financial risk exposures;
·reviewing and approving all proposed related party transactions;
·meeting separately and periodically with management and the independent auditors; and
·monitoring compliance with our code of business conduct and ethics, including reviewing the adequacy and effectiveness of our procedures to ensure proper compliance.

 

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Compensation Committee. Our compensation committee consists of Fuya Zheng and Yunjie Liu. Mr. Zheng and Mr. Liu satisfy the “independence” requirements of Rule 5605 of Nasdaq Stock Market Rules. Mr. Zheng is the chairperson of our compensation committee. The compensation committee assists the board in reviewing and approving the compensation structure, including all forms of compensation, relating to our directors and executive officers. Our Chief Executive Officer may not be present at any committee meeting during which his compensation is deliberated. The compensation committee is responsible for, among other things:

 

·reviewing and approving, or recommending to the board for its approval, the compensation for our chief executive officer and other executive officers;
·reviewing and recommending to the board for determination with respect to the compensation of our non-employee directors;
·reviewing periodically and approving any incentive compensation or equity plans, programs or similar arrangements; and
·selecting compensation consultant, legal counsel or other adviser only after taking into consideration all factors relevant to that person’s independence from management.

 

Nominating and Corporate Governance Committee. Our nominating and corporate governance committee consists of Song Wang and Yunjie Liu. Mr. Liu satisfies the “independence” requirements of Rule 5605 of Nasdaq Stock Market Rules. Mr. Wang is the chair of our nominating and corporate governance committee. The nominating and corporate governance committee assists the board of directors in selecting individuals qualified to become our directors and in determining the composition of the board and its committees. The nominating and corporate governance committee is responsible for, among other things:

 

·selecting and recommending to the board nominees for election by the shareholders or appointment by the board;
·reviewing annually with the board the current composition of the board with regards to characteristics such as independence, knowledge, skills, experience and diversity;
·making recommendations on the frequency and structure of board meetings and monitoring the functioning of the committees of the board; and
·advising the board periodically with regards to 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 on all matters of corporate governance and on any remedial action to be taken.

 

Duties of Directors

 

Under Cayman Islands law, our directors have a duty of loyalty 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 has the right to seek damages if a duty owed by our directors is breached.

 

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 are removed from office by special resolution or the unanimous written resolution of all shareholders. We do not have a mandatory retirement age for directors. A director will be removed from office automatically if, among other things, the director (i) becomes bankrupt or makes any arrangement or composition with his creditors; or (ii) dies or is found by our company to be or becomes of unsound mind.

 

D.Employees

 

We had 1,128, 861 and 611 employees as of December 31, 2015, 2016 and 2017, respectively. The following table sets forth the number of our employees by function as of December 31, 2017:

 

Functional Area  Number of Employees  % of Total 
Customer service  111   18.1%
Sales and marketing  121   19.8%
Research and development  271   44.4%
Management and administration  108   17.7%
Total  611   100.0%

 

88

 

 

Of our total employees as of December 31, 2017, 518 were located in Beijing, 53 were located in other cities throughout China and 40 were located outside China. We remunerate our employees with a base salary as well as performance-based bonuses. We have also granted stock options to management and key employees in order to reward their performance and provide them with equity incentives. In February 2016, about 30 of our employees initiated arbitration for labor dispute against Xin Run, Beijing Shouming, Beijing Zhao Du and Xin Run’s Tianjin Branch with Shunyi Labor Dispute Arbitration Committee and Chaoyang Labor Dispute Arbitration Committee.  They withdrew the arbitration request in June 2016 and later re-initiated the arbitration proceeding in May 2017. The arbitrators ruled that our subsidiaries should pay compensation in the amount of approximately RMB0.6 million to those employees. The arbitration award was supported by the judgement of trial court.  We have appealed the judgement to the appellate court in October 2017 and the appellate court dismissed the appeal and sustained the original judgement in October and November 2017. We believe that these are isolated cases and that our employee relations are good.

 

Our full time employees in the PRC participate in a government mandated defined contribution plan pursuant to which certain pension benefits, medical care, unemployment insurance, employee housing fund and other welfare benefits are provided to employees. Chinese labor regulations require that our PRC subsidiaries make contributions to the government for these benefits based on a fixed percentage of the employees’ salaries.

 

E.Share Ownership

 

Please refer to “Item 7 — Major Shareholders and Related Party Transactions.”

 

ITEM 7.MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

 

A.Major Shareholders

 

The following table sets forth information with respect to the beneficial ownership of our ordinary shares as of March 31, 2018, by each of our directors and executive officers, and the beneficial ownership of our ordinary shares as of March 31, 2018 by each person known to us to own beneficially more than 5.0% of our ordinary share:

 

The calculations in the table below are based on 426,267,345 ordinary shares outstanding as of March 31, 2018 for the purpose of calculating the beneficial ownership in the following table. 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 following March 31, 2018, 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.

 

    Ordinary Shares Beneficially Owned 
   Number   % 
Directors and Executive Officers:          
Song Wang(1)   86,600,733    20.3%
Jean Xiaohong Kou(2)   86,600,733    20.3%
Yunjie Liu        
Fuya Zheng        
Bang Zhang   *    * 
Guangsheng Meng        
All Directors and Executive Officers as a Group   86,920,733    20.4%
Principal Shareholders:          
Consolidated Capital Holdings Ltd.(1)(2)(3)   56,543,248    13.8%
Investor AB(4)   42,391,092    10.4%
FIL Limited(5)   40,300,208    9.8%

 

89

 

 

 

*Less than 1%.

 

(1)Consists of (i) 56,487,472 ordinary shares and 3,486 ADSs representing 55,776 ordinary shares directly held by Consolidated Capital Holdings Ltd., (ii) 313,293 ordinary shares directly held by Harvest Century International Ltd., (iii) 18,864,096 ordinary shares that Mr. Song Wang has the right to acquire upon exercise or vesting of equity incentive awards within 60 days after March 31, 2018, and (iv) 10,880,096 ordinary shares that Mr. Wang’s wife, Ms. Jean Xiaohong Kou has the right to acquire upon exercise or vesting of equities incentive awards within 60 days after March 31, 2018. Song Wang and Jean Xiaohong Kou possess the power to direct the voting and disposition of the shares owned by Consolidated Capital Holdings Ltd. and Harvest Century International Ltd. through Hong Song Family Trust and are deemed to have shared voting and investment power over the shares held by Consolidated Capital Holdings Ltd. and Harvest Century International Ltd. The business address for Mr. Wang is Section A, Building 3, Dian Tong Creative Square, No. 7 Jiuxianqiao North Road, Chaoyang District, Beijing 100015, China.

 

(2)See Note (1) above. Mr. Song Wang and Ms. Jean Xiaohong Kou are husband and wife, and may be deemed to share beneficial ownership of the shares and ADSs held by each other. The business address for Ms. Kou is Section A, Building 3, Dian Tong Creative Square, No. 7 Jiuxianqiao North Road, Chaoyang District, Beijing 100015, China.

 

(3)The business address for Consolidated Capital Holdings Ltd. is c/o Jean Xiaohong Kou, Section A, Building 3, Dian Tong Creative Square, No. 7 Jiuxianqiao North Road, Chaoyang District, Beijing 100015, China.

 

(4)Consists of (i) 22,954,468 ordinary shares and 419,996 ADSs, representing 6,719,936 ordinary shares held by Investor Investments Asia Limited, (ii) 9,836,608 ordinary shares and 180,005 ADSs representing 2,880,080 ordinary shares held by Investor Group Asia, L.P.,as reported in a Schedule 13G/A filed on February 14, 2018 by Investor AB. We refer to these funds collectively as Investor AB Funds. The business address for Investor AB Funds is Arsenalsgatan 8C, S-103, 32 Stockholm, Sweden. Investor AB, a limited liability company incorporated under the laws of Sweden, through one or more intermediate entities, possesses the sole power to vote and the sole power to direct the disposition of all the shares held by Investor AB Funds. Investor Group Asia, L.P. is a Guernsey limited partnership.

 

(5)Consists of 40,300,208 ordinary shares beneficially owned by FIL Limited as reported in a Schedule 13G/A filed on February 13, 2018 by FIL Limited and other filers. The business address for FIL Limited is Pembroke Hall, 42, Crow Lane, Hamilton, Bermuda.

 

To our knowledge, as of March 31, 2018, 386,583,680 of our ordinary shares, or approximately 84.8% of our total outstanding ordinary shares, were held by three record holders in the U.S., including Citibank, N.A., the depositary of our ADS program. The number of beneficial owners of our ADSs in the U.S. is likely to be much larger than the number of record holders of our ordinary shares in the U.S. To our knowledge, we are not owned or controlled, directly or indirectly, by another corporation, by any foreign government or by any other natural or legal persons, severally or jointly. None of our shareholders has different voting rights from other shareholders. We are not aware of any arrangement that may, at a subsequent date, result in a change of control of our company.

 

B.Related Party Transactions

 

Contractual Arrangements with Our Consolidated Variable Interest Entities

 

See “Item 4. Information on the Company — C. Organizational Structure — Contractual Arrangements with Our Consolidated Variable Interest Entities.”

 

Employment Agreements

 

See “Item 6. Directors, Senior Management and Employees — A. Directors and Senior Management — Employment Agreements.”