Sound Group(SOGP) - 2019 Q4 - Annual Report

PART I ITEM 3. KEY INFORMATION This section presents selected financial data for fiscal years 2017-2019, highlighting significant revenue growth alongside persistent net losses and detailing comprehensive risk factors related to business, corporate structure, China operations, and ADSs Selected Financial Data Net revenues grew from RMB 453.5 million in 2017 to RMB 1,180.6 million in 2019, yet the company incurred a net loss of RMB 133.0 million in 2019, with total assets decreasing and net cash used in operating activities shifting to RMB 95.8 million Selected Consolidated Statements of Comprehensive Loss Data (2017-2019) | Indicator | 2017 (RMB in thousands) | 2018 (RMB in thousands) | 2019 (RMB in thousands) | 2019 (US$ in thousands) | | :--- | :--- | :--- | :--- | :--- | | Net revenues | 453,529 | 798,561 | 1,180,597 | 169,582 | | Gross profit | 122,707 | 232,927 | 270,442 | 38,846 | | Operating loss | (149,922) | (11,998) | (141,837) | (20,373) | | Net loss | (153,665) | (9,342) | (132,957) | (19,097) | | Net loss attributable to ordinary shareholders | (444,940) | (225,527) | (1,073,143) | (154,146) | | Basic and Diluted Net loss per share | (1.73) | (0.87) | (4.13) | (0.59) | Selected Consolidated Balance Sheet Data (as of Dec 31) | Indicator | 2017 (RMB in thousands) | 2018 (RMB in thousands) | 2019 (RMB in thousands) | 2019 (US$ in thousands) | | :--- | :--- | :--- | :--- | :--- | | Cash and cash equivalents | 206,509 | 205,604 | 82,709 | 11,880 | | Total assets | 242,547 | 236,659 | 140,683 | 20,207 | | Total liabilities | 155,009 | 155,814 | 192,124 | 27,596 | | Total shareholders' deficit | (703,081) | (925,959) | (1,998,431) | (287,057) | Selected Consolidated Cash Flow Data (Year Ended Dec 31) | Indicator | 2017 (RMB in thousands) | 2018 (RMB in thousands) | 2019 (RMB in thousands) | 2019 (US$ in thousands) | | :--- | :--- | :--- | :--- | :--- | | Net cash (used in)/generated from operating activities | (31,334) | 13,962 | (95,753) | (13,754) | | Net cash used in investing activities | (13,195) | (17,375) | (29,370) | (4,219) | | Net cash generated from financing activities | 237,787 | — | — | — | Risk Factors The company identifies numerous risks across business, corporate structure, China operations, and ADSs, including user retention, regulatory changes, a history of net losses, VIE control uncertainties, and the impact of a dual-class share structure - Business success critically depends on retaining and engaging users, as substantially all net revenues come from virtual gift sales for audio entertainment, and a decline in user base or engagement would materially harm financial results[32] - The company faces significant regulatory risk from the PRC government, which may tighten regulations on online audio platforms, as demonstrated by the Lizhi app's 30-day suspension in June-July 2019 due to inappropriate content[35][38] - The company has a history of net losses, incurring RMB 153.7 million, RMB 9.3 million, and RMB 133.0 million in 2017, 2018, and 2019, respectively, and may continue to incur losses in the future[50] - The business operates in China through a Variable Interest Entity (VIE) structure due to foreign ownership restrictions, and non-compliance with PRC authorities could lead to severe penalties, including forced relinquishment of interests in these operations[164] - A dual-class share structure grants holders of Class B ordinary shares (founders Mr. Jinnan Lai and Mr. Ning Ding) 10 votes per share, giving them complete control over shareholder matters and representing 77.2% of the aggregate voting power as of the report date[241] - A material weakness in internal control over financial reporting was identified as of December 31, 2019, relating to a lack of sufficient accounting and financial reporting personnel with appropriate knowledge of U.S. GAAP and SEC requirements[144][145] ITEM 4. INFORMATION ON THE COMPANY This section details the company's history, business model, and organizational structure, highlighting LIZHI INC.'s role as a leading online UGC audio community in China, monetized primarily through virtual gift sales within a VIE structure History and Development of the Company The company commenced operations in 2010, established a VIE structure in 2011, launched the Lizhi app in 2013, and completed its Nasdaq IPO in January 2020 as LIZHI INC., incorporated in the Cayman Islands - The company began operations in 2010 through Guangzhou Lizhi and established a VIE structure in March 2011 to comply with PRC foreign ownership restrictions[278][279] - The Lizhi app was launched in October 2013[279] - The current holding company, LIZHI INC., was incorporated in the Cayman Islands in January 2019, and it completed its IPO on the Nasdaq Global Market on January 17, 2020[283][286] Business Overview LIZHI operates as a leading online UGC audio community and interactive entertainment platform in China, with 51.9 million average total mobile MAUs in Q4 2019, monetizing primarily through virtual gift sales and leveraging AI for content and engagement - The company operates a leading online User-Generated Content (UGC) audio community and interactive audio entertainment platform in China[288] Key User Metrics (Q4 2018 vs Q4 2019) | Metric | Q4 2018 | Q4 2019 | YoY Growth | | :--- | :--- | :--- | :--- | | Average Total Mobile MAUs | ~38.8 million | ~51.9 million | 33.8% | | Average Monthly Active Hosts | ~5.3 million | ~5.9 million | 11.3% | - The business model focuses on offering most podcast content for free to attract a large user base, which is then monetized primarily through virtual gift sales in the audio entertainment segment[294] - The company is expanding its overseas presence, having launched a localized version of its audio entertainment product in the Middle East and North Africa (MENA) in July 2019[292] - A content monitoring system utilizing AI-based automatic filtering and a manual review team is in place to ensure compliance with regulations and remove inappropriate content[347][352] Organizational Structure LIZHI INC., a Cayman Islands holding company, operates in China through a VIE structure, primarily Guangzhou Lizhi and Guangzhou Huanliao, to comply with PRC foreign ownership restrictions, maintaining control via contractual arrangements - The company operates in China through a VIE structure to comply with PRC laws restricting foreign ownership in value-added telecommunication services, with the primary VIEs being Guangzhou Lizhi and Guangzhou Huanliao[438] - Control over the VIEs is established through a series of contractual arrangements, including Equity Pledge Agreements, Exclusive Equity Transfer Option Agreements, Exclusive Technical Consulting and Service Agreements, Operation Agreements, and Powers of Attorney[439][799] - The company's PRC counsel, JunHe LLP, is of the opinion that the ownership structures and contractual arrangements are valid, binding, and enforceable under current PRC laws, though substantial uncertainties remain regarding the interpretation of future laws like the PRC Foreign Investment Law[439] ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS This section analyzes the company's financial condition and operating results, showing net revenues increased 47.8% to RMB 1,180.6 million in 2019, but net loss widened to RMB 133.0 million due to increased costs and operating expenses, alongside a discussion of liquidity and working capital deficit Operating Results In 2019, net revenues grew 47.8% to RMB 1,180.6 million, driven by audio entertainment, but gross margin declined to 22.9% and net loss significantly increased to RMB 133.0 million due to rising costs and operating expenses Results of Operations (2018 vs 2019) | Metric | 2018 (RMB million) | 2019 (RMB million) | YoY Change | | :--- | :--- | :--- | :--- | | Net Revenues | 798.6 | 1,180.6 | +47.8% | | Audio entertainment | 785.1 | 1,167.9 | +48.8% | | Cost of Revenues | 565.6 | 910.2 | +60.9% | | Gross Profit | 232.9 | 270.4 | +16.1% | | Gross Margin | 29.2% | 22.9% | -6.3pp | | Total Operating Expenses | 244.9 | 412.3 | +68.3% | | Operating Loss | (12.0) | (141.8) | -1081.7% | | Net Loss | (9.3) | (133.0) | -1330.1% | - The increase in cost of revenues was primarily driven by higher revenue sharing fees, which grew 61.3% due to business growth and a short-term incentive program launched in Q3 2019[489][490] - Selling and marketing expenses increased by 54.5% in 2019 due to the launch of new products and enhanced marketing efforts[495] - Research and development expenses increased by 89.9% in 2019, reflecting efforts in developing AI applications and enhancing data security[496] Liquidity and Capital Resources As of December 31, 2019, the company had RMB 82.7 million in cash and a working capital deficit of RMB 87.7 million, with net cash used in operating activities at RMB 95.8 million, planning to use IPO proceeds and operations to meet liquidity needs - As of December 31, 2019, the company had RMB 82.7 million in cash and cash equivalents and a working capital deficit of RMB 87.7 million[547][548] Consolidated Cash Flows Summary (2017-2019) | Cash Flow Activity (RMB in thousands) | 2017 | 2018 | 2019 | | :--- | :--- | :--- | :--- | | Net cash from operating activities | (31,334) | 13,962 | (95,753) | | Net cash used in investing activities | (13,195) | (17,375) | (29,370) | | Net cash generated from financing activities | 237,787 | — | — | - The company plans to manage its working capital deficit by strengthening monetization, managing content sourcing costs, and controlling operating expenses, while utilizing proceeds from its January 2020 IPO[549] ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES This section details the company's directors, senior management, and employees, including their compensation and share ownership, highlighting the dual-class share structure that grants founders significant voting control and the company's 641 employees as of December 31, 2019 - The company's leadership includes founder and CEO Mr. Jinnan (Marco) Lai and co-founder and CTO Mr. Ning Ding[575][576] - For fiscal year 2019, the aggregate cash compensation paid to executive officers was RMB 6.5 million[582] - The company adopted the Amended and Restated 2019 Share Incentive Plan, authorizing up to 100 million Class A ordinary shares for issuance, with awards for 33.7 million shares outstanding as of March 31, 2020[589][590] - As of December 31, 2019, the company had 641 employees, with 407 (63.5%) in research and development[614][615] - As of March 31, 2020, CEO Jinnan (Marco) Lai controlled 64.7% of the total voting power, and CTO Ning Ding controlled 13.0%, giving them substantial influence over the company[623][625][626] ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS This section confirms major shareholders possess different voting rights due to the dual-class share structure and details related party transactions, including VIE contractual arrangements and share incentive plans - Major shareholders possess different voting rights, as detailed in the share ownership section (Item 6.E)[631] - Key related party transactions consist of the contractual arrangements with the company's VIEs, employment agreements, and share incentive grants[632][633] ITEM 8. FINANCIAL INFORMATION This section presents the company's consolidated financial statements, noting no material legal proceedings and no plans to declare dividends, with earnings retained for business expansion - The company is not currently party to any material legal proceedings but acknowledges the risk of future litigation arising from the ordinary course of business[636] - The company has no plan to declare or pay dividends in the near future, intending to retain earnings to operate and expand the business[638] ITEM 9. THE OFFER AND LISTING The company's American Depositary Shares (ADSs) have been listed on the Nasdaq Global Market under the symbol "LIZI" since January 17, 2020, with each ADS representing 20 Class A ordinary shares - The company's ADSs began trading on the Nasdaq Global Market on January 17, 2020, under the ticker symbol "LIZI"[641] - Each ADS represents 20 Class A ordinary shares[641] ITEM 10. ADDITIONAL INFORMATION This section details corporate governance, including the dual-class share structure outlined in the memorandum and articles of association, and discusses taxation considerations for shareholders, including the risk of PFIC classification - The company is incorporated in the Cayman Islands and its affairs are governed by its Second Amended and Restated Memorandum and Articles of Association[648] - The company has a dual-class share structure: Class A ordinary shares have one vote per share, while Class B ordinary shares have 10 votes per share and are convertible into Class A shares[656] - The company believes it was not a Passive Foreign Investment Company (PFIC) for the 2019 taxable year, but notes that its status could change depending on the market price of its ADSs and the composition of its income and assets[697][275] ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company's primary market risks include interest rate, foreign exchange, and inflation, with a 10% USD depreciation against RMB potentially decreasing cash by RMB 4.0 million as of year-end 2019 - The company's main market risks are interest rate risk on cash holdings, foreign exchange risk due to RMB-denominated revenues, and inflation risk[712][714][718] - As of December 31, 2019, the company held US$5.7 million in cash, and a hypothetical 10% depreciation of the U.S. dollar against the Renminbi would result in a decrease of RMB 4.0 million in the value of its cash and cash equivalents[717] PART II ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS This section confirms no material modifications to security holder rights and details the use of US$38.1 million net proceeds from the January 2020 IPO, with US$3.1 million allocated to product development and general corporate purposes - The company received net proceeds of approximately US$38.1 million from its initial public offering in January 2020[733] - As of the date of the report, US$3.1 million of the IPO proceeds had been used for innovative product development and general corporate purposes[734] ITEM 15. CONTROLS AND PROCEDURES Management concluded disclosure controls and procedures were ineffective as of December 31, 2019, due to a material weakness in internal control over financial reporting, specifically a lack of sufficient U.S. GAAP and SEC-knowledgeable personnel, with remediation efforts underway - Management concluded that disclosure controls and procedures were ineffective as of December 31, 2019[737] - A material weakness was identified related to a lack of sufficient and competent accounting and financial reporting personnel with knowledge of U.S. GAAP and SEC requirements[739] - Remediation plans include hiring additional qualified staff, establishing ongoing training programs, and engaging consultants to assess Sarbanes-Oxley Act compliance[740] ITEM 16. CORPORATE GOVERNANCE AND OTHER INFORMATION This section covers corporate governance, including an audit committee with financial experts, a code of ethics, RMB 5.36 million in principal accountant fees for 2019, and the company's reliance on Nasdaq exemptions as a foreign private issuer and controlled company - The board's audit committee has two independent directors, Mr. Yipeng Li and Mr. Yinquan Li, who both qualify as "audit committee financial experts"[744] Principal Accountant Fees (PricewaterhouseCoopers Zhong Tian LLP) | Year | Audit Fees (RMB in thousands) | | :--- | :--- | | 2017 | 1,887 | | 2018 | 1,887 | | 2019 | 5,358 | - As a foreign private issuer, the company is permitted to follow home country practices and relies on exemptions from certain Nasdaq corporate governance rules, such as the requirement for a majority-independent board[752] PART III ITEM 18. FINANCIAL STATEMENTS This section presents LIZHI INC.'s audited consolidated financial statements for 2017-2019, prepared under U.S. GAAP, including balance sheets, statements of operations and comprehensive loss, statements of changes in shareholders' deficit, statements of cash flows, and detailed notes Consolidated Balance Sheets As of December 31, 2019, total assets were RMB 140.7 million, total liabilities RMB 192.1 million, and total shareholders' deficit RMB 1,998.4 million, reflecting a decrease in assets and an increase in liabilities and deficit Consolidated Balance Sheet Highlights (as of Dec 31) | Account (RMB in thousands) | 2018 | 2019 | | :--- | :--- | :--- | | Cash and cash equivalents | 205,604 | 82,709 | | Total current assets | 218,013 | 104,462 | | Total assets | 236,659 | 140,683 | | Total current liabilities | 155,814 | 192,124 | | Total liabilities | 155,814 | 192,124 | | Total shareholders' deficit | (925,959) | (1,998,431) | Consolidated Statements of Operations and Comprehensive Loss For 2019, net revenues increased 47.8% to RMB 1,180.6 million, but operating loss widened to RMB 141.8 million and net loss was RMB 133.0 million due to significant increases in costs and operating expenses Consolidated Statement of Operations Highlights (Year Ended Dec 31) | Account (RMB in thousands) | 2017 | 2018 | 2019 | | :--- | :--- | :--- | :--- | | Net revenues | 453,529 | 798,561 | 1,180,597 | | Gross profit | 122,707 | 232,927 | 270,442 | | Operating loss | (149,922) | (11,998) | (141,837) | | Net loss | (153,665) | (9,342) | (132,957) | Consolidated Statements of Cash Flows For 2019, net cash used in operating activities was RMB 95.8 million, a reversal from 2018, with net cash used in investing activities at RMB 29.4 million, resulting in cash and cash equivalents decreasing to RMB 82.7 million Consolidated Cash Flow Highlights (Year Ended Dec 31) | Account (RMB in thousands) | 2017 | 2018 | 2019 | | :--- | :--- | :--- | :--- | | Net cash from operating activities | (31,334) | 13,962 | (95,753) | | Net cash used in investing activities | (13,195) | (17,375) | (29,370) | | Net cash generated from financing activities | 237,787 | — | — | | Net (decrease)/increase in cash | 188,106 | (905) | (122,895) | | Cash at end of year | 206,509 | 205,604 | 82,709 | Notes to the Consolidated Financial Statements The notes detail accounting policies, including the VIE structure, ASC 606 revenue recognition for audio entertainment and podcast subscriptions, convertible redeemable preferred shares, share-based compensation, and subsequent events like the January 2020 IPO and COVID-19 impact - The company adopted ASC Topic 606 for revenue recognition, with audio entertainment revenue from virtual items recognized on a gross basis, and consumable items recognized at the point of consumption while time-based items are recognized ratably over the contract period[867][873][874] - The company's convertible redeemable preferred shares were classified as mezzanine equity and were subject to accretion to their redemption value, with all preferred shares automatically converting to ordinary shares upon the IPO in January 2020[999][1037] - As of December 31, 2019, total unrecognized compensation expense related to unvested share-based awards was RMB 58.3 million, which was contingent on the IPO performance condition[1012] - The company notes the recent COVID-19 outbreak as a subsequent event, stating that while there was no significant impact on Q1 2020, the future impact for the remainder of the fiscal year cannot be reasonably estimated[1039]