Sound Group(SOGP) - 2023 Q4 - Annual Report

PART I ITEM 3. KEY INFORMATION The company operates in China via a VIE structure, facing significant regulatory and operational risks, with VIEs contributing 99.9% of 2023 revenues - The company utilizes a VIE structure for its operations in China, as PRC laws restrict foreign investment in value-added telecommunication services, exposing investors to risks as they hold equity in a Cayman Islands holding company, not the PRC operating entities[13] VIE Contribution to Total Net Revenues and Assets | Year | Revenue Contribution from VIEs (%) | Asset Contribution from VIEs (%) | | :--- | :--- | :--- | | 2021 | 93.0% | N/A | | 2022 | 98.6% | 45.2% | | 2023 | 99.9% | 35.6% | Service Fee Transfers from VIEs to PRC Subsidiaries | Year | Amount (RMB million) | Amount (USD million) | | :--- | :--- | :--- | | 2021 | 26.4 | N/A | | 2022 | 76.0 | N/A | | 2023 | 137.0 | 19.3 | - The company was previously identified by the SEC under the Holding Foreign Companies Accountable Act (HFCAA), but the PCAOB vacated this determination in December 2022, and the current auditor, Enrome LLP, is subject to regular PCAOB inspection[43][44] Risk Factors The company faces risks from internal control weaknesses, complex Chinese regulations, potential delisting, and a dual-class share structure concentrating voting power - An audit committee investigation completed in October 2024 regarding a US$12.8 million deposit highlighted internal control weaknesses, posing risks of financial loss and negative publicity[48][68][69] - Two material weaknesses in internal control over financial reporting were identified as of December 31, 2023: insufficient financial reporting personnel with U.S. GAAP and SEC experience, and lack of a comprehensive risk monitoring mechanism for financial assets[49][73][74] - The company's business is subject to complex and evolving Chinese laws, particularly regarding data privacy and cybersecurity, which could result in additional expenses and operational changes[53][98][100] - The company's dual-class share structure grants holders of Class B ordinary shares 10 votes per share, while Class A ordinary shares have one vote, giving Class B shareholders complete control over shareholder matters and limiting ADS holders' influence[64][374][375] - The company believes it was likely a Passive Foreign Investment Company (PFIC) for the 2023 taxable year and faces a significant risk of being a PFIC for 2024, which could lead to adverse U.S. federal income tax consequences for U.S. investors[432][434] ITEM 4. INFORMATION ON THE COMPANY Sound Group Inc., formerly LIZHI INC., is a global audio-centric social and entertainment company operating in China through a VIE structure, monetizing via virtual gifts - The company changed its corporate name from "LIZHI INC." to "Sound Group Inc." and its Nasdaq ticker from "LIZI" to "SOGP" in January 2024 to reflect its global audio-centric social and entertainment strategy[449] - The business model is centered on an audio ecosystem with a portfolio including Audio Entertainment, Social Networking (TIYA App), and Podcasts, leveraging user-generated content and proprietary technologies like DOREME and VoderX[473][475][479][481][486][487] Key Operating Metrics (2021-2023) | Metric | 2021 | 2022 | 2023 | | :--- | :--- | :--- | :--- | | Average Total Mobile MAUs (millions) | 58.4 | 50.4 | 43.3 | | Average Total Monthly Paying Users (thousands) | 488.0 | 483.9 | 418.3 | - The company operates in China through VIEs (Guangzhou Lizhi and Guangzhou Huanliao) controlled by a series of contractual arrangements, including Equity Pledge, Exclusive Equity Transfer Option, and Exclusive Technical Consulting and Service Agreements[621][624] ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS Net revenues decreased in 2023 to RMB 2,071.8 million, resulting in a net loss of RMB 134.5 million due to fewer paying users and higher operating expenses Consolidated Financial Performance (RMB in thousands) | Metric | 2021 | 2022 | 2023 | | :--- | :--- | :--- | :--- | | Net Revenues | 2,119,514 | 2,185,266 | 2,071,772 | | Gross Profit | 617,009 | 716,345 | 585,375 | | Operating (Loss)/Income | (138,518) | 66,651 | (147,668) | | Net (Loss)/Income | (127,250) | 86,504 | (134,515) | - Net revenue decreased by 5.2% in 2023 compared to 2022, primarily due to a decline in average paying users for audio entertainment products[674] - General and administrative expenses increased significantly in 2023 to RMB 193.9 million from RMB 106.7 million in 2022, mainly driven by an increased provision for credit losses[679] Consolidated Cash Flow Summary (RMB in thousands) | Cash Flow Activity | 2021 | 2022 | 2023 | | :--- | :--- | :--- | :--- | | Operating Activities | (40,426) | 136,267 | (117,045) | | Investing Activities | 52,101 | (122,783) | 105,653 | | Financing Activities | 212,682 | 4,771 | (71,674) | ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES The company is led by its founder, with a five-director board, and had 563 employees in 2023, primarily in R&D, with founders holding significant voting power Director and Executive Officer Compensation (FY 2023) | Group | Aggregate Compensation (RMB million) | Aggregate Compensation (USD million) | | :--- | :--- | :--- | | Executive Officers | 13.9 | 1.9 | | Non-Executive Directors | 2.0 | 0.3 | - The company adopted the Second Amended and Restated 2019 Share Incentive Plan, authorizing up to 170,000,000 Class A ordinary shares for awards, with 60,651,040 Class A ordinary shares granted and outstanding as of September 30, 2024[792][794] Employee Breakdown by Function (as of Dec 31, 2023) | Function | Number of Employees | % of Total | | :--- | :--- | :--- | | Research and development | 386 | 68.6% | | Operations and products | 57 | 10.1% | | Sales and marketing | 53 | 9.4% | | General and administration | 67 | 11.9% | | Total | 563 | 100.0% | ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS Founder Jinnan (Marco) Lai holds 19.5% of shares and 62.7% of voting power due to a dual-class structure, with a notable 2023 subsidiary share issuance to a related party Beneficial Ownership of Major Shareholders (as of Sep 30, 2024) | Shareholder | % of Total Ordinary Shares | % of Aggregate Voting Power | | :--- | :--- | :--- | | Mr. Jinnan (Marco) Lai | 19.5% | 62.7% | | Mr. Ning Ding | 4.0% | 12.7% | - In January 2023, VOCAL BEATS Inc., a subsidiary, issued 31,481,481 ordinary shares to Sky Voice Limited, a company controlled by a family trust of CEO Mr. Jinnan (Marco) Lai, for an aggregate price of US$340,000[835] ITEM 8. FINANCIAL INFORMATION An independent investigation into a US$12.8 million deposit revealed internal control weaknesses, leading to a full credit loss provision in 2023, with no plans for future dividends - An independent investigation regarding difficulties in withdrawing a US$12.8 million deposit from a third-party financial institution, completed in October 2024, found internal control weaknesses related to documentation, data retention, and approval records[839][840][842] - Due to the uncertain recoverability of the US$12.8 million deposit, the company recorded a full allowance for credit loss provision of RMB 90.7 million in its consolidated statements for the year ended December 31, 2023[844] - The company has no plan to declare or pay any dividends in the near future, intending to retain available funds and future earnings to operate and expand the business[845] ITEM 9. THE OFFER AND LISTING The company's ADSs are listed on Nasdaq, with a name and ticker change in January 2024, and an ADS to Class A ordinary share ratio change in September 2023 - In January 2024, the company's name changed to Sound Group Inc. and its Nasdaq ticker symbol changed to "SOGP"[849][852] - On September 20, 2023, the ADS ratio was changed, with each ADS now representing two hundred (200) Class A ordinary shares, up from twenty (20)[850] ITEM 10. ADDITIONAL INFORMATION Incorporated in the Cayman Islands, the company has a dual-class share structure and faces potential PRC taxation and significant PFIC risk for U.S. investors - The company has a dual-class share structure where each Class A ordinary share has one vote, while each Class B ordinary share has ten votes and is convertible into one Class A share[861] - The company is an exempted company under Cayman Islands law and is not subject to profits, income, gains, or appreciation taxes in that jurisdiction[880][884] - The company faces a risk of being classified as a PRC "resident enterprise," which would subject it to a 25% enterprise income tax on its worldwide income and could result in withholding taxes on dividends paid to non-PRC shareholders[887][888] - The company believes it was likely a Passive Foreign Investment Company (PFIC) for its 2023 taxable year and faces a significant risk of being a PFIC for 2024, which has adverse U.S. federal income tax implications for U.S. Holders of its ADSs or shares[899][900] ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The primary market risk is foreign exchange due to RMB-denominated revenues, with interest rate and inflation risks also noted - The company's main market risk is foreign exchange risk, as nearly all revenues are denominated in RMB, and it does not currently use hedging transactions to mitigate this risk[924][925] - As of December 31, 2023, the company held US$11.5 million in U.S. dollar-denominated cash and cash equivalents; a hypothetical 10% depreciation of the U.S. dollar against the RMB would result in a decrease of RMB 8.1 million in cash[926] - Inflation in China has not been a material factor, with the consumer price index increasing by 0.2% in 2023, 1.8% in 2022, and 1.5% in 2021[927] ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES This section details ADS service fees, including a US$1.0 million payment received in 2020 and a US$1.5 million reimbursement made in 2023 ADS Holder Service Fees | Service | Fee | | :--- | :--- | | Issuance of ADSs | Up to US$0.05 per ADS issued | | Cancellation of ADSs | Up to US$0.05 per ADS cancelled | | Distribution of cash dividends | Up to US$0.05 per ADS held | | Other cash distributions | Up to US$0.05 per ADS held | | Depositary services | Up to US$0.05 per ADS held on record date(s) | - In 2020, the company received a US$1.0 million payment from its ADR program depositary bank, and in 2023, it returned approximately US$1.5 million to the depositary bank as reimbursement for costs related to the ADS ratio change[937] PART II ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS Details the use of proceeds from the January 2020 IPO (US$38.1 million net) and April 2021 follow-on offering (US$28.5 million net) Use of Proceeds from Initial Public Offering (Jan 2020) | Item | Amount (US$ million) | | :--- | :--- | | Net Proceeds Received | ~38.1 | | Proceeds Used (as of report date) | 39.2 | | Intended Use of Remainder | As disclosed in registration statements | Use of Proceeds from Follow-on Offering (Apr 2021) | Item | Amount (US$ million) | | :--- | :--- | | Net Proceeds Received | ~28.5 | | Proceeds Used (as of report date) | ~1.8 | | Intended Use | General corporate purposes | ITEM 15. CONTROLS AND PROCEDURES Management identified two material weaknesses in internal control over financial reporting as of December 31, 2023, and is implementing remediation measures - Management concluded that as of December 31, 2023, the company's disclosure controls and procedures were not effective due to two identified material weaknesses[950] - The first material weakness identified is a lack of sufficient financial reporting and accounting personnel with adequate knowledge of U.S. GAAP and SEC reporting requirements[951] - The second material weakness is the lack of a comprehensive and continuous assessment and risk monitoring mechanism for the company's financial assets and associated collection risks[953] - Remediation measures are underway, including hiring new staff with relevant expertise, enhancing training programs, and updating fund management and risk assessment policies[952][955] ITEM 16. CORPORATE GOVERNANCE AND OTHER MATTERS The company authorized a US$3 million share repurchase, changed auditors due to a "reportable event," and utilizes foreign private issuer exemptions from Nasdaq rules - In December 2023, the Board authorized a share repurchase program for up to US$3 million of the company's Class A ordinary shares over a 12-month period[967] - On July 9, 2024, the company dismissed PricewaterhouseCoopers Zhong Tian LLP (PwC) and appointed Enrome LLP as its new independent registered public accounting firm[970] - The change in auditor was preceded by a "reportable event" where PwC raised concerns about the substance and recoverability of a US$12.8 million cash balance and noted the need for an expanded audit scope[973][974] - As a foreign private issuer and a "controlled company," the company relies on home country practice exemptions from certain Nasdaq corporate governance rules, such as not having a majority of independent directors on its board[978][980] - The company has a cybersecurity risk management program overseen by a specialized internal panel, which reports to senior management and the board, with no cybersecurity threats materially affecting the company in 2023[984][985][986] PART III ITEM 18. FINANCIAL STATEMENTS Consolidated financial statements for 2023 show total assets of RMB 566.6 million, a net loss of RMB 134.5 million, and have been audited by Enrome LLP Consolidated Balance Sheet Highlights (RMB in thousands) | Account | Dec 31, 2022 | Dec 31, 2023 | | :--- | :--- | :--- | | Cash and cash equivalents | 568,192 | 494,965 | | Total current assets | 723,492 | 533,088 | | Total Assets | 776,337 | 566,574 | | Total current liabilities | 371,526 | 272,625 | | Total Liabilities | 383,673 | 276,561 | | Total Shareholders' Equity | 392,664 | 290,013 | Consolidated Statement of Operations Highlights (RMB in thousands) | Account | 2021 | 2022 | 2023 | | :--- | :--- | :--- | :--- | | Net revenues | 2,119,514 | 2,185,266 | 2,071,772 | | Gross profit | 617,009 | 716,345 | 585,375 | | Operating (loss)/income | (138,518) | 66,651 | (147,668) | | Net (loss)/income | (127,250) | 86,504 | (134,515) | Consolidated Statement of Cash Flows Highlights (RMB in thousands) | Account | 2021 | 2022 | 2023 | | :--- | :--- | :--- | :--- | | Net cash (used in)/generated from operating activities | (40,426) | 136,267 | (117,045) | | Net cash generated from/(used in) investing activities | 52,101 | (122,783) | 105,653 | | Net cash generated from/(used in) financing activities | 212,682 | 4,771 | (71,674) |