Xunlei(US:XNET)2021-04-25 16:00markdown PART I [Item 3. Key Information](index=6&type=section&id=Item%203.%20Key%20Information) This section summarizes Xunlei's key financial data and outlines significant risks related to its business, operations, and ADSs [Selected Financial Data](index=6&type=section&id=A.%20Selected%20Financial%20Data) This section presents key financial data, highlighting fluctuating revenues, narrowing net losses, declining total assets, and consistent negative operating cash flow Selected Consolidated Statements of Operations Data (in thousands of US$) | Indicator | 2018 | 2019 | 2020 | | :--- | :--- | :--- | :--- | | **Net revenues** | 230,604 | 180,665 | 186,371 | | **Gross profit** | 114,937 | 80,752 | 93,734 | | **Operating loss** | (44,329) | (56,422) | (18,793) | | **Net loss from continuing operations** | (40,793) | (53,415) | (14,140) | | **Net loss attributable to Xunlei Limited** | (39,278) | (53,169) | (13,840) | | **Net loss per ADS (Basic & Diluted)** | (0.59) | (0.79) | (0.21) | Selected Consolidated Balance Sheet Data (in thousands of US$) | Indicator | As of Dec 31, 2018 | As of Dec 31, 2019 | As of Dec 31, 2020 | | :--- | :--- | :--- | :--- | | **Cash and cash equivalents** | 122,930 | 162,465 | 137,248 | | **Total current assets** | 362,899 | 316,583 | 302,282 | | **Total assets** | 455,431 | 424,687 | 415,605 | | **Total current liabilities** | 108,035 | 111,286 | 103,276 | | **Total liabilities** | 111,251 | 129,144 | 125,232 | | **Total shareholders' equity** | 344,180 | 295,543 | 290,373 | Selected Consolidated Statements of Cash Flows Data (in thousands of US$) | Indicator | 2018 | 2019 | 2020 | | :--- | :--- | :--- | :--- | | **Net cash used in operating activities** | (35,608) | (45,649) | (13,911) | | **Net cash (used in)/generated from investing activities** | (69,357) | 79,260 | (20,756) | | **Net cash generated from financing activities** | 929 | 12,177 | 2,679 | [Risk Factors](index=9&type=section&id=D.%20Risk%20Factors) This section outlines significant business, corporate structure, China-specific, and ADS-related risks, including model transition, regulatory uncertainty, and potential delisting under the HFCA Act - The company identifies its business model is undergoing significant innovation and transition, with new ventures in cloud computing and blockchain technology facing **substantial uncertainties and unproven profitability**[31](index=31&type=chunk)[32](index=32&type=chunk) - The subscriber base for its traditional PC-based download acceleration has **declined**, from **4.4 million** in 2014 to **3.8 million** as of December 31, 2020, partly due to intensified government scrutiny of internet content[33](index=33&type=chunk) - The company faces risks from the Holding Foreign Companies Accountable Act (HFCA Act), as its China-based auditor is not currently inspected by the PCAOB, which could lead to the **delisting of its ADSs** from U.S. exchanges if the situation persists for three consecutive years[246](index=246&type=chunk)[247](index=247&type=chunk) - The company believes it was a **Passive Foreign Investment Company (PFIC)** for the 2020 tax year and will likely be one for 2021, which could result in **adverse U.S. federal income tax consequences** for U.S. investors[287](index=287&type=chunk)[288](index=288&type=chunk) [Item 4. Information on the Company](index=61&type=section&id=Item%204.%20Information%20on%20the%20Company) This section details Xunlei's corporate history, business overview, organizational structure, and property, including its evolution, core products, and VIE structure [History and Development of the Company](index=61&type=section&id=A.%20History%20and%20Development%20of%20the%20Company) This section outlines Xunlei's history from its 2003 founding, its 2014 NASDAQ IPO, and strategic shifts like the 2015 sale of its video streaming business - The company commenced operations in **January 2003** through Shenzhen Xunlei, which is now its Variable Interest Entity (VIE), with the current holding company, Xunlei Limited, established in the **Cayman Islands** in **February 2005**[290](index=290&type=chunk) - Xunlei completed its **initial public offering** of ADSs on the **NASDAQ Global Select Market** under the symbol "XNET" in **June 2014**[297](index=297&type=chunk) - In a strategic move to streamline its business and focus on mobile internet, the company **sold its entire stake** in the Xunlei Kankan online video business in **July 2015** for **RMB 130.0 million**[298](index=298&type=chunk) [Business Overview](index=63&type=section&id=B.%20Business%20Overview) Xunlei is a leading innovator in shared cloud computing and blockchain, offering cloud acceleration services to approximately **52 million** monthly unique visitors and monetizing through subscriptions, advertising, and value-added services - Xunlei's core product, Xunlei Accelerator, had approximately **52 million** monthly unique visitors in December 2020[300](index=300&type=chunk) - The company's mobile strategy includes a **partnership with Xiaomi** to pre-install its Mobile Xunlei acceleration plug-in on Xiaomi phones sold in China, enhancing user traffic generation[303](index=303&type=chunk) - Xunlei has developed a **shared cloud computing business**, using devices like OneThing Cloud to crowdsource idle bandwidth and storage from users, which it then sells as CDN services to enterprise clients like iQiyi and Xiaomi[304](index=304&type=chunk) - In 2018, the company launched **ThunderChain**, a high-performance open blockchain platform for enterprise users, followed by a **BaaS (Blockchain as a Service) platform** in 2020[305](index=305&type=chunk)[306](index=306&type=chunk) Revenue Breakdown by Service (FY 2020) | Service | Revenue (US$ million) | % of Total Revenue | | :--- | :--- | :--- | | Cloud acceleration subscription services | 84.3 | 45.1% | | Online advertising services | 13.2 | 7.1% | | Cloud computing and other IVAS | 87.8 | 47.0% | | Sales of cloud computing devices | 1.4 | 0.8% | [Organizational Structure](index=99&type=section&id=C.%20Organizational%20Structure) Xunlei operates in China via a Variable Interest Entity (VIE) structure, where its PRC subsidiary controls the operating entity through contractual agreements for effective control and economic benefits - The company utilizes a **VIE structure** where its PRC subsidiary, Giganology Shenzhen, has **contractual arrangements** with the VIE, Shenzhen Xunlei, and its shareholders[483](index=483&type=chunk) - Key agreements providing **effective control** include a **Business Operation Agreement**, **Equity Pledge Agreement**, and **irrevocable Powers of Attorney** from Shenzhen Xunlei's shareholders to Giganology Shenzhen[483](index=483&type=chunk)[484](index=484&type=chunk)[485](index=485&type=chunk) - **Economic benefits** are transferred to the company through **Exclusive Technology Support, Consulting, and License agreements**, which entitle Giganology Shenzhen to a significant portion of Shenzhen Xunlei's earnings[486](index=486&type=chunk)[487](index=487&type=chunk)[488](index=488&type=chunk) - An **Equity Interests Disposal Agreement** gives Giganology Shenzhen an **exclusive option to purchase all equity** in Shenzhen Xunlei for a **nominal price**, solidifying its **long-term control**[490](index=490&type=chunk) [Property, Plant and Equipment](index=102&type=section&id=D.%20Property%2C%20Plant%20and%20Equipment) The company leases principal offices in Shenzhen and Beijing, hosts servers in third-party data centers, and is constructing a new headquarters building expected by late 2021 or early 2022 - The company's main offices are leased in Shenzhen and Beijing, totaling over **17,000 square meters**[495](index=495&type=chunk) - Xunlei is constructing a **new headquarters building**, with expected completion by the **end of 2021 or early 2022**, after which it will relocate its principal executive offices[495](index=495&type=chunk) [Item 5. Operating and Financial Review and Prospects](index=103&type=section&id=Item%205.%20Operating%20and%20Financial%20Review%20and%20Prospects) This section analyzes Xunlei's financial performance, highlighting increased revenues, improved profitability, narrowed net loss, and sustained negative operating cash flow, while affirming sufficient liquidity [Operating Results](index=103&type=section&id=A.%20Operating%20Results) In 2020, total revenues increased by **3.0%** to **$186.7 million**, driven by cloud computing and subscriptions, leading to improved gross profit margins and a narrowed operating loss due to reduced expenses Revenue by Segment (in thousands of US$) | Segment | 2018 | 2019 | 2020 | | :--- | :--- | :--- | :--- | | Subscriptions | 81,877 | 81,532 | 84,299 | | Online advertising | 27,781 | 15,643 | 13,206 | | Product revenue | 54,604 | 8,269 | 1,412 | | Cloud computing and other IVAS | 67,870 | 75,823 | 87,766 | | **Total** | **232,132** | **181,267** | **186,683** | - Revenue from cloud computing and other internet value-added services **increased by 15.8%** in 2020, primarily due to increased demand for shared cloud computing services[543](index=543&type=chunk) - Product revenue **decreased by 82.9%** in 2020 due to a decline in sales of OneThing Cloud hardware[544](index=544&type=chunk) - Gross profit margin **improved from 44.5% to 50.2%** in 2020, driven by the revenue mix shift towards higher-margin cloud computing and subscription services[546](index=546&type=chunk) - Operating expenses **decreased by 18.0%** in 2020, mainly due to reduced office lease expenses, optimized labor costs, and fewer marketing activities[548](index=548&type=chunk) [Liquidity and Capital Resources](index=123&type=section&id=B.%20Liquidity%20and%20Capital%20Resources) As of December 31, 2020, Xunlei held **$255.1 million** in cash and investments, experienced negative operating cash flow for three years, and faces PRC restrictions on asset transfers, yet believes current liquidity is sufficient - As of December 31, 2020, the company held **$255.1 million** in cash and cash equivalents and short-term investments[606](index=606&type=chunk) Summary of Cash Flows (in thousands of US$) | Activity | 2018 | 2019 | 2020 | | :--- | :--- | :--- | :--- | | Net cash used in operating activities | (35,608) | (45,649) | (13,911) | | Net cash (used in)/generated from investing activities | (69,357) | 79,260 | (20,756) | | Net cash generated from financing activities | 929 | 12,177 | 2,679 | - Net cash used in operating activities was **$13.9 million** in 2020, an improvement from a **$45.6 million** outflow in 2019, primarily due to a smaller net loss[613](index=613&type=chunk) - The company's PRC subsidiaries, VIE, and VIE's subsidiaries had **restricted net assets of $168.5 million** as of December 31, 2020, which are **not readily transferable** to the parent company as cash dividends, loans, or advances due to PRC regulations[607](index=607&type=chunk) [Research and Development](index=126&type=section&id=C.%20Research%20and%20Development) Xunlei maintains a strong commitment to research and development, employing **336** engineers as of December 31, 2020, to drive innovation and market leadership - As of December 31, 2020, the company employed a team of **336 engineers** for research and development[621](index=621&type=chunk) [Trend Information](index=126&type=section&id=D.%20Trend%20Information) The company is unaware of any significant trends, uncertainties, or events from 2020 that would materially affect its future financial condition or operations beyond what is already disclosed - The company is not aware of any specific trends, uncertainties, or commitments from 2020 that would materially affect future results beyond what has been disclosed elsewhere in the report[622](index=622&type=chunk) [Off-Balance Sheet Arrangements](index=126&type=section&id=E.%20Off-Balance%20Sheet%20Arrangements) Xunlei has not entered into any off-balance sheet arrangements, financial guarantees, or derivative contracts that could materially impact its financial condition - The company has **no off-balance sheet arrangements**, financial guarantees, or variable interests in unconsolidated entities[623](index=623&type=chunk) [Contractual Obligations](index=126&type=section&id=F.%20Contractual%20Obligations) As of December 31, 2020, total contractual obligations were **$11.7 million**, primarily for bandwidth leases and capital expenditures, with most due within one year Contractual Obligations as of December 31, 2020 (in thousands of US$) | Obligation Type | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | | :--- | :--- | :--- | :--- | :--- | :--- | | Bandwidth lease obligations | 3,794 | 3,388 | 406 | — | — | | Capital obligations | 7,953 | 7,040 | 913 | — | — | | **Total** | **11,747** | **10,428** | **1,319** | **—** | **—** | [Item 6. Directors, Senior Management and Employees](index=127&type=section&id=Item%206.%20Directors%2C%20Senior%20Management%20and%20Employees) This section details the company's directors, senior management, compensation, board practices, and employee breakdown, including the adoption of a new share incentive plan in 2020 [Directors and Senior Management](index=127&type=section&id=A.%20Directors%20and%20Senior%20Management) The board comprises eight directors, including Chairman and CEO Jinbo Li and co-founders Sean Shenglong Zou and Hao Cheng, supported by an experienced management team - Jinbo Li has served as **Chairman and Chief Executive Officer since April 2020**, was part of Xunlei's founding team, and is also the founder, chairman, and CEO of Itui International Inc[628](index=628&type=chunk) - **Co-founders** Sean Shenglong Zou and Hao Cheng continue to serve as directors on the board[629](index=629&type=chunk)[630](index=630&type=chunk) [Compensation](index=129&type=section&id=B.%20Compensation) In FY2020, executive officers received **$1.9 million** in cash compensation, and the company adopted a new 2020 Share Incentive Plan, authorizing up to **31 million** common shares for awards - In FY2020, aggregate cash compensation for executive officers was approximately **US$1.9 million**, and for non-executive directors was approximately **US$0.1 million**[640](index=640&type=chunk) - In June 2020, the company adopted a **new 2020 Share Incentive Plan**, authorizing up to **31,000,000 common shares** for future awards[641](index=641&type=chunk)[642](index=642&type=chunk) - As of March 31, 2021, there were **10,862,500 restricted share units** granted and outstanding under the 2020 Plan[643](index=643&type=chunk) [Board Practices](index=131&type=section&id=C.%20Board%20Practices) The eight-member board has established Audit, Compensation, and Nominating and Corporate Governance committees, with the Audit Committee comprising two independent financial experts - The board has **three primary committees**: Audit, Compensation, and Nominating and Corporate Governance[655](index=655&type=chunk) - The audit committee consists of **two independent directors**, Jenny Wenjie Wu (Chair) and Ya Li, both of whom are determined to be **audit committee financial experts**[656](index=656&type=chunk)[750](index=750&type=chunk) [Employees](index=133&type=section&id=D.%20Employees) As of December 31, 2020, Xunlei had **595** employees, with the majority (**444**) dedicated to research and development, reflecting its focus on technology Employee Breakdown by Function (as of Dec 31, 2020) | Function | Number of Employees | | :--- | :--- | | Research and Development | 444 | | General Administration | 92 | | Sales and Marketing | 59 | | **Total** | **595** | [Item 7. Major Shareholders and Related Party Transactions](index=134&type=section&id=Item%207.%20Major%20Shareholders%20and%20Related%20Party%20Transactions) This section details Xunlei's ownership structure, with Itui International Inc. as the largest shareholder, and outlines significant related party transactions, including VIE arrangements and agreements with Xiaomi and Itui [Major Shareholders](index=134&type=section&id=A.%20Major%20Shareholders) As of March 31, 2021, directors and executive officers collectively owned **47.7%** of shares, with Itui International Inc. as the largest shareholder at **39.7%** Principal Shareholders (as of March 31, 2021) | Shareholder | Beneficial Ownership % | | :--- | :--- | | Itui International Inc. (controlled by Jinbo Li) | 39.7% | | Sean Shenglong Zou (Co-founder) | 6.9% | | Morgan Stanley entities | 5.3% | | All directors and executive officers as a group | 47.7% | [Related Party Transactions](index=135&type=section&id=B.%20Related%20Party%20Transactions) The company engages in significant related party transactions, including VIE contractual arrangements, mobile pre-installing services with Xiaomi, and advertising outsourcing and cloud computing services with Itui International Inc - The primary related party transactions are the contractual arrangements that establish and maintain the company's **VIE structure**[675](index=675&type=chunk) - The company has a **mobile pre-installing services agreement with a Xiaomi group company**, recognizing **$2.5 million** in revenue from this arrangement in 2020[688](index=688&type=chunk) - In May 2020, Xunlei entered into a **user traffic monetization agreement with Itui**, its largest shareholder, **outsourcing its advertising operations**, and recognized a net revenue of **$7.3 million** from this agreement in 2020[690](index=690&type=chunk) - The company also provides **cloud computing services** to both the Xiaomi group and Itui, generating revenues of **$2.2 million** and **$1.1 million** respectively in 2020[689](index=689&type=chunk)[691](index=691&type=chunk) [Item 8. Financial Information](index=138&type=section&id=Item%208.%20Financial%20Information) This section covers legal proceedings, including the dismissal of a U.S. class action lawsuit, and outlines the company's policy of not paying dividends to retain earnings for business expansion - A putative shareholder class action lawsuit filed in the U.S. in 2018, alleging that the company's OneCoin (LinkToken) was an illegal initial coin offering, was **dismissed with prejudice in September 2019**[696](index=696&type=chunk) - The company has a **policy of not paying dividends** and intends to **retain future earnings** to fund business development and growth[698](index=698&type=chunk) [Item 11. Quantitative and Qualitative Disclosures about Market Risk](index=147&type=section&id=Item%2011.%20Quantitative%20and%20Qualitative%20Disclosures%20about%20Market%20Risk) The company's primary market risks are foreign exchange fluctuations between RMB and USD, impacting ADS value, and interest rate risk on cash deposits, with no current use of derivative hedging instruments - The company faces **significant foreign exchange risk** as its business is effectively denominated in RMB, while its ADSs are traded in U.S. dollars, and fluctuations in the **RMB/USD exchange rate** can impact the value of investments in its ADSs[732](index=732&type=chunk) - As of December 31, 2020, the company held **RMB 632.9 million** in RMB-denominated cash and short-term investments and **US$157.8 million** in USD-denominated cash and short-term investments[735](index=735&type=chunk) - **Interest rate risk** is primarily related to the interest income from its cash and cash equivalents held in interest-bearing bank deposits[736](index=736&type=chunk) PART II [Item 15. Controls and Procedures](index=150&type=section&id=Item%2015.%20Controls%20and%20Procedures) Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2020, a conclusion attested to by the independent auditor - Management concluded that the company's disclosure controls and procedures were **effective** as of December 31, 2020[742](index=742&type=chunk) - Based on the COSO framework, management concluded that the company's internal control over financial reporting was **effective** as of December 31, 2020[745](index=745&type=chunk) - The independent registered public accounting firm, PricewaterhouseCoopers Zhong Tian LLP, audited and **confirmed the effectiveness** of the company's internal control over financial reporting[747](index=747&type=chunk) [Item 16. Other Information](index=151&type=section&id=Item%2016.%20Other%20Information) This section covers governance, including audit committee financial experts, a code of ethics waiver for the CEO, a **$4.5 million** share repurchase in 2020, and the company's use of home-country practices for NASDAQ compliance - The board of directors has determined that independent directors Ms. Jenny Wenjie Wu and Mr. Ya Li are both **audit committee financial experts**[750](index=750&type=chunk) - The board **granted a waiver from its code of ethics** to CEO Jinbo Li, allowing him to simultaneously serve as CEO of both Xunlei and its principal shareholder, Itui International Inc[752](index=752&type=chunk) - In 2020, the company **repurchased 1,191,392 ADSs** for a total cost of approximately **$4.5 million**, as part of a **$20 million share-buyback program**[758](index=758&type=chunk)[759](index=759&type=chunk) - As a **foreign private issuer**, the company follows certain **Cayman Islands home-country practices** in lieu of NASDAQ rules, including not having a majority-independent board of directors and having an audit committee with two members instead of the required three[761](index=761&type=chunk)[762](index=762&type=chunk) PART III [Item 18. Financial Statements](index=154&type=section&id=Item%2018.%20Financial%20Statements) This section presents Xunlei's audited consolidated financial statements for 2018-2020, with an unqualified opinion from PricewaterhouseCoopers Zhong Tian LLP, highlighting goodwill impairment as a critical audit matter - The independent auditor, PricewaterhouseCoopers Zhong Tian LLP, issued an **unqualified opinion** on the consolidated financial statements and the **effectiveness of internal control over financial reporting** as of December 31, 2020[776](index=776&type=chunk)[777](index=777&type=chunk) - The auditor identified the **goodwill impairment assessment as a Critical Audit Matter** due to the **significant management judgment** involved in estimating the fair value of the reporting unit, particularly concerning assumptions about revenue forecasts, operating margins, and discount rates[785](index=785&type=chunk)[786](index=786&type=chunk)